The Global Battle for Money's Soul

Why does money make me feel so badly?

Modern economic thinking has imparted a strange form of uncertainty to the average citizen in the developed world, like a new Catholic guilt. Since we have been told for the last 40 years that spending drives the economy, and that one person’s expenditures are another person’s earnings, we’ve become torn between our own interests and those of the community at large. We look into our wallets; do some soul-searching and think, “I really should spend this…”

I’ve often said that Keynsians and Austrians don’t actually disagree on that much, particularly when you introduce time frames into the debate. It’s not always publicized that the preeminent flag bearers of these opposing views were actually quite fond of one another, and that Keynes wrote a resoundingly positive reaction to Hayek’s “The Road to Serfdom” when it was published.

When modern economists say that a large government “sequester” would be damaging to the economy, they aren’t wrong – but it depends on how you define “damaging,” “economy,” and most importantly, what time frames you are looking at. From a simplistic point of view, a sequester would put less currency in people’s pockets, so they would spend less, so the people they buy from would earn less, ad infinitum.

The story changes depending on how far you expand the scope. Where does the government get the dollars to pay federal employees in the first place? Whom does this harm? What are people spending money on? Then you can look outside the nation. How does this affect trade, or Japan, or the bond market? What happens after 10 years?

The point is that the global economy is a big messy non-linear feedback machine, and that nobody can understand all of its details with any semblance of accuracy. We may do our best to track dozens of metrics, but they are all just proxies to an underlying unfathomable beast of economic reality. However, even though we can never profoundly understand this creature, we can develop principles to guide our understanding.

Somewhere in the quest for comprehension, the principle that “spending drives the economy” has become the bedrock of economic planning, an axiom that gets repeated over and over by academics and laypeople alike. It also happens to soundly confuse people and be almost completely wrong.

Production precedes consumption

Where does spending come from? It comes from savings. You can’t spend something that hasn’t yet been earned. Or can you? The Keynsians propose an elegant solution to the chicken and egg problem of spending vs. earning. Simply pump the economy with new money and it will look like there is more savings. Then people will buy things and the people they buy it from will prosper and then those people will buy things, etc.

But it doesn’t really work out that way, at least not in the long term. Short-term, these bursts of economic demand look wonderful on paper. And everybody involved seems so happy! People open up a second restaurant, buy a new car, or invest in stocks. But eventually, somehow, the beast wakes up and settles the score. NO! There isn’t that much capital. There isn’t that much stuff. You squandered what there was on things that neither you nor your customers (if you have any) actually want or need and now it’s time to sell those stocks to pay your rent, pawn your car, and foreclose on that restaurant.

Spending is the easy part; anybody can spend. The acts that truly grow and sustain an economy are savings and investment, not spending and consumption. If you vaguely recall your grandfather saying something about free lunches, then you are welcome to apply that wisdom here. Before the spending comes the “making,” through risk and sacrifice. It’s hard work creating a product or service that can pry the dollars from consumers’ hands. 

Consumption is the reward you reap from your hard work. It is the ultimate goal of production and it comes last, not first. You, or somebody else, has to make that sandwich before you eat it.

Attacking the business cycle, but missing the phase

Simply put, Keynsian economists posit that the unfettered free market will cycle back and forth through boom and bust, that during periods of unsustainable growth or irrationally low demand, the government can step in to flatten out the curves, to dampen the peaks and valleys to reduce their harmful effects. In practice, the government tends to be a bit heavy-footed with the gas pedal, reluctant to curb the good times, and then panicking during the bad.

We have adopted, and been almost exclusively led by Keynsian thinking since the early 1970’s, and the Keynsians have had their shot to create the ultimate utopian managed economy. The author puts 100% of the blame for today’s economic ills - the unemployment, the debt, the loss of savings, the tax burdens - on the ill-founded conceit that individuals in power, clever enough, can technocratically deduce the proper amount of money that the economy “needs,” and act accordingly.

The wonderful magic of interest rates

Stable money supplies seem to be out of fashion these days. But in the past they’ve been responsible for building empires. The reason is that free economies have their own ways of dealing with overextension and contraction, and they are called interest rates.

Interest rates are wonderful things, when you can trust them. They boil down all of the economic mayhem into a single number. And this number tells you whether capital is scarce or abundant. When times are lean, high interest rates prevent you from borrowing money for foolish things and encourage you to save and invest. When times are rich, low interest rates allow you to take more substantial risks and disincentivize you to save. The economy does go up and down, but it’s the abundance or scarcity of capital – raw materials, energy, people’s time, etc. – that clues us in to whether we should tighten our belt or buy a new ones.

Saving the dollar from the deflation Devil

Today, the interest rates are all mucked up, and it’s entirely because of the nature of the reserve currency, the soul of the US dollar. Not only is the US dollar unstable, it is purposefully designed to be unstable or, euphemistically, flexible. The Fed has the power to expand and contract the money supply through three blunt techniques. Paul Krugman might argue that it hasn’t been enough, but over the past 7 years all Fed actions have been expansionary.

It’s trying to fight off deflation! But ironically, it sewed the seeds of deleveraging years ago. The supply of US dollars increases when individuals and businesses take out loans, something that they have been prodded to do by artificially low interest rates. You don’t have a house? No job? No problem. Here is $500,000. Hey, your house just went up in value! How about an interest-only home equity loan? (Keep in mind that this private profligacy pales in comparison to that of the largest borrower of all, the Federal Government.)

But what goes up must come down. Just as dollars are born through loan initiation, they die though debt extinction. When people realize that they’ve over extended themselves, they begin to pay down their debt, which evaporates the money supply, and makes everybody really sad.

So the Fed must continue to fight the fire, but it’s only armed with two things: gasoline, and a hydrogen bomb. It can either pump more credit into the economy, which will makes people feel good in the short term but will gut the world’s capital in the long term, or it can stop the printing press and scorch the earth, creating mass unemployment and financial destruction in the short term, but laying the foundation for a true recovery down the road.

Are you depressed yet? None of this would have been necessary with a sound money supply. A little purse string tightening in 1997 would have prevented a decade of eating ramen noodles in 2013.

Bitcoin as a sound currency (What?)

It’s only four years old, but the world’s first cryptocurrency has been through a lot. It was bullied in 2010 for being used by drug dealers, and then had a growth spurt in 2011 before having its knees broken by exchange hacks. It was used and abused by fraudsters who swindled people for millions (of dollars) in 2012, and then suddenly became the popular kid in 2013 before all of its new friends decided they didn’t like it anymore.

But it still has its old friends, and lots of them. They believe that due to its limited supply (among other unique and desirable properties), that Bitcoin could unlock a world of wealth and prosperity – one to contrast today’s debt and poverty. These “true believers," unfazed by recent price activity, are busy creating an infrastructure of services that can help the Bitcoin economy flourish. Call them crazy if you like, but you have to admire their mettle.

If Bitcoin were ever to become a significant player in global commerce, it would have to be much more stable, and much more valuable. People know this, which can explain a lot of the recent buzz, but it’s going to take time, at least years if not decades to reach this plateau. On the way there will be countless peaks, valleys, and violent swings.

Luckily, many Bitcoiners have a sense of humor regarding the price volatility. They call Bitcoin the “honey badger” of currencies. It walks around, eats snakes, and really doesn’t give a shit.

As the modern clash of ideas for what money should be unfolds, it probably doesn’t hurt to have a honey badger on your team.

So what do you think? Is sound money the answer to all of our problems, or does the author need to be educated about the issues with the gold standard?