[Marxism] Beyond Keynes to Inflation
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Sat Jan 14 11:31:59 MST 2006
Beyond Keynes to Inflation
by Richard Benson
Benson's Economic & Market Trends
January 9, 2006
Orthodox economic training in the United States in the post-World War II
world, centered on the observations of John M. Keynes who claimed that to
keep an economy rolling, spending (aggregate demand) needed to be kept alive
at all costs. The biggest post-depression fear was that saving too much
could cause spending to fall short and recession, or worse, could befall the
economy (from 1929 to World War II, the worse did happen). The Keynesian
trick used for our central bank was to cut interest rates to a level low
enough to encourage businesses to spend excess savings. Low interest rates
encourage low financing costs and urge businesses to recycle savings into
productive investment, which keeps the economy humming especially if
consumer spending is weak.
In the hallowed Ivy League halls of academia (where this author spent too
many happy years before having to work for a living), they preach that it is
the governments duty, and the central banks mandate, to spend and print
money to keep the economy afloat. The Keynesian trick is certainly easier to
pull off when there is some inflation and the Fed can drop interest rates.
Interest rates that are below the rate of inflation clearly subsidize old
and new borrowers alike, and give an extra boost to the economy. Subsidized
borrowers borrow and always find ways to spend money. Even though this
economic stimulus trick consisted of a little extra government spending,
recycled savings, and credit creation, recycled savings gave the economy the
biggest boost, with credit creation adding some inflation to the spending
mix. Then, everything began to change.
In the late 1990s, this economic model was scrapped. After Alan Greenspan
gave his famous irrational exuberance speech about the stock market, he
stopped being rational and prudent, and became rational and profligate. He
discovered that the stock market bubble fostered by too much easy credit
made consumers feel really wealthy. By letting money and credit run wild the
economy roared, and rising stock market prices created such a false sense of
wealth that consumers stopped saving. By 2000, Americans had hardly saved
anything and domestic savings to recycle didnt exist. Around this time, Mr.
Greenspan declared that bubbles should not be popped but the Federal
Reserves job would be to clean up the mess if the bubbles collapsed on
their own. So, how does a popped bubble get cleaned up? With easy money, of
Cleaning up the first bubble required dropping interest rates to virtually
nothing and creating an even bigger bubble in housing. The real estate
bubble was far more powerful for spending because of the asset-backed and
mortgaged-backed debt markets, which allowed for the virtual unlimited
creation of new mortgage credit and money. Moreover, it was seductive
telling a potential homeowner to feel comfortable about spending a lot of
money to buy a home because property values were always going up. By 2004,
it was time to help another sitting President to get re-elected. The housing
market was booming and home equity extraction added about $800 billion (a
year) to spending, even though this spending left a massive trail of debt.
In looking back now, you cant help but notice how the economic model has
changed. For decades, America had an economic model built around recycling
savings into investment. In a few short years, those savings have simply
vanished and our society has become comfortably cavalier about borrowing far
more than they earn.
The first bubble in stocks taught Americans how not to save. The second
bubble in housing taught them how to live off their house and spend even
more than they make. From a macro-economic perspective, our country no
longer has savings to recycle as part of a stimulus package. Instead, we are
left with a massive debt to foreigners and its growing at the rate of $700
billion a year. Americas net debt to the rest of the world is approaching
$3 trillion, with no end in sight.
It is important to note that the incoming Fed Chairman, Ben Bernanke, is the
top academic student of the previous depression and a true believer in the
power of the press; the Federal Reserves printing press, that is. Mr.
Bernanke believes we will always need some inflation, and the inflation and
growth of money and credit must be kept alive. Despite the fact that total
debt to GDP is now 310 percent (well in excess of the 290 percent it was
before the 1929 crash), he is determined to keep debt and inflation growing.
(For a balanced economy, total debt to GDP is about 150 percent). Today, it
takes $4 of new debt to create just one new $1 of real GDP. Under Bernankes
watch, the Federal Reserve will have a lot of printing to do.
>From an historical economic perspective, we are clearly in the middle of a
very interesting time. Our post-World War II economic model is totally
broken. If our economic model is built on spending, where will the new
spending come from? The Achilles heel for our economy is the fact that
wages have not kept up with inflation and the average American worker has
little or no savings, nor can they afford to service their debt and pay for
the rising cost of living.
Without constant monetary stimulus, the credit-based U.S. economy would die.
Our current economic model is similar to the one used by banana republic
countries that are running hyperinflation* and end up in hock to the IMF:
*Hyperinflations are caused by extremely rapid growth in the supply of
paper money. They occur when the monetary and fiscal authorities of a
nation regularly issue large quantities of money to pay for a large stream
of government expenditures. In effect, inflation is a form of taxation where
the government gains at the expense of those who hold money whose value is
declining. Hyperinflations are, therefore, very large taxation schemes.
America is now extraordinarily vulnerable to the whims of foreign
governments. What if our creditors demanded a higher rate of interest?
Perhaps they already have, and the Federal Reserve will have to raise
interest rates higher than the capital markets currently expect.
What about the housing bubble? Mr. Bernanke may be left with only one course
of action: Given housing price inflation of 50 to 100 percent in some areas
over the past few years, the Feds goal for the next several years will be
how to get inflation up without crushing housing prices because of rising
interest rates. A housing price crash could severely affect the financial
markets in our country and take the economic system down with it. Mr.
Bernanke has spent his entire adult life studying to prevent this from
happening and I suspect he will do everything in his power to keep inflation
going. When everything else is inflated, housing prices (at their current
levels) wont appear to be so over-valued. Getting money into the hands of
consumers who cant tap their savings (because most Americans dont have
any), or use their credit cards (because theyre over-extended - welcome to
the new bankruptcy law), or draw cash from the home equity loan ATM
installed on the side of their house (housing prices are stagnant or
falling), will be a real challenge. To get money into the consumers hands,
the Fed will have to print more money and encourage the creation of more
debt. Mr. Bernankes illusion about dropping money from helicopters may
actually come to pass as a direct way to distribute money to the consumer to
service old debts and keep spending alive. The new economic model should be
inflate, or face deflationary collapse.
In reviewing my own personal financial returns last year, I realized the
following: Even though cash performed much better than stocks without the
risk or excitement it did not keep up with inflation. Also, the stock
market was flat but actually down after inflation. (The CPI underestimates
actual inflation by 1.5 to 2 percent by excluding housing prices and using
hedonic price adjustment.) My familys portfolio of I-Bonds (inflation
adjusted savings bonds) did better than cash and kept close to inflation,
while our investments in gold and silver gave a strong real return after
For 2006 and beyond, I expect the inflationary war on savers will continue,
and I just dont see how financial assets stocks and bonds will keep up.
The preservation of real wealth at a time when the Federal Reserve will be
dedicated to building debt, money and inflation, is not going to be an easy
task; Good luck investing in the New Year!
© 2006 Richard Benson
Specialty Finance Group
Benson's Economic & Market Trends
Editorial Archive l www.sfgroup.org
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