8 July 2007, partially updated 27 November 2011
(With minor revisions, the text of this article remains as originally posted on July 8, 2007. I have added current charts to confirm up-to-date money supply and inflation figures):
I am here revisiting a topic I have discussed previously.
Consider the news topics of the past several months:
1. Escalating terrorist attacks (planned or executed) against the west, most recently in the UK and Canada.
2. Continued deterioration in the quality and safety of civil life and the rise (return) of Al Qaeda and the Taliban in Iraq and Afghanistan.
3. Rising commodity prices (recently oil, lead and copper have been highlighted).
4. Shifting currency values (the rise of the Euro and the Canadian Loonie, the decline of the US dollar, etc.).
5. Civil war in the oil states of Africa.
6. The ongoing rise of violent Islamic fundamentalism both at home and in the Islamic world.
7. Rising human migration and homelessness around the globe.
8. Corruption, greed and excess of every imaginable kind in the world of business, including flawed accounting practices used to conceal the worthlessness of balance sheet assets, and corresponding systematic executive overpayment.
9. Government overspending and unrepayable deficits.
10. The global real estate bubble.
11. Tension in the Middle East around Palestine and Israel, Iran, and Lebanon.
12. Rising US antipathy towards China due to cheap imports and an under-valued Yuan.
13. Continuing military and civilian casualties at the battlefronts of the Middle East.
14. The return of the KGB and the dismantling of democracy in Russia.
15. The resurgence of anti-American, anti-business movements in Latin America following a long quiescence.
16. Irresponsible practices in the provision of consumer and mortgage loans to unqualified recipients, with the repackaging and sale of portfolios of these questionable loans to third parties (often pension funds, mutual funds and other large “arm’s length” investors).
17. Mexican peasants can no longer afford the cost of corn meal.
What do these news events have in common?
All are driven by global imbalances, and in my view, by monetary imbalances in particular.
Though contrary to common knowledge, the underlying thread of excess liquidity actually plays a key, and in many cases, a primary role in the causation of each.
Let’s walk through the basics again.
Excess liquidity refers to the “printing of money” to generate “instant cash” so as to provide immediate solutions to economic problems that have complex and often non-economic causes. Basically, governments expand the supply of money to an extent that exceeds the supply of new goods and services, making possible the continued easy availability of funds to meet public and private debt obligations.
Governments resort to policies of excess liquidity when they are cut adrift in terms of policy direction and lack the courage to address shifts in public mood and perception. In today’s era, virtually every government on the planet is pumping up its money supply at a drastic clip, resulting in what has sometimes been referred to as a global liquidity boom.
A rough estimate of current US liquidity growth is 10-15% per year (the best measure is the "Austrian true money supply"), against an increase in goods and services of probably 2-3% per year, resulting in a real inflation rate in the range of 7-12%. (The other oft-cited - but also misleading - variable in the calculation is the "velocity of money," or the rate of turnover of money as it changes hands, and this is presumed to remain constant over moderate periods of time.)
The true inflation amount (currently 11-12%) is now 7-8 percentage points higher than officially-published government inflation figures (click here). Governments “massage” the inflation numbers through various manipulative practices in order to enable their ongoing commitment to money printing as a strategy to address all constituent needs and as a panacea for all social ills.
Economics 101 will teach you that this policy causes monetary inflation, and in practical terms, this means that money loses its value. The inevitability of monetary inflation is based on the simple principle of supply and demand. That is, the supply of money exceeds the demand for money, so money loses its value.
However, Economics 101 will not teach you that inflation of the money supply generates disruptive and dangerous psychological, social and political imbalances and readjustments as well.
How does this occur?
Monetary inflation always and everywhere is an act of (involuntary) redistribution of wealth. The newly-created money never works its way through local, national and international economies smoothly or predictably. At its root, monetary inflation engenders deep psychological insecurities in its human participants.
A simple way to picture this is that the economic pie is growing 7-12% larger in inflation-adjusted terms every year. Therefore, if your piece of the pie is not also growing at 7-12% per year - you are falling behind. And if your piece of the pie is constant or shrinking, you are in fact losing ground at a rapid pace.
This rapidly shifting economic ground creates a psychology of "entitlement." Individual and collective participants in a global economy in flux are quite able to see not only that the size of the pie is ever-changing, but also that the rules for slicing it up are also inconstant.
Each of us for his or her own reasons feels a natural sense of entitlement to a fair share of the increase. Thus we become embroiled in disputes at every level of society - from the individual to the international level - in which each of us feels increasingly driven to struggle to win recognition of our own right to receive a fair share of the (in fact largely illusory) gains.
A more subtle aspect of the psychology of entitlement is that winners are perhaps more driven to protect their gains - which can be easily lost as the pie continues to grow - than those who are merely holding their own or falling behind. It is a peculiarity of human psychology that we are more averse to losing what we have than to foregoing what was never ours. Thus the global winners - those with expanding opportunities to gain from excess liquidity - become the most dangerous and potentially disruptive participants in the global liquidity game.
In my view, this key psychological insight explains much of the wave of terrorism and violence now sweeping across a Middle East burgeoning with liquidity, as well as the growing hostility of the resurgent Russian neo-communists and the so-called populist leaders of the Latin American commodity-producing nations (presently most visible in Venezuela and Bolivia, but similar movements are growing in Peru, Ecuador, Colombia, etc.)
In response to inflation, individuals on fixed incomes perceive their financial security to be dwindling and possibly threatened. Savers see the returns on their savings – in interest rate terms – lagging behind real rises in the cost of living. Politicians feel empowered to promise more funds to more parties and projects – but those in receipt of the funds develop a competitive mindset with respect to gaining their “fair share” of the increased funds. Those who are left behind in the process may feel cheated, mistreated, bitter and hostile.
Excess liquidity generates shifting price imbalances associated with capital misallocation. That is, the revaluation of goods, services and assets never proceeds smoothly when the value of money is disrupted by inflation.
In most cases, excessive increases In the money supply result in temporary and unsustainable but often dramatic bursts of economic growth, typically driving up the prices of materials or services which are in relatively short supply – often, and certainly in our present era – commodities in particular.
Periods of excess liquidity tend to drive increasing amounts of this new wealth in the direction of “new players” in the global economy, and this can be seen today in the flow of previously inconceivable quantities of funds to the Middle Eastern, Russian and Venezuelan oil producers, for example, and to the providers of low-cost manufactured products (in today’s case, typically located in southeast Asia).
Under these conditions, money is loaned and spent in increasingly irrational – even crazy – ways, and budgeting decisions are driven by ever shorter-term considerations (for example, “flipping condos in Florida,” packaging loans for low-income and unqualified home buyers, generating investor excitement over riding the wave of new trends – such as marketing portable communication devices in China and dominating the web search marketplace, launching grand military adventures that could not be considered in more sober eras – in our case, the American invasion of Iraq, and investing in ever-riskier and ever more improbable ventures – in particular, hyper-leveraged hedge funds, unprofitable technology companies, third world business ventures, low quality corporate and consumer loans, etc.).
The point I wish to emphasize is not that excess liquidity is monetarily risky, though it certainly is.
My primary point is that excess liquidity is psychologically, socially and politically risky.
The environment of global competition over how various assets will be revalued in response to monetary devaluation creates a background atmosphere of deep psychological insecurity.
This insecurity – caused by increasing financial uncertainty – is devastating in its implications for individuals, families, communities and societies. Ultimately, the process is politically disruptive as well, as individual strives against individual, interest group against interest group, and nation against nation, to be dominant players in the direction of the flow of the newly-created wealth caused – at its heart – by the devaluation of global currencies through the expansion of the global money supply.
Humans are extremely dangerous when they are insecure, and the policy of money supply expansion (excess liquidity), by its very nature, makes humans everywhere progressively more insecure – and therefore – progressively more dangerous.
I have stated several times that poor people are rarely dangerous or disruptive. Dangerous behaviour arises when anyone anywhere – whether poor or rich – is placed in a position to have to compete for new resources (and to defend the resources they already possess), particularly those coming available through disruptive adjustments in value resulting from currency devaluation.
In the Middle East, Russia and Venezuela, rising oil prices have forced the citizens of those societies into competition to be participants in the new wealth resulting from the rise in the value of a commodity (oil in this case) which is largely driven by the collapse in the real value of the currencies with which it is purchased (though this part will mostly be played out years later).
The competition to be participants in – and recipients of – the flow of new oil-generated wealth is creating massive psychological and social insecurity in the nations affected by the oil boom.
Because the new wealth is in fact of low quality (due to the collapsing value of the currency which is paying for the commodity), the competition for the inflow of new funds becomes more dangerous and disruptive still.
This drama is being played out many times over in many spheres around the world.
African despots and dictators are redirecting their energy to plays in the new global game of excess liquidity, creating disruptive social and ethnic conflicts over who shall and shall not participate in sharing the new wealth.
Pakistani clerics are preaching vitriol while funds flow into their coffers from wealthy donors who are themselves players in the global oil money game.
Latin American dictators (Chavez in Venezuela is most notable) are driving their popularity with anti-American and anti-business rhetoric while feathering their nests with the proceeds of oil revenues attributable to excess liquidity.
North American executives are rewarding themselves with ever grander salaries, option packages and bonuses in order to seize their over-sized slice of the excess liquidity pie.
North Americans generally are borrowing as never before (at artificially lowered rates driven by rapidly inflating currencies) in order to invest in anything that is increasing rather than decreasing in value – and the current craze remains for real estate together with consumer goods purchased with low or no-interest loans, particularly big-ticket items such as automobiles, furnishings, appliances and electronics equipment.
Anti-democrats are running roughshod over democracy advocates from Russia to Venezuela to Afghanistan to China to Africa so as to assure their monopoly over their piece of the overflow of devaluing global funds.
Mexican peasants have become unable to purchase cornmeal, their staple for centuries, because American government policy has sought to placate agricultural and environmental interests by artificially promoting the production of ethanol from corn.
What is the common theme here?
Again – excess liquidity (expansion of the money supply beyond the value of new goods and services produced) is making humans everywhere psychologically insecure due to the declining value of their money. Individual insecurity leads to social struggles focused around social alliances and political interest groups. Disruptions are visible at the community, national and international levels.
Too much money makes people feel insecure. Insecure people are dangerous. This pattern is repeating itself almost everywhere around the globe today, making our planet an increasingly hazardous one to inhabit.
Consider for example the rise of the National Socialist (Nazi) movement in Germany in the 1930s and 1940s following the notorious inflation of the Weimar Republic in the 1920s. (images of German citizens transporting money in wheelbarrows and burning money in place of firewood are iconic to the present day). It is almost certainly no accident that one of the most despicable political movements in recorded history arose immediately subsequent to such a great period of hyperinflation.
What is the cure?
It is both simple and painful. For some, this tried-and-tested solution will be unimaginable, perhaps because most all of us alive today are children of the great era of excess liquidity that with only brief periods of respite has dominated the post-World War II period.
I acknowledge that virtually no world leader will publicly champion the following plan, though history has shown across millennia that what I propose is always and at all times the correct response to the multitude of problems caused by monetary inflation.
As Paul Volcker (then the Chairman of the US Federal Reserve Board) did in the United States in 1980, we must slow the rate of money creation to match the natural rate of expansion in the production of goods and the delivery of services.
This simple measure will create – at this point – a deep, painful and extended economic recession probably lasting many years – and this is what will temper the excessive growth in the global money supply.
This recession will be more severe than past (recent) recessions because the duration and extent of the preceding monetary expansion has been so egregious (in fact, unprecedented in world history). The greater the excess of liquidity, the greater the resultant pain that must be endured in order to quell it.
The process of withdrawal from excess liquidity is aptly analogous to withdrawal from a severely addictive drug such as heroin. Liquidity is the addictive substance that the dependent user cannot get enough of. Withdrawal from the drug is the only prospective option for survival.
This will create a stable – and paradoxically more difficult – environment within which humans can and must re-learn how to work out the multitudinous problems involved in sharing wealth.
When access to wealth (money) by any means (including borrowing) becomes difficult rather than easy, humans revert to virtuous rather than reprehensible behaviours. Why we do this is somewhat mysterious, but it is a clear lesson from human history – perhaps a topic for another essay at some point in the future.
In response to the proposed necessary economic recession, poor business ideas will fail (they will no longer be sustained by excess liquidity) and good business ideas will thrive (though at a greatly tempered and much more manageable pace of growth), with the result that humans will gradually recover a sense of normality and with it an accompanying sense of recovered security.
This slower-paced and more secure economic environment will gradually restore us to psychological health, re-equip us for cooperation rather than competition, and quell the presently raging flames of liquidity-driven global strife.
Terrorists will return home to feed and care for their families. Self-serving executives will lose their jobs and learn to toil by the sweat of their (collective) brow. Politicians will return to reducing rather than expanding government debts. And warmakers will be voted (or otherwise driven) out of office as a consequence of a broad popular movement towards normalcy and restraint.
Excess liquidity is our present primary social and political problem because accumulating economic imbalances generate escalating psychological imbalances.
The restoration of economic balance through reigning in the growth of the global money supply will make possible the restoration of psychological, social and political balance.
While we humans are dangerous when we are insecure, we are generous and resourceful when we know where we stand and when we perceive that our situation is fair and just.
Bringing an end to excess liquidity is the key global economic policy step that will restore us to this more desirable state.
I've gotta say this, with apologies to my liberal/progressive friends. "Occupy Wall Street" is totally misdirected and unnecessary. I am not saying this to offend. But here are the facts:
(3) The shareholders are deserting, and this will continue over the next decade - which will ultimately constitute 2 decades (and counting) of value destruction on Wall Street. By the end of the present decade, I'm pretty sure that mainstream investors will have "caught on" that self-serving directors and executive decision-makers are not in the game to create value for them, and they will have voted with their feet!
The free market knows how to fix THIS problem. What it can't fix is over-intervention by central planners, particularly the practice of money printing.
Seriously - protest the guys pulling the strings behind the stage, not the snow-blind executives who are destroying their own companies and paying themselves millions to do it!
I for one would be protesting (1) the Federal Reserve; (2) the Treasury Department; (3) the SEC; (4) Congress; and (5) the White House. What do they have in common? Their interference in the market has caused the majority of the present problems, particularly the creation of a distorted business climate that rewards speculation, excess, litigation, misdirection of capital and greed!
The value-destroyers will all disappear through natural processes (otherwise known as "hard times"). But it will take citizen action to put a stop to the intrusions of central planners, as they operate freely behind the scenes, and exhibit little change in behaviour under either Democratic or Republican administrations.
The present problem in the US (an excess of central planning) is thus most directly analogous to the decades of stagnation under central planning which still characterize Russia (under Putin, Russia has reverted to central control following a brief flirtation with very limited free market reforms), and which plagued China until its (still active) central planners began to unleash citizen initiative in the post-Mao years.
The Chinese have more or less figured it out. They are arguably further down the road towards free market reform than the still constricting economies of the West. Time for us to catch up!
While the Wizard of Oz still pulls the strings and works the levers behind the curtain, the centre of global economic power has rapidly shifted to Asia's less fettered markets.
What happened? The central planners intervened, and the US government - with taxpayers' money - bought the dysfunctional company. Now WE own it! While salvaging GM may seem like a "good thing" on a short-term basis, what we have forgone is the opportunity to open up the competitive landscape in one of our still very important industries.
Rescuing mismanaged companies from a natural death is NOT how to fix the problem!
(Think first, then act.... it saves a lot of time and energy!)
Unfortunately, this proposition has proven to be the "best bet in the casino" since 2001.
26 November 2011: As the "OWS" movement has worn on and developed, I suspect that all of us have grown more "accustomed" to it. My fundamental criticism remains that the occupiers are about three decades late, and are now protesting a "self-extinguishing" class, the operators of American public companies, whose shareholders are obviously already deserting them. I have thus been arguing more recently for a movement to "Desert Wall Street."
That is, the desertion of Wall Street is already in progress, and, as Tom Lehrer might have said, we might as well get on with it! When the last shareholder has left, the excesses will certainly be repaired.... It is not mainstream Americans who must protest the excesses of "the street," but the longsuffering and deeply exploited shareholders, who have been robbed of potential profits to fund inordinate compensation, buybacks, speculative behaviour, etc. Do not forget that the craziness all started with inflationary monetary policy, a topic on which I have written extensively elsewhere (click here)....
