Money, Savings and Debt
by Pater Tenebrarum
This post
can in a way be seen as an addendum to what we wrote regarding the 'gold narrative' the other day. Specifically,
we want to return to the argument made in closing, namely that the present
situation in terms of private and public debt relative to the economy's ability
to create enough wealth to service and repay said debt is a reason to remain
bullish on gold and by extension, to remain skeptical regarding the economy's
future.
It is
important to keep in mind that the level of outstanding debt
as such actually does not prove the point. For instance, if all the credit
extended were backed by real savings and if the great bulk of
the extended credit were employed productively, then the size of the debt would
obviously not represent a problem. After all, we would then have very good
reason to expect that the investments that have been undertaken are largely
sound (given the fact that they are backed by real savings) and that therefore,
the economy's future output of final goods will increase sufficiently to create
the profits required to service and repay the debt.
However, we
know for a fact that a vast portion of the debtberg does not consist of credit
that has been productively employed. Moreover, we also know for a fact that
much of it is not backed up by real savings. How do we know all this?
Let us first
discuss savings. What are savings? In a monetary economy, people save in the
form of money. Money is a claim on real goods, it is the ultimate present good.
However, in order to save, one has to refrain from consumption. Let us say that
someone saves $200 per month. He certainly could spend these $200 instead of
saving them, in which case he would exert a claim on the pool of final goods
and consume the goods purchased. Note that by refraining from this act of
consumption, not only are there now $200 in his savings account, but the goods
the saver has not consumed remain with the economy's pool of real funding (the
pool of real funding is the stock of produced, but unconsumed final goods).
This
addition to the pool of real funding is what actually makes an increase in
production possible. If ten savers put aside $200 per month, the
$2,000 worth of goods thus saved could e.g. be used to maintain the life and
well-being of one worker employed in production activities. When an entrepreneur
applies to a bank for credit in order to expand production, he is ultimately
not trying to obtain money as such, but capital. What is required
to effectively fund new production activities is not money, but real resources.
To
illustrate this, imagine that a few people find themselves stranded on a
deserted island, and by coincidence one of the things that has been
successfully recovered from the shipwreck is a printing press for banknotes and
all the paraphernalia required for the printing process. Obviously they could
not create any wealth for themselves by printing banknotes. It would be a
pointless exercise: the banknotes could not be used to buy the necessary
capital goods required to e.g. build a new boat, since these goods are simply
not available on the island. This would be so glaringly obvious that they would
certainly not even try – they could print billions and would not be an iota
richer. If they decide to mix their labor with the natural resources available
on the island so as to create primitive capital goods that bring them a few
steps closer to their goal of building a boat, they would still be confronted
with the problem that at the outset, their pool of real funding would be zero.
They would at first have to produce whatever is necessary to keep them alive
(i.e., food). If they want to spend time on producing capital goods, enough
food would have to be produced that some of it could be saved to maintain their
lives while they are busy with building an ax, a net, rudders, sails and so
forth.
This example
serves to highlight a universal truth: no wealth can be created by
printing money. Money is indispensable for an economy based on the division of
labor, as a medium of exchange (and all the subsidiary functions that flow from
this, such as the store of wealth function) and a unit of account that enables
economic calculation. It should be obvious though that adding to the supply of
money does not add to the economy's wealth (in case a commodity money is used,
it could be argued that the non-monetary uses of the commodity make additional
supplies valuable beyond their exchange value, but as a rule the general medium
of exchange derives the great bulk of its value from monetary demand).
Since 1971,
the world has been on a fiat money standard. Moreover, the banking system is
fractionally reserved, which means that it can literally create additional
money from thin air. There is no effort involved except a few keystrokes. This
system is backstopped by central banks that 'accommodate' this creation of
money from thin air by supplying bank reserves, which are likewise created at
the push of a button. In this system, a lot of credit is created that is not
backed by real savings. We can get an inkling regarding the size of this credit
creation from thin air by looking at the amount of uncovered money substitutes
in the economy, i.e., deposit money that is not backed by standard money in the
form of currency or bank reserves which can be converted to currency on demand.
US money
TMS-2 by economic categorization. Covered money substitutes (dark blue) consist
of deposit money that is backed by either vault cash or bank reserves held at
the Fed. Uncovered money substitutes (also known as 'fiduciary media')
represent deposit money that has literally been created from thin air and for
which no standard money backing exists – click to enlarge.
As can be
seen above, although the Fed's 'quantitative easing' policy has vastly
increased the portion of money substitutes that are covered by bank reserves
(the often cited excess reserves), the amount of uncovered money substitutes
outstanding nevertheless stands at a new record high. In theory, all of this
money should be available on demand. In practice, the banks could only pay out
the covered portion and would have to contract credit if they were required to
pay out more than that.
The main
problem with the creation of money from thin air is that by throwing additional
fiduciary media on the loan market, the market interest rate is pushed below
the natural interest rate dictated by society-wide time preferences. This sets
the boom-bust cycle into motion. The lower interest rate makes long-term
investment projects that appeared to be unprofitable at a higher rate look
profitable, so investment will be drawn toward such projects. The lower market
interest rate suggests that the pool of real savings has increased so as to
make the funding of these long-range investment projects possible. However,
this is a mirage: the additional real savings do in fact not exist. To
paraphrase Mises, the entire class of entrepreneurs finds itself in a situation
akin to that of a master builder who attempts to build a palace with three
stories, while unbeknown to him, the building material available is only
sufficient for two stories. Obviously, the later he discovers this error, the
more significant the loss will be, as a lot of resources will have been wasted.
Moreover,
the creation of fiduciary media makes exchanges of nothing for
something possible. The early receivers of newly created money can
exercise claims on the pool of real savings, although no commensurate
contribution to the pool has actually been made. The earlier receivers of newly
created money will benefit to the detriment of later receivers, as by the time
the new money has percolated through the economy, prices will have risen to
reflect the increase of the money supply. Obviously, the earlier in the process
one gets to spend newly created money, the bigger one's advantage will be. Thus
wealth is redistributed from late to early receivers. Moreover, by exercising
their claim without an offsetting contribution to the pool of real savings
having been made, these early receivers make life more difficult for genuine
wealth creators, who now must contend with a diminished pool of savings. In
short, printing additional money enables consumption without preceding
production. Obviously this cannot possibly be sustainable – ultimately
consumption is constrained by production (one cannot consume what hasn't first
been produced).
In a
nutshell the problem posed by the mountain of debt that has been built up over
time is the following: it has misdirected investment and falsified economic
calculation, which in turn has distorted the structure of production and led to
the consumption of scarce capital (which is usually disguised as illusionary
accounting profits) during the boom periods. Subsequently this became painfully
obvious as the inevitable economic busts set in.
What's more,
the duration and amplitude of the boom-bust sequences has continually grown, as
after every failed boom, the amount of new credit and money thrown at the economy
to 'rescue' it from the bust has been vastly increased. Ever larger additions
to the amount of money and debt outstanding have resulted in ever smaller
additions to economic output.
US: total credit market debt outstanding – click to enlarge.
If we
consider the total amount of credit market debt outstanding depicted above, it
is clear that large portions of this debt are indeed unproductive and represent
a millstone hanging around the economy's neck. There are for instance (in the
case of the US) more than $16 trillion in cumulative public debt. This
represents the government's debt-financed consumption of the past. Even those
who erroneously believe deficit spending to be economically beneficial must
realize that this debt that is the residual of past deficit spending can only
harm future economic development.
US: total public debt on the federal level – click to enlarge.
As Ludwig
von Mises wrote regarding this point in Human Action:
“But if the government invests
funds unsuccessfully and no surplus results, or if it spends the money for
current expenditure, the capital borrowed shrinks or disappears entirely, and
no source is opened from which interest and principal could be paid. Then
taxing the people is the only method available for complying with the articles
of the credit contract. In asking taxes for such payments the
government makes the citizens answerable for money squandered in the past. The
taxes paid are not compensated by any present service rendered by the
government's apparatus. The government pays interest on capital which has been
consumed and no longer exists. The treasury is burdened with the unfortunate
results of past policies.”
(emphasis
added)
We would
note to this: one of the many Achilles heels of deficit spending that aims to
provide 'economic stimulus' is precisely that the wealth creators in the
economy know very well that they will eventually be taxed to pay for it. It is
a good bet their reaction will reflect this knowledge. They will become
cautious, take fewer risks and curtail their investment activities. This is one
of the reasons why massive deficit spending schemes such as that enacted in
Japan over the past two decades consistently fail to work.
Another
point worth considering is that there is also still a vast amount of mortgage
debt outstanding that is effectively 'underwater'. The collateral is worth less
than the remaining debt, as a consequence of the housing bubble. No-one dares
to write this unsound debt off, as doing so would denude the banks of capital.
And so various extend and pretend schemes have been enacted (ranging from the
adoption of dubious accounting methods to delaying foreclosure proceedings to
various tax-payer funded interventionist schemes that aim to prevent a
write-off of this debt). This is in many ways a drag on the economy, as both
lenders and potential borrowers are paralyzed by this overhang of unsound debt.
Wealth Creation in the Market Economy and the State
In spite of
the foregoing, it is important to stress that the market economy, even though
it is extremely hampered, continues to create wealth. We once attended a
presentation by Professor Hans-Hermann Hoppe, in which he discussed the 2008
crisis and its aftermath. There was one remark he made during the Q&A that
struck us as especially pertinent to this discussion. He essentially said (we
are paraphrasing from memory): “We can gauge how powerful the market
economy's ability to create wealth is by considering that in most modern-day
regulatory democracies, perhaps 30% of the population can be said to be
involved in genuine wealth creation activities. In spite of the fact that the
entire amount of wealth is created by this small minority, and that this
minority is subjected to the most onerous regulations and taxes, it still
manages to improve the well-being and standard of living of all of society over
time.”
Along
similar lines, Mises stressed that although an artificial credit-induced boom
leads to impoverishment, this does not mean that we should expect that we will
necessarily be poorer overall at the end of a boom than at its beginning. This
is so because even under the unhealthy conditions of a boom, genuine wealth
creation continues. If that were not the case, the capitalist system wouldn't
have been able to increase the world's stock of wealth continually ever since
capitalist production processes have been adopted. However, it is also
important to realize that all of this has happened in spite of
the hampering of the market economy by taxation and regulations and the failed
central economic planning by central banks.
Obviously
though, there must be a limit to the depredations the economy can handle.
Today, the State has created an environment in which most of the intellectuals
who propagate political and economic ideas are essentially bought off, as the
government can offer them levels of remuneration that are way beyond the value
their services would command in a free market. Naturally they will tend to sotto
voce engage in the vilest statist propaganda. Very few dare to bite
the hand that feeds them, even if they are aware that they are promoting a
harmful ideology. Presumably, quite a few of them even believe in what they are
promoting.
We can see
this in many obvious contradictions, such as the fact that e.g. most economists
today agree that the market economy represents the by far best system for
creating wealth, but at the same time support fiat money and central economic
planning by the central bank, deficit spending by the state, and all sorts of
state interventions in the economy. This is an inconsistent position. Either
the free market is the best system, or its opposite, full-blown socialism, is.
It is simply absurd to claim that what we really need is just enough socialism
so as not to kill off the market economy altogether.
We are happy
to report though that the intellectual handmaidens of statism are finding it
ever more difficult to propagate their memes due to the internet having opened
up alternative channels of communication and information that are outside of
establishment control. This has made it possible for many people to learn of
ideas that have previously been suppressed. On the other hand it is clear that
we are still very far from the tide having decisively turned.
In fact,
because the State now finds itself under increasing financial and economic
pressure, it reacts in a manner that it regards as the politically palatable
'solution' to the debt problem. This solution consists primarily of
inflationary policy (see the chart of TMS-2 above for evidence), and various
forms of 'financial repression'. Inflation mainly robs the poorest members of
society, while financial repression, depending on what forms it takes, robs
everyone. The alternatives, such as writing off the unsound debt that has
accumulated or cutting unsustainable government spending, are policies that are
regarded as highly detrimental to winning elections. The welfare state has
created so many dependents and hangers-on, not least including a vast and powerful
class of bureaucrats who represent a large block of votes, that no politician
dares to veer off established lines too much. Hence financial repression is
chosen as the 'lesser evil' from the point of view of the ruling classes (whose
main aim it is to preserve their rule and privileges).
However,
there is a big problem with this. As the above-mentioned Professor Hoppe e.g.
remarks in “The Economics and Ethics of Private Property” with regard to
taxation:
“Thus, by coercively
transferring valuable, not yet consumed assets from their producers (in the
wider sense of the term including appropriators and contractors) to people who
have not produced them, taxation reduces producers’ present income and their
presently possible level of consumption. Moreover, it reduces the present
incentive for future production of valuable assets and thereby also lowers
future income and the future level of available consumption. Taxation is not
just a punishment of consumption without any effect on productive efforts; it is
also an assault on production as the only means of providing for and possibly
increasing future income and consumption expenditure. By lowering the present value associated
with future-directed,
value-productive efforts, taxation raises the effective rate of time
preference, i.e., the rate of originary interest and, accordingly, leads to a
shortening of the period of production and provision and so exerts an
inexorable influence of pushing mankind into the direction of an existence of
living from hand to mouth. Just increase taxation enough, and you will have
mankind reduced to the level of barbaric animal beasts.”
Hoppe also
points out that regulations (which compel or prohibit exchanges between private
parties), while they are just as economically harmful as taxation, don't
increase the economic resources in the hands of the government. They merely
satisfy the lust for power. He concludes that this is the main reason why in
wars between industrialized Western States, the less regulated ones tended to
win against the more regimented ones.
However, we
would point out that even the US economy, which is still widely regarded as one
of the less hampered and regulated Western economies, boasts the following
statistics as of 2012 (Source: the Ten Thousand Commandments):
• Total costs for
Americans to comply with federal regulations reached $1.806 trillion in 2012.
For the first time, this amounts to more than half of total federal spending.
It is more than the GDPs of Canada or Mexico.
• This is the 20th anniversary
of Ten Thousand Commandments. In the 20 years of publication, 81,883
final rules have been issued. That’s more than 3,500 per year or about nine per
day.
• The Anti-Democracy Index –
the ratio of regulations issued to laws passed by Congress and signed by the president
– stood at 29 for 2012. That’s 127 new laws and 3,708 new rules – or
a new rule every 2 ½ hours.
• Regulatory costs
amount to $14,678 per family – 23 percent of the average household income of
$63,685 and 30 percent of the expenditure budget of $49,705 and more than
receipts from corporate and personal income taxes combined.
• Combined with $3.53 trillion
in federal spending, Washington’s share of the economy now reaches 34.4
percent.
(emphasis added)
Read the rest at:
.jpg)
