by Gary North
But whilst there may be intrinsic reasons for the scarcity of land, there are no intrinsic reasons for the scarcity of capital. . . . It will be, moreover, a great advantage of the order of events which I am advocating, that the euthanasia of the rentier, the functionless investor, will be nothing sudden, merely a gradual but prolonged continuance of what we have recently seen in Great Britain, and will need no revolution.
John Maynard Keynes
General Theory, p. 376
Keynes was the most influential economist of the twentieth century, which speaks poorly of the twentieth century. He left behind three widely quoted phrases: gold as a "barbarous relic," "the euthanasia of the rentier," and "in the long run, we're all dead." He also left behind an utterly incoherent but widely accepted theoretical justification for high marginal tax rates, government make-work projects, and government budget deficits. His General Theory of Employment, Interest and Money (1936) is read by few, understood by fewer, and is the Das Kapital of our era: widely respected by academics who have not read it.
(The clearest refutation of Keynes is Henry Hazlitt's book, The Failure of the "New Economics" . Hazlitt never went to college, so he was not taken in by Keynes.)
Keynes' legacy was a theory of the free market that argues that the state must intervene into the operations of the free market in order to keep depressions from taking place. The free market cannot be trusted. Keynes believed that the national government's fiscal policy is the key to leading a nation out of recession: taxing, spending, and running deficits. The common phrase regarding this theory of government intervention is one applied to Franklin D. Roosevelt: "He saved capitalism from itself." (Keynes and Roosevelt met once in 1934, but they didn't think highly of each other.)
Milton Friedman has always agreed with Keynes regarding the inability of the free market to be reliably productive apart from government intervention, but he has focused on monetary policy rather than fiscal policy. Friedman has long promoted the idea that a central bank should constantly increase the money supply by 3% to 5% per year by buying government debt. This of course requires a long-term increase in government debt. His disciples, the monetarists, agree with him regarding both the legitimacy and the necessity of central banking.
Then there are the supply-siders. They are verbal anti-Keynesians, at least when tax rates are on the downward slope of Arthur Laffer's famous tax revenue curve, i.e., where the government's fiscal policy produces lower revenues at high marginal tax rates because of legal tax avoidance programs that are less economically productive, people's unwillingness to work, and reduced entrepreneurship and profit.
Supply-siders recommend tax rates set at whatever rates produce the greatest revenues: the top of the revenue curve. Former Congressman Jack Kemp is the spokesman for "practical" supply-side economics. As for monetary policy, they are anti-monetarists. The faintest trace of an economic slowdown produces cries from the supply-side camp — Jude Wanniski excepted — for "more liquidity, now!" They will have none of Friedman's penny-pinching 5% limit. "Get the printing presses rolling!" is the supply-siders' invariable call to action. This means, "Get the Federal Reserve buying more government debt."
One slogan unites all three camps of economists: "Deficits don't matter." All three are convinced that if governments adopt the correct taxation policies, and the central bank adopts the correct monetary policy, economic growth will overcome the negative effects of government debt.
As government debt grows larger, so do business debt, consumer debt, and mortgage debt. Everybody joins in the economists' chorus: "Deficits don't matter!" Problem: any serious recession threatens the economy with widespread default on debt. This in turn threatens the fractional reserve banking system: cascading cross defaults among banks, Greenspan calls the threat. That was what happened in 1930—32. The money supply shrank. Anything that threatens the debt-based monetary system is anathema to Establishment economists.
Government protection of the banks (e.g., the FDIC), government fiscal policy, and central bank policy have pumped up the money supply through the expansion of bank-purchased government debt. Therefore, the free market — bank depositors — is now a threat to both the expanded money supply and the structure of invested capital that monetary inflation has produced. Depositors who withdraw currency can pull the plug on the fractional reserve banking system. This is what is happening in Japan today. The central bank's response is to open the spigots even more to keep the tub filled with money.
The economists cry, "Deficits don't matter," but because a portion of these deficits is funded by central bank credit money creation, depositors' decisions to withdraw currency matter a great deal. This is why all Establishment economists hate the free market when it comes to money and banking. They all believe that "central bankers know best." They therefore hate those depositors who grow suspicious of the banks and withdraw currency. They recommend government intervention into the economy in order to overcome the interests of these depositors. The war against savers is basic to modern economic theory.
The agreed-upon anti-recessionary monetary policy of all three schools of Establishment economic opinion was summarized perfectly in four words by Martin Feldstein, who served as Reagan's chairman of the Council of Economic Advisors, in an article that appeared on the opinion page of the Wall Street Journal (Feb. 2, 1992). That was an election year, an election that President Bush lost in November because of a recession. Here is the Establishment economists' universal solution, which was the title of Feldstein's article: "Goose the Money Supply."
As for the Austrian school of economics, its members want no government control over the money supply beyond the fulfillment of contracts between banks and depositors. They also don't trust any government-licensed monopoly, including the most powerful of all government-licensed monopolies, the central bank. As for fiscal policy, they call for tax cuts even on the upward slope of Laffer's revenue curve. With Laffer, they insist that taxes should be cut until they produce maximum government revenue. Then taxes should be cut some more — quite a bit more, actually. So, nobody in government pays any attention to them.
THE WAR AGAINST THRIFT
What has all this got to do with the plight of savers? A great deal.
The Keynesians have an underlying contempt for the private saver who acts in his own self-interest. The government can allocate capital more efficiently, they believe. Anyway, pure Keynesians believe this. The practical Keynesians — most academic economists over age 50 — think that savers are tolerable, but not when they prefer to save so much money that the prices of most retail goods begin to fall. When consumers do this, the government must sell more debt to investors, including the central bank, and spend more money on employment-generating projects. Keynes literally called for the construction of pyramids, if necessary, to supply jobs (General Theory, p. 220). Keynesians are demand-siders. They regard consumption as the key to economic growth, not private saving and private capital formation.
The monetarists and supply-siders are favorable in general to savers, but not so favorable that they don't call for more monetary expansion whenever a recession appears. Friedman made his academic reputation by arguing in Monetary History of the United States (1963) that the Great Depression was the fault of the Federal Reserve System, which did not pump up the money supply, 1930—32. The FED actually allowed insolvent banks to go bankrupt. In other words, Friedman opposes the effects of the free market in wiping out bad debt, including poor entrepreneurs called bankers. His view of banking is promoted by 99.9% of the introductory economics textbooks used in every college on earth, and all of the textbooks in money and banking classes.
Supply-siders (again, not Wanniski) are knee-jerk inflationists. Their solution to every recession is always monetary expansion at whatever rate it takes to lower interest rates and get businesses borrowing again, plus a little more money, just to make sure. They have great faith in businessmen as the source of society's wealth, and they want the central bank to subsidize businesses with artificially low rates of interest whenever the free market calls into question prior monetary inflation-generated malinvestments by businessmen, i.e., during a recession. Supply-side economists are to monetary policy what mercantilists were to international trade policy: Subsidizers Of Business.
When the government taxes savers to get the government into accelerated spending mode (Keynesianism), this hurts savers. When the central bank buys government debt with newly created money in order to keep prices from falling (monetarism), this hurts savers, i.e. creditors, who are then repaid with money of reduced purchasing power, i.e., lower than what the free market would have determined was efficient. When the central bank pumps new money into the government debt market to lower commercial interest rates (supply side), it hurts savers, especially holders of short-term certificates of deposit, money-market fund owners, and passbook savings account holders.
In short, the saver gets blamed for the recession by all three schools of Establishment economic opinion. His interests are the first to be sacrificed on the altar of government intervention in order to "save capitalism from itself."
This is happening today, all over the world.
There is an old line, "You should save for a rainy day." The problem is, for the last sixty years, governments in the West have promised perpetual sunshine.
In the United States, the personal savings rate went negative in 2001. During recessions, the savings rate historically has risen because people are reminded that income is not a sure thing. They get worried about losing their jobs, so they save more. This time is no exception; the personal savings rate has climbed back to a little over 3% of disposable income. This is not exactly confidence-building. In previous recessions, it has hit 10%.
Recently, I went to the Web site of the St. Louis Federal Reserve Bank. This site is probably the best source of economic charts that are issued by any single organization. In any case, they're free. Far be it from me to turn down a free lunch. (Economagic is even better, but it's a compilation of sources.)
I was curious about the rates of savings in various countries. So, I clicked on International Economic Trends, the SL FED's quarterly publication. I have read it, or at least glanced at it, for many years. Its data page has a nation-specific list of topics: "Output and Growth," "Inflation and Prices," etc. You can check data for nine major countries. I clicked "Saving and Investment." This took me to a page with a chart on "Hourly Earnings and Output Per Worker." This was not what I had in mind.
With due diligence, I sent an e-mail to the SL FED, telling them of the glitch. I received this reply the next day:
I'm sorry for any confusion our webpage caused. The Savings and Investment charts were replaced with Inflation (depicting CPI and PPI) charts. I am correcting the webpage now to reflect the change.
I returned to the page. Sure enough, there was no longer any listing for "Saving and Investment." I sent back a reply:
I sure will miss Saving & Investment. Maybe when both are disappearing, it's time to drop them.
I've got a million of 'em! Rodney Dangerfield, don't look behind you. I'm gaining on you.
Then I received this response:
Yes, that is exactly why we discontinued them. Unfortunately, several of the countries that we were reporting savings and investment data for were no longer updating their files with the OECD (our source — the Organization for Economic Cooperation and Development), and we felt that it would be better to include charts that had current data. Hence we chose the CPI and PPI to represent inflation.
That response got me to thinking. We are in the midst of a worldwide slowdown of economic growth. Europe is in what appears to be permanent economic stagnation. Stock markets in the West and Japan are way down, and none of them looks healthy.
Where is any population's commitment to long-term thrift, which alone can restore both productivity and the stock markets? If the 20% of the population that supplies 80% of the capital (Pareto's Law) refuses to save, then the capital necessary to enrich the other 80% will be absent. We will then experience a secular decline in the rate of economic growth. As capital consumption spreads, we could even see a contraction of the West's share of the world economy.
This is already taking place. Capitalism is spreading to mainland China and India. As the two largest nations on earth abandon their old economic views — Chinese Communism and Indian Fabianism — the masses of these two countries are entering the modern world. Between these giants, there are at least two and a half billion people. Hundreds of millions of them work for less than a dollar an hour.
These low wage rates will not last. Capital expansion will raise their wages, along with their productivity. That's what capitalism always does. But the West's politicians have yet to come to grips with twin economies whose foreign trade sectors are larger than most nations' entire economies.
If the balance of payments deficit continues at its present rate of 4% of the U.S. economy — unlikely, of course — then what will happen to the ownership of capital in the United States? This surplus 4% in the hands of foreigners gets invested in dollar-denominated assets. Orientals are not inscrutable. They are investors in search of currency-risk diversification. They are saving by purchasing dollar-denominated assets. This is what sustains our consumer goods buying spree. As Asians increase production in comparison to Europeans, Asians will begin to dominate America's capital markets. The trend is clear: Asians are steadily securing legal ownership of America's wealth-producing assets. Because Europeans and Americans are reducing their savings rate, they are being replaced by Asians.
Japan once led the way. It set the example: export, and invest the surplus abroad. But Japanese policy-makers in government bought Keynesianism: hook, line, and economic sinker. The result since 1990 has been economic stagnation or worse. Japan has a commercial banking sector that looks exactly like any government-licensed, central-bank-protected monopoly does after a generation of fiat-money-generated good times: paralyzed with fear and bad debts.
JAPAN'S DILEMMA: TOO MUCH FIAT MONEY
Capital follows freedom. Where taxes are low, economies are competitive. This is another reason why Japan is suffering today. It has too many taxes and too many regulations on business. State bureaucrats are making too many decisions regarding the allocation of capital. Other Asian nations are steadily replacing Japan as the source of low-cost goods and ready capital in American markets.
The Cato Institute's Alan Reynolds wrote a piece for the Washington Times on October 13. He identifies Japan's problem.
Japan's problems began with the 1988 Basle Accord that created tough new rules for the world's banks. By the early 1990s, those heavy-handed capital standards began to force banks to slash loans to business and boost their holdings of government IOUs. Japan's banks were compelled by the Bank of Japan to severely ration credit.
As the Bank of Japan was working hard to "burst the bubble" in stock and land prices, the Japanese Treasury decided to do the same with new taxes on retail sales, capital gains and land. The capital-gains tax made it far less attractive to hold stock, shoving stocks down further. The land tax had the same depressing effect on land prices, and nasty ripple effects on stocks and banks. Land had been a key asset behind corporate stock and important collateral for bank loans. Stocks, in turn, were a significant portion of bank capital. When stocks the banks owned dropped in value, the Basle rules required an even tighter squeeze on business and consumer loans.
Brutal monetary and tax policies sank the value of Japanese land and stocks, and wiped out bank capital and loan collateral. The mandated cutbacks in bank lending to businesses slaughtered many companies. Good loans became "bad loans" because of a bad economy. Meanwhile, the government wasted huge sums on costly public works schemes that saddle future taxpayers with a gigantic public debt. As the Economist put it, "Japan's policymakers appear to have followed the Keynesian textbook."
Keynesian fiscal policy produces economic stagnation and rising government deficits. It assumes that the free market needs assistance from the government. Keynesianism is the primary academic source of the theology of government-guaranteed sunshine.
Because Japan's banks have long been on the verge of collapse, with $423 billion of bad debt, fearful Japanese take money out of the banks and hoard currency. This bank run in slow motion forces banks to keep extra cash in reserve, in case too many depositors cash at once.
This is the inescapable curse of fractional reserve banking. Bad loans eventually threaten the solvency of the banks, which leads depositors to withdraw currency, which hastens the erosion of bank solvency. This has been going on in the West for five centuries.
Instead of requiring 100% reserves for banking — no issuing of IOU's to money metals that are not backed up by money metals in the vault — government policy-makers have insisted on establishing state-chartered monopolies, central banks. These agencies are supposed to serve as lenders of last resort to insolvent commercial banks. This is ancient policy stretching back to the creation of the Bank of England in 1694. So, I cannot understand why Reynolds thinks that the following recommendation is anything but business as usual.
The currency the Japanese are stuffing under mattresses plus the extra bank reserves add up to the "monetary base." The Bank of Japan could increase the monetary base by buying Japanese or U.S. securities and paying for them by adding to banks' reserves. Once the banks had enough reserves to feel comfortable, they could increase profits by using extra reserves to create new checking accounts by buying bonds or making loans.
I read this and think, "Keynesianism with a Wall Street face." (Note: when he says "securities," he means government debt.) He then laments the fact that the Bank of Japan is holding back.
Unfortunately, the Bank of Japan just doesn't get it. So the demand for cash keeps outpacing supply. The result shows up in rapid growth of currency, which is hoarded, but very slow growth of broad measures of the money supply. Over the past year, the broadly defined money supply grew by 8.3 percent in the United States but only 3.5 percent in Japan.
Horror of horrors: the central bank is not inflating fast enough. The extension of newly created credit money to the government is being restricted by the Bank of Japan's policy not to debase the currency too fast. This hampers the banking system's ability to defraud depositors through inflation. No, no, no: let's get those digital printing presses running!
Contrary to Reynolds, the Bank of Japan is inflating like mad. The adjusted monetary base is up by more than 20% since last year. M-1 is up by 30%. (This panic-level increase in money began in 2000.)
The Bank of Japan is at fault. The CD rate is just slightly over 0%. Government bonds pay a little above 1%. In short, the Japanese saver is getting reamed by the Bank of Japan.
Is it any wonder that bank depositors are withdrawing currency? Why shouldn't they? It is costing them almost nothing to get into currency, which leaves no records, and which will appreciate if banks collapse. Prices are falling, so the hoarding of currency leads to increased purchasing power, meaning increased wealth. What rational person wouldn't do this in Japan, where hardly anyone uses credit cards or debit cards?
Yes, the M-2 rate is not growing by much: a little over 3%. That's because people are reducing their bank savings accounts, which pay no interest, in favor of increasing their holdings of currency.
The Bank of Japan is following Reynolds' recommendations to the letter. It isn't working. The sovereign consumer is bringing the bankers to their knees. The Old Boy Network in Japan — large firms, large banks, the BoJ, and the Liberal Party — is getting its head bashed in by individual citizens, who are voting no against mass monetary inflation, which the BoJ is producing precisely because the banks are rotten. And the economists all wring their hands. "Naughty, naughty depositors. Have faith in the banks."
If economists had any sense of irony, they would choose one singer from each Establishment school — Keynesian, monetarist, and supply side — and do a reworked version of the Beach Boys' "Fun, Fun, Fun." The chorus:
And they'll have fun, fun, fun
Till inflation takes the T-bills away!
Once again, let me remind you: only the Austrian School of economics stands fast against the deliberate debasement of the monetary unit by a government-licensed, monopolistic central bank. All other schools are cheerleaders of the central banks. They all call for "restrained" counterfeiting. And every time recession looms, the language of restraints disappears.
Monetary inflation rather than thrift is the hope of Western economists and policy-makers. Instead of calling for a radical reduction of taxes, to be accompanied by a comprehensive abolition of government regulations on business, both of which would help restore Japan's faltering productivity, the policy prescription is more fiat money. Reynolds blames the consumer.
To get the cash they crave, the Japanese have no choice but to liquidate goods and assets at distress-sale prices. The result is falling prices — deflation. The real burden of old debts rises because producers have to sell more widgets to raise the same amount of yen. Consumers and businesses are slow to buy, because everything is expected to be cheaper if you wait.
Reynolds used to be a monetarist. He launched his career in journalism back in 1971 with an attack on Austrian monetary theory, which he said was not accommodative enough, i.e., not expansionist. Years later, he switched to supply-side economics. He still promotes the same old solution to recession: more fiat money. His tune has changed, but the lyrics remain the same.
Whenever a recession appears, Friedman's words in 1965 are ratified by Establishment economists: "We are all Keynesians now." He meant methodologically, but there is no question that he also meant at the fundamental level: an acceptance of the state's role as the primary activist agency for overcoming recessions. The debate is over how: fiscal policy (Keynes) or monetary policy (Friedman). Reynolds presents the familiar analysis that has plagued the West ever since the Great Depression: Keynes' "liquidity trap." Oh, that short-sighted, self-interested, unreliable depositor, who does not fully trust the banking system, and who therefore hoards currency whenever the central bank's policy of money-creation reduces the interest rate to approximately zero. The policy-makers and the economists go into St. Vitus Dance just thinking about price cuts for anything except borrowed money.
They all laud Adam Smith's central concept of the growing wealth of nations as the product of the self-interested individual, but only up to the point when this individual walks into a bank and says, "I want my money, in small bills please." At that point, he becomes a public menace.
The fact is, Japan's mild reduction of prices is granting to consumers some relief from seven decades of price increases. There is no "deflationary spiral" in Japan. Richard Katz has warned against seeing Japan's situation as anything even remotely like the Great Depression. In the Oriental Economist (March 2002), he wrote:
Japan's deflation is quite mild. The GDP deflator has been falling about 1.5% to 2% since 1999. The consumer price index is falling at an even milder, 0.5% rate. In the US, incidentally, wholesale prices fell 2.6% last year, yet the economy is in recovery.
The key point: while weak demand is causing prices to fall in Japan, those falling prices are not, in turn, causing demand to weaken further. (There is also a bit of "good deflation" — a drop in monopolistic prices in a few products, such as food, clothing and long-distance phone calls.)
Deflation is a symptom of Japan's problems, not their cause. Deflation does have some side-effects, but these are marginal in the overall picture. Excessive focus on deflation is like trying to cure a fever by putting ice on your thermometer.
Today, officials at the BoJ are floating this unorthodox idea: the BoJ should create money and buy depressed equities that are held by the banks. This is a whole new way of turning economic power over to central bankers. Instead of becoming the lender of last resort, the central bank should become the speculator of last resort. Instead of confining itself to buying certificates of future wealth-confiscation by the state, it should buy control of the entrepreneurial process itself — businesses. It should gain the legal authority to choose who will sit on the boards of directors. It should decide directly which businesses deserve capital rather than using the commercial banks as intermediaries. In short, it should make official what the Old Boy Network has been doing unofficially in Japan since 1868.
This transfer of power to the Bank of Japan would lead to the final removal from the corporate decision-making process of all those pesky, quirky, profit-seeking private investors. This is what the Old Boy Network has been after for a century . . . and not just in Japan.
Depositors in Japan are now playing Joe Bfstplk for the government's guaranteed sunshine. Maybe you aren't old enough to remember Joe Bfstplk. He was a character in Li'l Abner who wandered through the world with his own built-in rain cloud, which hovered above him, raining. Wherever he went, disaster followed. He remained untouched by these disasters. Wet, yes, but unscathed. For a picture of Joe, click here:
What the Old Boys want is for bank depositors to be schmoon (plural of schmoo), those fat, ham-shaped little creatures that laid eggs, gave milk, and would drop dead whenever a hungry person looked at them. But cartoonist Al Capp understood the implications of such creatures.
Ironically, the lovable and selfless Shmoos ultimately brought misery to humankind because people with a limitless supply of self-sacrificing Shmoos stopped working and society broke down. Seen at first as a boon to humankind, they were ultimately hunted down and exterminated to preserve the status quo.
The same is true of savers who are willing to roll over and play dead every time a recession threatens. When savers stop saving, misery will result. The Establishment economists have never accepted this universal fact of economic life.
Central bankers have not yet grasped the implications of the substitution of fiat money for thrift. They expect savers to roll over and play dead. They ask rhetorically, "Who needs savers when you have the legal authority to create digits and print pieces of paper with politicians' faces on them?"
Anyone who worries about imminent price deflation has not thought through the Old Boy Network and its solution to every economic slowdown: more fiat money. In contrast, anyone who worries about the long-term decline of productivity due to the euthanasia of savers has indeed thought through the Old Boy Network's solution.
November 13, 2002
Copyright © 2002 LewRockwell.com