Dylan Grice on the Money Printers
Yesterday Dylan Grice of Societe Generale published a brief piece on the debasement of money that has rightly garnered quite a bit of attention. Readers who have missed it can read a summary of the salient points at Zerohedge.
As we have mentioned in the past, Grice appears to be a 'closet Austrian'. He regularly advocates Austrian ideas and viewpoints, but we have never seen him identify them as such. Be that as it may, it is the ideas that count, not their label. It should perhaps also be pointed out in this context that people like Ludwig von Mises or Murray Rothbard did not see themselves as 'Austrian' economists either – rather they felt they were simply economists advancing the science of economics – albeit economists whose work was certainly firmly rooted in the subjectivist tradition of the Austrian school.
To return to Grice, he makes several important points that are well worth considering. For one thing he points out that the institution of money is extremely important to social cooperation. In order for the market economy to function, one must trust a great many people one doesn't know. Money is the means by which this trust is established: we can assign value to the goods and services offered to us by others in monetary terms. They in turn can do the same with thew things we offer them.
It follows that when money is debased, social cooperation is hampered. There is even more to this in fact: the fiat money system, which has become such an indispensable feature of the modern-day welfare-warfare State, severely erodes peoples moral values. This is because it enables the belief that one can get something for nothing to become ever more entrenched.
The 'spontaneous order' of the market economy depends on the ability of economic actors to calculate and to receive proper price signals. Sound money is thus an indispensable feature of a healthy market economy.
In 'normal times' we can be fairly certain that the value of money won't fluctuate around a lot. Peoples' expectations about the purchasing power of money today are informed by their knowledge of its purchasing power of yesterday, and so on, in an infinite regression. Of course money has no 'fixed value' – there are no constants in economics and money is no exception to this rule – but it should be obvious that it is extremely important that one be able to rely on money's ability to fulfill the functions outlined above. When the authorities begin to debase money in ever greater strides, this is soon no longer the case.
Grice uses a number of historical case studies to drive the point home: once the debasement of money crosses a certain threshold, social cooperation breaks down. The societal order collapses. On the way to this collapse we can always observe the same phenomena.
One of these phenomena is something we have often discussed in these pages: money is not 'neutral'. When additional money is introduced into the economy, whether by means of a credit expansion that creates additional fiduciary media (deposit money ex nihilo) or outright inflation on the part of the government by printing of currency or discounting government debt with the central bank, there are always winners and losers. Obviously it cannot be the case that society as a whole gets something 'for free' when new money enters the economy. Someone – namely those who are closest to the source – will gain at the expense of someone else – those who are further away from the source. This is why in the course of a progressing monetary inflation, we always observe that the rich become richer and the poor become poorer.
Distrust and Disorder
This month (and next month, and the one after that, and so forth ad infinitum) the Federal Reserve intends to create an additional $40 billion in bank reserves by buying mortgage backed securities with money it creates from thin air. Not all of these bank reserves will necessarily leak out into the economy, but in theory they could actually be levered up by the fractionally reserved banking system to a multiple of the original amount expended by the Fed.
This money will be created and enter the economy without anyone producing an offsetting contribution to the economy's pool of real funding. Obviously those with first dibs on the newly created money will be at a very big advantage: prices will only adjust over time, as the money percolates through the economy. The early receivers will still pay the old prices for goods and services – by the time lowly wage earners get paid their salaries, the effect on prices may already be noticeable. The more time passes, the more obvious this will become. People will notice that something is amiss, but most will be unable to diagnose the cause. Why does the paycheck no longer stretch as far as it once used to?
Those dependent on fixed incomes or their accumulated savings – the proverbial 'widows and orphans' – will be hit the hardest. The gap between rich and poor will widen ever more. It should be obvious that the rich have a far better chance to be among the winners of inflationary policy - as a rule the bulk of their wealth is in assets that rise in price disproportionately as inflation progresses. It is generally no problem when the rich get richer – but it becomes one when the poor become poorer at the same time.
Distrust of the existing order begins to grow. Something must be done, but what? Many believe that the solution lies in even more intervention by the State. They begin to cry for a forcible redistribution of wealth. Politics becomes more polarized – political radicals and extremists come to the fore.
At the same time, the unseen, but actually most pernicious effects of the inflationary policy, continue to undermine the economy's structural integrity day after day. Capital malinvestment and capital consumption become an ever greater burden, gnawing away at the economy's ability to create wealth. One could also say: the bills must be paid, but the means to pay them are slowly but surely eroded ever more.
At the very extreme end of an unending policy of monetary debasement stands the complete collapse of the existing societal order. As Grice shows in the historical examples he uses to buttress his points, this was of course never the intention of those pursuing the policy. They all thought they were only 'temporarily' helping the economy to get out of a tough spot. Often they were people who were well aware of the dangers, but still thought they could keep things under control. In short, they held that they could get whatever 'good' short term effects they expected the policy to produce without having to pay a price. They would step on the brakes in time: 'we'll do it just this once'.
Readers of this site may recall that we have pointed out again and again that this never works in practice. Once one embarks on a deliberate policy of monetary debasement, it becomes extremely difficult to 'step on the brakes' and discontinue the policy. This is because the temporary revival in bubble activities the policy produces tends to immediately die down again whenever the inflation as much as pauses. And so there is the constant temptation for policymakers to continue down the same path: 'we'll do it just one more time, that will surely do it'.
The Fed's Remaining Hawks
According to Ben Bernanke, it is all 'worth it', but is it really? In recent weeks we have heard from both the few remaining 'hawks' at the Federal Reserve as well as the many supporters and defenders of the newest iteration of 'QE'.
Let us briefly consider the 'hawks'. They are all presidents of Fed districts, i.e., not one of them is at the Fed's board of governors in Washington. This is so because in the districts, a banker or businessman is occasionally nominated to lead the district board. Only one third of the members of the district boards are nominated by the board of governors. As a result there fewer pure academics presiding over the districts.
