Playing with fire

How bad economics, the apathy of the public, and wishful thinking have created the perfect storm.

A path to nowhere

It’s March 2020 and the world goes into lockdown. Something we have never done before in our long history of catastrophes, wars, epidemics, and disasters. But in March 2020 the Chinese Communist Party decides this new danger can only be affronted with draconic measures. And the rest of the world follows suit. There was no experience in treating entire countries like quarantine facilities, no scientific literature, and no protocols.?But for some reason beyond my comprehension, the motto in spring 2020 was learning from the CCP is learning to win. Confronted with an extraordinary danger with the potential of killing millions worldwide, questions of constitutionality were not massively en vogue. Solidarity and allegiance were the topics of the hour. What amounted to homicidal negligence in the eyes of many, however, was publicly voicing concern about the economy. How could someone think about money when people are literally dying?

Setting aside, that life is a series of decisions on trade-offs, and that poverty still is the number one cause of death and suffering in the world, many questions arose in those who at least roughly understand the complexity of a system like the global economy. In a free market system the maximally efficient wins. And so, our economies have been optimized for efficiency for decades. Goods flow relatively freely between nations, companies produce where the cost is minimal, and inventories and stock are kept low to avoid unnecessary costs. A well-oiled machine that cannot be stopped without partially breaking it. A system that lifted hundreds of millions out of poverty in the global south and benefitted the consumer through low prices, albeit often to the detriment of industrial workers in industrialized countries.

Shutting off the economy for a few months to an economist sounds about as feasible, as shutting off the oxygen supply to the brain of a patient must sound to a doctor. It might not mean death as long as the oxygen eventually starts flowing again, but the damage will certainly be great. And sure enough, global supply chains collapsed, food security for hundreds of millions has become endangered, the economy shrunk, and several human development indices have gone down for the first time since the second world war. But what is broken can be repaired, and after all, haven’t we overcome worse economic crises? Fair enough.

?But when it comes to the implementation of a countermeasure that will have the most dire consequences, an honest conversation about tradeoffs would be desirable. And any discussion should always keep in mind those on the lower end of the welfare distribution. Germans and Canadians might largely accept shaving 10% off their income for a year if it increases security. Inhabitants of the global south, who might barely make ends meet, or don’t make ends meet at all, might have different opinions.?

Another question that was even less popular than those of the continuity of the global economic machine, and the expected loss of welfare was the question of the cost. We might try and stop human commercial and leisure activity but that doesn’t stop the need to heat homes, consume food, transport goods or people. “Well duh,” you might say, “the government jumped in”.

?Practically every western country introduced a system of transfers, compensating those with financial payments who could not work from home, and who else had been forbidden from exercising their commercial activity. But not just individuals, entire industries, like the aviation industry have been put under government protection and kept afloat during a time of “slowing down”. Far from being perfect and reaching everybody with the fair quantity on time, these schemes nonetheless largely kept small businesses and independents afloat and helped many companies pay the wages of their employees. Employees, who else would have been rendered unemployed by that company’s failure. So, in the end, it was thought, we got away with a few bruises, but we got away. With the rollback of restrictions, the economy was going to grow and grow and grow, and all the losses of 2020 would soon be forgotten. ?Unfortunately, that was counting the chickens before they hatched.

Again, nobody bothered to ask, “Where does the money come from?”.?

The government has three main ways to finance itself if wants to spend more money, and all 3 come out of your pocket.

?Number one is of course tax revenue. Taking a sizable portion of your earnings off before they even reach your bank account, taxing the ground you own, or the gains you make on financial markets while your savings melt away due to inflation. Adding additional cost to the food you buy, the gasoline that powers your car, or the electricity that heats your home. Taxing every activity imaginable and making commercial activity accessible only through payment for a “concession”. Sometimes even taxing already taxed incomes through an inheritance tax like for instance in Spain.

The second possibility is accruing additional debt. Additional debt is much more subtle than new taxes. They don’t have to be paid today and are put on the tab of the people of the future. This can be you, your kids or grandkids, or whoever has the misfortune to foot the future bill for what we consume today. Debt is more subtle, but it is also more sneaky, as debt has to be refinanced, in other words, interests paid. Given the huge amounts of debt accumulated by previous spending-happy governments, the interests most countries are paying today alone cost billions every year.

?But if that’s still not sneaky and subtle enough for you there is always a third way, and that is changing the value of the money that you hold your operations in. In other words, turning on the printing press. By printing additional money or increasing the balance sheet the government solves many problems at once. First of all, the additional dollars or euros can be used to pay for whatever you want. Then of course printing more money on the same underlying value or having more money chasing the same amount of goods will decrease the value of every note. This might sound bad for the individual but it’s actually good for the government because all the nasty debt that has been accumulated now has to be paid back in money which is worth a lot less. The problem with the ensuing inflation however is that it is much harder to remedy than to create. Since this was already seen as an easy way out for fiscally lazy or incompetent politicians, central banks, like the FED or the ECB were created to be independent of politics. At least on paper.

Which way did governments choose in the spring of 2020? Raise taxes and increase the burden on an already ailing population? Do the hard thing and tell the population that this will not be cheap and that the price will have to be paid for many years? Explain that the value of their savings and their future incomes will decrease because it is necessary to inflate the amount of circulating money? Of course not. And why would they? Nobody asked the question, and most people assumed it was just paid for. Economics is difficult, and it’s boring to discuss. Economists and financial experts don’t even seem to understand the bigger picture, much less agree on policy, and if you’re looking for an almost certainly wrong prediction on the economy, Nobel Prize laureates like Paul Krugmann are always a safe bet. So, why should we be concerned with such matters?

Well, closing your eyes to a problem and having it disappear only works if you are a toddler without object performance. You might not care for financial markets, monetary policy, or government spending, but unless you have largely detached yourself from society, they will have a massive impact on your life. Our apathy in all things concerning numbers, allowed the governments and the supposedly independent central banks to take the quiet way. Massively increase the balance, print trillions, and let the debt explode.

Creating Inflation and expanding debt

The central banks are organs created to guarantee price stability. Price stability on one side means avoiding a devaluation of the currency, but on the other, much more questionable side, it also means preventing the sinking of prices (which is the natural state due to technological advancements, and productivity gains in production. Think for instance about the price and performance of a computer in the nineteen fifties with the price and performance of a computer today).

But let us concentrate on the former part of this equation. Article 2 of the ECB statute teaches us the following: “In accordance with Article 107 (1) of this Treaty, the primary objective of the ESCB shall be to maintain price stability.” ?The fact that price stability is nowhere to be seen, of course, begs a few questions: How is there an organ which is full of professionals in economics and finance with decades of experience, an organ created to be independent of politics, and whose raison d’être is to guarantee price stability, and where nobody suspected that printing additional money in service of current governments might cause said price stability to go down the drain? And if this group of experts doesn’t understand the most basic mechanisms in economics, or worse, ignores them, and cannot fulfill its most basic function, why does it need to exist?

The graph on the development of M2 Money Supply in the United States shows a clear picture of where the money came from. And that is the printing press of the Federal Reserve. In fact, 80% of the dollars the US have issued in its entire history have been printed since January 2020.

But why is inflation so bad? It might have been best summarized in Henry Hazlitt’s 1964 Book What you need to know about Inflation: “Inflation, to sum up, is the increase in the volume of money and bank credit in relation to the volume of goods. It is harmful because it depreciates the value of the monetary unit, raises everybody's cost of living, imposes what is in effect a tax on the poorest (without exemptions) at as high a rate as the tax on the richest, wipes out the value of past savings, discourages future savings, redistributes wealth and income wantonly, encourages and rewards speculation and gambling at the expense of thrift and work, undermines confidence in the justice of a free enterprise system, and corrupts public and private morals.”

To have a look at what happened to the national debt level, it is equally sufficient to have a look at a chart of the GDP to debt ratio (also US):

What this chart doesn’t show, however, is that the debt to GDP ratio had already grown from 62% at the beginning of the ‘07 financial crisis to 100% in 2012. This leads to an astonishing 85,552 USD in public debt per US citizen. But the US can shoulder debt. After all, it is the most productive economy in the world in absolute terms, countries like China buy massive amounts of its debt, and the dollar is the global reserve currency. Countries in Europe or developing countries will face a very different situation.

The combination of enormous debt levels, rampant inflation, and a recession on the horizon is a poisonous trifecta that leaves little to no room for action for politicians and central bankers.

?The effects of the detrimental monetary policy of the past years (meaning inflation) must be reined in, while at the same time the economy is in dire need of relief, as external factors, combined with the effects of a poorly executed energy transition make energy prices soar, and the overheated financial markets begin to cool down (another effect of monetary policy). Unfortunately for the planners in Washington, Brussels, or Berlin, one often goes to the detriment of the other.

The UK has just impressively proven this. Announcing tax cuts, the soundest economic stimulus there is, just sent the pound sterling into a tumble. That is because, with the existing debt levels, there is a lack of trust, that the UK will be able to service that debt with globally rising interest rates. In the long run, reducing taxes might very well increase the amount of tax revenue (see Laffer Curve) but only, if the tax cuts stimulate the economy. Financial markets don’t seem to believe that the announced tax cuts will bring net revenue growth, i.e., offset the effects of the expected global recession, thus widening the deficit. These policies pushing for economic growth weakened the pound further and made the dramatic energy prices crisis even worse, as these commodities are always traded in dollars.

?On the other hand, we are seeing the first signs of money not circulating or flowing out of the market as a result of interest rate hikes by the central banks. As busy as central banks have been in creating inflation in the past years, they also haven’t been idle in fighting it. Especially Chairman of the Fed Jerome Powell, trying to trace the steps of Paul Volcker in the nineteen-eighties has taken aggressive steps to rein in inflation with several increases in the federal reserve interest rate and quantitative tightening. Such a policy of removing liquidity from the market, which is currently happening at a rate of 100 billion USD per month, creates serious headwinds for stock market valuations and general economic development. Surely a needed correction of stock market prices which have been heavily inflated as a consequence of more than a decade of easy money policy, but a painful correction nonetheless.

?Central banks are now also openly admitting that their programs to reduce inflation will have negative consequences on the stock market, economic growth, and employment. While at the same time there is serious doubt if these rate hikes are sufficient, still being much lower than inflation and the effective interest rate thus still negative.

?The spiraling effects of an overall downturn are hard to foresee. American banks have done well since the last financial crisis, something which cannot be said about their European counterparts. But also, across the pond, unsound business practices seem to be all the rage again, as illustrated by schemes like buy-now-pay-later, or loans, not based on credit score but on ethnicity. The fractional reserve system which is currently fixed at 10%, meaning a bank can hold 10 billion USD at the federal reserve and on those give out loans for 100 billion USD in itself is a timebomb always waiting to go off as soon as conditions deteriorate.

In a shocking parallel to the offset of the 1929 stock market crash and following Great Depression, we have a situation where the market has been flooded with central bank money, national debt is extremely high, the market overregulated, and the governments and central banks sitting in waiting to jump in and make everything a lot worse[1].

If you combine this with soaring energy prices comparable to the recession of nineteen-seventies, and a globally interwoven economy whose arteries are threatened by current and potential future wars, the situation is indeed quite dire. Compared to the subprime and Euro crisis, Germany will most likely not be in capacity to keep the European financial system afloat given its own economic woes. China might not be around like last time to pull up the global economy, given the ever graver concerns about its economy. The massively important real estate and with it the financial sector are showing large cracks and we have seen the first large company failures. The ticking demographic time bomb or the possibility of a Taiwanese military adventure, immediately halting large parts of global commerce, removing critical components from the global supply chains, and probably isolating to Sinosphere from the West add to the list of headaches.

A painful but viable alternative, austerity will encounter steep resistance, especially in Europe. The effects of the subprime crisis are far from having worn off in many countries of the old continent. Spain still has an impressive 12% of its population without finding employment. The wounds of a crisis where banks were kept afloat, but citizens lost their homes to said banks because they couldn’t service the predatory loans are still fresh enough. Cutting back on government transfers will therefore most likely be met with fierce resistance. Of course, a country like Spain could cut back on its unproductive spending, like that of the largest ever government, holding more ministers than the twice the size Germany, or reducing the unproductive administrative apparatus. But such operations are complicated and need to be done well. Even if this was an alternative that governments consider (and they never do) this is not a short-term alternative to cut costs. Cutting back on social spending will prove difficult to implement, especially in the countries still suffering the effects of the last crisis. Germany, a country that currently has 2 open positions per unemployed person just recently disincentivized work further by increasing social benefits.

Quo Vadis Humanitas

The only viable alternative, in my opinion, is to unleash the economy. That means unleashing the creative and productive potential of billions of human beings, whose collective intelligence has proven time and time again to be superior to any central planner or collectivist.

Cut back on regulations that are more motivated by ideology than by sound economic principles. Do away with Voodoo economics like price controls for energy or housing, which tend to have the inverse effect of the intended. Work on the supply side, remove regulations, and build houses, pipelines, and power plants. Governments don’t even have to build them themselves. They just have to make it possible for private entrepreneurs to do so and not smother them with permits, stipulations, and prohibitions. Stop the nonsensical disinvestment from fossil fuels and nuclear energy while not having a viable alternative for plentiful and cheap energy.

You might ask “Won’t that destroy the environment?”. Well, guess who doesn’t care about the environment? People scraping for survival. ?I’ve grown up in Germany in the nineteen-nineties. I have seen the return of beavers, wolves, and bears to our landscape and of salmon to our rivers. The same rivers that were poisonous two decades earlier. This was possible because a) the consciousness of the value of an intact natural environment has risen and b) because we could afford it. This happened at a time when Germany was integrating an entire country into its political and economic system, a country that the wonders of more than 40 years of socialism had turned into an ecological and economical nightmare.

?The Western Federal Republic had gone a very different way than its brethren with their centrally planned economy. After 12 years of disastrous rule by the national socialists, what was left of Germany was divided, occupied, and in ruins. What is more, the collectivist fascist government and the previous Weimar administration had left an economy riddled with tariffs and price controls, more guided by ideology than by natural principles or the rules of the market. Ludwig Erhard, the architect of the German Economic Miracle saw this early on and put away with market restrictions, unleashing the power of private enterprise. Within only a few years, the country managed to become the third largest economy on the planet, creating the wealth that made the German social state and later the push for sustainable energy even possible. Today Germany doesn’t have a single company to show for, among the world’s 100 most valuable enterprises.

We also need to take care of the future. Invest in education, digitalization, productivity, and a functioning infrastructure. These spendings might be a net loss today, but they have a compounding effect in the future. We owe as much to future generations who are laden with the debt accumulated by our consumption. Don’t just let goods, but also let people flow freely. Countries of the same economic sphere, the EU are suffering from a labor shortage, while other countries, like Spain, suffer from a job shortage. Admitted some difficulties, it doesn’t need much fantasy to see the opportunity here.

And most importantly, relieve the suffocating tax burden on enterprises and individuals alike. Especially in Europe, the individual spends most of his productive energy serving the state, paying close to half of his income in taxes, and paying taxes on anything he or she does with the remaining money. Or do you believe the marvels currently provided by your government warrant that you spend more of your lifetime serving the community than yourself and your loved ones?

There are plenty of reasons to look ahead into our future with a sense of optimism. The UN millennium goal of cutting global poverty in half between 1990 and 2015 was met 5 years early. The number of people living in extreme poverty just recently was at its lowest ever, and world hunger was almost eradicated. New promising technologies appear every day. And while we are challenged by the dangers of a changing climate, there is no need to push a message of impending doom. And if you don’t believe me, ask the UN’s International Panel on Climate Change.?

Again, Norwegians or Australians might not shudder at the perspective of not seeing further economic growth in the future, with their stagnant populations and relative wealth. After all, any current injustices might just be a question of unfair distribution of existing resources in their economies. People in Bangladesh however might digress.

The world needs a more positive message than living in a pod and eating crickets, while energy is rationed, international flights and combustion engines outlawed, and the right to have kids (nothing more than a burden on the environment for many) will be decided in a government lottery or depending on your social credit score. For most people, this is nothing short of a dystopia and the level of mobilization, creativity, and effort you can reach with such a message is going to be nil to negative. It might be the idealist inside of me speaking, but I refuse to believe, that despite all our efforts and technological advancements, this generation, and those to come, for the first time in human history are to be poorer and unhappier than previous generations. Let’s stop shrinking ourselves into a measly existence that nobody wants, and let’s give way to creativity and enterprise again.

[1] There is hardly a more pervasive lie than the myth about the Great Depression of the nineteen-thirties. The usual story goes like this: Speculative investment by Wall Street sharks bloated the financial markets in the nineteen-twenties. When the bubble burst, laissez-faire Republican Herbert Hoover refused to take any steps to remedy the situation, until FDR stepped in, and wisely guided by Keynesian economics saved the situation with the New Deal. In fact, it was the incessant injection of money into the market by central banks and overregulation leading to distorted incentives that create the asset bubble. Herbert Hoover, who was a progressive and interventionist introduced a plethora of measures to counter the effects of the crisis, as did his successor Franklin D. Roosevelt, both worsening and prolonging a depression that didn’t come to an end until World War 2. See Murray Rothbard “America’s Great Depression” (1963). Similarly, the subprime crisis would not have been possible, hadn’t the government pushed financial institutions to give out insecure loans to people of low income for reasons of social justice.