A recent article in the Guardian mocks JC Juncker’s latest scheme to produce some €300 billion in “investment” with a magical money multiplication scheme. Naturally, we agree that Juncker’s plan is deeply flawed, to put it as politely as possible. We have pointed this out already, even before he made the financing details known, which make very little sense.
The article also correctly notes that “QE” has not achieved anything worth noting. However, it is otherwise based on an utterly flawed analysis. The author pleads for “QE bombing” the citizenry itself, i.e., he wants central banks to print money and simply hand it out to everybody. A similar proposal has been made by several economists recently, in Germany and elsewhere. It follows on the heels of the just as absurd idea that central banks should simply “cancel” the government debt they have bought.
Apparently the purveyors of these hoary inflationist schemes – which arguably are economically an order of magnitude more crazy than what modern-day central bankers have already perpetrated – have forgotten about John Law and post-revolution France. The assumption that the British pound would have retained anything close to its current purchasing power if 24,000 pounds had been mailed to every family in the UK is absurd. But this is by far not the only or even the most important problem. The main problem is that all these supporters of unbridled inflationism are making the cardinal mistake of confusing money with wealth.
We want to pick out just one quote from the article and briefly explain what is wrong with it:
Ever since the credit crunch the continent has been suffering what Keynes called a classic liquidity trap. There is too little money around and thus a chronic shortage of demand. People have too little to spend, which means shops close, supplies dry up and no one invests.
This analysis is makes no sense whatsoever. There is no such thing as a “liquidity trap” or a “demand deficiency”. Those are Keynesian figments of the imagination. We personally know people in Europe who want to buy a big yacht, their own jet plane and their own island. They are evidently anything but “demand deficient”.
Their problem is only that they have not enough to offer in exchange. This is however not a question of there being “too little money”. As the chart below shows, there is now more money in the euro area than ever before and the money supply in fact continues to grow by leaps and bounds (current y/y growth rate: 6.5% and rising).
The problem is that a massive amount of capital was malinvested and consumed in the previous boom and that due to the ECB’s inflationary policy since the outbreak of the crisis, more of the same has happened subsequently.
It is important to realize that much of this consumption of real wealth has already happened. It cannot be undone by printing money. On the contrary, even more real wealth is now consumed. So why are the banks are not lending, even though there is more than enough money? This is not because they have no access to “money”. It is because there is literally nothing left to lend.
The Economy’s Pool of Real Funding is Under Pressure
The European economy’s pool of real funding is evidently under severe pressure . It may even be close to exhaustion. Consider how the economy’s production structure works. It is a complex latticework (paraphrasing Rothbard) of individual plans and processes, the aim of which is to ultimately produce consumer goods. For this purpose, goods must move through a great many stages of production, from raw materials to intermediate goods and finally consumer goods.
It should be obvious that these processes not only take effort, but also take time. Many of them take a lot of time actually – and this is quite independent of the fact that these processes take place in synchronous fashion (the time from when a raw material is produced to the point when it has become part of a consumer good still has to pass).
How do all the people engaged in raw material and intermediate goods production, or what is known as the higher stages of the capital structure, get paid? Iron ore miners are evidently not condemned to wait for their product to be turned into a consumer good and sold as such before they get paid. The payments are advanced to them by the company in the form of money. However, money is merely a medium of exchange. What actually sustains these workers is the economy’s pool of real funding, its “free capital” if you will (this terminology was employed by Richard von Strigl).
A production structure of a certain length requires that previously produced, but not consumed final goods are available. Some of them have to have been saved beforehand, some need to emerge “in time” as a result of ongoing production processes. The entire process must mesh like the gears in a gear box to ensure this actually happens. It is moreover a highly dynamic process, subject to constant change, as entrepreneurs reallocate investments, found new companies and disband old ones, etc.
The effect of lower consumption, and hence higher savings and gross investment on interest rate spreads and the production structure (adapted from Rothbard, man, Economy and State). The old, pre-savings structure is represented by the line A-A, the new post savings structure by B-B. Interest rate spreads decline, and longer processes increase in viability, allowing the structure to be lengthened. If it is lengthened due to new money, but no additional real savings entering the economy, it becomes unsustainable. This is why every artificial boom is followed by a bust.
When central banks or commercial banks add new money to the money supply, not one iota of real wealth is created. If the ECB were to send out a “money bomb” to every citizen tomorrow, society’s wealth would have increased by precisely zero.
However, monetary pumping does disturb the finely tuned dynamic processes mentioned above, as it distorts interest rates and prices. Economic calculation is then falsified and malinvestment invariably ensues. Have the housing bubbles in e.g. Spain and the US not shown this quite clearly? The profits made during such artificial booms are illusory. They are “money profits”, but they are the result of erroneous economic calculation. The emergence of such illusory profits leads to the consumption of capital, as they are paid out as higher dividends, higher wages, higher taxes, and so forth.
Eventually it turns out that companies actually lack the funds to maintain their real capital. This is what we mean when we refer to the pool of real funding being under pressure: the capital structure has been damaged. Actors in the economy need to be given the opportunity to so to speak “repair” it again – this invariably means that it must be shortened, as its previous, artificially induced lengthening can no longer be sustained. Then the economy is in “recession”, but this is really a healing process. It takes time to heal.
Additional money printing actively sabotages this healing process. It achieves nothing but even more impoverishment in the end, especially if it succeeds in igniting another boom by redistributing existing wealth and spurring more capital-consuming activities in the economy.
Inflationism is apparently more popular than ever. It doesn’t seem to matter how often and how consistently it fails to produce the desired results, there are always more people in the world who have an epiphany about saving the economy by printing money. When we say that the “banks have literally nothing left to lend” we are saying this: the economy has become so structurally damaged by previous credit booms that if banks indeed were to lend out more money, they would be almost guaranteed to lose most of it.
What is necessary to “fix” the economy is not the printing of more money, not even if it is distributed to citizens directly instead of being given to banks in exchange for both their dodgy and not-so-dodgy securities. The best thing government can do is nothing at all. However, we will amend this advice by adding that if governments really feel a need to be proactive, they should reduce regulations, lower taxes or simply generally shrink the State with all that implies.