STORE OF VALUE / CREDIT BUBBLE BULLETIN

Store of Value

Doug Nolan

Friday, February 13, 2015

If I had my druthers, politics would be kept a safe distance apart from economic analysis.  The economics profession, however, is guided by a policymaking focus.  Economists are compelled to choose sides – Democrat or Republican - “liberal” or “conservative.” This arrangement has proved the death knell for objective analysis.  Worse yet, such divergent views of how the world works ensure there can be no meeting of the minds or compromise – especially during crucial periods of economic instability.

I admit to providing space for Krugman on my bookshelves.  There was a time when I respected the Nobel prize-winning economist as a thoughtful and provocative economic thinker. He’s evolved into a forceful political commentator.  Paul Krugman’s New York Times’ columns are widely read.  Of importance to me, Krugman has become the most public figure espousing the virtues of inflationism.   

It’s crunch time for money and Credit analysis – discredited Greek debt and the question of ongoing participation in the euro monetary experiment; faltering currencies and Credit at the EM “periphery”; a runaway Credit Bubble in China; flagrant competitive currency devaluation; ongoing open-ended QE by the world’s major central banks; collapsing commodities markets, general global disinflationary forces in real economies and record securities prices; and generally unprecedented central bank intervention at home as well as around the globe.   A Friday headline from the Financial Times:  “Central Banks Take Extreme Action to Stave off Deflation.”  Thursday from Bloomberg:  “Central Banks Now Open 24/7 Fighting Currency Wars and Deflation.”  

After six years of unprecedented central bank monetary measures, an end is still nowhere in sight.  The highly abnormal has become the enduring normal.  Indeed, the global monetary backdrop gets crazier by the week – and everyone’s fine with it.  Federal Reserve policymaking is now celebrated as an indisputable success – testament to what injecting $3.6 TN of new “money” into securities markets can accomplish.  And each week the world seems a bit closer to coming completely unglued.  

Of late, Dr. Krugman has directed his attention – and caustic partisan aggression – around the critical issues of money and Credit.  There was Monday’s “Nobody Understands Debt”, Tuesday’s “There’s Something About Money (Implicitly Wonkish)” and Friday’s “Money Makes Crazy.”

From “Money Makes Crazy: Monetary policy probably won’t be a major issue in the 2016 campaign, but it should be. It is, after all, extremely important, and the Republican base and many leading politicians have strong views about the Federal Reserve and its conduct… So it matters that the emerging G.O.P. consensus on money is crazy — full-on conspiracy-theory crazy. Right now, the most obvious manifestation of money madness is Senator Rand Paul’s ‘Audit the Fed’ campaign. Mr. Paul likes to warn that the Fed’s efforts to bolster the economy may lead to hyperinflation; he loves talking about the wheelbarrows of cash that people carted around in Weimar Germany. But he’s been saying that since 2009… So now he has a new line: The Fed is an overleveraged bank, just as Lehman Brothers was, and could experience a disastrous collapse of confidence any day now. This story is wrong on so many levels that reporters are having a hard time keeping up, but let’s simply note that the Fed’s ‘liabilities’ consist of cash, and those who hold that cash have the option of converting it into, well, cash. No, the Fed can’t fall victim to a bank run.”

“Monetary policy… after all, is extremely important” – is an understatement.  I have argued misguided policy activism unleashed the “global government finance Bubble” - the “Granddaddy of All Bubbles”.  I remain a proponent of sound central banking, having never called for abolishing the Federal Reserve.  I have pleaded instead for a disciplined rules-based approach to monetary management.  Giving a small group of unelected officials full discretion to experiment with “printing” Trillions of new “money” is a recipe for unmitigated disaster. 


Indeed, global central bankers are these days at the precipice of a crisis of confidence in the “money” they too freely propagate.  This runaway six-year (plus) monetary experiment should be hotly debated right now – outside the realm of political mudslinging.

From “There’s Something About Money (Implicitly Wonkish)”: “Here’s my current thought: in some sense money is a really weird thing, which can look to individuals like a real asset — cold, hard, cash — but is ultimately, as Paul Samuelson put it, a ‘social contrivance’ whose value is more or less conjured out of thin air. Mainstream macroeconomics acknowledges the weirdness — in particular, makes heavy reliance on the ability of central banks to create more fiat money at will — but otherwise treats money a lot like ordinary goods. But that intellectual strategy doesn’t come naturally to many people, so there’s always a constituency for monetary cranks.”

Finding rare common ground, I agree “there’s always a constituency for monetary cranks.” Throughout hundreds (for that matter, thousands) of years of history, inflationism has time and again been debunked and the inflationists revealed as “monetary cranks.” Yet these days monetary inflation’s sordid history goes completely neglected – as if it doesn’t even exist.  Krugman’s discussion touches upon money as a “medium of exchange.”  Naturally, the critical issue/attribute of money as a “Store of Value” goes, as it invariably does, unmentioned by inflationists and monetary quacks alike.  And using monetary inflation to inflate securities and asset markets ensures an inflation constituency of tens of millions (certainly including the “rich and powerful”).   

This gets to the heart of today’s critical issue – just as it did about 300 years ago with John Law’s failing paper money experiment in France (“Mississippi Bubble” period):  Once commenced, monetary inflation and resulting unsustainable Bubbles and economic maladjustment swell beyond control.  At some point, money’s critical “Store of Value” attribute begins to be questioned.  Officials invariably counter with a (terminal) reckless Credit expansion in a desperate attempt to sustain the teetering financial scheme.  A crisis of confidence becomes inevitable.  

Krugman: “But the conclusion of generations of macroeconomists has been that for most purposes models that treat money as if it were an ordinary good are good enough; whereas attempts to ground everything in models in which the role of money is in some (weak) sense derived rather than assumed have been generally useless. Still, there’s always an undercurrent of unease. And you can find heterodox economists on the left as well as the right unhappy with the standard approach. Now, the elder and younger Pauls know nothing of this, nor, I suspect, does Paul Ryan. But that may be the point: having no contact with the intellectual tradition of macroeconomics, they find the role of money in the economy a great mystery and possibly an outrage — how dare banks/governments/the Illuminati pretend to create value out of nothing! Fiat money, whether created by the government or by banks, seems to them to be a violation of natural law; creating more fiat money in an attempt to relieve economic distress must surely lead to disaster.”

Unless they’ve exposed themselves to a lot of “outside” reading, contemporary economists are poorly prepared for today’s Great Monetary Debate.  After all, economic curriculums are sadly devoid of money and Credit history and theory.  As lunatic fringe as it sounds, one can throw out virtually everything conventional economics has to say on the subject. “The intellectual tradition of macroeconomics” – at least from the fashionable American perspective – leads to misunderstanding, confusion, misdiagnosis and deeply flawed policies.

“This in turn leads to the basic Hicks model of an economy in which there are three markets — for money, bonds, and goods — which are treated symmetrically; add price stickiness and that model becomes IS-LM. New Keynesian economics pretty much takes that base and adds explicit modeling of intertemporal choices and rational expectations. Dealing with monetary economics this way lets you address monetary and fiscal policy in terms of lucid, elegant little models that are quite intuitive once you get used to them, but not at all intuitive to people who haven’t learned to think this way — witness the debates we’ve had since 2008… The sad thing is that this epistemological panic is gaining a growing hold over American conservatives at a time when the standard way of dealing with money has, in fact, been covering itself in glory. That Hicksian approach, in which money is treated symmetrically with bonds and goods, made strong predictions about what happens with interest rates near zero — predictions that the Fed could expand its balance sheet many times over without inflation, that governments could borrow vast sums without driving up interest rates, that slashing government spending would cause private spending to fall rather than rise.”

“The standard way of dealing with money has, in fact, been covering itself in glory.”  Showing restraint, I’ll simply say, “history will be unkind”.  And toss out the “Hicks model,”  “IS-LM” modeling and econometric models in general.  They add no value when discussing today’s world dominated by market-based finance and aggressive market-distorting monetary management. Today’s inflationists call upon archaic econometric tools, at best, as pretext for sophistication and analytical credibility.  At worst, it’s blatant obfuscation.

From “Nobody Understands Debt.”  “All this austerity has, however, only made things worse — and predictably so, because demands that everyone tighten their belts were based on a misunderstanding of the role debt plays in the economy. You can see that misunderstanding at work every time someone rails against deficits with slogans like ‘Stop stealing from our kids.’ It sounds right, if you don’t think about it: Families who run up debts make themselves poorer, so isn’t that true when we look at overall national debt? No, it isn’t. An indebted family owes money to other people; the world economy as a whole owes money to itself. And while it’s true that countries can borrow from other countries, America has actually been borrowing less from abroad since 2008 than it did before, and Europe is a net lender to the rest of the world. Because debt is money we owe to ourselves, it does not directly make the economy poorer (and paying it off doesn’t make us richer). True, debt can pose a threat to financial stability — but the situation is not improved if efforts to reduce debt end up pushing the economy into deflation and depression.”

Credit is an economy’s lifeblood.  Mismanage Credit and a system will eventually confront myriad problems – financial, economic and social.  This truism has been on full display for a number of years now. Early economic thinkers were preoccupied with how seemingly sound economic booms could end in such mayhem.  Post-mortem analysis inevitably came back to debasement of money and Credit.  

“Because debt is money we owe to ourselves, it does not directly make the economy poorer (and paying it off doesn’t make us richer).”  

One of monetary inflation’s myriad problems is that it instills a (fleeting) perception of rising wealth.  Meanwhile, pernicious underlying forces perpetuate economic wealth destruction through the forces of misdirected spending, malinvestment and general misallocation of real and financial resources.  


Resulting wealth destruction, redistribution and misperceptions are for the most part masked so long as monetary inflation runs unabated.  Hence, the more protracted the boom the greater the pressure for “activist” policy measures that inflate and obfuscate.  In the end, systemic risk rises exponentially – in the face of rising perceptions of wealth and policy success – ensuring policymakers won’t either rock the boat or come clean on policy failings.    

U.S. securities prices are at record highs.  After peaking at about 14,000 in 2007, the DJIA Friday traded above 18,000.  Friday’s record S&P 500 level is about a third higher than 2007 record highs.  Broader market gains have been even more spectacular.  The S&P 400 Mid-Cap index is up almost 270% from 2009 lows, with Friday’s close near 1,500 compared to 2007’s high of 927.  The point is that perceived wealth has never reached such lofty levels.  Monetary inflation has well-masked underlying maladjustments – at least at home.  Elsewhere, the forces of monetary inflation – along with wealth misperceptions – are not holding up as well.

“You can see that misunderstanding at work every time someone rails against deficits with slogans like ‘Stop stealing from our kids.’”  

The social instability resulting from wealth redistribution – between generations, classes and nations – is on increasing display throughout Europe.  Indeed, the Greek economy, society and politics are today’s global poster child for the consequences of unsound money and Credit.  As part of the euro experiment, Greek debt luxuriated in the perception of moneyness.  This, in concert with global monetary abundance, ensured that Greece issued way too much Credit – extraordinarily loose finance that fueled unsustainable booms and attendant maladjustment.  Over-issuance ensured Greek debt destroyed its moneyness attribute.  

The powerful perception of a “Store of Value” was lost, with the resulting crisis of confidence in Greece’s debt having devastating consequences.  After years of recurring crises, bailouts and failed policy responses, the Greeks have given up on the conventional.  Too much of their population has come to believe they have little to lose.  Desperation has taken over and the status quo is no longer acceptable.  Radical policymakers have been elected to lead the country in a different direction.  It’s time to regain sovereignty and dignity.  Indicating the end of the status quo with important global ramifications, Greece will be forging closer relationships with Russia and China.

The Russian ruble has collapsed 43% in six months.  It appears Russia’s leaders have also given up on the conventional. It’s time to regain sovereignty and respect – at the barrel of a gun if necessary.  In Putin’s eyes, the status quo of a U.S.-dominated world is no longer acceptable.  Both Russia and China are moving aggressively to build alliances, trading blocks and a financial apparatus that will function outside of U.S.-dominated systems.  The Russians and Chinese have taken issue with U.S. monetary management – policies they now see as running counter-productive to their nations’ interests.

I have posited that recent decades have been unique in economic history.  For the first time on a global basis, there were no constraints on either the quantity or quality of Credit.  History has shown Credit’s proclivity for instability.  I have argued that the transformation to market-based Credit – first in the U.S. and then globally – ensured acute instability.  We’ve now seen global monetary managers go to incredible extremes – zero rates, massive ongoing monetization and previously unthinkable market intervention and manipulation – desperate to keep this financial scheme from imploding.

Inflationism is always the same.  There’s never recognition that money printing is the root of the problem.  Instead, the inflationists proclaim that policy has actually not been forceful enough.  The answer is always to be found with just one more round of monetary inflation.  The propaganda drifts precariously farther and farther away from reality.  

“But I also suspect that conservatives have a deep psychological problem with modern monetary systems. You see, in the conservative worldview, markets aren’t just a useful way to organize the economy; they’re a moral structure: People get paid what they deserve, and what goods cost is what they are truly worth to society… Modern money — consisting of pieces of paper or their digital equivalent that are issued by the Fed, not created by the heroic efforts of entrepreneurs — is an affront to that worldview.”

By now, many should view “modern monetary systems” with deep concern.  But record securities prices and market exuberance provide powerful palliative.  They clearly ensure that the widening cracks in the global financial system go unnoticed.  The inflationists have at this point succeeded fully in convincing everyone that deflation is the greatest risk to mankind.


Meanwhile, the “Store of Value” issue festers.  Gangrene is apparent at some extremities, as central bank “money printing” (as far as the eye can see) holds a crisis of confidence in global “money” and Credit at bay.  Still, global policymakers won’t be able to create new debit and Credit electronic journal entries and convince folks it’s real wealth forever.  

There will be no separating economics from politics – monetary management from ideologies.  


But could we at least debate the issue of sound money and Credit without resorting to partisan demagoguery.  Considering what’s at stake, it is so pathetic it’s embarrassing.