Posted on December 9, 2014 by Charles
Hugh Smith
http://www.washingtonsblog.com/
Financial and risk bubbles don’t pop in a vacuum–all the
phantom collateral constructed with mal-invested free money for
financiers will also implode.
If there’s one absolute truism we hear again and again,
it’s that central banks are desperately trying to create inflation. Perversely,
their easy-money policies actually generate the exact opposite: deflation.
I will leave the debate as to what constitutes deflation to
my economic betters. My definition of deflation
is simple: deflation is any increase in the purchasing power of nominal wages.
By nominal I mean unadjusted: $1 is simply
$1. It is not seasonally adjusted or adjusted for inflation/deflation or
anything else.
When your paycheck loses purchasing power–that is, it buys
fewer goods and services– that’s inflation. When your paycheck gains in
purchasing power–it buys more goods and services, even though you didn’t get a
raise–that’s deflation in my terminology.
I find that purchasing power cuts through a
lot of economic jargon and data-clutter: how much does your paycheck buy today,
compared to last month or last year?
Since the economy is dynamic, purchasing power is constantly
increasing or decreasing on a variety of goods and services. This bedevils any
attempt to discern systemic inflation/deflation.
The Federal Reserve and other
central banks desperately want inflation, even though it destroys the
purchasing power of paychecks and savings, for one reason: in a
system based on phantom collateral supporting ever-increasing mountains of
debt, the Prime Directive of central banks is to make it ever easier to service
yesterday’s debt.
The only systemic way to make it easier to service existing
debt is to inflate the nominal value of money by debasing the currency. The net
result of inflated money is a debt of $100 stays $100, but the face value of
newly issued money keeps rising.
If a person earns $10 an hour, it will take 10 hours to earn
the money to pay off the $100 debt. But if central banks debase the money so
that it takes $20/hour to buy the same goods and services that were once bought with $10/hour, then it only
takes 5 hours to earn enough money to pay off the $100 debt.
The fact that the owner of the debt will suffer a 50% decline
in the purchasing power of the $100 is of no concern to the central banks, as
long as the decline is gradual enough
that the hapless owner of the $100 doesn’t notice the loss of purchasing power.
Hence the central banks’ favored inflation target of 2%, which destroys over
20% of the purchasing power of money every decade, but does so so gradually
that everyone being robbed is not motivated to protest their impoverishment.
So now we understand why central
banks are desperate for inflation: it’s the only way to keep the Ponzi scheme
of ever-expanding debt from collapsing in an era of stagnant wages. Since the vast majority of people aren’t
increasing their income, inflation is the only way to enable them to keep
servicing their debts.
Unfortunately for the central banks, thanks to the rise of
software, robotics and global wage arbitrage, wages are not rising along with
prices. As a result, everyone who depends on earned income is getting poorer.
Japan is the leading example of
this dynamic. Despite the Bank of Japan’s failure to ignite 2%
inflation, they’ve succeeded in undermining their currency (the yen)
sufficiently to cause the purchasing power of wages in Japan to fall a
catastrophic 9% in the past few years.
Everyone who depends on earned
income, i.e. the bottom 95%, all get progressively poorer in inflation. Meanwhile,
technology is deflationary, as the costs of producing anything digital decline
to near-zero, and progressively cheaper software and robotics replace costly
human labor and all the horrendously expensive labor overhead of healthcare,
etc.
Central banks might want to
ponder Woody Allen’s famous quip, If you want to make God laugh, tell
him about your plans, for the actual real-world result of
central banks easing, money pumping and zero interest rates is deflation.
As my colleague Lee Adler explains, central bank easing
and zero-interest rate policy (ZIRP) fuel over-capacity which leads to
declining prices: deflation with a capital D. The current oil glut is
a primary example of this dynamic: Why Oil Is
Finally Declining, Which Could Lead to Disaster (Wall Street
Examiner)
The central banks have been frustrated in their insane
and misguided aim to increase inflation because QE and ZIRP actually foster the
opposite of what central bankers expect. Central bankers and conomists think
that to get inflation they only need to print more money, not recognizing that
the inflation that does result from money printing, asset inflation, leads
eventually to consumer goods deflation. ZIRP and QE cause malinvestment and
overinvestment that leads to excess productive capacity.
That leads to overproduction and oversupply. Oversupply
puts downward pressure on prices. That spurs a vicious cycle where the central
banks print more money to try to create inflation. That puts more cash into the
accounts of the leveraged speculating community and off we go again.
While ZIRP and QE encourage waves of excess speculation
and malinvestment, they do so at the expense of investment in labor. Businesses
become speculators in their own stocks and products rather than in costly and
uncertain investments in labor. The value of labor falls in the marketplace.
Mass wage and salary incomes fall. Consumption falls. Demand trends weaken,
putting downward pressure on the prices of consumption goods.
That causes a vicious cycle in business where executives
perpetually look for ways to shrink costs, exacerbating the economic decline of
middle class working people. The “middle class” can increasingly no longer
afford to buy the products of those who employ them. Thus we get the spectacle
of things like WalMart holding charity food drives to benefit its workers, who
are not paid enough money to feed their families.
The oil price experience is a perfect illustration of
what happens when central banks promote over speculation in commodities and
commodity production. A boom built on virtually free and unlimited financing
becomes a ticking time bomb when the value of the collateral collapses.
Thank you, Lee. A collapse in the value of collateral is
precisely what’s happening as the value of oil has fallen by 40% in the past
few months.
The retail sector is another
poster child of the deflationary consequences of central bank-driven
mal-investment. The astonishing expansion of retail space in
the U.S. since the 2008 meltdown is increasingly divergent from the reality
that sales and profits of bricks-and-mortar stores and chains are under siege
from online retailers.
The market value of retail space is set to implode from the
over-expansion of commercial real estate, which was entirely driven by the
Fed’s cheap-money policies that destroyed low-risk returns on cash and savings.
Central banks have driven investors into increasingly risky
bets as investors seek some sort of return. The
bubble is not just in stocks, bonds, and other assets–most importantly, it is
in risk.
Doug Nolan explains why the systemic
risk created by central bank policies is ultimately deflationary– The
Unavoidable Peril of Financial Sphere Bubbles:
“Virtually unlimited cheap finance on a global basis has
over recent years certainly spurred unprecedented capital investment. And,
importantly, ongoing technological innovation and the “digital age” have played
a momentous role in creating essentially limitless supplies of smart phones,
tablets, computers, digital downloads, media and ‘technology’ more generally.
Throw in the growth in myriad ‘services’, including healthcare, and we have
economic structures unlike anything in the past.”
In other words, this time it is truly different, but not in
the way the conventional happy-story narrative would have it, i.e.
financial-risk bubbles can keep expanding forever.
Financial and risk bubbles don’t pop in a vacuum–all the
phantom collateral constructed with mal-invested free money for
financiers will also implode.
So go ahead, central bankers:
tell God about your plans to generate inflation.
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