Guest Analyst
June 6, 2001

Stuffing the Envelope
by Sean Corrigan

It seems the Keynesians are fighting back – telling us that all will be well, that there can be no inflation in a recession. The Monetarists are telling us that we must fight deflation and flood the market with liquidity to avoid the mistakes of the 1930s.

Greenspan is telling us to ‘Pick a card, any card’, or whatever phony hucksterism he is now employing to keep us believing he actually knows what he is doing. Increasingly, this is satisfying fewer and fewer people. It has been clear to us from recent conversations and e-mail traffic that traders, commentators and educated laymen alike have become attuned to the gulf which separates the prognostications from the unfolding reality, so let us once more try to define our alternative vision.

We Austrians think a little differently. For starters, we don’t consider price rises per se to be ‘inflation’: that, we define in the manner of a Jefferson as follows:- ‘Inflation, that process by which Central Banks serve the State, secure profits to the Banks and surreptitiously steal from the Producers of Wealth by debasing the Medium of Exchange.’

At a recent conference at which we were honoured to speak in Houston, TX, we and our gracious host (and very good friend) cooked up a little game as an opener. In front of each guest when they took their seats, there were two envelopes - one yellow and one red. The host welcomed his audience and then invited them to open the red envelope in which was to be found a toy, $1 million bill.

‘Do you feel any richer?’ he asked, to chuckles and the shaking of heads from the floor. ‘Then, Ladies and Gentlemen, ‘ he went on, ‘could you please open the yellow envelope.’ Inside was a genuine $1 bill. ‘Now let me repeat my question, ‘ said our host. ‘ Do you feel – however marginally – any richer?’ Naturally, the audience all agreed that they did.

He went on: ‘Friends, if we had had the time and resources - not to mention bigger envelopes – we could have put a million such bills in these. I take it that, if we had, you’d have been much more enthusiastic about feeling richer.’ Again, the audience assented.

‘So, ‘ he continued, ‘if we had had the time and resources – bigger envelopes – and Alan Greenspan’s help, we could have given everybody in the country a million of these bills. Would you have felt richer then?’

Instantly, the mood changed – the people assembled instinctively knew something was wrong and a perplexed murmur went up.

‘I see you disagree, ‘ said the MC, reaching the climax. ‘ So what we have taught you today is that mere “money” is not to be confused with wealth - and what we have also shown is that, at root, the contents of the second envelope were just as much a counterfeit as those of the first.’

As Murray Rothbard succinctly put it in ‘The Case against the Fed’:

The invariable result of an increase in the supply of a good is to lower its price. For all products, except money, such an increase is socially beneficial and living standards have increased in response to consumer demand. But an increase in the supply of money cannot relieve the scarcity of goods; all it does is to make the dollar or the franc cheaper, that is lower its purchasing power in terms of all other goods and services. Hence the great truth of monetary theory emerges: once a commodity is in sufficient supply to be adopted as money, no further increase in its supply is needed. Any quantity of money is “optimal”. Once a money is established, an increase in its supply confers no social benefit.

So far this year, the Greenspan Fed has presided over and encouraged a process of stuffing money and monetary substitutes into envelopes at the rate of $3.1 billion a day, or $11 a day for every man, woman, child and person of indeterminate gender and uncertain age in the Land of the Free.

At an annualized rate of around 16%, this is a prodigious piece of the production of something which confers no social benefit (which must not be read to imply it does no harm either!). We can best put it into perspective by saying that US M3 has expanded this year at a pace roughly equivalent to the whole output of the Italian economy in the same period.

The only time in the last 40 years we have seen such a virulent gain was in 1970-71. The US fell off the gold exchange standard then, presaging a more complete breakdown of world monetary order and sowing the seeds for the inflationary recession of 1973-4 (oh, sorry, they’re not supposed to happen, are they?).

Money performs its primary function when it represents real goods and services in the process of exchange and it becomes capital when it transfers the right to command over goods and services already extant, but not consumed by their owners, to those who wish to move away from the immediate satisfaction of consumers’ wants and to work instead at some process more removed, but which it is hoped will be - eventually - more fruitful in the ultimate fulfilment of those wants.

Thus it is not consumption which drives investment as today’s Macromancers would have it, but it is rather saving which signals a temporary satiety with existing goods (and thereby a potential market for newer, more exciting wares – even DSL lines and routers!) and allows for the subsistence of those involved in the extra levels of specialization of function and division of labour which will later make us more productive and so truly richer.

In turn, this ‘lengthening of the productive structure’, as the Austrians put it, or ‘capital deepening’ in today’s parlance, will allow the real cost of goods to fall, making existing resources and incomes worth more, raising the standard of living and automatically allowing for the creation of yet more savings, so reseeding this generation of prosperity.

Secularly lower prices, ‘deflation,’ if you must, coincident with increasing wealth. This is, to us, such a self-evident process, at work over the broad history of civilization, yet it has been so confused and camouflaged by State-mandated corruptions of the monetary function over the last three or four generations that to most it either seems a fanciful Utopia or a Looking Glass world of strangely twisted perceptions.

To Austrians, feeding artificially cheap funds to producers gives them false signals about the long-term prospects for their businesses and so begins to divert resources needlessly away from their most urgent uses. We end up laying miles of superfluous fibre-optic cabling rather than gas pipelines, for example.

Feeding money to consumers at the same time allows them to buy what they have not earned, nor saved for. This may temporarily engender enough ‘demand’ to seemingly validate the equally-misled entrepreneurs that they are on the right track, but wasting yesterday’s labour (Capital) to satisfy a call upon tomorrow’s (Credit) is a route to the Poor House, not the Palace.

Greenspan may avow its merits in saying, as he did last Summer, that `Consumer debt has been a remarkably beneficent force in moving people into the middle class over the last two to three generations, and it continues to be a potent financial institution’, but while we would agree with him as to the potency, he has the effects completely back-to-front (as usual).

Of course, creating funny money to finance the unwarranted building of semiconductor fab plants and server factories may end up boosting that totemic aggregate of ‘productivity’ and an inflation - especially a hidden one - may boost nominal profits in the short run, as it usually does (see Big Oil), but time will inevitably reveal that much of this ‘productivity’ was confined to building square-wheeled unicycles and high-tech buggy whips.

Pharaoh may well have been told by his scribes that he was getting many more tons of rock shifted per Israelite hour, but, when all was said and done, he ended up with a useless, if spectacular, set of monuments to malinvestment. After a series of plagues – profit warnings, inventory write-downs, earnings restatements, energy shortages and ‘inflation’ – Moses had to abandon his stock options in the Valley (of Kings, not Silicon) and reallocate his people to other work in a different labour market after forty years of filing for the manna of unemployment benefit.

The trenchant irony of the last six years has been that the lure of the New Era has seduced Greenspan and lesser CB members across the globe into deluding themselves that none of the above was true.

They thought that increased, often-fictional, accounting profits meant productivity was both higher than measured and more entrenched and that the particular things whose extra supply was driving the aggregates (largely, if not exclusively, computer-related items) were really required in such profusion and that they were even generative of greater efficiencies elsewhere.

Coupled with this was the widespread doctrinal fallacy of ‘price stabilization,’ whereby a small creep up in an arbitrary basket of goods was encompassed even though this productivity miracle should have been depressing it (meaning too rapid credit creation was endorsed).

Furthermore, there was a phobic refusal to consider that assets with shrinking ’risk premia’, as Greenspan terms it, or valuations growing exponentially in the face of a slow, but steady, geometric increase in overall output, could be signalling a Bubble – a non-tangible, but nonetheless harmful, result of inflation – and we thus had error institutionalized.

Critically important in supporting this Ponzi Productivity scheme was the ability to persuade foreign creditors that to keep swapping their labours for pledges of a share in America’s future riches was in their best interest. That way the enormous hollowing out of the US pool of resources caused by the debt-financed overconsumption and malinvestment – even, at length, overinvestment - could be papered over (pun intended).

Neither internal nor external constraints bound so long as the mirage of the Boom kept the Dollar strong and promises to repay foreign creditors and suppliers were readily returned to the US to stand as the base for yet more lending.

Finally, however, that came to an end last year. If we want a flag to raise to mark this exhaustion, we could pick out energy, the ultimate good which all demand and no central bank can conjure out of nothing. Both consumer good and productive input, this is literally the oil on which our wheels of commerce turn. Rising oil, coal, and gas prices showed as clearly as anything that the productive structure had been horribly twisted on its diet of Central Bank steroids and that purchasing power, erroneously generated, had not been able to bid factors of production into meeting its desired outlets.

In the 1930s, Keynes’ General Theory argued that the free market could find itself stuck in a local minimum of underemployment - not realizing, or being disingenuous about the fact, that it was Government and CB interference with the free market which had first brought it and then locked it there.

His answer was to pump in extra money, driving the interest rate to zero to stimulate activity, and to reduce entrepreneurs’ labour costs through an inflationary reduction in real wages which the horny-handed sons of toil were patronizingly deemed to be too stupid to notice.

Greenspan – equally arrogant and, curiously, an equally confusing and intellectually dishonest rhetorician – has a similar answer: pump in money, drive the interest rate to zero (in real terms, at least) to stimulate consumption and to gull today’s populace that the inflationary increase in the market price of their assets somehow represents an increment of wealth.

Nothing the acolytes of the first did worked and it took both a hot war and a cold one until some limit was set to the worst of their incursions onto our property rights. Nothing Greenspan and Dodge and George and McFarlane & Co does is guaranteed to do any better.

Saving and liquidation is what we need and if households can be fooled into avoiding this therapy, you can be assured that, barring levels of financial support even the Japanese are now steeling themselves to abandon, companies will do the first in order to avoid being forced into facing the second.

Meanwhile that monetary pumping is running on apace and that money will assuredly be spent on trying to align productive output to consumptive requirement – and the only way it can do that is through the price mechanism.

Yes, we can have ‘inflation’, price rises, in a recession and the central bank is the source of both.

Mr. Sean Corrigan is a principal of capitalinsight.co.uk, a London-based economic consultancy. He can be reached at sean@capitalinsight.co.uk