Karen and I are in the Windy City visiting the NIRI chapter and escaping gales on the Front Range that were delaying flights to Denver and blowing in spring snow due Friday while we’re in Palo Alto for the Silicon Valley NIRI Spring Seminar (we sponsor both chapters). Hope to see you!
I’m going to challenge economic orthodoxy. Whatever your reaction as an adult to hearing the term “Santa Claus” (follow me here; it’s a mechanism, not commentary on religion or culture), you know the imagery of adolescent expectations is a myth. Even so, parents perpetuate it generationally.
Today we’ll unravel the Saint Nicholas Theory of economics. Because at root equities reflect economics even when the barometer is errant. Economic orthodoxy – conventional wisdom on economies – says we need rising prices. For businesses selling things it’s called “pricing power,” the capacity to increase the cost of goods and services. The Federal Reserve and other global central banks have an “inflation target,” and bureaucrats wearing half-glasses at droll news conferences pore over boorish scripts about “structural malaise” and the exigency of combating deflation.
Few know what they’re saying except we gather they think prices should rise. Yet we consumers stop spending when things cost too much. If our spending is the engine of the economy – what economists call consumption – how is it that rising prices are going to drive more of it? In fact when stuff’s not selling, businesses hold sales. They cut prices.
Big Economic Idea No. 2 (we all know from childhood what “number two” means) is that access to credit – borrowed money – is the key to more consumption. If the economy slows, the problem, we’re told, is we need more spending. Central banks the world round want you whipping out a credit card lest the global economy slip into falling prices.
This is Santa Claus Economic Theory. It says spending drives the economy, which grows when prices rise. There is only one reliable way to drive up prices: Inflation. Milton Friedman taught us “inflation is always and everywhere a monetary phenomenon.” While prices temporarily increase when more buyers chase fewer goods (say, Uber at rush hour), costs will revert when supply and demand equalize. So inflation – rising prices – is sustainable only if the supply of money increases faster than economies produce things.
Money as we presently know it can only expand one way: Through debt. If the Federal Reserve wants to increase currency in circulation, it buys debt from the Treasury with cash it manufactures (backed by you and me). Likewise, when you use a credit card, you create money. A bank isn’t reaching into deposits to pay a bill you incurred. The bank creates electronic funds. When you pay your bill, that electronic money disappears.
Stay with me. We’ve almost arrived at the bizarre and impossible logic that animates the entire global monetary system, as I’ve illustrated with three charts here. Today Janet Yellen will try to convince us we need inflation. Rising prices. What drives prices up? More money. How does the global monetary system create money? Through debt. So we’re left to conclude that prosperity can only happen if debt and spending perpetually rise. Because if you pay off debt, money is destroyed and prices fall.
Two weeks ago I was on CNBC with Rick Santelli declaiming how rising debt and rising prices are the enemies of prosperity, and purchasing power is the engine of growth. Purchasing power is when your money buys more than it did before, not less. Example: Uber. It used to cost $100 for a cab to the Denver airport. Uber is about $40. Guess what? Cabs are coming down. Purchasing power is improving.
Central banks are perpetuating a myth that will destroy the global economy, and I’ve proved it with three charts. The first – call it the Quast Curve – shows what happens to the US economy if the value of the money denominating goods and services is consistently diminished over time. Growth rises but then collapses (eerily, in this model it topped in the 1960s before we left the gold standard and hit zero around 2008).
What will follow from the Quast Curve is rising debt and rising prices, illusions of growth – exactly what images two and three show. As money buys less and less, prices go up, and consumers have to replace the missing money with debt, a terminal cycle. It’s now on the balance sheet of the Federal Reserve.
Real economies are simple. If money has stable value, and enterprising humans create things that improve lives, costs should stay steady or decline, not rise, which increases purchasing power and wealth rather than debt. It’s infinitely sustainable. Economist Herb Stein said if something cannot last forever it will stop. You never want an economy built on things that will stop. What should stop instead are bad policies.