With the US stock market on yet another vertical tear amidst a backdrop of news that Japan’s central bankers openly admit to debasing the Yen, it seems necessary to reconsider all this in light of Bastiat’s brilliant insight.
The visible effects of central bank actions are obvious. It is the unseen effects that interest me, and I’ll describe the U.S. system as I understand it.
First, by purchasing government IOU’s (bonds) with credit created from nowhere, the Fed has given Congress the ability to spend vast sums of money they didn’t need to tax or borrow from someone else who actually produced something previously. This is the Keynesian “helicopter drop” of cash in every sense of the word, but that cash obviously fell on things for which the Federal government is the dominant payer: the medical-industrial-complex, the military-industrial-complex (including the new money-pit, “Homeland Security”) and the higher-ed-industrial-complex.
Sure, “the poor” have gotten a share of this swag, but most of it went to well-paid “middle income” people like doctors, nurses, hospital administrators, engineers, missile production technicians, employees of firms with military supply contracts, university instructors and administrators, etc. QE was clearly “middle class welfare” for those engaged in industries monopolized or semi-monopolized by Washington DC.
This has long-lived subsidiary effects, e.g., rendering unnaturally attractive the prospect of employment in one of these government-favored sectors and pumping up foreign interventionism.
How often have we heard someone tell their 18 year old kid to study medicine, nursing, or enroll in one of the numerous medical “technician” fields of study? How much might we attribute the USA’s “police the world” intervention to armies of military supplier lobbyists who, as de facto salesmen with sales quotas to meet, warp the worldview of elected and professional “officials” in Washington DC (and the public at large) with endless tales of boogeymen on every continent?
The second effect of central bank action is largely to temporarily amplify collective perception of wealth. A review of axiom is needed:
- Money does not flow into or out of asset markets. For every buyer there is a seller, so every buyer’s money that comes into the market leaves with the seller. In terms of money, every single transaction is a wash, including IPO’s (because the firm selling shares still “walks away” with the buyers’ money.) The Fed’s money “printing” does not ramp up stocks.
- Markets rise and fall based on shared belief and nothing more. In the aggregate, bull markets occur when participants simply agree that the value (in terms of dollars, or yen, or quatloos) is higher now for something than it was before. Nothing physical needs to have occurred for this to take place.
- This shared belief is in the realm of crowd psychology and not physics or even economics. All attribution of cause and effect in markets is post hoc rationalization and nothing more.
- Optimistic people gamble (because they just feel lucky; everything is awesome and nothing can go wrong.)
- Higher levels of perceived wealth embolden already optimistic people to gamble even more. About once every few centuries this feedback loop goes orbital and an asset mania occurs. Few people recognize it when it’s occurring.
So what do these axioms mean for what is unseen in central bank actions?
Modern central banks have simply expanded the rationalization for rapid increases in perception of wealth, which translated into a means for people to exercise the greatest rationalization for gambling ever. The path to great riches appears to be those who have gambled with the longest odds (by taking on the highest leverage in asset market trading) and central banks have encouraged the shared belief that borrowing for speculation is the path to riches. From people “investing” their 401(k)’s in stock mutual funds to Wall Street’s celebrity asset managers, the message has been a monotone: speculators win, savers are chumps. Borrow money (AKA “access the credit we offer”) because it expands wealth.
The FOMC and its brethren didn’t create the casino. They simply provided a positive feedback loop to optimism, enabling the pyramiding of agreed valuations higher and higher. People behaved like drunken gamblers in a casino, where every win on every gaming table was amplified and broadcast to every player, increasing his or her desire to roll the dice again while ordering another free scotch on the rocks.
What could encourage a gambler more than the perception that his bank account is bulging with assets? The unseen rub is that his “assets” are in fact nothing but the IOU’s (the markers) of other gamblers. In a vast echo chamber of group-think, optimistic people gamble ever higher because they are emboldened in their euphoria by wealth that exists only in the minds of their fellow gamblers.
This is not a change from any prior time, it is only in the magnitude of the pyramid so constructed that our experience differs.
Are there natural limits to this phenomenon? I submit that there are, but that the limits are governed not by physics or economics but by mass psychology. All attempts at “calling the top” so far have been fruitless, just as they were in early 2000 during the vertical ascent of the tech stock bubble. This is because there are no fixed signposts in a complex system characterized by the intersection of emotion and reason among many millions of people. We’re trying to guess “how high is up?”
What we know is that the wealth underpinning the urge to gamble is nothing but an ocean of IOU’s. From US Treasury Bonds to Corporate debt instruments and sub-prime car loans, the world’s balance sheet is stacked to the moon and back with IOU’s on the asset side of the ledger. This perception of unprecedented wealth rationalizes actions that have long term (occupation choices) and short term (stock speculation) consequences.
When (not if, when) the social psychology turns from optimism to pessimism the collective valuation of all assets (including the IOU’s everyone, including central banks, holds) will drop. Decreasing shared opinions about stock value have obvious effects, but recall that a decreasing shared opinion of the value of IOU’s that are part of a freely-trading bond market is the same as a rising interest rate environment. An ocean of existing debt at near 0% interest will birth a Godzilla when rates turn up due to the hive-mind’s about-face.
Ironically, nothing central bankers do can or will alter this. Even if they were inclined to issue more credit, we already know that today’s credit-money production simply circles back as “investment” in the debt so created. It’s a zero-effect activity, with only temporary mass psychological effects. When the social mood turns down, the “added wealth” of the new credit will simply evaporate, as though it never existed…except for the embedded, long-lived misery listed above. Whether it’s legions of medical-industry people made freshly unemployed by the collapse of Medicare/Medicaid or vast destruction of perceived wealth as oceans of bond and stock value simply disappear, what people were taught to depend upon will turn out to be pyramids of self-deception and group-think illusion.
We face a future where every feedback loop will be engaged in (psychological) asset value (wealth) destruction. Treasury bonds, corporate junk bonds, stocks, real estate and virtually everything else must erode in money value because the mental state required to sustain their subjective value will be reversed from the rising trend of the last 30 years. The gamblers will simultaneously eschew the gaming tables while their markers are called and their bank accounts (figuratively) evaporate. Central bankers didn’t initiate all this, but they enabled it to grow vast and last long enough to insure that every American booked passage on this SS Titanic. Like collectivists everywhere, they insured that when the consequences of their folly arrived, they would be catastrophic instead of limited.
Sobriety after a 32 year (and counting) casino-enabled bender will come with a hangover no one now can imagine.
From the random quote to the right:
“Deficits mean future tax increases, pure and simple. Deficit spending should be viewed as a tax on future generations, and politicians who create deficits should be exposed as tax hikers.” — Ron Paul
Ron Paul is incorrect. Deficit spending is not about tomorrow, it’s about today.
Deficit spending burns seed-corn (capital) today, substituting a belief in an illusion (debt value) for actual consumption of real stuff today. Deficit spending today warps decisions of people today, and to the extent that the assumptions that triggered those decisions turn out to be false, they embed error and losses whose costs cannot be undone.
We live in a time when such embedded costs are so large we cannot begin to imagine them.
Never have so many invested their lives in a paradigm so self-destructive.
DC sunsets
That is the first time I have read about the present impact of increased debt
Trading debt for consumption of real stuff really is an illusion. Here is a specific example of deluded people. They are numerous enough to have a name for their adherents: The Trust Fund Perspective. As you may know Medicare Part D is funded 25 percent by beneficiaries and 75 percent by the federal government. The 75 percent
Funding increases the deficit and the debt held by the public. Adherents of this Perspective believe the trust fund is fully funded for Treasury bonds can always be issued for it is impossible for the federal government to experience bankruptcy
Don Levit
Don Levit – It is not impossible for the Federal Government to experience bankruptcy. It depends on how you define bankruptcy. Remember Greenspans quote, “We can guarantee the currency to meet all obligations, we can not guarantee what in will buy.” The same applies to food stamps. What happens when there is no food or the prices are so high people cannot afford to eat? You have riots and when things bad enough he Government is overthrown. How is this different from bankruptcy?