Waste and Corruption Out of Thin Air

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June 23, 2009

If government proposed a 'stimulus' program to give each American $50 million, we'd immediately think of inflation. At that scale, the proposal would meet its deserved ridicule.

However, I'd like to look at how it would work ex-inflation, so let's pretend there is no inflation problem. The Federal Reserve's magic omnipotence determines that there's 'slack' in the economy so that government can create and give everyone $50 million (and Goldman Sachs its commission), with no significant inflation. We'll make no assumption about ever repaying the $50 million per capita, which is a realistic expectation in the current real world of money and credit expansion anyway.

So with no inflation, should the Fed get really excited (they must have been at least starting to doubt the magic) and do it again?

No. Even without inflation, the artificial abundance of credit money will cause plenty of other distortions to economic behavior.

For starters, some people will simply retire to become consumers only. With their production removed earlier than it otherwise would have been while their consumption is still there (and may increase in early stage 'stimulus' euphoria), overall wealth measured in production (rather than money out of thin air) has gone down.

In our decades-long credit roller coaster, this retirement miscalculation has certainly occurred, with credit expansion giving people false signals that they can retire or semi-retire when actually they still needed the economy and the economy still needed them (provided they could somehow have been directed to real production and not to Bubbleland).

The scope of this gift from the Fed and the banking system to our seniors and near seniors is still unknown. Some people soon to be forced into unretirement now that the credit veil has slipped will have skills they can market at the level they're used to in the face of impaired economy headwinds, and some won't. Since that's about all we can know for now, we'll have to leave these folks high and dry where the helpful stewards of the economy have put them, and move on to other expansionary credit 'life blood' effects.

With my $50 million, I'll probably stop everything else to pursue a writing career. Any other productive possibilities from me will be permanently (or at least until everything blows up even more) lost to society.

In the $50 million for everybody story, plenty of other part-time writers will join me in pursuit of the full-time dream. Also, actors, film makers, dancers, models, painters, sculptors, chefs, fashion designers, musicians, and of course, singers. American Idol will need at least a few extra rotations--maybe even its own network.

Something like this happens in real life credit expansion. It's not just directly bohemian pursuits, but other apparently more practical endeavors that become overindulged because of false expansionary signals: We get more retailers, restaurateurs, boutiquerateurs, financial and real estate tycoons in training, 'internet marketing gurus,' advertisers, public speakers, and miscellaneous experts--every type and stripe of consultant who once did something successfully for a decade (or at least didn't fail too publicly), and have now risen above doing the expert activity to advise others.

Pursuing the dream, or advising others on dream pursuit, isn't bad as such (too late, I've insulted everyone--no one is reading anymore). And it's certainly not that many people in professions this piece may appear to denigrate aren't exactly in their productive niche and awesome there. However, regardless of whether we make those judgements that money and credit creation make the economy too fluffy, it clearly does make it too frothy--entrepreneurs get hasty in pulling the trigger, and then hang on waiting for the next boom that credit expansion signals have promised them. This paper promise must eventually be broken since no amount of paper, nor any bookkeeping entry of whatever size, is ever going to eat a single restaurant meal, or otherwise consume anything except for a dwindling supply of economic clarity and perspective.

(It isn't entirely a vacuumful of wishful thinking on the production side, of course. The psychological extremes of overreaching are naturally late stage, while consumers will all along have been helpfully translating their expansionary false signal receptions into 'real' but ultimately regretted demand for dreamy non-essentials-- the new era feedback loop that the Fed thinks it wants, and doesn't really even seem to much doubt after it collapses.)

In the $50 million story, Fed magic is still on the job, and there's no collapse yet. There are no laborers--everyone is retired, an artist, or an entrepreneur--but we still haven't got to the true elephant in the central bank.

The 'slack' has come out of the economy--at $50 mil per head, probably with a pop. The artificial boom has ratcheted up the optimism of the players. Those entrepreneurs with apparently successful businesses will be getting signals to expand them. The Fed, not wanting to 'choke off' the apparently vibrant economy, and getting plenty of cheerful feedback from the banking system that new credit can be 'absorbed,' will feed the frenzy, as they were born and structured to do.

Now the future looks so huge that the entrepreneurs believe they can take on bigger and more distant expansionary projects. Indeed, the situation seems to demand it. The closer borrowed money gets to being free--a favorite central bank ploy--the more dangerous it seems to decline expansion. Your competitor may be using the free money to grow to infinity and then smother you.

Because the credit is artificially created, it can signal temporary enthusiasm, but it can't signal an actual match up to future available resources. The flashing, screaming pedal to the metal promise of future resources to complete every entrepreneur's project is a screaming pedal to the metal lie that no actual arriving future can possibly fulfill. (For one thing, there aren't any laborers, somebody's bound to notice that eventually.)

This is where the true 'confidence' issue shows up. It doesn't matter if players are confident that government 'will provide liquidity.' Speeches, guarantees, backstops and loans of last resort don't help--in fact make it worse, because these are rational doubts about what is and is not being produced from finite resources, how much of the future is being crammed into the present, and when exactly this denuded future will make its appearance (or from where we are at the moment, its curtain call).

No Bernanke or Geithner speech can address this, because all they can produce is debt and more speeches, and all that brings is economic and political miscalculation, waste, instability, and possibly on top of that, inflation.

Les Lafave writes about banking reform at themaestrosrep.org.

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Waste and Corruption Out of Thin Air

by Les Lafave

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Les Lafave works in the insurance industry.  The opinions in this column are his own.