The great Ludwig von Mises once said: “In essence, economic history is a record of failed government regulation because of an arrogant disregard for the laws of economic science.”
The current state of the economy is a consequence of the dirigist economic policies of all the governments of the last two decades, from Bush Jr. through the Biden administration. The current tossing and turning of the government between two threats they themselves have created – inflation and recession – is a clear confirmation of the indisputable correctness of von Mises’s assertion.
As a political economist, social behaviorist and asset manager, I find it difficult to be thrown off balance by economic and even political distortions. Emotional reflection in the form of annoyance, anger, and irritation can only be allowed to the researcher in the hypostasis of the average citizen, not the analyst. However, the recent story of the Inflation Reduction Act and its initiation by former finance ministers, including Mr. Summers, has taken me out of my usual “analytical equilibrium” and caused real frustration. And now I will explain why.
Larry Summers and four former Treasury Secretaries (both Republicans and Democrats) supported the Inflation Reduction Act, which is essentially a simplified variation of Biden’s famous and highly questionable Build Back Better project. Mr. Summers, himself a Keynesian economist and a major contributor to the rise of government expansionism, is now a critic of the FED, arguing that without more unemployment and a firmer move to raise rates, inflation will not be brought under control. This obvious thesis is nothing new, to say the least, and is commonplace. But here is what is really disconcerting about the position of the adherents and defenders of this law. On the one hand, for years and decades all these guys have created economic imbalances and worsened the competitive environment by tying agents to cheap money, the value of which was directly or indirectly determined by the state, not the market mechanism. On the other hand, they now propose to solve problems … by increasing taxes on corporations!!! Instead of recognizing the ineffectiveness of constant non-equilibrium stimulation of economic activity through monetary expansion, low interest rates, and ever increasing consumer leverage, these guys are proposing to further expand the government’s distributional mandate! This is another step toward the elimination of the free market and a deepening of the quasi-socialist paradigm of the economic order.
But let us remember again what monetary stimulus policies have led to and why they are becoming a direct path to a perverse socialism and etatism, where in fact social and economic stratification takes on tremendous proportions.
Low interest rates carry two killer “warheads” for the economy and society as a whole. The first is the actual Cantillon effect. It is the low rates that create an even greater and more dramatic stratification between the rich and poor of society, increasing inequality.
Cheap money is primarily received by the elite strata of society, naturally investing it in assets, thereby increasing inflationary pressures. The middle and lower strata gain access to cheap money and accelerate their needs by increasing opportunities, creating a consumption impulse inconsistent with income and thus accelerating the inflationary flywheel. Inflation is thus driven by the growth and expansion of consumer preferences ahead of income growth, and by the rise in asset values, including those of commodity markets.
All of this, again, is happening on the impulse of cheap money: the emergence of the ability to borrow cheaply and increase consumer power and the need to seek value added in high risk against a backdrop of zero return in risk-free assets.
This is how leverage is created. The rich get richer by investing in assets and thus accelerating their value, while the poor consume greedily, trying to take advantage of cheap and available money to satisfy and expand their consumption preferences.
On the “poor” side, outpacing consumer demand swells, while on the “rich” side, the level of prosperity rises at an accelerating rate. But with the inevitable arrival of the inflation tornado, the poor, being indebted and without assets, become even poorer and are often deprived of benefits that do not correspond to their real incomes, while the rich receive only a drawdown in the value of their wealth, which has risen to much higher levels than in previous periods.
The second “warhead” is the expansion of the state’s redistributive mandate and the general expansion of the state as a whole, disrupting the competitive market environment. The state as a source of welfare–consumer for the poor or investment for the rich–expands its boundaries while constricting the boundaries of individual freedoms and opportunities. In fact, this is yet another paternalistic technique of the state, a way to get society hooked on social welfare and protection by creating new narratives in civic consciousness in its favor. Leviathan does not break its chains, but persuades society to remove them itself.
What do we get as a result today?
We all remember the repeated statements by the FED about the transitivity of inflation and that this temporary problem created by covid constraints would quickly dissolve due to elastic global supply. Instead of controlling inflationary processes amid wild and unrestrained fiscal stimuli driven by political cowardice and the expanding appetite of power elites for powers in redistributing public goods, the FED shifted its focus to engaging in political, but rather populist, objectives, in particular reducing income inequality. This became in fact the third mandate of the FED, along with controlling inflation and unemployment.
It seems false to claim that low rates have significantly stimulated job creation in the wave of the post-crisis recovery. In fact, they were triggered by the demand lockdown that preceded it, the breakdown of supply chains, and the dramatic outflow of foreign labor from the country. And even if we accept that in the short term the ultra-soft monetary policy had something to do with job creation, it was, as usual, only an additional booster of inflationary galloping – recall here the failure of the Phillips curve and the fidelity of Friedman’s “vertical curve. However, it seems clear that low interest rates have performed the exact opposite function to the original, I should note – vicious, goal of reducing the income gap, that is, to increase economic stratification and social tension. By dispersing incentives and direct subsidies to absolutely unthinkable values, when the lower social strata began to direct the flow of monetary surpluses into financial assets, the authorities got a de facto stagflation – intense inflation and a decline in economic activity. The trap has slammed shut, and now the government is in the inevitable rut of “no-alternative” bad scenarios: both actions – tightening or not tightening monetary policy – do not lead to a positive result.
This is partly a Pareto efficiency dichotomy: it is impossible to improve one component of a homogeneous system without worsening the other. Raising rates worsens the economic condition of agents and depresses economic growth – consumption and production. Not raising rates and holding economic growth keeps inflation at high levels or accelerates it further, reducing, as a consequence of “tomorrow,” the economic capacity of agents and reducing their purchasing and productive capacity. And taking into account the fact that the participation of broad social strata in the investment boom in financial markets contributed to the nonequilibrium growth of assets, we can assume – the investments of banks, pension funds, insurance companies and ETFs – the main aggregators of savings of economic agents – are at risk.
In the event of a prolonged and profound decline in asset values, there would obviously be social tension. In order to avoid this, the government will have to stimulate low rates on 10-Y Treasury Notes, because they are the discount factor in the valuation of productive assets. How is this stimulus possible? Only by reducing the supply of 10-Y Treasury Notes in the market, i.e. by means of another QE. Or an improvement in the economic outlook that shapes investor expectations and decisions. Such improvements are primarily mediated by a decrease in inflation expectations, which can only be achieved in the current situation by monetary tightening and a slowing of economic activity, primarily demand. There is a familiar casus as a consequence of the Keynesian economic policy of the state, mediating the actual loss – at least partial – of the independence of the FED as a separate branch of economic power.
It is worth repeating once again the statement that there is no way to do without a recession – a painful bailout of the economy, normalization of the factor structure of economic cycles of the free market and deleveraging. This is why all the talk about a “soft landing,” all the “hawkish-dovey” statements are nothing more than phantoms or manipulations of the FED, playing along with the government and trying to put a good face on a hopeless game in advance. And it has nothing to do with inflation targeting.
The only option for softening the hard landing could be fiscal easing and fiscal tightening, a U-turn if not to the “Austrian paradigm”, then to the concept of “supply side economy” at least, as I have repeatedly said in both academic articles and public opinion-posts. And such a reversal is a vital necessity, not “mind games.
Here the topic of the influence of elites’ political interests on socio-economic development is already coming up, elites who have become accustomed over two decades to expanding their right and toolkit to redistribute goods and verticalize economic exchanges. This is certainly worth talking about separately, but at another time.
Reagan once said: “Government is like an infant – monstrous appetite at one end and total irresponsibility at the other.” He said it brilliantly, and one wants to ask the question: now who will clean up the cradle and dare to keep his nose clean?