In our continuing analysis of the muddleheadedness that passes for conventional economic thinking, we look at this morning’s headline from USA Today, “Stocks rise as Fed meets to consider its next move.” We see here once again the power of wishful thinking impacting investment decisions, as “traders hoped that the Federal Reserve will come up with a plan to jump-start the economy.”
The same article reports some concrete business news also influencing the market’s gains. Microsoft and Oracle showed strength on the news of product releases and earnings growth. Analysts are also reading housing data as “signs that the housing market is healing.” These concrete data are the necessary and fundamental elements of stock valuation decisions. But of course we cannot eliminate emotions or projections from decision-making, even in the stock and bond markets!
But this mixing of actual results from the real economy with the heart flutterings from the massive act of fiction called the financial markets is the problem. And this problem stems from the collective misunderstanding of the relationship between money and wealth.
Wealth can be simply defined as “stuff one produces that other people want and are willing to pay for.” Money, on the other hand, is simply the main, although not sole, method by which this buying and selling are accomplished.
We humans regularly produce wealth regardless of the health of the money system, although the money system can either suppress or encourage the production of wealth. This is because our collective agreement through long-term historic habit to employ money as the most reliable and cost-effective instrument of exchange has subjected the productive sector to the vagaries of the currency system.
Throughout most of our political economic history, the money system has unobtrusively performed its role. The institutions we created to monitor and check the occasional tendencies toward inflation or deflation for the most part have worked. And because this inconspicuous system generally does its job as it’s supposed to, we get lulled into assuming it will always work.
But from time to time the money system breaks down, and very often these occasions are extremely disruptive to the political economy. And sometimes these disruptions are so acute that they threaten to wreck havoc on entire societies; the last time this happened it led to a general global depression and war.
We have again entered a similar breakdown period, and like the 1930s there are very few good choices before us. The death throes of the Eurozone are simply the most visible fallout of the 2008 financial collapse. But here in the United States the Federal Reserve Bank has also run out of its usual tricks to bring the financial system and the economy back into alignment. Its “quantitative easing” program is a response of last resort, since it is expressly based on “electronically created money.” Critics assert that the program runs the risk of “currency debasement and inflation” without causing an improvement in employment. So far they have been right.
So it’s no wonder that we are in general denial that we face a radical remake of the international financial system as a prerequisite to general economic recovery.
What makes it all so wobbly is this. The world economy day after day produces billions of items that billions of people want at prices they are willing to pay. What’s left over after everybody buys what he wants is available as socioeconomic surplus, and can be used to reinvest in the next cycle of goods and services. But the value of the currencies with which they make these purchases and sales has become increasingly unreliable, while at the same time the portion of the surplus of all this production that must be siphoned off to pay for non-productive items in the financial and government sectors is increasing dramatically.
This is the problem Spain and Italy are facing head on. The gross profits of their economies must increasingly go to interest payments on their sovereign debts; every euro going for debt payments ceases going into productive activity. As the surplus available for reinvestment dwindles, economic activity slows. As economic activity slows, less surplus is generated. The less surplus that is generated, the greater the absolute percentage of it that has to go to interest payments, because the rates are pegged to the power of the economy to generate sufficient surplus to both pay off the debts and generate sufficient reinvestment for economic expansion. Without an intervention, sooner than later the entire surplus starts going to debt payment and the economy grinds to a halt. This is already more or less the fate of Greece and Cyprus—the canaries in the Eurozone mine shaft.
There is really only one way out of this gross disconnection between the economy and the ailing financial system: bankruptcy. We must face the fact that we can no longer afford both our accumulated debts and adequate reinvestment for economic expansion.
The first instinct of the leadership has been to try every trick in the book to avoid this option, because they have forgotten the simple truth that the economy is not the money system. They have become identified with the bankers, bond traders, stock analysts, money managers, tax collectors, and appropriators who staff the financial system. Many of them are personally highly invested in its goods and services.
It is a delicious irony that the “progressive” Democrats have become the party of No here in the U. S. President Obama, strongly supported by Goldman Sachs and other Wall Street interests, is campaigning as the champion of the government-money system status quo. Similarly here on the Left Coast, as Joel Kotkin points out, Jerry Brown has declined the opportunity to be the Gorbachev of California; instead he and his legislative allies are imitating Chernenko's mulish Politburo by feverishly and illogically defending the dysfunctional blue social model that has stifled the state's once robust economy.
It remains to be seen what particular event will trigger the coming financial disintegration. In the meantime it is salutary for the average citizen to hone his or her understanding of the distinction between our economy and our financial system. The sooner we get that the two are not the same, the sooner we will champion the former over the latter, and get on with the next generation of prosperity.