1984 was one of the darkest books I have ever read. It also seemed at the time as far removed from reality as you could get. But the writer’s mind is a soup of sorts, that takes time to ferment (or foment), and perhaps like life itself, the seeds of our destruction are constantly being sown, waiting for the right moment: 1984 is a constant, a statement of how close we stand between the life we know and an alternate dark reality.
As the Euro crisis unfolds you can see how the individualism and democracy of the old free market state could be at risk of being subsumed by a centralised control. Central control by what though, and how do we risk getting there?
In a recent post, Simon Johnson discussed the rock (deflation) and a hard place (inflation) as two potential outcomes to the current crisis in Europe.
A great inflation though requires the nominal value of demand to exceed the nominal value of supply, requiring an increase in the nominal value of supply or an increase in the real amount of supply. At present there is insufficient demand to strain capacity utilisation and labour supply, although skills shortages could start to impose some form of supply shortage in the labour market.
Expansion of nominal demand to a large extent requires either a constant relationship between the monetary base and broader money supply growth, an expansion in broader money supply growth relative to the monetary base or an increase in the velocity of narrow money supply measures.
If all monetisation of debt does, is to compensate for a collapse in the stock of broad money supply once allocated to financing consumer demand, housing and production, then we may still have a deflationary risk.
Why? Well, monetisation (unless it reflects indirect purchases of newly issued government securities) may only affect portfolio cash holdings at outset, and while this may compensate for a decline in money supply, what we really need is an increase in that part of money supply which is allocated towards expenditure and not portfolio holdings. Getting people to spend cash is key, whether this involves selling assets for cash or using cash itself.
If banks are not lending then we need to increase the velocity of the consumption focussed narrower money supply components.
If asset values have fallen, unemployment is high and economic growth declining or growing very slowly, then consumers may be more likely to tend towards austerity. This leaves governments and central banks to generate demand, printing money and putting stress on the ability of supply to meet demand.
To do this could require an enormous amount of monetization: central banks create new money out of thin air, buy vast amounts of newly issued government debt, recently parked in the secondary markets, and governments spend the vast amounts raised on economic projects, tax cuts etc. Governments may no longer be able to sell debt to anyone outside of the central bank fraternity; government budget deficits and national debt will likely grow much further and there is a risk of a significant misallocation of resources.
Tremendous amounts of capital may be destroyed as demand shifts to different economic sectors and real economic growth could trickle to a halt as new capital is allocated to areas with potentially lower real growth prospects, and debt/capital previously allocated to effectively non-performing assets act as a drag on growth itself.
Both nominal and real assets will lose value, but inflation may well pick up, eventually, while the economy is even more is misallocated and unproductive than it was. The risk, therefore, is that the economy moves even further away from a natural structural balance, risking tremendous long term damage to real growth and living standards. Such a scenario requires central control of allocation of funding of productive resources.
With debt markets collapsing in Europe, and austerity settling in as the first defense of the old guard, economic conditions are set upon a new path, a dangerous path. I do not believe that the system should be protected at all costs, because that is what we will invariably end up with.
Perhaps the “Occupy Movement” is intuitively a defense of the individual and an understanding of the adjustment that needs to be made to take the world back 50 years. Perhaps, without realising it, the “Occupy Movement” is a defense of the unitary against the composite, which in truth is what Capitalism should be about.
The composite is the death of capitalism, the death of individualism and the death of choice!
In other words, we should take fiscal policy as far as we can while remaining within the confines of the free market. If this fails, then deflation is the quickest way home.