You need ‘courage’, according to Rudd anyway:

Prime Minister Kevin Rudd has called for world leaders to show political courage at the climate change talks in Copenhagen in three weeks' time.

"What's required is a bit of political courage for everyone collectively to step up to the plate, put behind the familiar, put behind the fears and concerns of the past and embrace instead the opportunities of the future," he said.

"We're at one of those crossover points in the world, one of the crossover points in Australia.

"Let's rise to the challenge rather than simply succumb here at home and abroad to the politics of fear."

The ability of these guys to convince themselves of anything always amazes me.

The banks don’t have to lend to inflate

Contrary to popular belief, banks do not need to lend to expand the money supply and eventually create price inflation. Yes, the Australian banks are still lending at an impressive rate but since the bust this has been predominantly to the housing, individual and public sectors, with commercial lending actually declining year-on-year (although it is already on the way back up from July lows).

Just because the demand for loans by businesses fell off does not mean that the monetary pumping undertaken by the RBA will have no effect on price inflation. Banks never have to be passive and, indeed, they usually waste no time in spending their new cash reserves. All they have to do to expand the money supply is buy existing securities, whether from each other or other corporations, thereby increasing deposits. They do not have to depend upon business firms to request commercial loans, or to float new bond issues.

…But it doesn’t matter anyway

Saying that, in a speech today the RBA's head of domestic markets department, John Broadbent, revealed that “…listed corporates have raised a record amount of equity this year, totalling some $60 billion, with issues broadly based across all sectors.” So not only are banks buying existing securities but they are buying up new bonds at record levels. This will be inflationary.

Mr Broadbent continued to say that most of these equity raisings had been used to pay down debt, with some companies explicitly saying the funds raised were to repay bank loans. While this may sound deflationary, it is not.  When someone pays back debt, the money used to pay that debt with does not suddenly disappear but simply goes to the creditor, in the case the bank. The bank then spends on additional security purchases, shares, or issues more loans which increase deposits. In other words, most if not all of the ‘repaid debt’ flows straight back into the economy.

The seeds have been sown

“The first sign of a hyperinflation is a rally in the stock market,” Jens O. Parrson, Dying of Money: A History of the Great German and American Inflations.

The new money and all-time low interest rates from the RBA coupled with a record fiscal deficit and added public debt obligations has created a new wave of malinvestments (investment in areas not aligned with consumer preferences but that which appears profitable thanks to the artificially low cost of credit and rising prices) in Australia that will eventually need to be liquidated. As an example of the rising confidence, the latest Dun & Bradstreet business expectations survey of 1200 business owners and executives shows expectations for investing in capital are at the highest level in 10 quarters, registering an index level of eight points. It is only a matter of time before the distortions created by all of the new cash created by the banks – and enabled by the RBA – will be revealed. While it may take a few years thanks to factors such as China’s demand for Australian resources, foreign accumulation of the Australian dollar (as bad as it was, every other nation appears to be inflating more) and so on, those same factors will mean the eventual bust will be worse in Australia than elsewhere.

The Australian recovery is not sustainable and rapid price inflation is a very distinct possibility.

The Bank of England is pumping another 25billion quid into the UK economy - up to a total of 200billion quid (Source).

Fantastic if you're a large corporation/bank in the UK - they 'ease' by buying corporate bonds. You get the cash first, spend at normal prices, by the time it feeds down to the poor/middle class prices have risen (the ‘Cantillon effect’). It's great way to further erode the already shrinking middle class and transfer wealth (after all, as printing more money devalues existing fiat, it’s also a form of wealth redistribution) to your buddies…then blame the free market for it and increase government intervention!

Quantitative easing may work in the short term by propping up prices and creating the illusion of prosperity but in the longer-term it means none of the necessary restructuring – liquidating of bad business (malinvestment) – will occur. The result is another more severe bust in the future.

Money 101

It all stems from a misunderstanding of what money actually is. Money is a medium of exchange; it represents a claim to an existing – already produced – good. But money itself is also an economic good like any other commodity in the economy and is therefore subject to diminishing marginal utility – in other words, if you create more of it, its exchange value declines. The methodology behind ‘quantitative easing’ – that people ‘horde’ money due to ‘animal spirits’ or something similar, thereby creating a ‘deficiency’ in aggregate demand, is false. Think about it: if people ‘horde’ money in a time of crisis, the price of all other commodities will continue to fall relative to money, therefore ‘deficiencies’ in aggregate demand won't occur. Allowing prices and wages to adjust is all that is necessary for recovery.

As stated, if you have an over-supply of all commodities it will mean a temporary fall in their value relative to money. As John Stuart Mill said in 1830, to suppose that the markets for all commodities could, in any other sense than this, be over-supplied, involves the absurdity that commodities may fall in value relative to themselves.

…and that right there is the Keynesian (and unfortunately, government/academic) position. It was the argument the Mercantilists used and was disproved many times over – Keynes simply restated the same fallacy.

Quantitative easing is nothing more than wealth redistribution that will create further distortions in the capital structure of the economy that will need to be addressed in the future. We can’t get rich (in the aggregate – some individuals obviously benefit immensely!) by printing. You can’t increase wealth by dividing it!

This was originally sent out on 30/10/2009 to a private mailing list; the content has not been modified. This article is also available in PDF format.

Crack the Champagne, the US is out of Recession

…but you might want to hold that thought. The announcement last night that the US had posted GDP growth of 3.5% should spur markets on in the short-term and temporarily delay the correction, but a quick glance at the numbers reveals things are not as rosy as it seems. Growth in GDP was led largely by the ‘cash for clunkers’ program which contributed 1.7%, or 48% of total GDP growth, with a large part of the remaining growth created by the government’s $8,000 tax credit for first-time home buyers. It is important to understand that these types of government initiatives do not create lasting growth, they create ‘statistical growth’.

When the government pays for someone to trade in their ‘clunker’ – a vehicle that is still functioning and probably could keep functioning for years – they are paying someone to destroy their property, something with real value. The short truth is that the destruction of anything of real value is always a net loss, a misfortune, or a disaster and whatever the offsetting considerations in a particular instance, can never be, on net balance, a boon or a blessing.

So while ‘cash for clunkers’ created positive gains according to GDP, a figure which measures all spending regardless of how destructive it is, it will not improve the long-term wealth (growth) of the nation. In summary, the latest GDP figures are nothing but a short-term burst of consumption created by the government. In real terms, taxes increased, personal income fell, disposable income fell and the savings rate sank, all while personal consumption increased, paid for by an increase in the federal deficit. This will not create lasting growth.

Australian CPI Up; Rate Rise Imminent

The latest CPI figures indicate that price inflation is coming (the ‘basket of goods’ the RBA measures increased by 1% QoQ) and the RBA will respond by hiking rates by an (estimated) 25 basis points on Melbourne Cup day in line with their inflation-targeting policy. We expect CPI inflation along with subsequent rate rises to continue into the new year.

What most people don’t realise is that the RBA is the culprit – rising prices are occurring because of the monetary pumping and financial sector bailouts the RBA engaged in back in late 2008/early 2009 as discussed in the October edition of Ausnomics. Inflation (monetary) is indiscriminate; its effect will be different on different parts of the economy. The same monetary pressure which in some parts of the economy may have reduced unemployment will in others produce definite and disastrous inflationary effects. The aggregate thinking and disregard of the economy’s capital structure by academics, the RBA and the government necessitates that these important implications are neglected.

Market Correction is Happening Now

The United States public and mainstream media are finally waking up to the fact that their government has been recklessly spending, creating massive new ‘initiatives’ (i.e. health) without funding them, dishing out cheap credit to politically favoured sectors and telling businesses where and how to invest. Unfortunately the Australian media still has no clue that we have been doing exactly the same – the smokescreen that is China and the resources industry is, so far, covering up the evidence.

The Fed has been (not-so)secretly bailing out the banks with massive reserves that they pay interest on. It is actually quite amusing – economic fascism at its best! The Fed gives banks cash, pays them to keep it at the Fed/buy Treasury bonds (you see if they spend it – like the Australian banks have already done – it creates ‘price inflation’), the banks simultaneously write off their bad debt and make a profit to boot. They then pay themselves big bonuses which the government criticises them for: funny, as all of that free money was dolled out to them by the government in the first place!

All of this bad news and growing anxiety could see the Australian market, as it has historically, follow the US-led correction.

Growing Public Angst

General Motors has asked for even more federal money to keep them going – surely the better option was to let them fail and allow the good parts (yes, they still have a lot of good assets and employees) to be bought and for the rest to necessarily liquidate. Unfortunately the government has declared their hand and they have to follow through to the end, something the public is growing concerned about. Further doubts about the health of the recovery will be raised over the next couple of months which should temporarily push the bulls to the side.

Australian welfare state keeps growing and growing and growing…

The big question is: how are we going to support this when resource prices eventually crash as they did back in the 1970s? Will we have another decade of double digit price inflation as the RBA tries to inflate away our public welfare, debt and other obligations?

Unless this trend changes, that is the most likely scenario. Rudd’s national healthcare policy (no doubt to be unveiled as an election promise) and emissions trading scheme, if successful, will only add to the nation’s commitments and future debt levels. Australia simply cannot afford these ‘initiatives’ – the resources boom won’t last forever and the nature of politics is to spend spend spend with little regard for the future. As the late Dr. Adrian Rogers said, ”…the government cannot give to anybody anything that the government does not first take from somebody else. When half of the people get the idea that they do not have to work because the other half is going to take care of them, and when the other half gets the idea that it does no good to work because somebody else is going to get what they work for, that my dear friend, is about the end of any nation. You cannot multiply wealth by dividing it.”

…Now for Some Political Economy: Why More Government is Not the Answer

To quote Gordon Gecko, the fictional character from the movie Wall Street, “greed is good!” The world runs on individuals pursuing their separate interests. History has shown us time and time again that the only way in which people have escaped from poverty are where they have had capitalism and largely free trade. If you want to know where people are worst off, it is exactly in the kinds of societies that depart from that. There is no alternative way of improving the lives of ordinary people than the productive activities that are unleashed by the free market.

As Adam Smith famously said in the Wealth of Nations (I.ii.2: pp 26-27),  ”…it is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard to their own interest. We address ourselves, not to their humanity but to their self-love, and never talk to them of our own necessities but of their advantages.”

Ask yourself this: how is political self-interest somehow better than economic self-interest? Where are these omniscient angels going to come from? With capitalism, the only people who can rise to the top and stay there are those who consistently meet the changing demands of the consumers. Under economic competition, people compete (earn economic profit) by best serving the consumer. By contrast, the worst tend rise to the top of the political ladder as there is a tendency for these people to both desire power and be effective at using it. Under political competition, politicians compete (earn political profit) by supplying wealth transfers to interest groups through legislation and regulation.

Just remember that the free market or “excessive greed” did not cause this crisis; political self-interest, market interventionism and mercantilist policies did.