Saturday, June 2, 2012

Deflationary depression, austerity, and zero interest rate policies

In a recent post, I introduced the problem of the Money Illusion.  Aside from a focus on currency type and GDP measures (which I analyzed in that post), one of the major problems resulting from the Money Illusion is our complete misunderstanding of savings. 

In reality, savings don't exist.  You can't "save" the output of your current labor for future usage.  After completing it, your current labor is gone, probably consumed by someone else.

In truth, what we think of as "savings" is just a claim on the value of someone else's production at a future time. This brings up a number of problems.

--If your "savings" is contractual, it can disappear instantaneously if that particular social contract breaks down.   An example of contract-based savings is a pension, Social Security, or paper currency.

--If your "savings" is physical (such as gold, land, cars, bullets, whatever), its value depends on the market conditions of the future.  [But, hey, at least it can't totally disappear, like contract-based "savings"!]

But in either case, the real value of your "savings" depends on the overall state of the economy in the future, when you cash in your savings.  Seeing through the Money Illusion, we know that we cannot live off the wealth we created in the past ("savings"), only on the wealth created by others in the future.

The Inevitability of Austerity

 In a contracting wealth base, the value of all savings plummets.  With a smaller wealth base, there is less overall productivity going around, so "what you get out" (savings consumed) is going to be less than "what you put in".

Due to the demographic collapse caused by the retiring/dying Baby Boom generation, which is a worldwide problem, we face the inevitability of a contracting wealth base.   Baby Boomers are switching from being a massively productive part of the wealth base to being a massively draining subtraction from the wealth base (due to retirement from work and the health care costs of old age). 

This demographic problem is exacerbated by socio-cultural factors.  One of which is crime, drugs, and an overall culture of slothfulness/non-productivity among young people (well, people of all ages really).   Another is our preference for governmental regulation.

Those are clear examples of where the Money Illusion bites us in the ass.  GDP numbers actually rise as dollars change hands in an economy of entertainment, police/security, health care, and regulators. The problem is, those "jobs" do little to increase our wealth base.   In other words, we are getting poorer.

How Austerity Manifests - 0% interest rates, FOREVER

As previously stated, savings have no value outside the condition of the current economy, and the real value of savings is falling in a shrinking wealth base.  Two economic/price adjustments will happen under these conditions, which we are already seeing.

One is a sustained attack on currency/contractual savings in the form of ZERO INTEREST RATE policy.   Perusing contemporary economic analysis articles, you will see numerous jeremiads concerning the catastrophic effects awaiting us when interest rates rise.   The fact is, interest rates will not rise, any  time in the foreseeable future, I am thinking, 20+ years at the minimum, maybe until "the end of this age".

By running a low but steady inflation rate, combined with a zero percent interest rate, currency-based savings are being crushed.  This is happening right now, and we cannot expect this to change.  The retired people of today are not living in the social wealth base of a generation ago, i.e., their savings are not worth as much today as they were back then.

Seeing through the money illusion, we know that retirees are NOT living off the wealth they created in the past; they are living on the wealth created by others now.  The problem is, wealth is not growing, wealth is shrinking, and our total standard of living is going down.  The crushing of savings by inflation merely reflects that fact.

All contract-based savings will be forced to be revised downward.  When they are currency-based, like pension funds, they are simply crushed via the inflation effect.  When they are purely contract-based, like Social Security,  they will be legally modified to pay out less and pay out later (pensions can also be modified this way).

The Reality of Deflation

Physical-based savings cannot be inflated away or contractually-canceled, so they are clearly the preferred form of savings in times of austerity.  However, these assets will be assaulted by the problem of deflation.  In a contracting wealth-base, everything goes down in value.  There is no magic bullet (such as gold) to get around this.

Under the zero-interest rate, high-debt regime, all assets will be deflated, especially those dependent upon speculative value (such as gold).   There will be no hyperinflation, just a long, slow grind of liquidation and austerity, as "savings" and asset prices are crushed.    

The ultimate "wealth play" in a contracting economy is productive capital.  In short, the ability to produce something.    This will become especially clear when the US dollar loses its status as reserve currency, which will cause price inflation on the domestic economy on all imported goods.  Under conditions of peace, this shift could take years, but it could happen quickly if given a system shock like war.

No comments: