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.

What is the Money Illusion?

The current concept of the Money Illusion means that people think in terms of the nominal value of money, rather than its real value.  However, the truth of the Money Illusion goes much deeper than that.  The truth of the matter is that real value of money is nothing at all.  In short, the illusion is that money has any value at all. 

Seeing beyond the Money Illusion, we realize that money is nothing but a trick to gets us to cooperate.  Money is both the stick and the carrott, in that it inspires both the fear and the greed to get us motivated.

The existence of money is not even necessary to the function of the economy.  Just imagine what would happen if all money disappeared tomorrow: all cash, all plastic, all bank balances, everything, just magically erased.  What would happen if everyone's wallet was completely empty, and every bank vanished?   Most people agree, if it happened in the real world, human civilization would pretty much end rapidly in a violent conflagration.   

But... what if.... instead of going Mad Max in collapsing economy... what if everyone just PRETENDED they were exchanging money.  You go to the store, the cashier pretended to ring you up.... and you pretended to giver her money.  You buy items from your vendors, and pretend to pay their invoices...  Your clients pretend to pay you...  so on and so on. 

In other words, what if everyone just went on doing what they normally do, but WITHOUT the MONEY???  Viola, Mad Max apocalypse averted!  If everyone would just fulfil their role in the economy as if money didn't matter, in truth, money wouldn't matter, and the economy would go on quite nicely without it. 

Of course, the average listener objects, if you could just "pretend" to pay for stuff, why would you work?  Well, yeah, that is the rub, human nature.   Stands to reason, some people would shirk off and refuse to work, and if enough people did it, the economy would collapse. 

But my point is not to suggest a model for a real-world working "cashless" economy.  Rather, I just wanted to give a concrete example of the true depth of the Money Illusion.   The fact is, money is totally unnecessary to the function of a real economy. 

If people could just be trusted to do something productive everyday and give it away, we could totally dispense with money.  THAT is the Money Illusion, the idea that money is anything necessary or worthwhile at all.  In reality, it is just a big trick to get us to work together and limit our consumption.   If we could agree to work together and limit our greed CONSCIOUSLY, we wouldn't need money. 

Arguments about the Type of Money

The Money Illusion also manifests in our arguments about what TYPE of money to use, especially among the Austrians, who have an irrational attachment to the use of gold as money.   What really matters when it comes to defining our standard of living is our overall level of PRODUCTIVITY.  The type of money we use is complete incidental, and the only argument we should have about money is how to make it facilitate the highest level of communal wealth. 

This is where the Austrian gold-fetish is revealed at its most primitive.   A solid, stable, tangible FORM for money is all-important to this strange mindset.   Whether it is most condusive to the creation of social wealth is totally irrelevant to the Austrian; the most important thing is its constancy, its permanency.

Ironically, it was the rise of the limited Money Illusion that proved the death knell of the modern gold standard.   Modern workers in the early 20th century fought hard for union power, higher wages, and guaranteed contracts.   All of these were totally incompatible with the operation of the gold standard, which required constant deflation of wages and prices (as greater productivity was piggy-backed into the static supply of money).  Workers, however, would not be contented with falling nominal wages, even if they were assured that it was part of the natural process of economic balancing under the iron discipline of the gold standard!  Deflation and mass unemployment are not a good combination in the modern, urban, industrial economy, and thus ended the gold standard era.

This is why Austrians are viewed as kooks and cranks in the modern economic milieu.   Everyone ELSE sees through the Money Illusion and is discussing the advanced theories of wealth creation and social stability, EXCEPT the Austrians.  It is like trying to make Christmas plans with someone who insists you have to be in bed at midnight for when Santa arrives.  Or trying to make travel plans with someone who insists you can't travel too far across the ocean because the earth is flat and you don't want to go off the edge, do you???   I mean, really, there is nothing you can do with such a person but ignore them and go about your normal plans despite their irrational beliefs.   Which is exactly how Austrians are treated. 

In the end, Austrians are left alone in the corner, muttering about hyperinflation causing the collapse of the economy.   We just pity the poor chaps, totally locked in to their irrational beliefs, unable to see through the Money Illusion.    They honestly can't separate the collapse of a currency with the collapse of the economy itself, and are totally flummoxed trying to imagine that money is just a tool to be used for the social good.  The very idea is offensive to them!

Mainstream economics is hardly better.  In fact, it is probably even more odious, being used to obfuscate, beguile, and confuse the public, through a massive smoke screen of jargon and faux-complexity, serving only to mask the exploitation of the masses by the parasitic Money Elite.