Wednesday, 15 February 2012

Desperate times…

Bessie Braddock: “Sir, you are drunk.”

Churchill: “Madam, you are ugly. In the morning, I shall be sober.”

The long term structural outlook is definitely deflationary. There are still huge stocks of debt to be paid down from the last credit cycle meaning asset price gains are unlikely save for short term central banking manoeuvres.

The inflationary argument rests solely on the fact the central banks are attempting to inject record amounts of cash into the economy and support asset prices. The underlying reality is massive deflation. ‘Proper’ inflation requires low unemployment, loose monetary conditions (we do have these) and a deficit of productive capacity and infrastructure. Therefore ‘proper’ inflation is totally non existent in the developed world.

At the moment investing feels like a binary gamble between who will ultimately be more successful; the central banks or the deleveraging process. Ill put my money on deleveraging with tactical moves into inflation. The Bernanke 2% inflation put was the war cry of a toothless tiger. You don’t play your hand like that until you have no aces left up your sleeve.

The reason why central banks will fail in the end and really have already failed is quite simple; at some level people just don’t want any more debt. When a man goes out drinking there is an inevitable point where the goodness of drinking shifts into a downward spiral of greater drunkenness. At some point he wants no more to drink and even ‘free’ alcohol cannot entice him to drink. This is called saturation. We are at this point with debt. People have no confidence in the future so don’t want to borrow on it today in case the future works out worse than the present. This is really a simple point and no amount of zero interest rates and quantitative easing will change this psychological mind-set.

So the current reality reflects this psychology. Everybody is sitting on cash waiting for a brighter day whilst the velocity of money slows down. Corporates are sitting on record cash but won’t invest for a lack of clear opportunities. At the same time governments are implementing fiscal austerity to cut their own spending as they are short of cash. Now something is amiss here. Doesn’t the government print, own, authorize and back the money supply? (Eurozone aside.) How can they not have enough of it?

Fiscal taxation and spending simply taxes productive uses of the currency and redistributes these currency units to non productive or public entities in turn are supporting the economy (Hospitals, roads, power grids). The government make up the rules. So claiming you are captive to ‘the market’ and ‘living within your means’ is a fiction. You control the money supply, the laws and the tax code. You are free to do as you please.

Now I am not advocating simply printing more money. This clearly isn’t working because the money being printed is not circulating in the economy anyway because either the banks (transmission mechanism) don’t want to lend it or the people don’t want to borrow it. The money supply is irrelevant if it is not circulating.

What the government should consider is that it has a pair of balls and therefore can do whatever it wants.

I think in due course persistently high unemployment will start to outweigh all other considerations. The social costs are too high. The government may start to realise that the entire mechanism for monetary exchange has broken down. At this point we can expect lots of unconventional measures to try and jump start the process.

I wouldn’t be surprised to see big tax grabs on corporate cash piles. What is occurring at present is the entire system has failed and it is now eating itself. Corporate margins are high and corporates are in rude health buying back shares, cutting costs (cutting jobs), merging and acquiring (cutting jobs), paying dividends, paying boards and hoarding cash for rainy days. Due to an artificially low cost of capital and relatively high cost of wages corporates fire employees and mechanize. This is a vicious cycle because every job cut means fewer consumers and more rainy days.

Other measures governments can consider because they make up the laws; (i) Make all commodity ETFs illegal and all physical holdings of gold illegal. This forces capital back into productive uses instead of ‘store of value’ trades and reduces inflation globally (ii) Tax wealth instead of income. Taxation on estates and property holdings would encourage consumer spending by raising the disposable income of poorer working people who spend money instead of rentier asset squatting which is currently encouraged by many tax codes (iii) Back ‘reunionization’ of employees across the private sector or create new unions for them. This would allow employees to start negotiating higher salaries at the expense of corporate margins. At most marginal rates of tax employees pay more tax than corporate so the government improves its tax take and the employees improve their take home pay. Just a few politically unpalatable ideas which might become more savoury as the economy sours.

Corporate behaviour is all rational at the micro level but at the macro level the end game is one giant mega merged super company which owns all the productive industry in the world, employs nobody, has a huge pile of cash and a very well paid board and a legion of unemployed proles. Before we get to this point I expect the government will start forcing corporates to spend. Or otherwise upping the tax take from them and spending the money themselves. The problem is they need to do this in a globally coordinated fashion and/or with capital controls because otherwise corporates just relocate to tax havens.

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