Living on stolen time
Consider a flame; a jet of methane, for example, injected into an oxygen-rich atmosphere and set alight. Now try to describe the shape and structure of the flame mathematically, in a way that will allow you to accurately predict how its shape and structure respond to changes in various conditions—oxygen concentration, gas pressure and so on. You will quickly discover that the mathematics of the problem can be derived from basic physical principles but is intractable: there are equations that accurately describe the situation, but they are too difficult to solve. Often the easiest solution, one that is practical in the case of a simple gas jet, is to build a physical model or a prototype, test it, and make some observations and measurements that characterize the system. But what if that's not possible? Then the usual recourse is to build a computational model that simplifies the physics in various ways and brute-forces the solution by crunching through lots of numbers.
Now consider that same flame again from a slightly different perspective: what's actually going on? Yes, the character and behavior of the flame are difficult to characterize and predict with great accuracy, but suppose you already know what a gas flame looks like, and just want to know what it is. Here, the equations are simple. First, methane oxidizes to carbon monoxide, hydrogen and water vapor, giving off energy (heat and light) in the process:
This is quite typical of how we go about explaining just about everything we encounter. To understand the flow of traffic, we think about individual vehicles and the interactions between them. To understand epidemics, we think about the course of the disease in individual patients and the spread of infection from patient to patient. To understand how an industrial chemical affects an ecosystem we look at its effect on individual cells in individual organisms. We take a specimen, study its behavior, and extrapolate it to the population as a whole. This approach gives at least the illusion of explanatory depth; more importantly, it often allows us to establish cause and effect relationships and, based on them, make constructive changes that decisively influence the outcome: impose speed limits, quarantines and environmental regulations, respectively.
Let us try to apply this same approach to a truly complex system: the economies of US and Europe, in the state in which we currently find them: raging government deficits, staggering levels of bad debt, continuous government bailouts and infusions of free money by central banks, record levels of poverty and long-term unemployment and underemployment, and a lack of any meaningful economic growth. Specifically, let us try to characterize the effect of the continuous monetary infusions, bailouts, and stimulus spending. The economics profession has failed to do this and so amateurs are forced to step into the breach. The economists' usual excuse is that it's all very complicated; sure it is, so is a gas flame.
All money is debt. It is created when someone takes out a loan, promising to repay it (with or without interest) with proceeds from his or her future labor. If that promise is broken, the money ceases to exist. In the normal course of affairs, the lender then “loses” the money. If the lender loses more money than he happens to have, then the lender is bankrupted and, economically speaking, ceases to exist as well. What happened during the financial collapse of 2008 is that the real estate bubble burst and many loans went bad at the same time. The response was not to liquidate the lenders who lost more than they had, but to prop them up by issuing further loans that were not supported by any specific mechanism or realistic chance of repayment—just the compulsive thought that big financial organizations must not be allowed to fail because that would irreparably damage the system. Propping up bankrupt institutions by issuing fake money (or, more precisely, fake debt) has been assumed to be less damaging to the system than doing nothing.
This assumption would perhaps have been justified if the financial difficulties were, as was once thought, temporary in nature, that the economy would roar back to life and growth would resume. Now, three years later, we find ourselves back where we started, and this assumption no longer seems tenable. It is not clear why growth should resume, as many factors, persistently high energy prices among them, continue to weigh it down. We shouldn't bet on any more economic expansion, at least not in the developed world. As Richard Heinberg argues persuasively in his latest book, The End of Growth, growth has reached its limits, which are both numerous and insurmountable.
There is a plain and simple distinction between the two kinds of money: real money, which was lent into existence with a specific and realistic promise of repayment by a specific party, and fake money, which was dreamt into existence by a central banker without anyone specifically promising to repay it. Suppose a person walks into a grocery with fake money in his wallet, and buys something. This is no different from paying with counterfeit money: the grocer is getting robbed. But there is also a difference: the officially issued fake money is indistinguishable from real money. But just because you can't spot a fake doesn't mean that you aren't getting robbed. And so the fake money mixes with the real money and sloshes about the economy, robbing each person who touches it, until everybody is poor. Since poor people can't pay back big loans, the central banker's conceit that the fake money is debt seems rather unjustified. It is owed by the central banker to the central banker, and it would be foolish of us to expect him to ever work it off.
I am using the word “robbery” here not to indicate moral indignation or feigned umbrage, of the “I am shocked! Shocked to find that gambling is going on in here!” variety. I might even say that sometimes robbery is justified (“expropriation” or “commandeering” are its more polite, civilized variants). I am using it because the trick—paying with a fake—is an obvious one, and the result—the robbed party becomes poorer—is obvious as well. And so whether it is a retiree spending his deficit-financed social security check at the dollar store or a banker spending his bailout-financed bonus on lavish gifts for his trophy girlfriend, or a construction worker drinking his economic stimulus-financed paycheck at the bar, somebody somewhere is getting robbed—and becoming poorer.
Rest assured, I am not advocating letting people starve or forgo beer or anything of the sort. A warm bed and three squares a day is, to me, a human right. I am not interested in policy (nor are policymakers interested in me). But I am interested in making a specific prediction: that government and central bank efforts to stabilize the financial system and restart economic growth will do the exact opposite: they will destroy that which they are trying to save more completely although a little bit later. They are living on stolen time.
The alternative (in case policymakers suddenly decided to pay attention and were capable of taking on board such a radical notion) is a jubilee: full repudiation of all debts public and private and a ban on all repayments, repossessions and collection activities. This would force a full shutdown and cold restart of the financial system. But it will probably have to happen anyway. In the meantime, do your best to avoid getting robbed.