This is sub-chapter #13, of Chapter #4, Economics, of my ongoing rewrite and open editing process Random Rationality: A Rational Guide to an Irrational World. Would greatly appreciate any feedback, corrections, criticisms, and comments. If you want the MOBI, ePub, or PDF, then please let me know in the comments—if you provide constructive criticisms in return, and live in the US, UK, or EU, then I’ll ship you a paperback copy of the book free of charge when it’s published.
INFINITE GROWTH FANTASIES
Keynesian economics, upon which most public economic policy is based upon (despite it being a distortion of what Keynes himself stipulated), carries with it, in the hearts and minds of our politicians and central bankers, an illusion of continuous economic growth year upon year. These public officials believe that government intervention only results in prosperity, and that without growth or government intervention, big problems will abound—the latter being true, but only within this model they have created for us. This is not the width and breadth of Keynesianism, but it’s all we need to dissect to realize its futility.
We’ll get into the ridiculousness of the infinite growth fantasy in a little while, but first let’s go over a few things; such as where money comes from, fractional reserve banking, why governments are bailing out the big banks, and why growth is so vitally important in today’s economic model.
Money, as I’m sure everyone knows, doesn’t just pop out of nowhere. Before we had the printing press and Wall Street, we used gold, silver, and various other tangible goods such as tea in Siberia or cheese in parts of Italy way back when. Though they differ to todays fiat standard, as they are naturally occurring and unable to be created at will.
Once the printing press arrived and we moved to the modern incarnation of the fiat standard at the beginning of the last century, we had to have a limit on our ability to create this money, otherwise what was to stop the printing rendering the value of its own money worthless (inflation)? The era of debt-based growth was born.
The modern economic debt instrument was born out of a need to put a limit on how much money could be put into circulation. For a government or private bank to borrow credit from the central bank, it had to be borrowed at interest, whether that interest was one-percent or five-percent made no matter.
So what effect does this interest rate have in restricting the money supply? As we all know, a loan has to be repaid eventually, so you don’t keep taking and taking: the principal and the interest. As the more astute among you may have figured out by now—I didn’t until it was shoved in my face—is that the principal plus interest is greater than the original loan amount of just the principal, and since all money can only come from the central bank, the amount to be repaid is always greater than the amount of money in the economy.
Compounding this, private banks that borrow this centrally issued credit can re-loan and multiply that credit via the process of fractional reserve banking to citizens and private businesses at further interest.
Fractional reserve banking works on the premise that not all people need access to their money all the time. So the bank loans out ninety-percent of your money to other people and businesses while you keep it parked in a savings account—this is where your interest comes from, other people’s interest repayments. This theoretically allows the efficient use of money to expand an economy, and is also why a run on a bank ends in bankruptcy of the bank, as there isn’t enough money to cover all the deposits. This is where confusion sets in as the average person sees terms such as M1, M2, and M3 bundled about in reference to this. Let me briefly explain them: M1 is the total amount of cash/coins outside the private banking system (there is also M0 which includes cash/coins inside the banking system), plus travelers cheques and other checkable deposits. Then there is M2, which is M1 plus savings accounts, money-market accounts, and some term deposits. Lastly, there is M3, which is M2, plus all other term deposits, institutional money market mutual funds, though M3 has not been used in economic analysis since 2006.
As they loan out part of your deposit, the new loan holder deposits his or her new money into another bank account, where it is regarded as an increase in the money supply (M2). This is called the money multiplier effect and is used as one of many signals in assessing the health of an economy. It is theoretically possible to turn $10 into $90 (not that the limit is always reached), which is a reflection of added credit into M2 over M1. (Only central banks can add to, or subtract from, M1 as that is minted cash and coins, and not electronic cash which a bank can create.)
When the money supply is being multiplied, the economy is seen to be expanding, and when it is not, it is perceived as contracting. This is why in a lot of recessions, money seems to disappear, it actually is disappearing. This is also why wealth has become extremely consolidated in the 1%. The fiat system is literally, accidentally or not, a way to funnel money upwards. The poor pay off their loans for their entire lives, while the rich park their money into savings accounts, and the interest from the lower and middle classes flows into it. Of course, they are good economic reasons to do this, but it is easily abused.
Generally, this system works well if left to its independent vices and machinations, as even the money multiplier effect only comes into effect when new businesses and consumption is required, but it can’t work forever, especially with the human desire to meddle. Since the dawn of time, people have always tried to bend their surroundings to their own will, and this may help you to understand why politicians and bankers manipulate the system to favor their friends, donors, and families—worse still, this susceptibility is actually magnified in a position of power, where they delude themselves into believing they deserve such power. (This probably explains why there are so few good politicians, and why politicians are caught, figuratively and often literally, with their pants down.)
The number-one abuse (or distortion) is the bailout system, even when given as a loan. Inflation has a twelve-to eighteen-month lag time once new credit is introduced into the system and all other currency units are affected. So the big banks that get bailout money are essentially getting a portion of it for free (if it isn’t free to begin with), and can turn around and use it to pay down debt, buy smaller banks, etc., before the inflationary effects of this new funny money erodes the purchasing power of every other currency unit in circulation. By the time it has circulated its way to the lower classes, it has lost some of its value as prices have risen while wages have not, hitting the poor especially hard.
The monetary system isn’t fair by nature, and that’s normal because life isn’t fair. Not all lions will be the head of a pride, not all trees will receive the same quantity of sunlight, and some Gazelles are unlucky enough to feel a cheetah’s jaw clenched around their necks. Some people are tall, some have brown eyes, others blue, and a few are born in rich countries, while most are born in poor countries. Nature isn’t fair, and since we are a part of nature, neither are we. (Though we are gradually overcoming this bias, but we shouldn’t try to do it via economics, more on this in Technology.)
This cruelty, if you can call it that, is part of the diversity of life, and without this diversity there wouldn’t be any life to begin with, since diverse conditions are what allowed for the formation of life, and its continuance is an underlying driver of evolution, never allowing the rot of stagnation to creep up. Fairness is not an inherent quality of nature. Although this extra kick in the face to the poor and middle class in a fiat currency system is a step beyond Mother Nature’s system of fairness, which begets change and freshness of ideas through diverse and unequal opportunities. It amounts to a cruel joke making the poor poorer and the rich richer in a system rigged beyond necessity to the upper echelon, and as history has shown us, is one of the biggest contributors to social unrest and revolution, and that’s where we are now. A recent study out of Cambridge has correlated the price of food, as the foundational issue (affected by politics, regulations, and inflation) which has instigated riots all over the world, most evidently in the recent Arab Spring, allowing them in a sense, to be predicted. (It was first published four-days before the start of the Arab Spring in Tunisia.) The study stipulated that when the price of food, by the FAO food prince index is above 210, conditions are fertile for social unrest (Of course, there are dozens of other factors that people will point to; such as freedom, censorship, jobs et al, but a hungry public is, in the words of the lead economist Bar-Yam, leads to the “range of conditions in which the tiniest spark can lead to riots.”)
Moving on to necessity of growth, there is a very specific reason that economies must constantly keep growing. Recessions happen when economies stop growing, or contract due to burst bubbles.
Here I must briefly digress. Sometimes central banks try to preemptively boost the economy in anticipation of worsening economic indicators by lowering interest rates and encouraging increased borrowing, but it only delays the recession, as the new funny money creates a further misallocation of capital, which requires a recession to fix (a bigger one now) than would have otherwise happened. The reason why is it gives false signals to businesses, imbuing them with a false outlook on things like consumer confidence and spending. Lower interest rates allow riskier projects, many of which, in the false environment, are more reliant on increased consumer confidence, and when the delayed recession hits, results in more money lost if the new project/s, contingent on a false outlook, breaks down. In this way, government, or central bank intervention, only delays and intensifies the problem. Just as we saw before with drugs, making them illegal only pushed the market underground and squeezed its undesirable effects invisibly onto a smaller subsets of the population, with larger negative ramifications for all.
This is why governmental intervention into an economy is a drag instead of a boost, as Keynesians boast. How could it be anything but? The politically connected rich get free money, while the purchasing power of the poor and middle class erodes. So left-leaning parties try to redistribute tax-money to the poor to compensate for the rising inequality, coupled with the inefficiency of the government wasting a portion of it. Simultaneous to this, increasingly, money is consolidated in the upper classes vis-a-vie interest, thereby restricting honest economic opportunities for the middle-class and poor, making them dependent on the handouts, which elevates the party politics of handouts for votes, and making the situation ever worse—and round and round the Ferris wheel we go.
The reason that an economy needs to grow is so that new credit can be issued and circulated throughout the economy to pay down the debt of the old credit. Every currency unit in every economy is owed to someone by someone else. So if you have no growth, when loans come due, there is not enough money to pay them down. You must always borrow more new to pay down the old. Depressions happen otherwise.
The Great Depression is the only recession in modern history in which the central bank restricted the money supply thereafter (note that they didn’t do nothing as they should have, but restricted), and the American poor welcomed with open arms the thirty-percent unemployment that came with it. This action, coupled with many other government interventionist policies at the time: confiscation of private property such as gold, constriction of money supply, new tax increases, and a plethora of regulations increasing business uncertainty and thus their reluctance to hire and expand workers, coupled with extreme investor uncertainty, exacerbated the situation and turned what would have been a normal recession into the Great Depression. Gross Private Investment during the thirties did not reach pre-depression levels until 1946-1950. In fact, from 1930 to 1940, net private investment was negative $3.1 billion. This is why the money supply must always grow in order to pay down the old debt, whilst still having an increased money supply—and Keynesians today boast the government saved us from the depression! As the economist Benjamin Anderson wrote in 1949, “The impact of these multitudinous measures—industrial, agricultural, financial, monetary, and other—upon a bewildered industrial and financial community was extraordinarily heavy.”
Finally, we arrive at infinite growth. Most economists’ wet dream is continual five-percent year-on-year expansion, and since humans have the funny habit of thinking that they live at the apex of civilization, especially those of us in the West, as a result we tend to project that our institutions and economic models will be around for all time. So let’s play with the numbers of compounded economic growth and see what happens. The results will definitely surprise you.
For the following example I am going to use two-percent year-on-year growth. Just try to imagine five-percent growth. (Hint: it will be an exponentially higher exponential increase.)
If we had an economy of $1,000,000 at the time of the crusades, approximately 1,000 years ago, and it grew at two-percent compounded year-on-year. Today, that economy would have grown ‘5,368,709,120,000’ its original size. Remember, this is an economy only 0.00000015% of current world GDP (approximately seventy-trillion dollars). I’m afraid to even run the numbers for today. That’s a five-trillion percent expansion. Today, that seventy-trillion dollars of global wealth is supported by just three-percent equity.
Compound Growth Methodology:
To arrive at that number, you take seventy and divide it by the percentage growth per year, in this case two-percent, so seventy divided by two gets us thirty-five; this is logarithmic math and beyond the scope of this chapter to discuss, but it’s can easily be googled. Therefore, at two-percent yearly growth, the economy will double every thirty-five years. One-thousand years divided by thirty-five doublings means that the economy doubles 28.6 times. Then it’s a simple matter of algebra.
Just to further nail the point home, the following is from an essay by Jeremy Grantham, a hedge fund manager with $97 billion in assets. The scenario he describes is a fictional re-telling on what would’ve happened to the ancient Egyptians if they’d had the same economic fantasy as us.
“Let’s try 1% compound growth in either their wealth or their population. In 3,000 years the original population of Egypt —let’s say 3 million—would have been multiplied 9 trillion times! There would be nowhere to park the people, let alone the wealth.”
Raise your hand if you still think we are at apex of human civilization? The very way our economy is designed to work ensures that it either destroys us, or the planet, or both. Though more likely, and luckily one might say, is that it simply fails before either of those scenarios takes place. This model guarantees eventual failure: that’s how not smart we are.
Both Option Status Quo and Option Yes We Can stand in stark contrast to reality. As it stands today, we are reaching the limits of this economic expansion. That’s why, one way or the other, the current status quo of bailing out the banks with taxpayer money is only going to hurt us in the end, and the banks are still going to collapse eventually. So…what’s the point? Why not just reset the system now and save us all the bother. This Keynesianism of public policy is delusional. When people talk about having—or needing rather—a sustainable economy, how about we listen to them instead of calling them tree huggers. Our future well-being depends on it. Without economic well-being, nothing else matters. (Note, this does not mean big numbers in a bank account, but the real, productive capacity of a society to make food, deliver clean water, build shelters, and everything else that contributes to well-being.)
“Depressions and mass unemployment are not caused by the free market but by government interference in the economy.” ~ Ludwig Von Mises (Economist)