When The Music Stops : How To Call A Bubble



In the beginning, there was virtue. Adam Smith’s Economics postulated that free markets would, in the medium term, automatically provide full employment, as long as workers were flexible in their wage demands. Keynes, however, improved upon this (at least in the conditions succeeding the 1929 depression). He instead argued that aggregate demand determined the overall level of economic activity and that inadequate aggregate demand could lead to prolonged periods of high unemployment. According to Keynesian economics, state intervention was necessary to moderate “boom and bust” cycles of economic activity. Keynes advocated the use of fiscal and monetary policies to mitigate the adverse effects of economic recessions and depressions.

Declaimer: This article was originally in August 2017, and some of the data points may be outdated

Why do children need sugar-coated medicines almost any human being prefers cough syrup to a colonoscopy. Keynes was the ‘good bartender’ who offered another 3 pegs of booze to a client already down with 4 pegs. He offered gin to get over a whisky hangover. By definition, a recession happens when there has been bingeing, an excess of froth in the real economy. Excess debt, excess capacity, and excess (market) valuations are the result of this bingeing, and inadequate demand (to absorb the excess capacity) is just the result of this economic bingeing.

Looking at it from the opposite angle, there is ‘inadequate demand’. Some of the ‘inadequate demand’ is from cyclical factors, such as inventory overstocking, while some is structural, because of excess production capacity. So “here come the US Marines”, Keynes brought in this doctrine of sending in government expenditure to shore up this ‘inadequate demand’. Actual cheque-writing was called fiscal policy and dropping the cost of money (so that credit-fuelled demand could be stimulated) was called monetary policy.

Why did Keynes catch the eye, and why is he still worshipped like a God, in the Puja Ghar of every government economist? Because he kinda prescribed vodka to cure alcoholism……and given the normal governmental proclivity for ‘intervention’, this was manna from heaven for the average politician.

Every human being is pain-averse, so it is not difficult to understand the public demand for the government to ‘do something’, and for any populist politician to be seen ‘doing something’ to roll back a recession. Keynes’s Theory fed into this proclivity of human beings, more than any actual insight that brought the world back from recessions. Like a medicine for viral fever, you recovered in 7 days if you took it, and you recovered in a week if you didn’t take it.

The actual recovery from recessions, even depressions, was the usual human initiative and ‘animal spirits’, but now the credit for such recovery was taken by a loud lobby of government bureaucrats/ economists, who decided that recovery was driven by them ‘doing something’. An entire vested interest developed, the economist-politician nexus that became a votary of government intervention in economic (mis)management.

To be fair to Keynes, he did prescribe that in better times, the debt had to be paid down. This was observed in the breach, like a drunkard who was prescribed a tablet with a peg of red wine. When the Doctor came by to ask, he was a few days behind on the tablets, but months ahead on the wine. Governments may be quick to announce and launch the ‘make-work’ programs but are mostly a few recessions behind on debt repayment.

After The New Deal, Franklin Roosevelt even changed the methodology of GDP calculations to include government expenditure (something that had been left out from Adam Smith’s time). This,  together with the introduction of the Fed, completely changed the nature of economic activity in the 20th century. And it is these 2 changes that are coming to haunt us as we go into the economy of the 21st century. Adam Smith’s objection to including government spending came from the fact that it was double-counting: we take money from the taxpayers and redistribute it among the general population, a different segment perhaps, but it is double-counting.

So thence we came to QE, originally called Deficit Financing, and the idea of Budget Deficits, funded by money printed by the Fed. And slowly, the world started slipping off the Gold Standard, linking itself to the “Dollar Standard”, a chimera, since the Dollar’s link to gold was continuously becoming tenuous. Until, the entire fig leaf of fiscal probity was dropped in 1971 by the redoubtable Richard Nixon (often, I find his name mentioned more for this chicanery than the personal one). When the Dollar lost the gold link, the world moved to ‘fiat currency’, i.e., it was left to the will of the Central Bankers of the world, who were mostly linked to the Dollar, and kept their reserves in Dollars. So that made the US Fed the keeper of the value of the world’s sweat. With Greenspan, the guardian of the world’s (fiscal) chastity turned into its rapist.

To the current situation then. False money printed has been used to make false jobs, producing things nobody needs. It goes into Social Security, keeping some old people alive, who do nothing for themselves or anybody else. The freshly minted money is given as debt to the government, which spends it as above, and this money is sloshing around in the economy. If the economy is still not growing, it is simply because people who are getting that money, are not spending it. And they are putting that money into assets, which are inflating. Since only the richest and most educated few are active in financial markets, the concentration of wealth is reaching historic highs, creating this ‘1%’ problem. This is slavery of a different kind, where the power to drive human behavior is getting so concentrated in the hands of the financial elite that it has created a ruling class that is driven by stock prices.

But wealth does not drive economic activity, income does. So you have rising wealth and stagnant income, and most of the increase in income (nearly 80%) can be traced to the increased wealth. In Ricardo’s terms, of the 4 factors of production, capital takes away most of the gains, while labor and organization are left with just a small slice of the cake. So you have stagnant economies sitting on gargantuan heaps of wealth, creditors to the world’s biggest debtor, the government.

Purists, adherents to Adam Simith’s original ‘Moral Philosophy” are appalled at this immoral state of affairs. This is the Biblical “Fat Of The Land”, Sodom & Gomorrah’s fate befalls those who live off the fat of the land. Something like that might happen, and it does not need divine intervention. In India, we have Modi-nomics, which has smartly and systematically targeted the 1% (demonetization, GST, cashlessness, the Aadhar economy) to redistribute purchasing power to the poor.

From what we know about wealth distribution, this will only be a temporary setback to the 1%. Yes, the bearcat-politician-babu will lose economic power, but a new elite will rise to the top, and stay there. Financialization is a worldwide trend and unless this pyramid of paper assets that sits atop the real economy is unraveled, it will sweep everyone into the vortex of the coming cyclone.

So now, 80 years after FDR’s New Deal, we have fake money driving fake economic activity (the make-work programs and subsidizing zombie banks), which gets measured as ‘growth’, justifying further taxes on real economic activity. This padding of the numbers hides the real problem and prevents even the recognition of a solution. Economies are driven by private enterprise when people make products/ services that are needed by real people. Consumption driven by free credit, or by direct government fiat, is not economic activity. As we go deeper into this surreal reality, we will start to accept this as the real thing and order our priorities to meet this new world order. Instead of figuring out how to produce things for others, better and cheaper, we have our youngsters now spending time figuring out how to get onto this new gravy train spawned by the “wealth economy”. Any change in wealth is seen by the money management industry as income, of which they get a part. And since this change in wealth is transitory, ending when the music stops, the only one who gets to take any money home is the financial services industry.

The continuous issuance of artificial money, which has led to the continuous feeding of asset bubbles, has to stop someday. Nobody has seen this stop, so nobody knows what will happen thereafter. The last time the music stopped, we had a World War. Just saying….!!!



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