Central Banks Exacerbate Economic Imbalances
Government control is becoming increasingly absolute, moving the economy away from the productively optimal level to its own view of the world. Imbalances are piling on at every level to pay for this, borrowing growth and now output from the future.
Beyond direct government spending, the ECB, for example, sets the price of money, around which all other prices and volumes are determined, and, through its balance sheet, controls 53% of M3 money supply. It determines what banks can hold as capital, directing money into funding government borrowing, and, through reducing the regulatory risk weightings of relevant assets, it is set to steer an increasing proportion of bank and insurance funds into renewables, which, given they are uneconomic, will require further base monetary expansion or increasingly negative rates and government control to underwrite.
Through raising asset prices relative to GDP, the government has raised the age at which the young can afford a house, pushing back when they can marry and have children, reducing fertility rates and altering the demographic.
Until the system clears, which I believe we are still a long way from, the economic and social distortions, and the imbalances and cost supporting them, are going to become much more extreme. Real yields will become increasingly –‘ve with base monetary expansion bridging the gap to more unproductive spending and output.
As highlighted in Hiding the Imbalances in Plain Sight, the reforms of the late 1970’s and early 80’s, which lifted U.S. real yields (10-year Treasury discounted by the spot PCE deflator) from a low of -292bpts in February 1975 to +935bpts in June 1984, reshaped the world economy.
The reforms were mainly in the private sector, preventing strikes, and Paul Volcker’s raising of interest rates to target and price out zombie production and thereby lower the effective cost of capital to the remaining productive players. This allowed the development of North Sea oil, for example, reducing the Middle East’s share of world oil production from about 37% in the mid-1970s, when it held the world hostage, to just 18% by 1985.
By restructuring the domestic economies, it also forced change at an international level, famously breaking the command economy of the Soviet Union by outcompeting it, opening its markets and labour to be developed and used more productively. Similarly, it raised the economic and political cost of the Chinese Communist Party, whose control started to be eased, opening the country up to subsequent growth.
Unfortunately, from the high real yield point in 1984, rather than pressing on with the restructuring, policy was quickly relaxed.
The Plaza Accord devalued the dollar 40%, Reagan and Clinton dismantled the anti-monopoly laws, and through his change of trade policies, Clinton opened the door to global monopolies, often with state backing, while Greenspan and his successors lowered interest rates to carry the growing imbalances, with the result that U.S. 10-year real yields are rapidly approaching the 1975 low.
The Middle East’s share of oil production has steadily climbed back to an average of 33% over the past 5 years, and I would argue is set to move significantly higher. Viewed in this light, the recovery in real yields in the late 1970s and early 1980s was a cyclical correction in a much bigger structural decline, which becomes obvious when you realise that the system of unlimited government is the imbalance that must be cleared, which instead, has been growing all around the world.
The U.S. Ten-year real yield, discounted by the spot PCE deflator, was recently -236bpts, the worst since mid-1975. The index linked real yield, which discounts the nominal yield by the bond market’s own 10-year inflation expectation, was a record low -122bpts. U.S. debt and broader measures of liabilities (or assets) are at the highest level relative to GDP since Bloomberg records began in 1947. Federal debt relative to GDP is the highest since WWII, and based on U.S. Congressional Budget projections, set to reach new record highs over the next few years, and unsurprisingly, other than a peak in WWII, U.S. total government spending is a record percentage of GDP. U.S. inequality is also the highest since the 1920’s, not only reflecting the unproductive allocation of capital, but also, as one would expect because of the accounting identity, causing it.
World energy production growth is the slowest since records began in 1900, worse even than the 20’s and 30’s, indicating that any economic growth beyond that is from degrading the internal energy gradient, such as from the aging of capital stock, and is therefore unsustainable. Whichever indicator you look at, the imbalances or unproductive allocation of capital relative to GDP, and the government control driving and sustaining those imbalances, are at or towards extremes.
This means that the economic, social, political and geopolitical risks are also towards highs, and based on record unfunded liabilities, a deteriorating demographic, the commitment to renewable energy policies and the prospect of peak oil, are set to get a lot worse. The positive is that once the system does eventually clear, there should be an “economic miracle'' similar to after WWII as prices are allowed to find their own levels, shifting from government dictate of what something is worth to productively optimal levels, but this can only happen once the imbalances are cleared.
In the late 1970’s and early 80’s, faced with negative real yields and the economic weakness that resulted, Volcker could have cut rates to soften the immediate blow from high oil prices and the consequent negative real yields, thereby supporting the imbalances at the expense of the productive economy. Instead, with the Fed’s new inflation mandate, he chose to raise rates, thereby focussing the economic damage on the imbalances.
Whilst I would argue we are in a bad or worse position today than back then, the Fed is far more likely to cut rates over the medium term rather than raise them, adding to the imbalances rather than clearing the system of them. This will be both at a domestic level, but also at an international level. I would further argue that, as the power is in the hands of the asset rich, they will use that power in support of themselves via further asset price inflation, and concentration of that wealth and power, which will mean taking interest rates negative.
Just as Nixon was not going to be held back by Bretton Woods and the discipline the gold linked standard provided, neither will today’s government be held back by the zero bound, which will become circumvented by digitising the official currency.
At a system level, all inputs and outputs are an identity. This means that the cost of production is equal to the value of what is produced. Allocating capital otherwise, such as for “social justice” reasons, will always be at the expense of reduced capital and lower GDP. By taking capital away from where it is produced and deploying it unproductively, it is a path to the lowest common denominator. It takes away from individuals their property rights, including their personal God-given gifts and individuality that they were endowed with, which is unforgivable, and by destroying capital and lowering productivity, it also takes away from society as a whole, making the world a much less rich place in all senses of the word. A monopolist’s profits are defined as revenues paid to factors of production in excess of the productivity they are generating, the perfect definition of the misallocation of capital.
This same definition would also apply to government policies that, directly or indirectly, move production and consumption away from where it is produced, and therefore away from where it would optimise productivity and utility. This is to be expected as the only reason for unlimited government is to allocate capital other than how it would optimally be produced, making it the ultimate monopoly. Whilst policy objectives may be to offset other unproductive and therefore unsustainable allocations of capital, as they can only be the result of a managed system, rather than government policies clearing the imbalances, they carry them.
Creating an unproductive dependency between the government and the electorate, the policies can only be sustained by adding more imbalances, and more control.
By taking capital from a productive part of the economy to finance unproductive spending, the government creates a secondary imbalance where it has taken the capital from, as, without it, maintaining its production is dependent on extracting capital from another part of the economy in what is called the Road to Serfdom.
The time delay between the capital being taken and the output falling is because we immediately revert to consuming down any reserves of capital, shifting from degrading the external energy gradient to the internal one. This can either be specific to the place where the capital has been taken from, or more likely from the broader economy as the system optimises within the new constraints, by changing the terms and quantities of trade. This creates a positive cash flow from, for example, underinvestment and letting the remaining capital age further, until eventually the cost of additional maintenance exceeds the value of what is produced, at which stage the maintenance can no longer be afforded and output falls.
The loss of capital is cumulative, with its growth initially decelerating, represented by positive but falling real yields, then the stock of capital peaking as the real yields fall to zero, and finally the loss of capital accelerating as the real return on capital goes increasingly negative. The cash flow that is released from the increase in debt relative to GDP is at the expense of future output, either lower growth if the real yields are positive, or a sharper fall in GDP if the real yields are negative.
This also means all outstanding imbalances are dependent on the next imbalance, including more extreme leaders, without which they would all clear in a catastrophic event. The only way to sustain them is with more imbalances, so if you cleared the system of 10% of the imbalances, the remaining 90% would be dependent on starting the process again, in a system of self-dependency, explaining much of the history of the 20th Century from the formation of the Fed onwards, and indeed to a lesser extent, going back further. This means that the government’s role should be limited to codifying the natural law into written law, and that any other role should be done by the market optimising the allocation of capital. It is only through zero government, removing its “truths'', or distortions to fundamental values, that we can understand that government is the problem.
Unfortunately, until we have such a system, the unproductive society will only tolerate politicians such as Margaret Thatcher and military generals such as George Patton for a very limited time to do the minimum that is necessary before it turns its backs on them, because to reward them otherwise would be to reject the unproductive society of which we are all part, highlighting the dilemma we are in.
Catastrophe theory explains how small changes in certain parameters of non-linear systems can cause equilibria to disappear, with forces that were attracting now repelling and vice versa, leading to large and sudden changes of the behaviour of the system, which is why a lot of the big clearing events in the past are from the system falling of its own weight or from an external body forcing the clearing such as through a war, or with global imbalances, a world war.
Whilst these events can appear to come out of the blue, catastrophe theory reveals that such bifurcation events tend to occur as part of well-defined qualitative geometrical structures. To this end, it is worth remembering that the 5th energy law means that the most productive economic and societal structure is a natural hierarchy or trophic pyramid, and therefore movements away from that will create points of stress, which if one breaks, could mean the whole system is unable to sustain itself and implodes.
As the distribution of wealth and power has become defined by the unproductive allocation of capital, it means that those with the wealth and power are the imbalances, and accordingly, that we are being governed by the imbalances, although it should be made clear that these people don’t generally understand that they are the problem, instead believing that they are doing what is best. The only way for them to prevent the system clearing, and thereby maintain that unproductive wealth and power, which is not creating the utility to pay for itself, is by taking more control by adding more imbalances and destroying more capital.
This would also mean concentrating the wealth and power in fewer and fewer hands, so a growing inequality not just between the top 1% and the rest of society, but within that 1%. It would also mean moving money and assets further away from productively optimal values and mixes, destroying capital and reducing the number of competing products and assets.
Most obviously this means value stocks underperforming, even as the parameters that define them as value change with time. It also means that things like gold, which one would expect to outperform if the system were to be cleared of the fiat imbalances back to a more productive monetary system, and thereby a more productive distribution of that money and power, will continue to underperform until nearer that eventual clearing event, when the movement would be exponential. Lower interest rates can only support an increase in debt relative to the GDP backing it by reducing capital.
This means less competition, thereby not only concentrating wealth and power in fewer hands but also in fewer assets, companies, and products etc. To prevent the system clearing and adding to the imbalances, the wealth and power must concentrate into fewer hands, and in so doing, into fewer instruments and products, and importantly, fewer productive ideas, and less knowledge.
Expect more M&A, share buybacks and an increased concentration of global capex in fewer firms. In order to concentrate the power into fewer hands and fewer products, those with the power, and what they are willing to do with it, must become more extreme, as must the tools or products they use to do that. Through monetary, fiscal, and regulatory policy, and through its more extreme interpretation, the government will shape the economy to that end, which inadvertently, will lead us in one direction.
Unwinding the imbalances would necessarily mean taking power away from the asset rich, explaining their hostility to the challenge from Brexit and Trump, and the apparent divide between the political class and the workers. Whilst superficially the ruling elite were defeated, as both Boris Johnson and Donald Trump largely continued the policies of bigger government, the imbalances continued to grow, just in a slightly different way. Neither figurehead, nor I believe the movements they represented, understood the reason for the social and economic pain, and therefore their solutions were, at best, insufficient, and with the government trying to manage any pain from them, added to the imbalances rather than clearing them.
They were just a continuation of the decline. Nevertheless, the scale of attack against Brexit and Trump, and the defiance of the political class to the will of the people, gave a small clue of what is at stake, of what the cost of sustaining the imbalances will be in terms of increased government control, and what the eventual cost of clearing of them will be.
This has obviously been taken another stage further with the lockdowns and removal of free speech on the back of COVID, but as one would expect, along with that increased control has come increased risk as the policies, and politicians behind them, become more extreme.
Whilst no one wants to hear this, it is to be expected as the imbalances compound, and therefore the forces from those imbalances trying to clear, and from the government adding more imbalances to prevent that clearing, will become increasingly extreme, as history attests.
The imbalances are at every level, including at a global level. All systems self-order to optimise the degradation of the energy gradient within its boundaries or constraints, which in the economy and society’s case, are largely the government and central bank policies.
Over recent decades, these have resulted in the imbalance most obviously being in asset price inflation relative to the GDP that is backing it, shifting the wealth and power from a productively optimal distribution of workers, entrepreneurs, and owners of capital, to concentrating the power in the asset rich. It has also shifted production abroad, making some of the imbalances global, which, given that we are defined and governed by the imbalances, has given the impression of a global government or “Davos Man”, especially from the international conglomerates that seem to stand outside or above the national level.
Ultimately, however, the power still rests with the sovereign, for the time being at least, and at a higher level, the people, but importantly, they need to remember that and start exercising that power.
This means re-engaging with the political process, defining the political parties which have become totally divorced from the public they are supposed to represent. Whilst the public could take back power whenever it wants, simply by withdrawing its collective labour or consumption, as it would come at a huge expense, it will only do so when the costs of not doing so are high enough to make it worthwhile.
Until it does, the inflation will remain largely focussed on asset prices rather than end goods. In this sense, we can see the end goods inflation of recent months as an “investment” in this trade. By closing the economy and paying people not to work, the government bought the public’s support, but in doing so destroyed capital, reducing productivity and therefore real GDP.
Whilst some of that loss was through damaged supply lines and reduced inventory resulting in end goods inflation, as the record wealth relative to GDP attests, most of it has been in asset prices as investment, competition, small businesses, and productive jobs, and competing ideas and opinions, were the real sacrifices. Recent data showing record inflows into equity funds whilst monetary growth aggregates slow suggest a continuation of this trend.
Whilst there are imbalances at every level, from within society to the global level, all of which are points of risk, it is the overall control that must grow to prevent the system clearing. This means individual risks will go in and out of fashion depending on the government or economics of the day, but overall the imbalances, and therefore risks, must continue to grow.
Many people believe that inflation will rotate to end goods rather than remain in assets, which is certainly possible, but it would mean taking power away from those that have it, who would use all their tools such as media, lobbying, and taking capital and jobs out of the country to oppose such a move. Shifting the focus of the imbalances would also change relative imbalances, which would add to risks, and change counterparties to those risks, although that may be necessary to avoid the system clearing.
Ceasing trade with China, for example, would create a massive imbalance between its capital stock and consumption, unless another trading partner, or other use could be found to balance that, would inevitably collapse the economy and turn the public against the government.
Whilst similar damage would be done in the U.S. This highlights the risks of changing the terms of trade too abruptly, potentially resulting in the system clearing, which is why the government is not going to voluntarily make the change. Trump did obviously impose tariffs and China adopted its “dual circulation” policy which is creating stresses between both counterparts but are only moving the imbalances in a different direction rather than clearing them. It should be remembered, however, that every time a new imbalance is created, it will change the economics of all production, and therefore of all economic and social relationships, or “terms of trade”, so the risks mount up just carrying on in the same direction.
People also believe that end goods inflation would clear the system, but as inflation is always monetary, and more specifically, monetary growth in excess of the productive demand for money, whilst it would change the location of the imbalances, it would still add to them rather than clearing the system of them. The only way this would not happen is if the money within assets rotated back to end goods in more productive ratios, i.e. the system cleared, which can only happen if the price and quantity of money were cleared of government control and started to be priced productively, which is a long way from happening.
Although a rotation into end goods inflation could easily be engineered, a productive rebalancing cannot happen if money supply is expanded faster than the productive demand for money, as it would add to the imbalances.
Instead, the central bank is likely to take more control through central bank digital currencies and the “full money” systems they would inevitably lead to. The imbalances are in the real economy, and just changing how they reflect in the nominal economy, from assets to end goods, does not alter that they remain unable to create the real return to finance themselves and are therefore at the expense of capital destruction, and reduced real GDP. This doesn’t take away from the fact that, to prevent the system clearing, the central bank must continue to either lower interest rates, or keep expanding base money supply, which inevitably means moving towards a “full money” system.
The ECB already sets the price of money, around which all other prices and volumes are determined, and, through its balance sheet, controls 53% of M3 money supply. It determines what banks can hold as capital, directing money into funding government borrowing, and, presumably through reducing the regulatory risk weightings of relevant assets, it is set to steer an increasing proportion of bank and insurance funds into renewables, which, given they are uneconomic, will require further base monetary expansion or increasingly negative rates and government control to underwrite.
Whilst real yields are not yet at the level of the major clearing events of the past, and I wouldn’t expect them to get there for another 10 years, the risks are clearly increasing, and for the purposes of this note, it is the path to that point that we need to worry about. If real yields follow their trend declines to around -5% over the next 10 years, which I would suggest is justifiable by government policy, the literal interpretation would be a 25% fall in real GDP, similar to the Great Depression, highlighting the scale of the problems we potentially face.
This doesn’t just mean economic decline, but also changes in relationships between, amongst others, the government and the governed, which can be seen in many areas already. By increasing control and adding to the imbalances, governments are buying individual public support, but in doing so, socialising costs, and thereby de-skilling individuals and devaluing its people and society; the government is getting bigger, but devaluing its own currency.
By determining how capital is allocated, the government is not only defining the absolute and relative value of output but is also determining the value of each of us and how we relate to each other. This is at an industry and skill level, at an economic level, at a social level, at a demographic level; it is at all levels. The cost of controlling those internal relationships is loss of capital at an overall level, and therefore slower GDP growth and eventual decline.
Through the global imbalances, the government is implementing similar controls at an international level, for example determining what American and Chinese people produce and consume, but at a cost of overall loss of capital. For individual countries to protect themselves from these international imbalances, such as from competition from a state subsidised company, or one that has benefited from China’s one child policy reducing the cost of labour and investment, it would have to use capital controls to ring fence itself from the rest of the world, making it too expensive.
Instead, the imbalances have become global, which means any clearing of them, must also be global, either in terms of all countries reforming or the relationship between different countries changing, like after WWII.
Government control can be direct, but also indirect with new policies, like stones in a pond, sending ripples out that have impacts that could not be foreseen. The policies that resulted in asset price inflation, for example, have had many knock-on effects, but what original policies were they? I would attribute the asset price inflation to Reagan’s changing of the entire body of anti-monopoly law to protect the “rights of consumers” rather than of citizens, which was taken a step further by Clinton who also applied the same logic to foreign state monopolies.
This unproductive allocation of capital was then financed by Greenspan and his successors lowering interest rates, bridging the gap between the revenues paid to the monopolies and the productivity they generate, or between asset prices and the GDP supporting them with the consumption of capital and less competition, resulting in the monopolies and increased concentration of wealth. Some of the ripple effects – (the capital that has been consumed) - are that by raising asset prices relative to GDP, the youth have had to push back investment in housing, marriage, and children, reducing fertility rates and altering the demographic.
Unable to afford to invest in a family, the young have instead spent their money on entertainment, creating new markets and industries, such as in social media and gaming, which has become a channel through which much of the capital is being consumed in unproductive activities. By creating the initial imbalance, funding the sale and purchase of goods at a lower price than the cost of production, the government has not only created the overall imbalance, but changed relative prices and relationships throughout the economy, all of which would necessarily change if the system were allowed to clear. This could mean more or less of a product or changing how it is produced and what it is used for, but without clearing the system of government, we cannot know what the true value of something is because it is only by optimising the economy and society as a whole that we can optimise each relationship and thereby find out the real value of products, rather than the government dictated values.
Unfortunately, this means that many so-called experts, which are rolled out on news programmes and in the media to give opinions, and the bodies they represent, are just expensive echo chambers for the unproductive government philosophy, and therefore imbalances in one form or another. Given the feedback loop between the government and these experts, you can see why the imbalances keep compounding and why neither they nor the government can understand that they are the problem. Instead of recognising the problem, we should expect more of these bodies to be created, supporting bigger government.
By shifting things away from the productively optimal level, the government has been moving industry, economics, society, and politics away from science and hard reality to philosophy, replacing real capital and real wealth and wages that the science represents with soft ideas that do not pay for themselves. It is reversing the Renaissance and Age of Enlightenment to a form of political religion where “science” is increasingly used to reinforce the government’s explanation of the world. Without these distortions, government control beyond codifying and enforcing the natural law would necessarily decline, as it would be cleared as an unproductive cost that the economy could not afford.
To prevent the system clearing, the government must add to the imbalances, moving prices increasingly further from their productively optimal level, adding to risks. This doesn’t mean purposefully going and finding something that won’t work, but rather extracting capital from another part of the economy to sustain the existing imbalances, thereby further misallocating capital and adding to risk. To sustain the European Union’s goals on renewable energy, for example, the European Commission has stated that, as the scale of investment required is well beyond the capacity of the public sector, its main objective will be to channel private financial flows into relevant activities.
It will propose changes to bank rules so that environmental, social and governance (ESG) factors are core to managing risks on their books. Insurance capital rules will also be similarly amended. On the other hand, referencing audited accounts on the capital and operating costs of 350 of the larger onshore and offshore wind farms in the UK commissioned between 2002 and 2019, the report The Costs of Offshore Wind Power: Blindness and Insight, concluded that the costs of building and operating offshore wind energy per MW of capacity is rising to such an extent that the current set of offshore projects being constructed and planned in North Western Europe are closely akin to speculative property development.
They are high risk projects that will only be able to repay lenders and offer a return to equity investors if the average wholesale power market prices rise to at least three to four times their current level throughout Northwest Europe. Not only will government mandate private and public sector money into these unviable projects, but it will also then have to further socialise that risk to avoid the system clearing by taking rates increasingly negative or expanding base money to make good in nominal terms the pension funds and banks it has directed into these unproductive assets. Whilst I have used a renewable energy example, the government must underwrite all imbalances with increased control, whether that is through monetary, fiscal, or regulatory policy, all of which will become much more extreme.
For the financial markets, assuming governments keep the inflation in asset prices, this will mean going further along the risk curve, taking valuations to more extremes. Assuming lower interest rates are used to carry more debt relative to GDP, as it would increase the present value of future earnings, it would direct money into longer duration assets, flattening curves and reducing term premiums. This already involves pension funds going further along the curve and shifting from the traditional 60%/40% equity bond portfolios to higher equity and other higher risk asset weightings as the interest income from the bonds’ declines. Within equities, growth stocks should continue to increase relative to value as growth itself becomes increasingly rare, and as the reduced term premium increases its net present value. As already discussed, it should mean fewer companies, both at the domestic level but also international level. It would also mean junk spreads tightening further against investment grade, and emerging market spreads to developed markets also tightening as the Fed is forced to pump more dollars into the global system to float all ships to prevent the system clearing. Overall, it means a continuation of the trends we have seen over recent years.
To move assets away from their productively optimum value – (it is not “fair” value as that will move with base rates which are being dictated by central bank policy) – increased control is necessary, concentrating wealth and power and socialising the costs. Whilst the need for a market to create the revenue stream to service the assets means that the rest of society collectively has as much power as the wealthy – (the liability side of the wealthy’s assets) - as it would be divided over millions of people, their ability to act as one to use that power will be very limited, as elections highlight, which is why government is able to take ever more control without being challenged. This identity also highlights the stupidity of the present system, that whilst the public collectively has as much power as the elite, they have allowed such an imbalance in wealth to form. Nevertheless, as Catastrophe Theory suggests, at some stage, when the imbalances and risks reach a certain level, forces that previously opposed each other are likely to come together and act as one, taking power back from the government.
This could be organised through groups forming and acting together or random independent actions and events combining in such a way to clear the system. Until that point, the imbalances will grow and the power concentrate in fewer hands, leaving fewer people able to afford their own house, to have children, or retire, or even vote for change as they will be increasingly dependent on government handouts or lower interest rates affording the increased debt and assets more generally relative to GDP.
This again highlights that the system will probably not clear other than if it falls of its own weight, when the imbalances are so large that enough of the public abandon the traditional parties in favour of leaders that offer an alternative view, or, if the clearing is imposed by another country, most likely rejecting an aggressor’s call on its capital to sustain its imbalances, like WWII. Part of the clearing process must be for the public to realise that they are not being told the truth – (by shifting values away from the productively optimal level, government is corrupting reality) - which is a necessary part of the imbalance of moving things away from the productively optimal or true level, which is why control of the Internet and media is so vital to sustaining power.
With the government clearly not understanding the implications of its policies, mistakes can be made that could bring the house of cards down. There have been 3 major corrections in asset markets over the past 20 years alone, which required major policy stimulus or additional control to prevent turning into proper clearing events.
The enormous demonstrations and empty cafes and restaurants in France at the moment suggest the government may have miscalculated in its policies related to the virus, and similarly the complete polarisation of politics in the United States, and the growing global mistrust of China, but these are all likely just objections to specific policies or politicians or events rather than the overall trend of imbalances as no one is going to voluntarily crash the system.
Europe’s renewable energy policies are raising prices and squeezing household budgets, leading to diversionary policies such as the carbon border tax to deflect some of the cost abroad, but like former President Trump’s tariffs on China to try and accommodate existing unproductive policies, they are just new imbalances, and are unlikely to result in the system being pushed over the edge.
The cost of the imbalances are just not high enough yet for the public to reject the government or even roll back some of the unproductive policies, that would at least partially give the economy back its legs like Roosevelt did when he rolled back some of the New Deal, enabling U.S. industry to compete profitably for government contracts, which then helped clear the imbalances and restructure the global economy and society.
The idea that Fed Governor Powell is going to tighten monetary policy to a level sufficient to start clearing the system over the medium term, or not going to loosen policy to prevent the system clearing, is laughable, which means the system can only clear by rejecting the kind of big government and central bank we have today. That is not going to happen until costs of the imbalances are high enough, which in my opinion is not until the true cost of the renewable energy policies become obvious for all to see.
This means we should expect more imbalances. By regulating that we consume certain things, most obviously renewables, the government will price out other things. Whilst it intentionally wants to price out internal combustion (I.C.) engine cars, Stellantis has warned that it "could price (the) middle class off the roads". Electrification could make cars too expensive for the middle class, making driving the exclusive preserve of the rich. By raising the cost of moving things around, including people, it will crush productivity and real wages, turning the public against the government. Obviously, this applies at a far broader level; by pricing out energy, government policies are pricing out GDP and imposing poverty on us all.
CEO Carlos Tavares’ comment that "I can't imagine a democratic society where there is no freedom of mobility because it's only for wealthy people and all the others will use public transport" should be taken literally, i.e. to have a democracy of any value, the system will have to reject these policies.
The counterparty risks are at every level. The identity between input and output or between demand and supply means that the government’s power is both an asset but also a liability, which means there is counterparty risk between the two. The government controls the people but in return it must deliver what they require to keep that contract in place. At any stage the public can walk away. Whilst the government can use force or rather increased control to maintain its power, which is what the imbalances are buying, at some stage they will have insufficient capital to avoid that default.
Obviously, we are seeing policies becoming more extreme, compounding the risks and the costs of containing those risks. As the real return on capital has gone negative, rather than borrowing growth from the future, the government is borrowing output from the future. In doing so, it is ensuring future output follows a declining path. If it borrows output from the future, supporting clearly unproductive spending as it has done over the past 18 months, the declining trend of GDP will accelerate lower.
Whilst U.S. GDP has rebounded heavily from its lows, with all output priced off 25 bpts base rates, which when adjusted for USD120bn a month of base monetary expansion is heavily negative, the rebound in output and jobs is at the expense of capital depletion and will therefore be given back just as the bond market’s negative real yields indicate.
Whilst bad enough for the United States, for the Eurozone, Britain, and Japan, which are still a long way short of their pre-crisis levels, it is extremely worrying. Whilst this is very different from the past when we were borrowing growth from the future, when the loss was just an opportunity cost, it still does not mean the public will force the system to clear.
Unfortunately, the only point where government can no longer borrow output from the future is when it has totally exhausted capital, at which stage we are all dead, however history does show that a long time before then, when real yields fall to around -5%, it loses sufficient political capital that the system does partially clear. We are still a long way from that point. Instead we should focus on new imbalances and where that will take us, before the system eventually clears. As long as the system continues to add to imbalances, real yields will fall, net investment rates decline, and capital stock and GDP fall at an accelerating pace.
How negative will rates go, how much base money will be printed, and what share of the broad money supply will the central banks’ control? How and where will they direct that money?
Will it go into specific targeted technologies and industries, like the Made in China 2025 plan, the European Sustainable Finance Framework, or the various U.S. stimulus plans, and how will that change how the public and countries relate to each ther?
Whilst most politicians act with the best of intentions, by moving the allocation of capital away from how it is produced, the government corrupts the system, creating the imbalances we have today, which we are all suffering the consequences of. Although I would say most of our politicians these days are low quality, the problem is not related to them specifically but rather to the system of unlimited government generally, as it is tasked with making decisions on which it cannot possibly have all the necessary information at any moment in time to make productively optimum decisions – (see Keep Digging, Mr Keynes). It can bring the collective resources together to achieve a specific result, such as to win a war, but it cannot ever allocate capital productively.
Whilst the public will eventually recognise this reality, taking power away from the government for a short time to allow at least a partial clearing of the system, we should not expect such a change in the short to medium term as we are too far down the path to reverse course without a major disruptive event. Instead, we should expect the imbalances to continue to compound, with governments moving the system further from economic and scientific truths until the costs of the imbalances become unsustainable, at which stage no force will be able to prevent the system clearing.
Written by Andrew Lees
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