ECONOMIC DISTORTION, COURTESY OF YOUR CENTRAL BANK

16 Dec

Written By Emile Woolf

This century's "big ticket" economic phantom has been the unprecedented

decade long wave of "fiat" money expansion by central banks cverywhere, as a

counter to the unwinding of the previous monster: debt that lacked any visible

means of support beyond the fairy-tale world of fictitious property prices

aided, as usual, by the fact that those guardians of financial integrity, the central

banks, failed to read the minutes of the previous crisis.

[Reminder: "Fiat" in this context is not a little automobile. It is the Latin subjunctive of

the irregular verh "sum" ("T am"). Thus "fat" is "let it he", or "may it be", or "may there

be". In the book of Genesis we have "fiat lux", meaning "let there be light" In economics,

therefore, ""fiat money" literally means, "let there be money", or money that simply

appears, like the dawn light. The image evoked is one of a magician waving and tapping

his wand on a hole in a tree trunk from which an endless stream of dollar notes flows.

But the magician is a sorcerer, and the consequences are very malign indeed!]

So popular was the wholesale creation of fiat money by the US Federal Reserve,

the Bank of England, the Bank of Japan and the European Centrai Bank that

central banks everywhere else replicated it. After all, with such illustrious

pacesetters it had to be the right thing to do. Who needs a magic wand when you

can click on a computer key?

But there are consequences

Artificiality always begets artificiality: one effect of flooding the credit markets

with so much artificial money was the artificial lowering of interest rates. In the

world of real business this obviously distorted calculations on which commercial

decisions are made, with particular reference to deployment of capital on longer-

term ventures such as mining, construction and transport infrastructure

[Please remember that we are here talking about the application of private capital

-I'1 come to government projects later.]

Committing private capital to long-term projects at the higher interest rates

previously prevailing would have been commercially prohibitive: the longer the

time taken to complete a venture, the greater the uncertainty of outcome. But at

artificially suppressed interest rates it will appear that profitability is within

reach, and new commitments will be entered into involving the cost of

specialised equipment, vehicles, hiring of labour and related production needs.

Operation of real interest rates

The notion of artificially lowering interest rates begs the question: "Is there such

a thing as a natural level of interest rates?"

Forget central banks. The natural level of interest rates is determined by

participants' respective time preferences for satisfying their needs and desires

This applies whether the participants in a transaction are individuals or

businesses.It is in the nature of long-term construction, infrastructure and mining projects

that their consummation lies in the distant future, requiring capital to be tied up

for years before seeing a return, implicitly involving greater uncertainty and

higher risk - allindicating that a higher rate of interest would naturally apply.

But if the central bank's policies have had the effect of artificially suppressing

rates, they have also distorted the distribution of resources in favour of

businesses that satisty a long-term preference, and resources will migrate in

their direction despite the fact that the time preferences have not really changed

at all - it's only the distortion caused by interest rate suppression that that makes it

appear otherwise.

Businesses set up to satisfy an immediate time preference such as sidewalk

sandwich bars and coffee counters, will have difficulty recruiting workers who

have shifted into infrastructure. In due course they will be tempted back by

higher pay, entailing in turn higher prices for consumers.

We see evidence of this ebb and flow of resources between short-term and long-

term time preferences whenever marginally viable businesses at both ends of the

spectrum are forced to close down. But losses are naturally far greater at the

long-term enà, where all that infrastructure spending has produced nothing at

all. Capital has been irretrievably destroyed and we can trace it all back to that

original madness of fiat money credit expansion.

NOTE ON GOVERNMENT EXPENDITURE

So much for the risks to private capital caused by government-induced

distortions. At least the owners of that capita! were able to estimate long-term

outcomes. It was, after all, their money. Expenditure of private capital, unlike

expenditure by governments, is susceptible to economic calculation, even while

projects are in progress. An example is the recent decision of the Airbus board to

cease production of its A380 "Superjumbo" in 2021 because of long-term order-

book uncertainty. As custodians of shareholders' money, they are accountable for

their decision.

Bitter experience shows, by contrast, that governments should refrain from

committing taxpayers' money to projects that no company shareholders, in their

right minds, would countenance. Today's classic vanity project is, of course, HS2,

intended to shorten the London-Birmingham link by 32 minutes at a cost

approaching £100 billion, when the nation's real needs for transport connectivity

lie much further North

Other ill-starred projects are in the same category: Heathrow's third runway

now faces judicial review, as well as air and noise pollution lobbies; Crossrail,

whose own boss cannot foresee any realistic delivery date, and massive

unbudgeted cost escalation; Wylfa and Moorside nuclear stations, abandoned or

suspended by their own contractors; and even Hinkley Point, the only nuclear

plant under construction, having no reliable delivery date, nor any real idea of Yet, whenever ministers are confronted by these costly white elephants, and

every sane voice declares "scrap it, they could happen anyway, due to the

default position of ministerial inertia, the lobbying power of engineering

conglomerates, property developers and special interest groups and, above all,

by the fact that spending taxpayers' money is what ministers do!

Whenever you weigh up the so-called return on a government-sponsored

venture, ask yourself whether, as a taxpayer, you would have been happy to

support it with your own money - given the choice.

Keynesian poppycock

It all goes back to the Keynesian obsession with government-induced demand,

as if that were an economic actor whose stimulation would magically lead to the

land of plenty. Keynes wrote: "Ifthe Treasury were to fill old bottles with

banknotes, bury them at suitable depths in disused coalmines which are then filled

up to surface with town rubbish, and leave it to private enterprise to dig the notes

up again, there need be no more unemployment and, with the help of the

repercussions, the real income of the community, and its capital wealth also, would

probably become a good deal greater than it actually is."

Even if you are able to decipher this drivel it may strike you as total hokum.

That's because it is hokum. And, if you think for a moment, you will see that this

is the very progenitor of the central banks' money-printing mania whose

unwinding we are about to witness big time!

Rewind 40 years and contrast Keynes's "demand stimulation" with the

Reagan/Thatcher reaction to this madness, often labelled "supply-side

economics", which ushered in a period of stability and steady growth. Think of

the supply side as the production that, according to Say's Law, MUST precede

consumption. Margaret Thatcher, and her Chancellor, Nigel Lawson, recognised

that the supply side does not require stimulus - other than the removal of

controls, regulations and other obstacles to business such as taxes on production

and employment. It works so well, unaided -what a revelation!

A final word on (dare I mention it?).....Brexit

With most of us so thoroughly disenchanted by the entire Brexit farce that we

scarcely care any more what happens to the blasted Irish border and want only

to get the whole damn thing over with, a very simple question occurred to me.

Since, in essence, the whole issue is whether membership, in some form, of the

EU's main economic institutions, the "single market" and "customs union" should

be pursued, why is it that no other trading bloc in the world has erected

comparable institutions, and yet survives, even thrives?

One good question deserves another: after a couple of decades of adhering to

those institutions, how has the EU (and in particular the eurozone) fared

economically in comparison with those other trading blocs?

The latest IMF data shows that over this period the eurozone's GDP grew by 26

per cent, compared with the UK's 44 per cent and the US's 42 per cent. I'll resist Yet, whenever ministers are confronted by these costly white elephants, and