The Recent Economy up to Covid-19

In the previous post I noted that Keynesian economics tended to fail because governments overlooked the second half of the prescription: when the going got strong, it was necessary to “pay back” the debt, or at least reduce the money supply. That results in politicians being party poopers, restraining the good times and what politician wants that with an election coming? The net result was with too much money floating around, we had the rather unexpected result of inflation coupled with stagnation/recession. More money would not solve that. Friedman had the answer, perhaps: stop government priming the economy and correct structural deficiencies. That was not followed either – Friedman had no more success than Keynes in getting politicians to behave. What resulted was the likes of Reagan reducing government expenditure, lowering taxes, and maintaining and expanding the government deficit. Then the US Federal Reserve set the tone by reducing the money supply, even though it knew that would send unemployment soaring. They simply did not care. Anything went in the name of “economic efficiency”. 

What was undefined was “efficiency.” To answer that we have to ask what is the purpose of the economy? To the bankers it seems to be to make nice profits for banks, but surely it is more than the keeping of tidy books. For some, it is to maximize wealth, especially for themselves. For some it is to generate the means of enabling people to live in a pleasant place and live alongside nature. For others it is to enable all people to get the best out of life. Under the new economics of Reagan and others, the emphasis was on the “basics”: get the government out of the economy because they don’t know what they are doing, focus on low and stable inflation, let the rich get richer, following which the wealth would trickle down. Except the evidence is, it didn’t.  Then when it became clear that squeezing the money supply, while it might have helped make the books tidier, was generating unemployment that was too great, so central banks switched to using interest rates as their primary tool. Which gets us to where the bankers are now. Interest rates have got to the point where depositing in banks is only good for security, as long as the bank does not go belly up.

What actually happened was that when the corporations noted that the government did not care about employment it fired its workers, thereby saving money on benefits, etc. and moved manufacturing to low wage countries. Basic manufacturing, like clothes, were exported to places like Indonesia or Bangla Desh, and more difficult manufacturing to China. That undoubtedly increased the wealth of the rich, but it sent the workers into low-paying jobs in the service industries. Meanwhile, there was a somewhat unrecognized crisis in the academic community, and in particular the physics community. Funding had dropped and we had a large number of highly educated unemployed. The physicists, in particular, were good at computer modeling, and they got jobs in banks to create new “financial products”. The banks made huge profits until about 2008. The problem with these “products”. which were sliced and diced debt, were based on the assumption that nothing significant could go wrong, but in the US, for political reasons, a huge number of houses were sold to people who had no hope of repaying the mortgages. Oops. 

We have sort of recovered from that, but the legacy is that thanks to COVID 19 the debt levels of so many countries is extraordinarily high, interest rates are ridiculously low they cannot go lower, so there is no incentive to save. Money goes into assets, which merely inflates the price of the assets. Stock at $100 is worth that if you can sell it for that, but at the end of a period of time, you have to look at the overall returns on investment. In a bubble, everyone makes money until the music stops, then the losses are concentrated on the then holders. COVID has forced the nervous investors to cash out and the stock market fell, but it is coming back because of the quantitative easing. So what happens when the quantitative easing stops and the bonds are cashed out?What is clear is that we cannot look to the past for ways to get out of this. We have to try something new, but what? If you look at our leaders, do any of them have a solution to what happens after quantitative easing? Or do they have their heads in the sand and assume that will be for another electoral cycle?