Few seem to grasp that we have arrived at an historic turning point: a nation and a world confronted with profound structural change. The hope to recover the past will not be helpful. We must pick ourselves up, hit the reset button, and respond to a rapidly changing reality.
I cannot accept assumptions about political policies or intentions without asking practical questions. I want to understand a complex transition that is having an immense impact on us all.
There are many aspects to the changes we are experiencing, some with immediate implications, others longer-term. To seek solutions we must recognize structural change.
I have given attention to the continuing financial crisis in recent posts because I believe that is where the closest danger lies.
So, I begin here with a financial question with structural implications: Why is the Federal Reserve unable to return the economy to some semblance of fairness and order? Or, to put it another way: Why have our financial liabilities not been corrected since the crisis in 2008?
The short answer is that they want to believe they are dealing with a cyclical crisis rather than a structural crisis. Again, why?
Because the truth represents an unbearable existential threat.
Here we find a powerful example of the problems presented by structural change.
The economy has shifted into a long-term deflationary trend, which presents banks and governments with an impossible situation.
I refer you again to James Rickards’ best-selling book, “The Death of Money: The Coming Collapse of the International Monetary System”. A monetary economist and former banker, Rickards has been advising the Pentagon and CIA concerning financial warfare and terrorism.
Using simple math, Rickards’ explains how, “in effect, the impact of declining prices [deflation] more than offsets declining nominal growth [GDP] and therefore produces real growth.”
Most of us would think this is a good thing.
He writes: “Despite possible real growth, the U.S. Treasury and the Federal Reserve fear deflation more than any other economic outcome. Deflation means a persistent decline in price levels for goods and services. Lower prices allow for a higher living standard even when wages are constant, because consumer goods cost less. This would seem to be a desirable outcome, based on advances in technology and productivity that result in certain products dropping in price over time….”
Why is the Federal Reserve so fearful of deflation that it resorts to extreme measures to oppose it? Rickards gives us four reasons.
First, deflation has a severe impact on government debt: “U.S. debt is at a point where no feasible combination of real growth and taxes will finance repayment…. But if the Fed can cause inflation…, the debt will be manageable because it will be repaid in less valuable nominal dollars. In deflation, the opposite occurs, and the real value of the debt increases….”
Second, deflation impacts the debt-to-GDP ratio, causing foreign creditors to lose confidence in the dollar and demand higher interest rates. This is an urgent problem because the debt is continually increasing. Budget deficits require new financing, and interest payments are already being financed with new debt.
Third, deflation is a major problem for banks. As Rickards’ puts it, “deflation increases money’s real value and therefore increases the real value of lenders’ claims on debtors…. But as deflation progresses, the real weight of the debt becomes too great, and debtor defaults surge.”
The fourth problem with deflation is about taxes. When a worker receives a raise, the additional income is subject to taxes. But, if the cost of living drops by the same amount, the worker in effect receives the same raise and the government cannot tax it.
“In summary,” writes Rickards, “the Federal Reserve prefers inflation because it erases government debt, reduces the debt-to-GDP ratio, props up banks, and can be taxed.”
“Deflation may help consumers and workers,” he says, “but it hurts the Treasury and the banks…. The consequence of these deflationary dynamics is that the government must have inflation, and the Fed must cause it. The dynamics amount to a historic collision between the natural forces of deflation and the government’s need for inflation.”
Such are the challenges of structural change.
Note to readers: You can support this blog and the book project by suggesting that your friends and associates take a look. And, watch for the next post on or about November 3.