Category Archives: Economics

Yet You Did Not Return to Me: Economic Disaster

I recently wrote that coronavirus might be judgment from God and an opportunity to draw nearer to God. But, by my observation, most people and many Christians seem to be focused on the sins of others. Uncivil discourse on racism, LGBTQ rights, MAGA, the pandemic, abortion, cultural Marxism, and a myriad of other concerns consume our time as people trample each other in a panic of virtue signaling. Instead of examining ourselves against God’s standards, we’re promoting ourselves as righteous based on which group or cause we identify with. This is not repentance.

Lost in all this turmoil is any sense that coronavirus might be a wake-up call from God. Instead of an opportunity for individuals to repent, various groups see the pandemic as an opportunity to advance their worldly agendas.

Prosperity & Turning Away from God

Before bringing catastrophic judgment, God gets a nation’s attention in a variety of ways. A nation that turns away from God and ignores him often does so in the midst of prosperity. This is consistent with Jesus’ teaching that we cannot serve both God and money, either we will hate one and love the other or we will be devoted to one and despise the other (Matthew 6:24). In the time of the prophet Amos, the rich in the northern kingdom of Israel oppressed the poor in their quest for wealth (Amos 2:7; 4:1; 5:11; 8:4,6).

Missed Opportunities to Repent

God brought calamities upon Israel to remind them—“I am the LORD; that is my name! I will not yield my glory to another or my praise to idols” (Isaiah 42:8). He brought disaster so that they might repent.

But they did not.

After each calamity the Lord declared—“yet you did not return to me” (Amos 4:6,8,9,10,11).  As a result, though God had been longsuffering, eventually Israel would be destroyed by Assyria.

Economic Disaster

The first calamity God brought upon Israel was economic disaster, which, in an agricultural economy, is expressed as draught, blight, locusts and famine (Amos 4: 6-9).

Sin reflects our desire for happiness and satisfaction apart from God. When God removes our prosperity, he thwarts our efforts to find heaven on earth and provides us with an opportunity to repent. However, a person with a rebellious and hardened heart “shakes his fist” at God and refuses to repent and draw near.

America’s Economic Sins

As did Israel in the time of Amos, the world in general, and the U.S. in particular faces economic distress. But the majority narrative that the U.S. economy was strong and our economic problems will go away when the pandemic is under control is a lie. It is strong delusion. This narrative ignores our economic sins. As long as we fail to recognize our sin, there is no chance anyone will repent.

What do I mean by economic sin? We are a debtor nation that cannot repay the debt owed to our trading partners. This is wicked (Psalm 37:21). Our lifestyle is subsidized in part by some of the poorest nations on earth. When the plunder of the poor is in your house it gets God’s attention (Isaiah 3:13-15). The pursuit of wealth dwarfs the pursuit of God as we convince ourselves that either God doesn’t exist or that we can serve both God and money. We condone an economic system that can only thrive on discontent and debt even as it demands our full allegiance. This is problematic for Christians as it leaves little time and energy to advance the Kingdom of God (Proverbs 23:4).

The Worst Is Ahead

Our economic actions have assured consequences. We reap what we sow. Record individual, corporate, national and international debt is evidence that we have lived beyond our means for decades. The party is over and the economic hangover will be the worst we’ve ever experienced. To make matters worse, U.S. monetary policy (with the Federal Reserve believing they can stave off another Great Depression by buying debt) is on a collision course with hyperinflation. If they don’t reverse course, everyone’s savings will be wiped out.

We dare not carry on as usual during these times unless we know for sure we have nothing to repent of. We do not want to hear God say of us, “Yet you did not return to me.” Our economic famine might turn into an actual famine. Furthermore, if our nation follows the pattern of Israel, we will also experience ”not a famine of bread, nor a thirst for water, but of hearing the words of the LORD.” Dare we think that those who desire to tear down our statues and our society will not come after Christians? When persecution arrives, will we be ready spiritually?

Still Doubtful About the Precarious State of Our Economy?

If you still hold doubts about the precarious condition of our economy, these articles explain why our economy was weak before the pandemic:

The Wizard of Odd – Trump Edition. Why debt is a problem and why our standard of living must go down in order to pay it back.

What Really Causes Inequality? Contains answers to this question that both conservatives and liberals will love and hate.

How Much Socialism Does it Take to Collapse an Economy? – Part 2 Explains why U.S. monetary policy is headed toward hyperinflation (this article is fairly technical).

The Money Changers Have Stolen From Our Future – Why We Will Have to Live on Less Explains why the prevalent financial practice of ignoring the future to attain short term gain makes our economic prosperity unsustainable.

America’s Level of Prosperity Is Not Sustainable – Explores the implications of our trade deficit.

Feeling Repressed? Discusses stealthy methods used to transfer your money to the government. Hint- it involves inflation.

Why Christians Care About Economics

How we make our money is just as important as how we spend it.

Economic activity is one of the most common and basic forms of human interaction and the Bible has much to say about it. However, it takes time to understand the complexities of our modern economy so that we can better apply God’s principles to our everyday activity. Here are five reasons your effort will be worthwhile.

1) Good stewardship includes taking care of the economy.

Everything is God’s (Psalm 24:1). We are given the privilege of being stewards of God’s creation. (Genesis 1:26–28). But good stewardship involves more than charitable giving, wise spending, and performing our jobs with integrity.

Good stewardship includes taking care of the economy. In Israel, people provided for their families utilizing land, capital (tools and animals), and their own labor. Prohibitions against theft, laziness, and moving boundary markers were designed to maintain everyone’s ability to steward his allotted piece of God’s creation.

In today’s complex economy, protecting each person’s ability to steward from the evil schemes of others is no less important. In an agricultural society you literally reap what you sow. But in our economy, most people entrust their money to a local bank, the government, or a financial institution. The problem is, as attested by events leading up to the 2008 financial crisis, they may invest your money in dishonest ways that enrich some while bankrupting others. You might become a victim or unwittingly victimize others.

How we make our money is important because, if we gain wealth at the expense of others rather than produce wealth, we take what God has given to others to steward and thus deprive them of that opportunity.

A better understanding of economics will help Christians identify, oppose, and refrain from participating in investment vehicles that simply transfer wealth rather than produce it.

2) God expects us to defend the defenseless and deliver them from the hand of the wicked.

The Bible often describes the wicked in terms of economic interaction. The wicked have no concern for the poor (Proverbs 29:7), use dishonest and deceptive means to gain wealth (Micah 6:10–12), and are free to oppress the poor when society honors their vile practices (Psalm 12:5–8).

Psalm 82:2–4 neatly sums up our responsibility to defend the poor, orphans, and the oppressed from the wicked. We can only maintain their rights and rescue them when we stop defending laws and systems that show partiality to the wicked.

Understanding economics helps us uncover wicked practices in an economy that is, by design, complex and non-transparent. Further motivation to study economics comes from knowing God’s heart to defend the poor and his determination to judge their oppressors (Isaiah 3:13–14).

3) We want our government to restrain evil, not enable it.

We know stealing and lying are wrong, but in our economy there are legal ways to get something for nothing and deceive others on a grand scale. Economists refer to one such practice as “rent seeking” which has been popularly described as an effort to grab a bigger slice of the economic pie rather than make the pie bigger. One familiar form of rent seeking is lobbying to gain an unfair advantage. Those with more money have more opportunity to obtain rents from the government. Thus these transfers of wealth tend to be from the majority of taxpayers to the rich, though sometimes, economic equals compete for rents.

Also, when government fails to properly restrain evil in financial markets, wealth is transferred by deceptive or fraudulent practices simply because people can do so without consequences. Quite the contrary, they often can expect the government to bail them out.

Legalized theft is not a new problem. Consider this from the Heidelberg Catechism (1563):

Question 110. What does God forbid in the eighth commandment? 
 Answer. Not only such theft and robbery as are punished by the magistrate; but God views as theft all wicked tricks and devices, whereby we seek to draw to ourselves our neighbor’s goods, whether by force or with show of right, such as unjust weights, ells, measures, wares, coins, usury, or any means forbidden of God; so moreover all covetousness, and all useless waste of His gifts. (emphasis mine)

4) We want to leave an inheritance to the next generation, not debt and a ruined economy.

A good man leaves an inheritance to his children’s children (Proverbs 13:22). One can argue, considering other passages that condemn the accumulation of wealth for selfish purposes (Luke 12:16–21) or for security (Job 31:24Psalm 52:7), that the biblical emphasis is on preserving the ability of the next generation to steward resources. In economic terms, this means stewarding present resources in a manner that leaves the next generation unburdened by debt and in a position to work productively.

5) We need to keep ourselves unstained by the world economy.

Any economic system devised by sinful humanity will often be opposed to biblical values. Our economic system encourages covetousness and scoffs at contentment. It rewards debtors and punishes savers. It implements immoral wealth transfers. It enables one generation to live beyond its means and pass the bill to the next.

We must not be deceived into thinking that conservatism or liberalism has the answers. God has given us the answers in the Bible. Our first priority is to learn what the Bible says about money, but an understanding of economics helps Christians test economic practices and the words of economists, bankers, business leaders, and politicians against biblical truth.

God, the “Father of the fatherless and the protector of widows” (Psalm 68:5), views our religion as pure and undefiled when we look after them in their distress (James 1:27). To rescue the needy or to be a Good Samaritan or oppose oppressors will always cost us something. Whatever cost, inconvenience, or trial we encounter because we choose to live by biblical economic principles cannot compare to the immeasurable joy that belongs to us who, because we are followers of Jesus, steward our time and money wisely (Matthew 25:22–23).

(This article first appeared at desiringGod.org.)

The Wizard of Odd – Trump Edition

wizard hat and money

Two years ago I wrote an article that poked fun at President Obama’s notion that America’s economy was strong and that it would adapt to the global economy. Since then the elephant in the room that President Obama and most of America ignored has only gotten fatter.

Swamped by debt, American households owe more money now than ever before. Government debt is at an all time high. Our trade deficit has worsened. America’s high standard of living rests on a foundation made of sand.

If you went out and borrowed a large sum of money you could purchase all sorts of goods and services and make it appear that your personal financial situation is strong. You might even think to yourself that future pay raises will allow you to pay off your debt and maintain your lifestyle. But deep down you know, or you should, that there is a limit to how much debt you can take on. Some day the party ends and you have to pay back what you borrowed. Then your standard of living will decrease.

But somehow, according to most politicians and economists, when you multiply the above scenario by 325 million people, it’s different. Magically, government debt presents no problem at all!

In his state of the union address, President Trump touted the rise in the stock market and decreases in unemployment since he took office. This is odd since during the presidential campaign he called the stock market a “big, fat, ugly bubble” and described the unemployment numbers as fake.

After the election, based on the promise of a business-friendly Trump administration, the stock market rocketed upward anticipating economic growth. Though it is true that consumers and companies spend more money when they feel wealthier because of asset price gains; it is also true that spending money based on unrealized gains may not be the most prudent plan. With recent tax cuts, an action that increases the national debt, many businesses felt even richer and they increased spending and hiring. This led many people to believe that all is well with the economy. Perhaps this explains the relative silence about the massive increases in spending (and debt) that will result from the latest budget legislation.

I have a few questions.

Who is going to buy the increased production of American workers this faux economic boom provides?

President Trump vowed to decrease the trade deficit but, in 2017, it increased. If he continues to fail in his goal, we will increase our debt to other nations as we consume our production plus that of export nations.

Oddly, hardly anyone is talking about what happens if he succeeds. In 2017, the U.S. dollar lost 12 percent of its value against a basket of currencies that included the euro, yen, pound sterling and Canadian dollar. This means the price of foreign goods will rise and that we can buy fewer of them. Significantly, a larger percentage of our collective work effort will be going into producing goods that foreigners consume—in other words, into exports. Since we will buy fewer foreign products and consume fewer of our own, our standard of living must decrease. The wealth that has been flowing our way for so many years will reverse.

How have we been deceived into thinking that our national debt doesn’t matter?

It is odd that President Trump and other elected leaders believe making America great again means prosperity powered by increased indebtedness.

Governments may think they can borrow forever but the Bible says otherwise. To repay debt with more debt is not repaying at all. The Bible says it is wicked to do so (Psalm 37:21). Christians surely know our nation will suffer serious consequences for this behavior. We should be outraged at recent tax cuts followed by spending increases.

Inevitably, massive debt erodes the value of a nation’s currency to the point where foreign holders of dollars would rather buy U.S. assets or our exports than buy treasuries (debt). This means interest rates must rise to attract buyers of government debt used to run our oversized government. The cost to run government becomes more onerous as interest payments on the national debt increase. (Think of an adjustable-rate mortgage on a national scale.)

Higher interest rates increase the cost of doing business and cut into profits. Consumers buy fewer houses and automobiles because of increased loan costs. The economy slows down into a recession and workers get laid off.

The supply of goods collapses because we can buy fewer imports and more of the goods made here are exported. Less supply means prices increase further. If we try to maintain the current level of government spending, inflation will get even worse.

Does this scenario sound to you like a booming economy? The power brokers in our nation would like us to believe the economy is so good that it is in danger of overheating. They turn the facts on their heads, claiming rising prices result from too much of a good thing (demand from a booming economy) instead of from too much of a bad thing (demand caused by inflation of the money supply via debt). Instead of taking blame for high prices resulting from money inflation, they tell us they can control it. (This article explains why they won’t be able to next time).

But, as I said in my article two years ago, reality takes a back seat to hope in the Land of Odd. In Obama’s make-believe world, government supplied us with hope; in Trump’s fairy tale, “free” markets that are “fair” to America will deliver us from our folly.

What Really Causes Inequality?

Inequality sign

Few topics invoke a maddening response like income and wealth inequality does. Just as Pavlov’s dogs salivated in response not only to food but also to stimuli (like lab coats and bells) associated with food, the mere mention of inequality causes many of us to salivate at the opportunity to make our ideological opponents look stupid or immoral.

Too many of us try to prove our self-proclaimed intellectual or moral superiority by describing our political adversaries either as jealous of the rich or as greedy. Both sides accuse the other of thievery.

It seems that underneath the anger lie the assumptions that the battle is about capitalism and socialism or about justice and fairness.

There really isn’t much discussion about inequality because both sides hijack the concept to argue their ideology.

Hear No Evil

When deeply held beliefs are threatened, our tendency is to conveniently ignore the arguments of those who disagree with us. Emboldened by our ideology, we give much consideration to the real evil we see in others but dismiss as imaginary the evil they see in us. We validate our arguments by focusing only on the facts that support our case while neglecting facts that undermine our worldview. And so, with civil discourse a thing of the past, we speak evil of others.

Inequality’s Lessons

Wealth and income inequality reveal the natural outcomes of human action, both good and evil.

Inequality validates the fact that we reap what we sow.

The more we work the more we produce. The better we work the more we produce per unit of time. Over time, skilled and diligent workers will attain more wealth than unskilled and lazy workers.

Inequality results from voluntary transfers of wealth.

If you produce something that large numbers of people want to buy at a price that gives you profit, you will attain much wealth as purchasers willingly give you their money to obtain your product. Even some monopolies involve voluntary wealth transfers. For example, you may have a monopoly because you have patented an invention. This is a monopoly we accept because it rewards innovation that benefits society and involves voluntary transactions. Likewise, we accept the monopoly that NBA and MLB players have because we want to watch the best athletes. The key point is that these wealth transfers are voluntary choices made with sufficient information.

Inequality results from involuntary transfers of wealth.

The Bible clearly states that God brings judgment on those who steal by force or deception. Our government grants monopolies and rents to special interests, bails out banks, practices financial repression and champions our trade deficit—all of which result in involuntary transfers of wealth from the non-rich to the rich.

But this is where defenders of capitalism and the conservative cause sometimes go off the rails. It is not sufficient to blame unjust inequality on government intervention in the economy. We must also hold accountable those who benefit from those interventions and those who take advantage of lax government oversight of the markets to transfer wealth to themselves. We must not use the fact that voluntary (and moral) transfers of wealth are commonplace to absolve the sins of the rich and powerful.

Here’s the problem as I see it. Capitalists err when they think that immoral wealth transfers to the rich only occur because of government intervention in the markets (because of crony capitalism). So, in their minds, the rich who don’t have a direct connection with government officials are off the hook. Many capitalists have imagined a self-regulating, laissez-faire free market in which no one can get away with financial sins. Therefore government regulation, particularly in the financial markets, becomes an object of scorn instead of a protection sanctioned by God.

Socialists make an equally grave error. They incorrectly see the government not as a major cause of inequality, but as its solution. This leads to the ludicrous conclusion that wealth transfers from the rich will solve the problem of inequality their big-government policies caused in the first place.

Hiding in Plain Sight

Increasing inequality is a red flag. It warns us of impending danger. Increasing inequality, much like a dead canary on the floor of our economic mine, beckons us to heed its warning that our economy is poisoned. Sadly, we either ignore the dead canary or we misdiagnose the cause of death. Debt, theft and corruption poisoned the canary. It will poison our society if we don’t wake up. We need to call out those who have done this, irrespective of their ideology. We need to reverse course.

What Really Causes Inequality?

The Bible doesn’t hide the answer to this question, but boldly proclaims it for all to see. Sin causes inequality. Our greed and our laziness cause it. So do covetousness and theft. Oppression, indebtedness, and deception cause it. Defending transgressors with our ideology instead of defending the weak and needy they subdue cause it.

The Bible tells us how to deal with economic sin. It tells us to reject the “eat drink and be merry for tomorrow we die” attitude. It tells us to be rich toward God and acknowledge that he owns everything.

The Bible warns us to stop excusing our economic sins while vilifying others for theirs.

Will our society listen?

How Much Socialism Does It Take to Collapse An Economy? – Part 2

Empty shelves depicting economic collapse
The Road to Economic Ruin

In Part 1, I asked if the economic havoc wreaked by socialist dictators can be replicated in a capitalist democracy. I also stated that while Venezuela exports oil to fund their social programs, we, in part, export dollars to fund ours.

But what if the price of our main source for funding our social programs drops dramatically, will we experience the same problems as Venezuela did when the price of oil plummeted?

If the U.S. dollar plummets in value we will not be able to import goods in the quantity that we do now unless it’s at inflated prices. As inflation increases, foreigners will not want to hold dollars that continually decline in value relative to their own currency. They will decrease purchases of U.S. debt used to fund our social programs. Instead of buying treasuries that yield little interest, they will dump their dollars for something that will at least retain its purchasing power.1

We have been in this situation before. Under the Bretton-Woods system the U.S. government spent more than it took in. But the dollar was tied to gold at a fixed price, so governments and individuals could redeem their dollars for gold if they saw their dollar holdings decreasing in value due to government spending. In fact, they redeemed dollars for gold at such a rate that, in 1971, President Nixon had to close the gold window and remove the dollar from its tie to gold. The dollar became a fiat currency.

Today, without the option to redeem dollars for gold at a fixed price and with U.S. Treasury interest rates at historic lows, it makes sense for foreigners to use their dollars to buy America’s assets putting even more upward pressure on prices.

So, why not raise interest rates on government bonds to attract foreigners to buy our debt? When inflation raised its ugly head after Bretton-Woods’s demise, Fed chairman Paul Volker raised the federal funds rate as high as 20% in 1981 to combat an annual inflation rate that had risen to almost 15%. By 1983 inflation had fallen to 3%. The cost to control inflation was a painful recession in which unemployment rose to 11%.

And that is one of the reasons the Federal Reserve doesn’t raise rates now – fear of a recession. However, critics of the Fed correctly claim that continuing the low interest rate policy will only make the inevitable recession and resulting economic pain worse.

But there is another reason the Federal Reserve doesn’t raise interest rates – it can’t afford to. In 1981 the U.S. debt to GDP ratio was at an all time low of 31%; now it is over 100%. We have so much debt that we cannot afford an interest rate significantly above zero. Our national debt is over $20 trillion. We owe foreign governments over $5 trillion. Raising interest rates would increase the cost of servicing our debt beyond what we can pay.

The Federal Reserve is in a prison of its own making. If they raise interest rates the economy will go into a deep recession. If they keep rates low they risk out of control inflation.

Tipping Point

The U.S. dollar will experience a serious devaluation when the creditors of the United States lose confidence in the dollar because they have become convinced that the U.S. will never get its fiscal house in order.

When everyone wants to dump dollars at the same time, the resulting sell-off will crush the value of the dollar in relation to other currencies and could induce an inflationary spiral.

Can the U.S. Dollar Maintain its Status as the World’s Reserve Currency and Safe Haven?

Some economists aren’t worried, claiming the United States cannot default on its debt because our debt is denominated in dollars and we can always print more of them. Notwithstanding the moral implications of such a statement, this assumes that the dollar will always be the reserve currency and that other nations must always accept it as payment.

But creditors may decide to dump the dollar even if it means taking a loss. The process may have already begun. China recently announced the launch of a Yuan-denominated oil futures contract. These contracts will be convertible to gold. This is significant because oil exporters under U.S. sanctions will be able to get around them by avoiding oil contracts denominated in U.S. dollars. Not only does this move signify a possible crack in dollar hegemony but also undermines political influence the U.S. enjoys because the dollar is the world’s reserve currency.

In other words, an economic catastrophe probably cannot be avoided simply because the dollar is the world’s reserve currency, at least not for long.

Others argue that it will be a long time before the U.S. dollar loses its status as the reserve currency because there is no better alternative to replace it and that the dollar is still a safe haven when troubles ripple through the global economy. Therefore we still have plenty of time to turn our economic ship around. Besides, many other nations with large economies are in worse financial shape than the United States.

A New Normal – Monetization of U.S. Debt

Nothing signals economic trouble quite like monetization of debt.

“If the Fed wants to lower interest rates, it creates money and uses it to purchase Treasury debt. If the Fed wants to raise interest rates, it destroys the money collected through sales of Treasury debt.”2

The Fed does not consider its purchase of Treasuries to be monetizing government debt unless the purchase of securities is permanent. Quantitative easing (QE), which included the purchase of mortgage backed securities as well as Treasuries, has resulted in $4.5 trillion created by the Federal Reserve.

But does anyone believe the Fed will follow through with any meaningful reduction of its balance sheet? Ben Bernanke has stated that reduction of the Fed’s balance sheet will not begin in earnest until interest rates are well on their way to normalization. The world has seen the U.S. go through three rounds of quantitative easing already without being able to normalize interest rates. They are still at one percent.

Janet Yellen announced on September 20, 2017 that the Fed intends to begin reducing its $4.5 trillion balance sheet in October. But the amounts are miniscule, 0.2% per month. Furthermore, Fed officials are on record as saying they don’t expect the Fed’s balance sheet to return to pre-2008 levels. In other words, the new normal actually does involve monetization of debt.

Signs of Trouble Ahead

The stock market is overdue for a crash. The current bull market is the second longest ever. The current economic expansion is the third longest of eleven since World War 2. Raising interest rates will pop the housing and stock market bubbles that the Fed’s low interest rate policies have inflated. Having propped up the stock market for over eight years, the Fed is not going to change course now. Any claims by the Fed to raise interest rates look more like self-deception or a bluff than implementable policy.

At the first sign of trouble, just like in 2008, the Fed will likely want to step in and attempt to stimulate the economy.

But the Fed is in a bind. They want to raise interest rates so that they will have a weapon to employ (lowering rates) when the next recession hits. If they raise interest rates too quickly causing a stock market crash, they will be blamed. If they are unable to raise rates for fear of recession, then per their own statements, they will not reduce their balance sheet and it becomes clear that the U.S. monetization of debt is permanent.

How then will the Fed fight the next recession? Interest rates cannot be lowered much from one percent unless they go negative. The Fed fears deflation above all else so they will try to stimulate the economy with more quantitative easing and will achieve the same dismal result.

Not only will QE4 not stimulate the economy, it will indicate to nearly everyone that quantitative easing will never end and that the dollar is in trouble. The Treasury will only find buyers for its bonds at higher interest rates. If the Fed tries to reduce its balance sheet by letting its bonds expire, the treasury has to sell that many more bonds to pay back the Fed, putting upward pressure on interest rates in order to sell the bonds it needs to run the government. If the Fed sells bonds on the open market they compete with the Treasury also causing rates to rise.3

What’s the Big Deal?

So what’s the big deal if the Federal Reserve unwinds its balance sheet and lets interest rates rise so people have incentive to buy U.S. bonds? They cannot for two reasons, 1) we can’t afford the higher interest payments, and 2) it will pop the stock market bubble fueled by low interest rates. People will put their savings in safer investments than the stock market if they can earn decent interest, thus decreasing demand for stocks.

Well then, if the Fed thinks we need more economic stimulus when the next crisis hits, why not employ another round of quantitative easing? After all, we’ve gotten away with it thus far.

Inflation, Inflation, Inflation!

Inflation is an increase in the quantity of money in circulation. Rising prices result from inflation, they are not in themselves inflation. Why is this distinction important? Because one cannot fight rising prices unless one attacks the root cause.

The identity equation of the Quantity Theory of Money, MV=PY, shows how the quantity of money affects the economy. In this equation, M is the money supply, V is the velocity of circulation (the number of times per year the average dollar is spent), P denotes the price of one unit of output and Y denotes the total output of the economy. PY is the same as nominal GDP from the viewpoint of the production or seller side.

Economists often assume that the velocity of money, V, is constant. They then use this equation to show that the price level changes proportionally to the money supply.

But Fed economists evidently don’t believe V is constant (It’s not). After a crisis, the powers that be seem to think that business and consumers incorrectly lose faith in the economy and don’t spend enough. In other words, when V falls (less spending), the Fed believes it must come to the rescue and increase the money supply to prevent a decrease in nominal GDP. What they fear most is price deflation. But, unlike the Fed, the average Joe knows what he is doing. He is in debt and broke, that is the reason for the decrease in spending (V).

That is why QE hasn’t caused much price inflation of general goods, though methods of measuring inflation hide some of the price increases. The average person or business doesn’t want to go into more debt so the velocity of money remains low. But QE hasn’t stimulated the economy either. What it has done is transfer wealth from the bottom to the top by generating asset price bubbles in housing and the stock market. I have often mentioned these wealth transfers but how they happen deserves repeating:

Increases in the money supply set in motion an exchange of nothing for something. They divert real funding away from wealth generators toward the holders of the newly created money. This is what sets in motion the misallocation of resources, not price rises as such. Moreover, the beneficiaries of the newly created money–i.e., money “out of thin air”–are always the first recipients of money, for they can divert a greater portion of wealth to themselves. Obviously, those who either don’t receive any of the newly created money or get it last will find that what is left for them is a diminished portion of the real pool of funding.4,5

Armed with the false belief that deflation is the worst possible outcome (and evidently with the belief that they must arm-twist financially broke Americans into spending) the Fed believes they can stimulate nominal GDP (PY in above equation)  by increasing the money supply (M) to make up for decreased spending (V). Austrian economists would counter that the equation balances naturally by allowing prices (P) to fall (inflated bubbles pop). With lower prices, people will spend more and (V) will return to normal.

The Fed’s plan hasn’t worked. The “recovery” from the Great Recession is a sham. Stock and housing prices inflated, transferring wealth to a small portion of society, but real economic growth is low and wages have stagnated.

Not only that, but instead of people’s bank accounts being filled with dollars that are worth more due to falling prices if nothing had been done, they are worth less because of the Fed’s “money printing.”

However, the inflationary effects of QE will eventually show up. At some point people will realize the government has gone too far. Both foreign and domestic holders of U.S. dollars will spend them before they become worthless. When spending (V) returns to normal or above, that along with the increased money supply due to quantitative easing increases the value of MV in the identity equation. But MV, by definition, must equal PY. Since the new money from QE was not put to productive use, but mostly into inflating the price of existing assets, Y (production or real GDP) was not increased by QE. This means that the price (P) of the goods and services we use every day must increase.

Inflation will take off. If we don’t want to end up like Venezuela, the Fed will have to admit defeat, raise interest rates and send the economy into a recession that will be far worse than if they had never implemented their easy-money policy.

Here’s the question – will the Fed be as stubborn as a socialist dictator and stay the course when crisis comes? If the Fed responds to the next recession with QE4, in my opinion, it will be “game over.” They will sacrifice the dollar and our economy with it.

So, will the path we are on predictably and inexorably lead to a currency collapse? Yes, but the Fed can change its path. I read years ago one man’s observation that when an economy reaches the critical point, rich Western nations choose deflation over inflation. I believed it then. Now I’m not so sure.

Finally, how much socialism does it take to collapse an economy? It only takes the amount necessary to direct an economy away from its natural course into the precarious position we now experience. Without quantifying how much socialism is required, it is safe to say that we have enough, especially since the government has a monopoly on money in the form of the Federal Reserve.

(Part 3 will offer some possible Christian responses to these grim prospects for our economy.)

Notes:

  1. This is not inconsequential. As of September 2016. foreigners held 30% of our public debt — $6 trillion in treasuries. But they also held $5 trillion in corporate bonds and another $6 trillion in mutual funds, ETFs and other portfolio assets.
  2. Federal Reserve Bank of St. Louis, “In-Depth: Is the Fed Monetizing Government Debt”
  3. Peter Schiff, “The Fed Is Going to Sacrifice the Dollar,”
  4. Frank Shostak, “Defining Inflation,” https://mises.org/library/defining-inflation.
  5. In the case of QE, the first recipients and primary beneficiaries of the newly created money are the too big to fail financial institutions such as Goldman Sachs. See the complete list of primary dealers here at the New York Fed.

References:

The Money Changers Have Stolen From Our Future – Why We Will Have to Live On Less

money changers hands

My recent article, America’s Level of Prosperity is Not Sustainable, dealt mainly with the yet to come lowering of living standards in the U.S. due to having to pay back external debt to our trading partners.

The Financialization of the Economy

But there is a more insidious, pervasive and direct cause of our current economic woes – the financialization of our economy. There are a number of ways to describe financialization. It occurs when the financial sector accounts for a disproportionate share of a nation’s profits at the expense of the real economy. The real economy is that part of the economy that is devoted to actually producing goods and services rather than to buying and selling assets and debt.

This increased diversion of income from labor to capital owners results in inequality as wages of workers stagnate and wealth is transferred to those who use money first, i.e., the financial sector. Financialization is characterized by a penchant to obtain short-term profit at the expense of long-term economic growth. Normal economic common sense becomes increasingly uncommon as the concept of making money from money takes priority over using capital together with labor to produce goods and services.

It’s as if our society has become infatuated with investments that, in fact, are not – at least not in an economic sense. Many of our “investments” are no more than the buying of assets hoping their price will increase. For example, when we buy stock in a company, unless we purchase an IPO, we are simply buying ownership in a company from another owner. This “exchange” of stock puts no money in the company’s coffers to invest in future economic output.1

The Financial Industry is not Part of the Real Economy

The distinction between the financial industry and the real economy has been lost, along with any notion that the financial industry’s excessive growth actually chokes the life out of the real economy. Financializaton has already caused a lower standard of living for many. Wages have stagnated despite the fact that those producing goods and services have become more efficient in their work. Financialization ensures that the fruit of increased productivity goes mostly to capital owners rather than to workers.

Short-term Thinking, Long-term Pain

When financiers are given free rein, the economy loses its bearings as firms seek quick profits by whatever means allowed. Leveraged buyouts and massive layoffs result as shareholder’s returns on their “investment” trump the earnings of employees who actually produce real wealth. Pension funds go the way of the dodo bird and companies are carved up into pieces so that the most valuable assets can be sold to satisfy the shareholders’ greed.

When financiers are given free rein, research and capital equipment investment (key drivers of economic growth and wealth creation) decrease substantially because they are long-term investments. Corporate CEOs (who are mostly compensated with company stock) who delay satisfying the insatiable desire of capital owners for yield, are quickly punished by a drop in their company’s stock price.

Such economic practices are irresponsible. A farmer would be foolish to eat all of his grain leaving none to plant in the spring. He would be foolish to neglect his equipment, letting it break down while spending his profits on lavish parties and trips to the Caribbean. If he does so and wants to farm the next year, he will have to go into debt. Why should we expect better results when we sacrifice our nation’s economic future on the altar of short-term greed?

What is the proper role of finance?

Finance does play an important role in our economy. When the financial community does its job well they provide a trustworthy bridge between savers with money to invest and businesses that need capital to expand. Expanding business means more and better paying jobs and an increased standard of living.

Unfortunately, because of a lack of transparency and past abuses, financial markets have lost much of the public’s trust. Today, financial institutions only use 15% of their capital to fund business investments in the real economy.2

So, where does all the money go? Much of it is used for lending to buy existing assets.3 When this happens, besides creating a bubble and transferring wealth to the first users of money, less money is used to create new wealth. The financiers profit but the economy stagnates.

What evidence is there that the financial sector has grown too large? The financial sector takes a disproportionate share of corporate profits (25%) while creating few jobs (4%).4

It is government’s responsibility to rein in excessive power and influence, but it is instead complicit in the rise of the financial sector. When interest rates are nearly zero and when government hands power to the financial sector with little accountability, should we be surprised when they take the easy path to profits instead of the prudent path to economic stability?

Modern Day Money Changers

While not the only modern-day example, I have long thought that Wall Street and our financial system is a good representation of what the Bible refers to as money changers in Matthew 21 and John 2. The money changers should have been outside the temple serving those who needed to buy animals to sacrifice in the temple. Instead, they were a distraction and a hindrance to them even as they took advantage of them. Jesus drove them out calling them robbers who misused the house of prayer.

I use the term money changers to describe the financial “industry” because they have moved almost entirely from their traditional role to serve the public and business by facilitating the use of savers’ funds for investment in the real economy to a role of traders who, in the pursuit of large short-term profits charge excessive fees for products that add little to economic growth. Like the money changers in the Bible they no longer serve others, but instead, serve themselves.

Why We Will Have to Live On Less

When an economy is skewed toward finance the future is largely ignored. Inequality increases as wages stagnate because gains go to capital owners rather than labor, jobs are lost and debt piles up.

Productive capacity is reduced when capital is wasted on bidding up the price of existing assets. Investment in capital equipment and new business will prove to have been inadequate to meet our future needs. The only way we will be able to sustain our previous standard of living is to go further in debt to our trading partners. But, never-ending trade deficits are unsustainable.

These mistakes can be corrected, but much damage has been done and it will take time to repair our economy, even if we have the will to do so. We won’t escape from our own folly without having to endure a significantly lowered standard of living. We cannot reap from what we have not sown.

 

 

Notes:
  1. Stock price does have an effect on the company’s ability to borrow money for business expansion. However, it is the creditors (corporate bondholders) who are investing in the company, not stockholders.
  2. Foroohar, Rana, Makers and Takers, New York, Crown Business, 2016
  3. Foroohar, Rana, Makers and Takers, New York, Crown Business, 2016
  4. Rana Foroohar, Makers and Takers, New York, Crown Business, 2016