A One Way Ticket to Central Planning

First up, we’d like to give the banks some credit. They’ve finally gone and done it. That’s what our friend Kris Sayce likes to say when he discovers something ground breaking like this.

So what have the banks gone and done? They have caught up with 1960s technology. They’ve figured out how to use PIN numbers. How to only use PIN numbers, that is. They’re considering scrapping signatures on credit cards to cut down on fraud. Apparently, having to verify your identity at the point of purchase is a good idea…

Credit card fraud costs the banks the banks around $35 million a year. In Canada, getting rid of signatures in 2008 saw card fraud fall by 36%. Sounds like a no brainer, right? In fact, it seems painfully obvious to us. Especially after being a victim of card fraud recently.

Can you imagine if bankers used their ingenuity and effort to make payment systems more efficient instead of devising weird investment schemes involving unaffordable mortgages or gold futures which don’t involve any physical gold? The economy would surge on a wave of efficiency instead of speculation.

But the banks’ revelations aren’t today’s topic. Instead, we’d like to confirm your booking on a one way trip to…well, we’re not entirely sure where to be honest. But it’s definitely a one way ticket.

Money printing, stimulus, currency wars, bailouts and just about everything else you’ve seen since 2008 is pretty much irreversible. In fact, the bailouts part has always been there. Governments have always bailed out financial institutions.

We don’t mean that the policies of the past can’t be undone. It’s more the fact that they will forever be haunting our future.

The market now knows that central banks will print money if they need to. ‘Whatever it takes,‘ said European Central Bank President Mario Draghi. And he pulled it off without sounding like Gideon Gono, Zimbabwe’s former chief central banker.

The market knows big financial institutions will get bailed out. ‘I’ve abandoned free market principles to save the free market,‘George W Bush told us with his sheepish grin.

Economists told American politicians that, if they didn’t approve stimulus packages, the unemployment rate would rise to a whopping 8.8%. Congress voted for the stimulus, and unemployment rose above 10%. But people still see economic stimulus packages as credible. As soon as a recession hits, presidents and prime ministers will be on about their ‘shovel ready projects’ again.

In Japan, the world had high hopes for Abenomics. The blend of monetary and fiscal stimulus, combined with devaluing the Yen, looked set to spur Japan back on track. It hasn’t.

If a private company performed like the world’s politicians and central bankers, what would happen? The company would fail, and someone else would pick up the capital to have a go at doing something better. Creative destruction steadily improves the consumers’ and producers’ lots in life.

Do you think that politicians and central bankers sell up shop and get a job elsewhere when they fail? No. They will do more of the same. The next time there is a recession, governments will pass stimulus packages without as much of a debate. Central bankers will revamp QE without any credible voices preaching about inflation. And every bank CEO will know his job is perfectly safe no matter what.

Rinse, lather, repeat. When you give someone the power to make laws, backed by a money printer to pay the bills, they will never see the error of their ways. It will always be a matter of doing more.

Until what? What breaks? How does this end? At what point do stimulus, money printing and bailouts fail so badly they lose all credibility? Because that’s the way we’re going. Even if there was a half decent recovery in the US and Europe, it’s only a matter of time before a new recession.

Economist Friedrich Hayek explained that socialism fails because it relies on central planning. In other words, the motivations and altruistic aims of socialism may or may not be workable and to your liking. Hippie communes, Israeli Kibitzes and nuclear families are examples where something resembling socialism can work. But it’s the central planning part that makes national socialism fail. National socialism as in socialism on a national scale, that is.

There are a myriad of reasons for this. But an interesting one is that everyone’s plan is different. Mario Draghi’s vision of Europe differs from Manuel Barrosso’s (President of the European Commission), which differs from Nigel Farage (Eurosceptic politician), which differs from everyone else’s.

That’s why you get a complete mess when you put a bunch of politicians in a parliament to decide how the world should work, instead of letting it work the way it inherently does. That applies whether it’s the European or the Australian parliament. If politics made any sense, the amount of laws needing to be passed would be a tiny fraction of those which are passed. Instead, each government meddles in its own different way. Right down to determining which way dinghies in Indonesian waters should be travelling.

This mess eventually becomes so bad that the people demand someone who can fix it. Someone strong, charismatic and accountable. That’s why all attempts at central planning end up with a power struggle at the top. And violent, corrupt and immoral people tend to win power struggles.

That was Hayek’s story of why socialism fails. These days we have all the problems of central planning without the warmth and fuzziness of socialism. In fact, socialism is discredited, despite the fact that conservative politicians practice it at home every day. But it’s central planning that is the problem.

Mainstream economists are completely clueless about this. To them, central planning makes a lot of sense. It provides data for their models (which is usually based on a mid-level bureaucrat’s fantasy), linear relationships (which don’t actually exist in economics) and a job.

Paul Samuelson’s 1960s economics textbooks featured charts showing how the USSR would outgrow the US because of its centrally planned policies.

Source: Marginal Revolution

The best he ever managed as an acknowledgement of his failed predictions was that the weather was bad in Russia.

The same types of predictions are being made today. The IMF boosted its outlook for global economic growth. Our favourite is this chart which shows the American Department of Transport’s predictions for road traffic.

Economists at Work
click to enlarge
Source: Andrew Gelman

How many times do they need to get it wrong?

The good news is that all this dawned on one politician recently. Strangely enough, it was the French President Hollande. Sure, it’s only lip service, but he’s rather good at that apparently.

He recently told his fellow countrymen about the ramblings of a 19th century French Economist called Jean-Baptiste Say. Quoting the modern version of what economists call Say’s Law, he said: ‘Supply creates its own demand.’ That’s not a very useful way of putting it, we know.

Say’s point was that, if you want to buy something, you have to produce something first. To most economists, this is a chicken and egg problem. Supply siders believe you need a chicken to lay an egg. Demand siders say there has to be demand for eggs before anyone will bother with the chickens.

Now demand is effectively infinite. People always want more eggs. The question is whether they can afford them. And how do they afford them? By producing something that a chicken owner wants. Like chicken wire. Hence, producing the chicken wire (supply) allows someone to buy an egg (demand). Without producing the chicken wire, it’s difficult to get your hands on an egg.

But what if you can create purchasing power out of thin air? What if you can print up a few dollars and buy the egg? Demand siders see this as solving the problem. Hence they want to stimulate demand.

And it does work…for a while. If it worked well enough, you wouldn’t ever have to produce much at all though. You could just print money and buy whatever you like. That’s what America has been doing. Hence the trade deficit. It simply prints dollars to pay people to sell them stuff.

This can go on as long as people are willing to accept printed dollars in exchange for real stuff. But eventually they’ll get sick of all those dollars. That’s why China’s monetary meddling is so important. It’s steadily increasing its holdings of real assets like gold and productive capacity. Once it stops accepting so many dollars, America will have to produce something for China if it wants China’s goods.

Back to our original point. Once central planning has a grip on the economy, it won’t let go. Power over the law and currency is just too great a power. In our opinion, it can only be broken when people stop following the law and faith in the currency collapses. Usually that’s a combination of hyperinflation and a grumpy populace.

Can Australia go on being an island of prosperity and calm in the midst of all this? More on that tomorrow.


Nick Hubble+
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Markets and Money offers an independent and critical perspective on the Australian and global investment markets. Slightly offbeat and far from institutional, Markets and Money delivers you straight-forward, humorous, and useful investment insights from a world wide network of analysts, contrarians, and successful investors.

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