Saturday, August 14, 2010

Deflation vs Revulsion

In our current predicament we find the mainstream of economists, seduced by the history and mathematics of a return to Neo-Classical monetary theory, insisting that there remains no space between the deflation that we currently face and currency revulsion they insist is the inevitable consequence of continued deficits. No new model needs to be constructed to contest this view, it exists in reality and is called Japan. For twenty years deficits have accumulated well beyond the Neo-Classical inflection point of 90% of GDP that is supposed to trigger inflation. Now at twice that level Japan has no experience of either inflation or it's supposed successor currency revulsion. Neo-Classicists insist this will all end any minute now. They have for twenty years.

Mathematical models of growing complexity began to be constructed in the late 1970s to explain the growth in Keynesian economies from 1936 to 1976 as having been in spite of rather than because of Keynsian policies. Occam's Razor was abandoned by a wooly new economics that obscures its motives in this complexity. Now equidistant from that inflection point, the macro economy has returned to a state very similar to that for which Keynes invented his policies.

There is a broad pattern that is so obvious that it apparently disappears into the landscape for Neo-Classists so obsessed with trees that they can't see the mountains. Since 1936 as annual deficits added wealth to the economy the economy grew at a rate that reduced the percentage of GDP the accumulated debt represented. This is because growth in the economy exceeded growth in the cumulative deficit. Each occasion where annual budget deficits were abandoned in favor of surpluses was followed either by a stall or contraction of the macro economy.

There is no doubt that Keynesian policies can be misapplied, price and wage indexing were a mistake the OPEC shock compounded to create a real inflationary episode. This reality does not however close the gap between incipient deflation we now face and the currency revulsion mainstream economics insist we face. The real threat to a fiat currency facing a debt deflation seems to me to be that the value of that currency is entirely dependent on the productive capacity and effective trade of the economy denominated with it which the deflation itself threatens to dismantle through bankruptcy and liquidation. When the US can no longer produce and consume, its currency will be valueless, and the quickest way to get there is a general deflation.

Inflation is a risk. Currency revulsion is a risk. Debt deflation is a risk. Demand deficiency is a risk. Neo-Classical economics refuses to recognize that demand deficiency can exist because it insists that debt dynamics are a purely monetary phenomenon. This view depends on "rational expectations" which describe the mathematicians fantasy life rather than any lived human experience and Say's Law that requires humans to deploy all their income at all times, and to do so effectively. Both necessary propositions for the Neo-Classical position place the human economy in the Procurstean bed of mathematics and would rather decapitate humanity than abandon the bed.

Five years on now, not only has QE massively inflated the balance sheets of the Fed and asset prices for the rich, but the GOP's continuing erosion of the authority of the IRS to collect tax from the wealthy is setting the conditions for revulsion. To gamble further with our patrimony, our sanctions efforts with Iran, Russia and Venezuela are all pushing toward a China centric integrated foreign exchange system.  So we have erosion of our own strengths while actively incentivizing an alternative. 1/28/15