The economy: "Things fall apart", Part 2

In Part 1 of this article, we looked at the current state of the US economy in terms of the devaluation of money, inflation (which is running right along at plus-or-minus 10% per year, irrespective of 'official' government figures, edicts or prognostications) and globalization.  It's not a happy picture.

In this second half of the article, I'd like to look at the latest ideas from central banks on how to deal with the current crisis, and what they're likely to do to 'ordinary people' like you and I.  I'll then make suggestions as to ways we can prepare for and handle the problems that lie ahead.

Let it be said, right at the outset, that central banks don't care about 'ordinary people'.  They look at the economy overall, examining issues and trends, trying to make it behave according to the blueprint of what they consider desirable and appropriate.  They're also constrained by political reality, irrespective of any lofty words about how they're 'independent'.  If the government of the day wants a given fiscal policy badly enough, it will force its central bank to go along, one way or another.  If persuasion won't work, it'll replace those in charge, or even pass laws that change the status of the central bank to bring it more directly under political control.  To take just one example, witness Japan in 2013:

A joint announcement between the Bank of Japan and government officials said the bank would pursue “open-ended” asset purchases starting next year. The bank also upgraded Japan’s economic growth forecasts...

. . .

Prime Minister Shinzo Abe’s government had pressured the Bank of Japan and Gov. Masaaki Shirakawa to enact bolder monetary policy in the run-up to January’s meeting. In light of the new policies, Abe’s chief cabinet secretary backed away from earlier threats by the Prime Minister’s LDP Party to push for reforms that would undermine the central bank’s independence.

There's more at the link.

If you believe that the Bank of Japan would have taken such steps without such pressure from the Japanese government, there's a bridge in Brooklyn, NYC I'd like to sell you.  Cash only, please, and in small bills.  Want another example?  Try German pressure on the European Central Bank.  There are many more, including the Federal Reserve enabling US government deficit spending by 'printing money' to fund it.  Quite literally, without the Fed, present US government spending levels could not possibly continue.  It's as if the Fed were a drug dealer, handing out free crack to keep addicted politicians dependent on it.  Whose fault is that?  The Fed's, for accommodating the politicians, or the politicians, for pressuring the Fed to do so?

Whoever's responsible, the result of the Fed's connivance is the US government deficit, the cumulative effect of which has pushed gross federal debt to almost $20 trillion at the time of writing.  How is that ever going to be repaid?  My guess is that the government and the Fed will tolerate - if not encourage - inflation levels so high that it'll be repaid in dollars that have been inflated into worthlessness.  We discussed that yesterday.  With real inflation running at about 10% per year, that can be accomplished in only a few decades.  The fact that the 'little people' - folks like you and I - will be impoverished in the process doesn't bother either central bankers or politicians, who will make sure they're insulated from such side-effects.

The central banks, influenced by Keynesian economics, went all-out for 'quantitative easing' in an attempt to recover from the 2007-08 financial crisis.  QE temporarily stabilized the situation, but could not solve the problems at the root of the crisis.  Its benefits are now wearing off, despite repeated applications.  Central banks are now talking about 'doubling down' on this approach by deploying so-called 'helicopter money'.  This is, at its root, nothing more than another form of QE:  money 'created' by a central bank, disbursed either to the government in the form of bonds for which it doesn't have to pay, or more directly to corporations and citizens, in an attempt to boost economic activity.

There are great dangers in such an approach.  As David Stockman points out:

... “helicopter money” isn’t some kind of new wrinkle in monetary policy, at all. It’s an old as the hills rationalization for monetization of the public debt—–that is, purchase of government bonds with central bank credit conjured from thin air.

It’s the ultimate in “something for nothing” economics.

. . .

The unstated essence of it is that our monetary politburo would overtly conspire and coordinate with the White House and Capitol Hill to bury future generations in crushing public debts.

They would do this by agreeing to generate incremental fiscal deficits—-as if Uncle Sam’s current $19 trillion isn’t enough debt—–which would be matched dollar for dollar by an increase in the Fed’s bond-buying or monetization rate. That amounts not only to teaching children how to play with matches; it’s tantamount to setting fiscal forest fires across the land.

There are a few additional meaningless bells and whistles to the theory, which we will dispatch in a moment, but the essential crime against democracy and economic rationality should be made very explicit. To wit, this is a central bank power grab like no other because it insinuates our unelected central bankers into the very heart of the fiscal process.

. . .

... what makes helicopter money so positively insidious is that it relieves elected politicians entirely from their vestigial fears of the public debt and from accountability for the burdens it imposes on future generations ... the crucial element in [Bernanke's] helicopter money scheme ... is an explicit and loud announcement by the Fed that the incremental debt will be permanent. It will never, ever be repaid——not even in today’s fictional by-and-by.

Again, more at the link.

A British financial journalist, discussing 'helicopter money' and its prospects in his country, notes:

But what form will [helicopter money] take? The most likely option is probably a direct monetisation of government debt ... The state could create infrastructure bonds to finance a public works programme and those could be bought directly by its central bank and then cancelled. Instead of adding to the national debt, the bonds would simply be written off.

A more radical idea would be directly putting money into people’s pockets. Technically, the Bank of England would simply credit everyone’s account with £1,000, or whatever sum it chose. A more subtle way of doing that might be through a basic citizen’s income, a proposal already being discussed in Finland and Switzerland, two countries either in or close to recession. Everyone could be paid £5,000 a year, and the central bank would pick up the tab.

Another option could be an incomes policy, which some economists are now advocating for Japan, with the government simply mandating a pay rise. Here in Britain, with our traditional reliance on the property market to boost the economy, don’t be surprised if it takes the form of a more generous “Help To Buy” scheme.

If any of those policies were implemented, expect retail sales to soar, along with car sales and house prices.

Of course, helicopter money won’t work any better than Zirp and Nirp did. It will just further undermine faith in the soundness of currency and reduce incentives to work and save. Worse, unless people can be convinced it is permanent, they may not spend it anyway – many of us might just use the “helicopter money” to reduce debts, which will defeat its purpose. It could backfire as badly as negative rates.

In reality, the major problem for our economy is that we have too much debt, the state is too big, productivity is not growing quickly enough, and technology is no longer delivering sufficient innovation to create new industries in the way it once did. None of those problems will be fixed by printing more money.

More at the link.  Bold, underlined text is my emphasis.

Please note the final paragraph quoted above.  Those problems are at the root of our current economic malaise.  None of the measures taken by central banks will solve them.  Those measures are merely 'papering over the cracks' - indeed, they are making some problems (e.g. the levels of debt in the economy) much worse.  What's more, by devaluing our currency and rendering it essentially worthless (as discussed yesterday), they're ensuring that we will never be able to dig our way out from under those problems as long as we follow current policies.  The longer those policies continue, the worse the situation will become.

These 'big picture' economic developments are all very well, but what do they imply for us as individuals?

1. Our incomes are being reduced in purchasing power by approximately 10% per year (the real rate of inflation, as discussed yesterday).  If I earn $50,000 per year, and receive a 1% increase this year to compensate me for the official rate of inflation, this is worse than meaningless.  In reality I will suffer a 9% decrease in my purchasing power.  Next year, my income of $50,500 (including the previous year's 1% increase) will be worth only $45,450 in terms of this year's purchasing power.  That decline will continue, year in, year out.  I have to plan accordingly, and expect that my money will buy less and less as time passes.  Unless I can somehow find extra money from somewhere, I'm going to be in serious financial difficulties in due course.  (Many people already are.)
2. Our financial preparations for the future will become more uncertain, and much more difficult.  For example, we're being urged to plan for a longer retirement, because we're living longer than our predecessors.  This is all very well . . . but in an era of interest rates so low as to be ridiculous, and with our budgets stretched to afford day-to-day necessities, how are we expected to save for our retirement?  A lot of US pension funds are in trouble.  Technically, their members are state-insured against their failure - but that insurance is very parlous indeed, and should not be relied upon.  Pensions may also be drastically cut if reserves aren't sufficient to pay out what was promised.  Playing the stock or bond markets (particularly given their current turmoil) is an expert's job, and even the experts often get it wrong.  Small investors are effectively reduced to participating in investment funds or other joint investment opportunities, where we're dependent on the judgment of others as to what to buy or sell and when to do it.  If they get it wrong, we suffer.  Furthermore, big Wall Street investors, deprived of meaningful yields in their traditional markets, are moving into avenues that were once dominated by small investors (e.g. the housing market - see this report for more information).  That makes it more difficult for those who lack the huge investment resources of the 'big boys' to compete with them, and get a decent return on their (much smaller) investments.

So, in the light of these cold, hard facts, we are confronted by some stark realities.

• Just to keep pace with inflation, we have to achieve an increase in disposable income (i.e. after taxes and other 'up-front' costs) of at least 10% per year - and higher than that, if inflation gets worse.  If we can't do that, the purchasing power of our disposable income is going to go down every year, whether we like it or not.
• If we can't achieve that increase, we have to take a long, hard look at our present economic circumstances, and plan for them to get worse.  We need to reduce our debt load, so that more of our disposable income can go towards everyday needs.  That means reducing or eliminating credit card and other consumer debt.  For example, that may mean buying cheaper vehicles, or buying them used instead of new, and saving up to pay cash for them instead of taking on a loan or lease to buy them.
• We need to plan for an entirely different savings environment.  It's no longer any use to keep large sums of money in a savings account or certificate of deposit, where the interest rate is a small fraction of the real inflation rate.  Our money will lose value - i.e. purchasing power - every day that it's in such accounts.  Instead, we need to treat bank accounts as convenient places to keep our short-term, day-to-day spending money and our emergency reserves.  Some of those funds (perhaps a significant proportion) might be better kept in a safe place at home or elsewhere, because banks are no longer necessarily a safe haven.  Longer-term savings (e.g. for retirement) will have to go into safer investments producing higher rates of return . . . even though finding them will be very difficult for 'small fry' like you and I.

Our spending decisions need to be realigned to take account of a high-inflation environment.  Every cent we spend on fripperies is basically wasted.  We can afford to do that when we aren't struggling financially, but we can't afford it in a high-inflation environment.  We need to get value for our money, and - apart from essentials like food and household needs - that means concentrating on things that will hold their value.  Let's be honest:  we can do without a lot, if we try.

• Our kids will have to learn that the latest Barbie doll, or a 'happy meal', isn't essential, no matter what the social pressure from their friends.
• Many Americans eat out relatively often - several times a week.  Cooking at home is more work, but it's a lot cheaper!
• The quality of US television programming is generally abysmal.  Miss D. and I haven't had a TV service since we got married, and we don't miss it at all.  We can get all the news, etc. we need over the internet, and if we want to watch a movie, there are streaming video services, DVD's etc.  Why pay a monthly cable subscription?
• In the same way, membership fees for gyms, subscriptions to periodicals, etc. are often luxuries rather than necessities.  One can keep fit and strong in the comfort of one's own home, if money is tight.  It's not even essential to buy fitness equipment.

Another benefit of reducing non-essential expenditure is that the money thus saved can go towards things of real value.  For example, Miss D. and I are paying extra on our mortgage every month, reducing the capital owed.  We'd like to pay it off within a decade, if possible.  That will give us several hundred dollars a month extra in disposable income, at a time when inflation is likely to be hurting us much more than it is now.  Another option might be to stockpile basic essentials that you know you're going to need in future.  That way, you won't have to buy as much of them in future when your money might be tighter - you can draw on your stockpile instead.  (Of course, you need space to store them as well, which can be a limiting factor.)

As a corollary, if a tax refund or 'helicopter money' program gives us some unexpected cash, let's use it to reduce debt, pay down mortgages, buy essential items like a more reliable or economical car to replace one that's costing us a lot of money, and so on.  Let's use the windfall wisely to improve our long-term financial position, rather than waste it.

We should take a long, hard look at where we're living, and why.  If we absolutely have to be close to family members, or to a particular job (perhaps because there are few or no other jobs available), perhaps we can't move;  but why not consider our options?  If we sell our existing home and move to one that's more affordable, we might save a bundle.  That might even involve moving to another city or state, where housing is cheaper.  Miss D. and I did that early this year, because a good house here cost less than half as much as one of comparable size and quality in our previous location.  We moved for a number of reasons, not only for cheaper housing, but the latter was a decisive factor.

We need to consider whether we will ever be able to afford to retire.  We may need to continue earning at least something, to supplement inadequate pensions and Social Security benefits (which won't keep pace with the real rate of inflation, as we've already pointed out).  Some examples:

• Have you noticed how many elderly people are working as greeters at Walmart and similar businesses these days?  There are a lot of them.
• In my case, I'll go on writing books for as long as I'm able.
• Other folks I know are using their knowledge of antiques or other markets to buy things at garage sales or from other sources, then re-sell them on eBay or other outlets.  Some are making a tidy living out of it.
• It may be that younger families will no longer be able to rely on free child care from grandparents while the parents are out at work.  Without grandparents' help, parents would have to pay for child care;  so why not expect them to pay at least something (in cash and/or in kind) to relatives doing the same job?

We can try to improve our self-sufficiency.  Many people are growing their own herbs, fruits, vegetables, etc. in their back yards.  The produce is usually cheaper than store-bought, and often tastier, too.  Others are learning skills such as plumbing, vehicle maintenance, furniture-making, etc.  By doing at least some of that work themselves, they're saving what they would otherwise have had to pay to others to do it for them.  Some groups (e.g. churches, neighborhoods, clubs, etc.) are pooling their skills and resources in this way.  One person might be good at plumbing, and help his friends in that area in return for help cutting the grass, or cleaning gutters, or in exchange for a piece of furniture he needs.  Another might can or bottle fruits and vegetables, and trade them for electrical work or vehicle maintenance.  (Best of all, such trades are tax-free, unless the taxman gets to hear about them!)

Finally, we can learn useful lessons from countries that have already experienced high inflation.  For example, in Zimbabwe, Venezuela, Argentina and other nations, canny consumers used their spare cash to buy goods that they knew were - and would continue to be - in constant demand:  easily stored foods (e.g. rice, pasta, cereals, etc.);  household goods (e.g. toilet paper, diapers, feminine hygiene products, soap, etc.);  automotive spare parts;  tools;  and so on.  When they found themselves in need of cash, they would take some of their accumulated stockpile and sell or trade it (at its then-inflated price) to buy what they needed.  If, after the transaction, they had money left over, they immediately bought more goods to add to their stockpile, in the confident expectation that they'd get more for them in future than they paid for them now.  (The danger, of course, was that if they bought goods that turned out to be not in high demand, their prices didn't rise as much, so they lost money.  This applied even to seemingly solid investments like jewelry or precious metals.  In a high-inflation environment, with all its stresses and risks, essentials come first;  and you can't eat diamonds or gold!)

I know a number of people who are already trying to do this in the USA.  Right now, their stockpiles aren't in much demand because there are enough goods available at affordable prices;  but in future, they expect that to change.  Some of them were encouraged by the recent 'ammunition drought'.  They took ammo from their stockpiles and sold it at greatly inflated prices, netting a return of several hundred per cent on their initial investment, then used their profits to buy other things they needed.  Now that ammunition is more freely available, they're replenishing their stocks in anticipation of another 'ammo drought' in future.

I'm sure there are more things we can do to prepare for and endure the problems that lie ahead.  Please contribute your suggestions in Comments.

Peter

(EDITED TO ADD:  There are those who say that in a high-inflation environment, it makes sense to incur more debt by buying items on instalment credit.  Future years' instalments will be the same dollar amount as this year's, but they can be paid in inflation-depreciated dollars, making them cheaper in real terms.  That's all very well if, and only if, one's income is indexed to the true inflation rate.  In other words, if real inflation is 10% per year, one's income will also rise by at least 10% per year.  If that's not the case (and for most of us, it isn't) then it makes no sense to increase one's indebtedness and incur higher monthly payments.)