The economy: "Things fall apart", Part 1

There have been a number of insightful articles in recent weeks that have started me thinking again about the world economy.  I've analyzed it often on this blog in recent years, and haven't seen much reason for optimism.  These recent articles have shed new light on a few things I've noticed and written about, and added new concerns.

First, here's how Don Pittis sees the value of money when it's being 'printed' by central banks at the drop of a hat.

A basic principle of economics is that money has value because there isn't enough to go round, but as governments keep creating more of it, the rules may be starting to change.

. . .

The greater the threat to the financial system (Turkish coup, anyone?) the more likely central bankers will propose to create more money.

There is an odd thing going on in global economics right now that's very hard to grasp because it's outside our day-to-day experience, and it's contrary to the founding paradigm of conventional economics: the world's central banks are increasingly making money valueless.

As I've mentioned before, it may be possible to adapt to a world where capital is free, but if so, the rules must change radically.

Among the conventions of economics, the idea that money is in short supply is near the top of the list. But if the value of money is zero or negative, many of the rules go out the window.

If governments produce all the money needed for finance, why should retired people expect interest on their savings? After all, interest is someone paying you for your scarce money. Why pay if it's not scarce?

Far more revolutionary, why should rich people — those who have somehow captured large chunks of money — profit from something that's being created, free, by governments, while so many other citizens get a much lesser benefit?

There's more at the link.

This has huge - I say again, HUGE - implications for investors large and small.  Let's put it in terms relevant to us as individuals.  We're told to save for retirement;  but what if the interest rate on our savings is so low that it's less than the rate of inflation?  If we leave our money in savings accounts or IRA's, we're effectively losing money on it.

In particular, with governments manipulating the 'official' rate of inflation so as to limit inflation-indexed spending (e.g increases in entitlement payments, Social Security, etc.), we can no longer rely on the 'official' numbers for planning purposes.  (I examined this in detail a few years ago.)  The current reality of inflation is dire.  I'll give you two examples.

First, from Shadowstats (which we've met in these pages before), two charts.  The upper calculates inflation according to the standards used in 1990, the second those of 1980.  Compare both lines to the standards currently in use, and you'll get a very good idea of how the 'official' numbers have been deliberately skewed in order to make the 'official' rate of inflation appear lower than the economic reality.  (You can learn more about why they're doing that here and here.)

Second example:  the Chapwood Index calculates actual (not theoretical) inflation rates for specific cities in the USA, using a standardized basket of goods as a hard measurement of year-on-year price increases.  It's very hard to 'fudge' that sort of calculation.  Here's Ed Butowsky, founder of Chapwood Investments, explaining what he does and why.  The video dates from August 2013, and the figures quoted in it are accurate for that period.

Here's an example of ten cities analyzed by the Chapwood Index, taken as a screen-shot from their Web site this morning.  (Click the chart for a larger view.)

Note that the 5-year average annual rate of inflation, averaged across those 10 cities, is 10.91% - let's round it up to 11%, for convenience.  The Chapwood Index thus indicates an even higher city-specific inflation rate than the Shadowstats calculations.  There's an easy way to check their calculations for yourself.  Compare the cost of a shopping trolley full of goods that you used to buy at the supermarket ten years ago, with the cost of that same trolley full of goods today.  For almost anyone in the USA, it's probably at least doubled, if not more so, hasn't it?  That indicates a real, compound inflation rate of at least 10% per year as experienced by consumers like you and I - and demonstrates in real life that Shadowstats and Chapman's calculations are far more accurate than the 'official' statistics.

Compare that real rate of inflation to the risible rates of interest you're being offered by the banks.  They range from fractions of one per cent up to a couple of per cent per year (the latter only for really big deposits).  On the other hand, inflation is eating the value of your deposit at five to ten times that rate every year.  What's even worse is that you have to pay tax on your interest earnings, so your return on your savings is even lower than that.  It's no longer worth leaving money in the bank except as a safe deposit facility for short-term use.  Apart from the safety aspect, you may as well keep cash at home (and if the bank should fail, you'll definitely be better off with cash at home, since your bank deposits are likely to be 'bailed-in' to save the bank!).

In the light of those real inflation figures, let's go back to Don Pittis' remarks quoted above:

Among the conventions of economics, the idea that money is in short supply is near the top of the list. But if the value of money is zero or negative, many of the rules go out the window.

If governments produce all the money needed for finance, why should retired people expect interest on their savings? After all, interest is someone paying you for your scarce money. Why pay if it's not scarce?

That's precisely the point.  The artificial 'creation' of money (merely binary zeroes and ones in an official computer system somewhere) means that there's no economic value underlying that currency.  It's 'funny money' in the un-funniest sense of the world.  If it can be created out of thin air, with no assets underpinning it, is there any wonder that the real inflation rate is so much higher than what officialdom would have us believe?  The value of our money is being deliberately undermined each and every year.  Inflation is merely a way to measure that officially-sanctioned and deliberately-caused reduction in value.

What's more, on top of inflation, globalization has contributed to a fall in real income levels across the lower- and middle-income sections of our society.  Thus, our already inflation-ravaged incomes have been even further reduced, to the benefit of a small upper-income slice of our population, and poorer nations abroad.  They have every reason to be grateful for globalization.  Apart from the flow of cheaper goods to our supermarkets, we have rather fewer reasons for gratitude.  Globalization has cost the average American and European a lot of money in terms of lower and/or lost earnings.

The impact of (real) inflation and globalization has led to people seeking better returns on their investments, by turning to the stock and bond markets, and to assets such as property.  However, all is far from well there too.  Central banks now own large parts of their countries' private corporations, as they've bought up bonds in an effort to stimulate economic growth.  They've also guaranteed loans and other financial instruments to aid companies (and entire sectors of their economies) that are in trouble.  Combined, those measures have led to a stealthy and possibly unintended form of partial nationalization, although they'd never refer to it as such - and it's having the same unhealthy effects on the economy.

Let's face it:  if a government - through its central bank - owns large parts of a nation's productive capacity, or owns or guarantees the debt (i.e. bonds and loans) owed by that productive capacity, it's going to face irresistible pressure to take economic measures that favor the productive capacity it owns, at the expense of other parts of the economy and of its trading partners.  That's one of the factors that's led to so-called 'currency wars' all around the globe, as well as countries with cheaper manufacturing costs 'dumping' their products on those with higher costs of production.  (China is a particularly egregious offender in this regard at present.)  The effects of those practices are currently affecting trade all around the world.  Local businesses can't compete price-wise with such low-cost imports.  That means more local workers lose their jobs as employers are forced to cut back.

What will these pressures lead to?  What can central banks do to 'fix things' that they are not already doing?  And what can we, as individuals, do to prepare for the risks these factors are bringing with them?  That'll be discussed in a second part to this article, later today or tomorrow.

Peter