Saturday, May 25, 2013

James S. White — Abundance And The Inevitability Of Deflation, Bubbles And Panics

My last post was designed to offer historical precedent for the rise of China. It might have achieved that. But it raises more important questions. The most important is: how do financial systems cope with a world of deflation (created by both China and technology)?
The solution has resulted in a bi-polar personality for financial markets: capital destruction and capital accumulation all in the context of low interest rates. Indeed, deflation and its consequences is the key lesson global financial markets must adapt to. This offers substantial challenges.
An Abundant World
Abundance And The Inevitability Of Deflation, Bubbles And Panics
James S. White
(h/t Andy Blatchford via FB)

1 comment:

The Rombach Report said...

Very interesting article which goes to a number of themes I have been thinking about for some time.

In Karl Marx’s critique of capitalist political economy, he argued that debt tended to expand at a faster rate than the underlying real productive components of the economy which create the real value to pay those paper claims, and this is what fuels the boom bust cycle.  In connection with this, I think Marx had it right on this fundamental problem that he saw for capitalist accumulation. 

 He claimed that rising levels of labor productivity attributable to applications of new technology had a tendency to undermine in real terms, the inflated values of existing paper capital investments in older technology from previous production cycles. In his article, James White makes no mention of Charles Schumpeter, but this Austrian-Hungarian-American political economist, a contemporary and antagonist of Keynes borrowed this theme from Marx, referring to it as the Creative Destruction of Capital.

In the macro economic picture, Marx referred to this process as the "Tendency of the Rate of Profit to Fall". However, credit expansion provides a way to temporarily prop up the outstanding mass of un-depreciated fixed capital by re-circulating the difference to the overall economic output of goods and services which could be sold at inflated prices. 

This ongoing inflationary credit expansion results in an accumulation of potentially illiquid capital holdings, or what in 2008 might have been called toxic assets which were then accumulating on bank balance sheets.

Marx and Schumpeter probably would have argued that these toxic assets must eventually be purged and liquidated in order for real economic growth to resume. However, the solution at that time was to reach for ways to prop up the fictitious values of these assets with measures like TARP & Fed Maiden Lane Holdings I, II & III.

Marx’s critique argued that greater and greater amounts of credit expansion are required to prop up older un-depreciated investment holdings and maintain full employment at the same time. I think this explains why entrenched capitalist oligarchs sought to have a buyer/lender of last resort in the form of a central bank.

Compare this to what Ron Paul and Jim DeMint wrote in a WSJ Op Ed ‘Americans Deserve a Transparent Fed’ on Nov 19, 2009. “The Fed has also for the past three decades, been required to engage in monetary policy with the goal of maintaining stable prices and full employment. Since the natural trend over time is for prices to decrease, a mandate to maintain stable prices is a mandate to pursue an expansionary monetary policy and inflate the money supply to counteract the lower prices we would expect from increased productivity.”

Paradoxically in this context I think Karl Marx and Ron Paul are on very similar wave lengths.