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Will excess money cause a new economic breakdown?

by on 11/02/2018

The major conclusion from the previous three essays about US debt was that the major financial event of the last ten years after the economic crisis of 2008, was transfer of private households debts, to the public debts.

This happened, when the policy of Quantitative Easement policy taken by federal reserve, that printed trillions of dollars of new cash didn’t caused the expected credit increase for the private sector. Instead of credit volume enlargement, the additional cash money printed by the FR, was accumulated in the commercial banks, and created excess reserves, deposited mostly back in the FR vaults. Since money creation is loan dependent, without new credit to the system the economy continued its languish state.

Partly it was caused by new regulations of banking system, called Basel III norms, introduced gradually in more substantial way since 2008 crisis, that among others, changed the rules of Minimum Capital Requirements. This change was necessary to stabilise the banking system, but in the short term of few years it caused credit squeeze. It seems by 2017 this process of capital restructalisation came to the end, and the banks are opened again to do business.

If we return to our first essay, where i defined the political-economic aim of all the governments, without difference of opinions;

  1. To make the citizens satisfied in their material and cultural life, under conditions of limited resources, by providing social services and security at politically agreed level.

  2. To create stable economic environment without inflation, so that businesses and households can trust the economic system, securing their well being and wealth in the future and also for the future generations.

  3. To secure full employment, so all the healthy adult citizens in their productive age can enjoy productive healthy life.

It seems as today, all these aims were achieved since the economic crisis. So what’s so wrong about transferring the private debts to public debts? Why are the US legislators obsessed with the question of public debt ceiling? The major problem with monetary policy of quantitative easing is the instability it created in the existing monetary system, that by its essence is intertwined with the non monetary side of the economy. Unstable financial state causes potential instability in the merchandise and services demand and supply, with all its potential negative political and social consequences. Other result of QE is low interest rates, causing increasing inequality on wealth distribution, impoverishing the wage and pension income dependent people and enriching the asset holders.

The goods-merchandises and services can’t be transferred from seller to buyer, unless an intermediation agent, with normative ruler accepted by both, seller and buyer is used. As today, the only such an agent known to us is Money. Even if money changes its form, from metal money, to paper money, checks, plastic money, and lately digital money, still it works according to the same principle. Money, has attribute of universal agent for exchange, with relatively stable exchange value, issued in responsible way and guaranteed by government, defended with all its political and military might. As such, the money is not only media of exchange, but also value securing asset. But to keep money’s value fixed, it has to have the capacity to be scarce. Scarcity is the attribute, that gives to any economic item its relative value. Not absolute quality or quantity, but relative scarcity with relation to the demand of the merchandise and service secures it’s value.

But money by itself is useless, and so it has to be. After all, if money would have other purpose than being an agent of exchange or/and value securing asset, it’s value would be subjective and relative for everyone. And it is important that money has an objective absolute value, and if possible stable. But it is hard to achieve absolute objective value of the money and even harder to maintain it. After all, money has also mysterious fetish value, and every individual relates different fetish value to money.

Since ancient times, the governments discovered, that money has to be regulated, so they monopolized the money creation. If not regulated, money can become too abandoned, then loses its absolute value, and even more its attribute as value keeper. Keeping money’s value stable became even harder, since fiat money was successfully introduced, and was finally disconnected from any kind of metal backing.

If few decades ago, the paper money was still the main instrument of exchange, since then it has been digitized. Digitalization of money made it even more abstract and non material. But the technological change didn’t stop there. Few years ago, functionality of money still needed big centralized computers, interconnecting all the banks together, to manage your digital money. All this has changing now. Just as everything becomes information, saved and stored in cloud, to which everyone is connected by his portable mobile phone, so will be the money. The cryptocurrency is exactly that, cloud stored money. But not only cryptocurrency, also internet banking, that disconnected the money owner from its holder, the banks. The contact between the two goes through call centers completely anonymous. Add to it the post 2008 economic crisis events, as quantitative easement, its meaning is trillions of new dollars and Euros poured into the monetary system, and the trust in money is shaken.

Yet money’s value, as agent of exchange, defined as purchase power of households consumers basket index, was not shaken. In contrary. Almost zero inflation rate of consumers products secures continuous general acceptance of money as exchange agent.

According to proclaimed goal of central banks policy, 2% level of inflation is considered as optimal. In average, since 2008 this goal was underdone. How is it possible? In spite of trillions of newly printed dollars since 2008, the central banks failed to achieve their inflation goal? More than that, the inflation level is the lowest since decades (viz the next chart). This needs explanation.

The new technologies decreases strongly the marginal cost of production. In many cases after the initial investment, the marginal production costs are close to zero, and so are the product prices. But new technologies, not only enable to purchase products, available for symbolic price, or even free of charge on the internet, but also reduce the labour hours needed to introduce products and services to the markets. More than that, the following chart shows dramatically low wage increase, relatively to the productivity increase.

The relative wage decline has a double edged sword influence on the price increase. It reduces the costs of the labour intensive products, but also decreases the purchase power of the employees, who are the vast majority of the population. So the aggregate demand has relative decline tendency, and the supply prices are suppressed too.

The data strongly supports the thesis, that price increase is caused rather by commodity price increase, that are supplied by monopolistic producers, than by aggregate demand increase. If there are expectations for price increase of the consumers expenditure basket, it will rather be due to basic commodity price increase, than any other parameter. The last big inflation breakout in the years of stagflation at seventies and eighties in the last century, was rather caused by price increase of commodities as fuel, corn and basic raw materials, than by public debt increase, or too much liquidity in financial system.

Why is all this important for predicting the next crisis? Because inflation in consumers price index influences central banks policy of interest rates. Interest rate hike changes investors preferences between forms of money savings on one hand and investments and borrowing on the other hand. Since money creation and money velocity has strong correlation with bank loans, these changes can cause spiral downfall events, ending with another economic crisis.

What about the value holding property of the money? Compared to other value holding assets, like stock prices, real estate prices, and the new phenomenon of cryptocurrencies values, the relative value of money compared to all these was strongly diluted.

The above chart represents the increase of net worth of US Households, that at the end of 2017 was close to 100 trillion dollars. Net worth collapsed at 2008 to about 55 trillion dollars, but since then added almost 100% to its value. All this happened while the level of real estate and debt remained almost unchanged from the pre crisis values, and most of the additional wealth was created in form of financial assets. Does it represent real value increase in corporate equities?

The nonfinancial corporate businesses equities index as to 2016 updated data increased from pre-crisis 2007 peak of 15,000 to 22,500, that represents 50% increase. But part of this equity itself is a bubble increase, since the corporate assets include overvalued financial assets. It seems, that the equity prices are higher than it was in pre 2007 economic crisis.

Financial assets composition in the US, as seen in the next chart, are mostly equities, in form of shares of corporations or private equities. These are the least stable assets as to their value if compared to currency and deposits. Stock exchange prices are the first to volatile and in a very strong way. Other financial assets include corporate securities and bonds are exposed to huge risks, if not been able to be recycled. This may happen if the maturity of the security happens to be in middle of an economic crisis. From this point of view, corporate securities are kind of Russian roulette risk taking assets. If their maturity is at right time, they are secured, unless for some other reason the corporation issuing the security doesn’t ceases to exist. If at time of maturity of the security an economic crisis rampant, most probably the heavily invested corporation is not liquid enough to be capable to repay the debt.

As to distribution of wealth, the next chart shows clearly, that since the seventies, the wealth gap difference between the top 0.1% rich and the 90% bottom households in the US has changed significantly. If at seventies the top 0.1% rich owned about 7%, and the bottom 90% households owned 36% of the total wealth in the US, the latest data show, that they are equal with about 22-23% of the wealth each.

Since the seventies of the last century almost an uninterrupted trend of increased inequality started in the US. This trend was temporarily disturbed between 2000-2002. Interestingly this change corresponds with the changes of the Nasdaq index.

My thesis is this correspondence is not and arbitrary one. The Nasdaq is a marketplace for high tech and startup companies, that are more risky than other assets. Most probable the difference between investors in Nasdaq shares and people with no tendency to such an investment, differentiate also between more risk and less risk taking people. It seems it also differentiates between those with increasing net worth, who are also with higher propensity for entrepreneurship, as against the employees or pensionaries.

The QE monetary policy changes radically the wealth distribution inequality between the monetary asset holders in different forms of deposits, pension funds, etc., and the corporate shares and real estate and even cryptocurrencies holders. Most probably the wage and pension income sector of the society will be the social group with relatively higher percentage of their net worth holds in some form of money.

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