Inflation & Gold (Photo credit: Paolo Camera)

The loss of trust and the Great Disorder

At its most fundamental level, economic activity is no more than an exchange between strangers. It depends, therefore, on a degree of trust between strangers. Since money is the agent of exchange, it is the agent of trust. Debasing money therefore debases trust. History is replete with Great Disorders in which social cohesion has been undermined by currency debasements. The multi-decade credit inflation can now be seen to have had similarly corrosive effects. Yet central banks continue down the same route. The writing is on the wall. Further debasement of money will cause further debasement of society. I fear a Great Disorder.

I am more worried than I have ever been about the clouds gathering today. I hope they pass without breaking, but I fear the defining feature of coming decades will be a Great Disorder of the sort which has defined past epochs and scarred whole generations.

“Next to language, money is the most important medium through which modern societies communicate,” writes Bernd Widdig in his masterful analysis of Germany’s inflation crisis, Culture and Inflation in Weimar Germany (2001). His may be an abstract observation, but it has the commendable merit of being true

all economic activity requires the cooperation of strangers and therefore, a degree of trust between cooperating strangers. Since money is the agent of such mutual trust, debasing money implies debasing the trust upon which social cohesion rests.

So I keep wondering to myself, do our money-printing central banks and their cheerleaders understand the full consequences of the monetary debasement they continue to engineer? Inflation of the CPI might be a consequence both seen and measurable. A broad inflation of asset prices might be a consequence seen, though not measurable. But what about the consequences that are unseen and unmeasurable—and are all the more destructive for it? I feel queasy about the enthusiasm with which our wise economists play games with something about which we have such a poor understanding.

Debasing money might be expected to have effects beyond the merely financial domain. Of course, there are many ways to debase money. Coin can be clipped, paper money can be printed, credit can be created on the basis of demand deposits which aren’t there… The effects are ultimately the same, though: the implied trust that money communicates through society is eroded.

To see how, consider the example of money printing by authorities. We know that such an exercise raises revenues since the authorities now have a very real increase in purchasing power. But we also know that revenue cannot be raised by one party without another party paying. So who pays?

If the authorities raise taxes explicitly and openly, voters know exactly why they have less spending power. They also know how much less spending power they have. But if the authorities instead raise money by simply printing it, they raise the revenue by stealth. No one knows upon whom the burden falls. People notice only that they can’t afford the things they used to be able to afford, or they can’t afford the things which everyone else can afford. They know that something is wrong, but they just don’t know what, why, or who is to blame. So inevitably they look for someone to blame.

So it is with monetary debasement, as Keynes understood deeply (so deeply, in fact, that it’s ironic so many of today’s crude Keynesians support QE so enthusiastically). In his 1919 book The Economic Consequences of the Peace, he wrote:

By a continuing process of inflation, Governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens. By this method they not only confiscate, but they confiscate arbitrarily; and, while the process impoverishes many, it actually enriches some. … Those to whom the system brings windfalls … become “profiteers,” who are the object of the hatred…. the process of wealth-getting degenerates into a gamble and a lottery. … Lenin was certainly right. There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose.

Lessons from history

…More tragic still was what German society became during the inflation. Like other Axis countries on the wrong side of the War and now in the grip of hyperinflation, Germany turned viciously on its Jews. It blamed them for the surrounding evil as Romans had blamed Christians, medieval Europeans had suspected witches, and French revolutionaries had blamed the nobility during previous inflations. In his classic Crowds and Power (1960), Canetti attributed the horror of National Socialism directly to a “morbid re-enaction impulse”:

Credit inflation in recent decades

Despite the CPI inflation of the 1970s receding, our central banks have continued to play games with money. We’ve since lived through what might be the largest credit inflation in financial history, a credit hyperinflation. Where has it left us? Median US household incomes have been stagnant for the best part of twenty years.

Yet inequality has surged. While a record number of Americans are on food stamps, the top 1% of income earners are taking a larger share of total income than since the peak of the 1920s credit inflation. Moreover, the growth in that share has coincided almost exactly with the more recent credit inflation.

These phenomena are inflation’s hallmarks. In the Keynes quote above, he alludes to the “artificial and iniquitous redistribution of wealth” inflation imposes on society without being specific. What actually happens is that artificially created money redistributes wealth towards those closest to it, to the detriment of those furthest away.

In other words, the beneficiaries of newly created money spend that money and bid up the price of goods with their higher demand. Those who suffer are those who have to pay newly higher prices but did not benefit from the newly created money.

The credit inflation analog to the Cantillon effect has played out perfectly in recent decades. Central banks provided cheap money to banks, the cheap money artificially inflated asset prices, artificially inflated asset prices made anyone connected to those assets rich as we became a nation of speculators, those riches were achieved at everyone else’s expense, and “everyone else” has now realized what has happened and is understandable enraged. As Keynes explained, “Those to whom the system brings windfalls… are the object of the hatred.”

And now the social debasement is clear for all to see. The 99% blame the 1%, the 1% blame the 47%, the private sector blames the public sector, the public sector returns the sentiment… the young blame the old, everyone blames the rich… yet few question the ideas behind government or central banks.

I’d feel a whole lot better if central banks stopped playing games with money. But I can’t see that happening anytime soon. The ECB has thrown the towel in, following the Swiss National Bank last year in committing effectively to print unlimited amounts of money for the greater good. The Bank of England and the Fed have long since made a virtue of what was once considered a necessity, with what was once the unconventional conventional. As James Bullard told everyone a few weeks before the last Fed meeting, lest there be any doubt: “Markets have this idea that, there’s QE1 and QE2, so QE3 must be the same as those previous ones. It’s not that clear to me that this is the way this is going … it would just be to do balance sheet policy as the exact analogue of interest rate policy.” In other words, the central banks’ balance sheets are the new policy tool. As interest rates embarked on a multi-year decline from the 1980s on, central bank balance sheets are set to embark on a multi-year climb.

So as Nobel Prize winning experts in economics punch the air because inflation expectations have been rising since the policy was announced, “It’s the whole point of the exercise” (Duh!), the Bank of England admits that QE has mainly benefited the rich, but vows to continue anyway.

All I see is more of the same — more money debasement, more unintended consequences and more social disorder. Since I worry that it will be a Great Disorder, I remain very bullish on safe havens.

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