Economic thinkers say Emperor has no clothes [update 2]

The mainstream, “textbook” economics of recent decades is under threat.

Ben Bernanke’s quadrillion-quintillion injection of counterfeit capital into the banking system of the world’s reserve currency has got the world’s economists beginning to scratch their heads in wonder at the system they’ve upheld for the last few decades—which (instead of relying on savings to fund growth) essentially relies on ever-inflating gobs of cheap counterfeit capital to be lent out to create asset bubbles to fund “growth” during the boom and, once the bubble bursts the growth stops and the pool of real savings has been diminished, to fund the “stimulus” on which politicians and other know-nothings now set their hopes.

Instead of relying on the questionable acumen of a monetary dictator to set interest rates (cue lots of media conversation about how the dictator is feeling this week, and the “semantic nuances” of his carefully chosen words in public), more far-seeing economists are beginning to say the current emperors have no clothes.

* * The market itself gave the economists a kick in the pants by responding to Bernanke’s openly inflationist cheque book by soaring past $1,400 per troy ounce for the first time.

* * The German Finance Minister helped kick off the head scratching by pouring opprobrium on the acumen of Bernanke and his colleagues (who could not be more mainstream)

“With all due respect, U.S. policy is clueless,” the German Finance Minister Wolfgang Schaeuble told a conference. “(The problem) is not a shortage of liquidity. It’s not that the Americans haven’t pumped enough liquidity into the market, and now to say let’s pump more into the market is not going to solve their problems.”

* * And the Chinese—the Chinese!—told a news briefing at the G20 conference the move “smacked of outmoded central planning.” Which, of course, it does.

* * In the British Parliament, the cradle of modern democracy, two Conservative MPs have introduced a bill to end shut down the spigot of endless credit—every new note of which dilutes the purchasing power of every note in your pocket—and replace the system that produced the boom and bust with a system of honest money and sound banking.  Introducing his bill, Douglas Carswell told the parliament:

Since the credit crunch hit us, an endless succession of economists, most of whom did not see it coming, have popped up on our TV screens to explain its causes with great authority. Most have tended to see the lack of credit as the problem, rather than as a symptom. Perhaps we should instead begin to listen to those economists who saw the credit glut that preceded the crash as the problem. The Cobden Centre, the Ludwig von Mises Institute and Huerta de Soto all grasped that the overproduction of bogus candy-floss credit before the crunch gave rise to it. It is time to take seriously their ideas on honest money and sound banking.

The bill is beginning to gather widespread support.

* * Indeed, the bill has been lent support by Britain’s own monetary dictator Mervyn King, the governor of the Bank of England, who told an audience last week it is time to talk about “eliminating fractional reserve banking.”

* * And just yesterday, the head of the World Bank chief Zoellick said the world needs to think seriously about “readopting a modified global gold standard to guide currency movements.” And he’s right, you know, it does. The US Federal Reserve’s insistence on diluting the world’s present “reserve currency” only makes it more urgent to re-adopt that more rational numeraire—the one that underpinned the enormous economic progress of the nineteenth century (not coincidentally, the period which enjoyed the most historically sustained economic progress ever).

So the world’s economists are beginning to turn. They’re beginning to realise their emperors of the last few decades have no clothes, and their their textbook theories so widely held hold no water.

It’s only early days, but as Malcolm Gladwell explains about tipping points, this is how change happens.

Gladwell’s Law of the Few contends that before widespread popularity can be attained, a few key types of people must champion an idea, concept, or product before it can reach the tipping point. Gladwell describes these key types as Connectors, Mavens, and Salesmen. If individuals representing all three of these groups endorse and advocate a new idea, it is much more likely that it will tip into exponential success.

We’re nearly there.

As Ludwig Von Mises, F.A. Hayek, et al. took great pains to explain, what this means is that the seemingly golden age — in reality, a thinly gilded one — during which the first, most favored issuers of cheap credit and artificially boosted equity prices enjoyed almost effortless success, has reached the limit of its ability to postpone the workings of fundamental economic law

And the people who need to are quietly, and not so quietly, realising that over sixty years after John Maynard Keynes died, his gig is finally up, and in the Hayek-Keynes debate (one of the most crucial of the twentieth century) a winner is conclusively being confirmed.

Not before time.

UPDATE: In New Zealand, meanwhile, the hegemony of the econo-morons continues.

Faced with the news that his government’s accounts now show him responsible for a 6.5 billion dollar hole in his accounts that he’s borrowing like mad to fill, Bill English promised nonetheless to keep on spending up to a billion more every year, and blamed the shortfall in his balance sheet on those pesky savers. “The lower-than-forecast tax take is largely the result of lower-than-expected consumer spending as New Zealanders pay down debt and save more,” said the know-nothing, before promising to keep right on spending in order to keep the govt “stimulus” flowing in order to artificially up NZ’s GDP figures  to keep the economy humming.

In response, Labour’s Associate Finance Spokesthing Stuart “Mangrove” Nash said Billy Boy isn’t spending enough. “As I have said before,” said Mangrove, “Keynesian economic theory states that in times of economic recession, you don’t give tax cuts to the highest income earners because they will tend to either save or retire debt (i.e. they won’t spend), and this is exactly what has happened.” Mangrove appears unaware of what those luminaries cited above have come to realise: that saving is simply a decision to spend later rather than now, and it is the pool of real savings on which all production actually relies, not the consumption that denudes it.

And over at Bernard Hickey’s place, the new fan of central planning and currency controls has a poll up asking you to pick your favourite of six different flavours of currency intervention (including the present failing modus) and no option to abandon the whole framework of intervention altogether, and bite the bullet that Zoellick and King and Carswell says needs to considered.  Hickey’s issue is that having the economic dictator setting interest rates for our economy only invites “hot money” into the country,  sending the NZ dollar into orbit (a problem exacerbated by Helicopter Ben’s concurrent downward dilution of the US dollar). He is totally unaware of what Zoellick et al are not: that under a gold standard, a country’s interest rates are set by the level of gold flowing into it.  When the flows increase, the interest rates decrease; when they decrease, interest rates do the reverse.  Unlike the present system (which Hickey and the econo-morons still haven’t realised is broken), there is a feedback mechanism promoting stability. A stability the economic dictators will never be able to match.

“Under the classical gold standard prior to World War I,” the period in which history records the world’s greatest ever sustained economic expansion, “ short term interest rates in both the United States and Britain tended to cycle between 2% and 5%,” while the numeraires of each country moved together with gold as their base.  Good for exporters, good for importers, good for producers of every kind. This is the kind of stability of which the Keynesians and currency controllers can only dream.

As Ludwig Von Mises pointed out sixty years ago:

The gold standard was the world standard of the age of capitalism, increasing welfare, liberty, and democracy, both political and economic. In the eyes of the free traders its main eminence was precisely the fact that it was an international standard as required by international trade and the transactions of the international money and capital market. It was the medium of exchange by means of which Western industrialism and Western capital had borne Western civilization into the remotest parts of the earth's surface, everywhere destroying the fetters of age-old prejudices and superstitions, sowing the seeds of new life and new well-being, freeing minds and souls, and creating riches unheard of before. It accompanied the triumphal unprecedented progress of Western liberalism ready to unite all nations into a community of free nations peacefully cooperating with one another.
    It is easy to understand why people viewed the gold standard as the symbol of this greatest and most beneficial of all historical changes.
    [It is also easy to understand why] all those intent upon sabotaging the evolution toward welfare, peace, freedom, and democracy loathed the gold standard, and not only on account of its economic significance. In their eyes the gold standard was the labarum, the symbol, of all those doctrines and policies they wanted to destroy. In the struggle against the gold standard much more was at stake than commodity prices and foreign exchange rates.
    The nationalists [fight] the gold standard because they want to sever their countries from the world market and to establish national autarky as far as possible.
    Interventionist governments and pressure groups are fighting the gold standard because they consider it the most serious obstacle to their endeavors to manipulate prices and wage rates.
    But the most fanatical attacks against gold are made by those intent upon credit expansion. With them credit expansion is the panacea for all economic ills…. What the expansionists call the defects of the gold standard are indeed its very eminence and usefulness. It checks large-scale inflationary ventures on the part of governments.
    The gold standard did not fail. The governments were eager to destroy it, because they were committed to the fallacies that credit expansion is an appropriate means of lowering the rate of interest and of "improving" the balance of trade.

He could have been writing that to Mr Zoellick just yesterday. And Mr Zoellick might very well have been reading it.

UPDATE 2:  This is the good news amid the recessionary gloom, people. It’s precisely because they are running out of options that the mainstreamers are looking outside their conventional nostrums to what the economics that worked well before their conventional textbooks wrote it out of history.  This is the light at the end of the tunnel, argues David Galland at Casey Research, that will bring about “The End of the Statist Quo.” [Hat tip Sovereign Life]

This sea change won’t happen all at once – and probably not without the global economy first going through a dark and troublesome period. But I have to believe that we’ll soon see a widespread recognition that there are problems to be solved, and opportunities to be captured, by breaking from the herd.