‘Money creation is not neutral. It is a massive transfer of wealth from the efficient sectors, savers and real wages to the indebted and the inefficient sectors’
Credit expansion, wrote John Maynard Keynes in 1943, “performs the miracle of turning a stone into bread”. Ludwig Von Mises responded in his 1952 work Planning for Freedom that Keynes had in fact taught “the not at all miraculous procedure of eating the seed corn”.
Were both economists alive today, they would see a fiscal and monetary policy framework and accumulated debt levels that go beyond anything Lord Keynes might have imagined as a positive effect of credit expansion. World debt has soared to more than three times the world’s gross domestic product (GDP), according to the Institute of International Finance. The balance sheet of the main central banks has ballooned to US$20 trillion, with the Bank of Japan at 100 per cent of the country’s GDP and the European Central Bank (ECB) at 40 per cent of the eurozone’s. Both economists would be startled to see negative nominal interest rates and $17 trillion of negative-yielding bonds, let alone talk of “Modern Monetary Theory”—in effect printing money to finance government spending. They would be amazed to see that current spending is being financed with deficits and debt.
Keynes’s recommendations included that governments spend on projects with real economic return, which in turn would generate revenues and allow tax cuts in periods of economic growth. None of this is followed today. Instead, we have high deficits in growth periods and even higher deficit spending during contractions.
Such levels of debt saturation and monetary and fiscal excess might baffle Keynes, but any Austrian-school economist will understand them perfectly. The Austrian School of Economics, founded in 1871 with the publication of Carl Menger’s Principles of Economics, “is not based on a fictitious homo oeconomicus, but rather on human beings as they really are and act”, according to the institute’s definition of the approach. The economy should not be politically regulated, nor should society be engineered by the state; human beings instead should be encouraged to freely interact in the markeplace, pursuing responsible entrepreneurial activity.
From the perspective of the Austrian School, we are now experiencing the negative side effects of a system that accommodates the perverse incentives of governments to spend, without paying any attention to other economic principles.
The reason why countries all over the world have exhausted the limits of monetary and fiscal policy can be rooted in two flawed lines of thinking. First, that all economic cycle changes are a problem of demand and, as such, governments and central banks must constantly step in to “incentivise internal demand” and create credit. This situation has become extreme. Expansionary budgets and monetary policies are implemented regardless of the level of growth, not because there is a credit crunch or a real demand issue, but simply because the increase in credit, investment and consumption is smaller than what policy-makers (in effect, central planners) want.
A second mistake is to believe that governments and central planners have better or more information than the private sector. Governments incentivise higher debt, overcapacity and malinvestment under the illusion that those imbalances will be resolved over time. However, the excess and slack built into the economy makes it weaker and less dynamic, while the ability to reduce debt declines. Through the constant refinancing and promotion of zombie firms (companies that cannot cover the costs of their debt with operating profit) and white elephants (useless and inefficient government-led spending projects), the economic system has gone from using a mere part of our savings for non-economic public spending to being based on debt and spending.
Just as our economy is no longer built on prudent investment and savings, governments operate under the false premise that they need not consider balanced budgets, because they can print currency.
But money creation is not neutral. It disproportionately benefits the first recipients of that money, while negatively impacting the last recipients. It is a massive transfer of wealth from the efficient sectors, savers and real wages to the indebted and the inefficient sectors. Who wins from a massive money printing programme? Governments and indebted sectors. Who loses? The average citizen who suffers the loss of purchasing power, rising inflation or the diminishing interest paid on their savings. Money printing, by causing massive inflation in goods and services, or (as now) in financial assets, always hurts the middle and lower class the most.
The reckless behaviour of the public sector is always paid for by citizens, which is why separating government and private debt is not logical. The private sector pays its own debt, and also for government debt with higher taxes.
Debt and unprofitable spending started as a small, acceptable collateral damage of counter-cyclical fiscal and monetary policy. The state intervened to help the economy in times of recession, in the expectation that the excess would be cleaned up in the next expansion. But today, debt and non-economic return spending are the base of many countries’ fiscal and monetary policies. By constantly eroding productivity growth and destroying the positive effect of the credit mechanism to perpetuate slack, even sovereign debt is being put at risk.
In short, instead of penalising savings with negative rates and creating perverse incentives for governments to overspend, we should defend sound money and prudent fiscal policy. In this way, the credit mechanism can have a positive impact rather than being used as a subterfuge to increase governments’ control of the economy.
We must remember and follow Austrian-school principles, because the negative effects we see today will be nothing compared to the devastating outcome of showering helicopter money over the economy, or direct central bank-financing of government spending. Ludwig von Mises would be entitled to say “I told you so” to Keynes. I can’t imagine how the author of monetary meddling’s might reply.