Most people who encounter economics do so in college. They take microeconomics first, and if they’re not completely turned off, they take macroeconomics. Unfortunately, there’s no such thing as macroeconomics separate from microeconomics. The idea that there’s one economics for individual entities and markets and another for government-directed aggregate behavior has led to an unmitigated stream of statist disasters stretching back over a century. There’s plenty of competition, but it ranks as one of recent history’s more insidious academic frauds.
Macroeconomic policy prescriptions rest on the belief that governments have special properties and powers that allow them to transcend reality. The unique essential of government is that it can legally initiate force against its people. Coercion gives governments no transcendent magic, any more so than it does for criminals (there is substantial overlap between the two groups), it only gives them the ability to force people to do things they would not voluntarily do. Governments legally tax, spend, issue debt, and in conjunction with a central bank, force acceptance of that debt as the medium of exchange.
The analyses of these activities are straightforward exercises in microeconomics. If government takes money from taxpayers and redistributes it to government employees, contractors, or beneficiaries, that’s money the taxpayer can’t spend, save, or invest that will be spent, saved, or invested by the government’s payee. The propensities to spend, save, and invest may differ between taxpayers and government payees, but all three activities are necessary in an economy and governments have no special insight into the optimal mixture. They don’t even know beforehand what those propensities are, although many studies in abstruse economics journals have tried to determine them. The studies amount to high-toned guesswork, a search for an answer to a question that doesn’t need to be asked unless one believes that governments are better at deciding how much people spend, save, and invest than the people themselves.
Debt funds current spending, saving, and investing from the future, and again, nothing changes when a government or central bank does the borrowing. Governments and central banks create fiat debt that can only be redeemed for more debt, and mandate acceptance of such debt as a medium of exchange. Imagine a neighborhood where a gang of hoodlums printed up their own scrip and made everyone accept it as payment for goods and services. Obviously their ability to bully has given the hoodlums an economic advantage, but their scrip is in no way an economic plus for the neighborhood. As the gang prints up an ever increasing amount of scrip, its value declines and only the gang receives any benefit from it. Coercion cannot produce economic value and it doesn’t matter whether it’s a neighborhood gang or a government gang doing the coercing.
The macroeconomic cover for central banks is that they serve as a lender of last resort during financial panics and smooth fluctuations in the business cycle. In reality, central banks have ushered in the transition from precious metals-backed money to fiat scrip. Precious metals cannot be created from thin air. Central bank fiat scrip can, and it can be used to buy a government’s debt. Whatever temporary stimulus such debt-fueled spending produces, it eventually runs head first into two microeconomic facts, often ignored in macroeconomic models that treats government debt as a consequence-free “exogenous” variable. Debt, like most everything else, has diminishing returns, or progressively less bang for the buck. Debt also carries an interest cost and it must be repaid, even if it is only repaid with more debt.
Diminishing returns and the interest and repayment burdens of debt means that the marginal value of an additional unit of debt can become negative, which is where we are now. The lender of last resort function has devolved into the Greenspan, Bernanke, and Yellen “puts”: injections of fiat debt meant to stop financial market perturbations. As with forest fire suppression, the perturbative underbrush builds up until it fuels unstoppable financial conflagration: the crashes of 2001, 2008, and the next one, coming soon. Fiat debt injection has reached record highs and interest rates record lows after the 2008 crash, not just in the US but around the world. However, the subsequent “recovery” has been abysmal, making a mockery of both governments’ and central banks’ claims of smoothing fluctuations in the business cycle—and the brands of macroeconomics on which such claims rest.
The dirty little secret of all those macroeconomic policy prescriptions is debt: governments issue it; central banks monetize it and suppress its cost. However, the microeconomic facts remain. Debt borrows from the future, imposes costs that can outweigh benefits, and has to be repaid. The biggest glut facing the world now is not oil, iron ore, steel, shipping capacity, or even coal, it’s debt.
That makes debt a short. The most heavily leveraged governments and companies relative to their revenues and profits will be the first culled, and SLL has advised conservative investors to stay away from all corporate and municipal debt (see “Neither a Borrower Nor a Lender Be,” SLL, 8/26/15). The more adventuresome may want to consider the speculative implications of the debt reversal and contraction. While credit spreads are widening, that move is in its infancy and there’s plenty more to come. Companies, indeed entire industries, have ridden on the debt wave, what happens when the tide comes in? One obvious example would be the automobile industry, where ever more lenient credit standards and loan terms have enabled robust car sales. Thinking about cars may lead you in the direction of consumer discretionary and finance sectors. Credit is the life’s blood of both. There is no shortage of overly indebted companies whose securities are good short sale candidates for imaginative and intrepid speculators willing to do their financial homework.
Compared to the years, even decades, in which debt builds up, it unravels with lightning speed, and as we’ve seen in 2001 and 2008, the effects on financial markets are calamitous. Volatility is the barometer of upheaval. If you own a broad portfolio of stocks and bonds, you are implicitly short volatility. In other words, you are betting that nothing is going to radically upend the apple cart. Conservative investors should reduce that implicit short bet. A small subset of knowledgeable investors with discretionary speculative funds and access to top-flight financial intermediaries may want to consider going long volatility, which is a bet on generally unanticipated upheaval. There are options strategies and Exchange Traded Funds that are ways to so speculate, but this is for people who can afford speculation and know what they’re doing, and should only be done in consultation with an expert financial advisor.
Unsustainable debt is contracting and the macroeconomic “theories” that blessed it stand exposed, once again, as hogwash. The powers that be will, once again, bluster about “unforeseen” consequences and their own blamelessness. The rest of us must do our best to stay out of harms way, and perhaps avail ourselves of the short-debt, long-volatility opportunities they’ve unwittingly bestowed upon us. Just because you can’t stop stupidity doesn’t mean you can’t profit from it.
BACK WHEN PEOPLE PROFITED FROM INGENUITY