Tuesday, October 15, 2013

The casino next door.

Have we created a dual economy of gamblers and others?

One does have some lighter moments even in the weighty world of economic journalism. At a pre-budget briefing long before many of my readers were out of high school, a battery of the country’s top fiscal and monetary policy makers spent some arduous hours with the financial journalist elite going into the finer details of the upcoming budget.

At question time, one of our colleagues got to his feet and asked: “Mr Minister, what does all this mean?” What followed was a stunned silence, until the school masterly Reserve Bank Governor, Dr Gerard de Kock, was instructed to take the confused fellow aside and brief him privately on fiscal affairs. It turned out that he was a junior sports reporter who had been assigned to cover “some meeting” at parliament.

Sometimes the simplest questions are the most difficult to answer, taxing not only your understanding of the subject, but the basic and self-evident logic that should underpin it. Which may explain why many “experts” are not only a bit at sea when it comes to explaining the complexities of our modern financial state, but often disagree about its detail and where it is headed.

Such as: what will happen when the deadline for raising the U.S. debt ceiling runs out? Can the world sustain mushrooming debt without avoiding a massive global depression? Or: with constantly increasing government debt and historically low interest rates why is there no rampant inflation? Related, but just as important questions ask why have low interest rates and government spending not encouraged stronger economic growth and job creation? Why are income disparities at socially unsustainable levels? How can the global economy sustain an exchange system based on increasingly worthless paper?

Try answering those questions at a family braai, and like that posed by a junior sports reporter, you revert to stunned silence. But I take some solace in the fact that even some of the world’s economic elite are not confident of their analyses and predictions. They range from the world heading for a depression; heading for hyperinflation; or both depression and inflation implying unprecedented stagflation; or – as the mainstream guru’s seem to believe – modern monetary management possesses the tools and instruments to keep the ship on a course that will gradually extricate it out of current turbulence onto a growth path where budget balances will be restored, debt repaid, and surpluses and prosperity created once more.

Frankly, despite lofty titles, I don’t think anyone really knows. The conflicting views themselves reflect a global economy that is in unchartered waters. Growing unease can reach a point where faith is lost in those instruments and the ability of those using them -- to ignite a spontaneous reaction from the broad masses that have always marked great economic calamities.

The cracks are severe and it may take little more than the jitters surrounding the running out of time for the U.S. Federal government to raise the debt ceiling on the 17th to trigger a run on the world’s biggest reserve currency and spontaneous de-combustion.

That uncertainty is based on a break with logic and wisdom that has informed our economic lives since Adam Smith. In effect we have created two economies: a money economy and a real one: a casino next door to a productive economy.

Analogies contain a huge risk of oversimplification, but it is an appropriate way of illustrating the human story in the midst of the complexities of the money mischiefs that have become the predominant driver of our socio-economic destiny.

The main casino is in the United States, with “satellite” operations in many other parts of the world. The owners of the house consist of the American Treasury, the Federal Reserve Board, and the operators, croupiers, card dealers and gamblers themselves made up of banks, stock markets, investment houses, and many others. They issue their own chips on players’ markers from a seemingly endless supply and in an incestuous exchange environment. For the most part, those chips stay in the casino, making a select few winners extraordinarily wealthy.

But there are two major problems: those chips are not little round plastic discs, but are indistinguishable from ‘real” money; and eventually they have to be covered from incomes earned in the real economy. The same way that a casino mesmerises its patrons into believing that wealth can be created at the press of a button on a slot machine or being dealt a good hand of cards, the world has placed that casino at the centre of fiscal and monetary policies and has made the destiny of the real economy dependent upon it.

It should, of course, be the other way around. Real and tangible wealth can only be created in the production of goods and services exchanged with fellow human beings. Real money, if not anchored in something of tangible value like gold or silver, and even if it is based on government backed I.O.U.’s, has to be balanced by the equivalent value of those exchanges. In time, that debt has to be paid for, either by income earners or taxpayers. Postponing that repayment simply by rolling it over, raising a debt ceiling, or borrowing money to pay due debt is nothing more than a giant Ponzi scheme.

The casino analogy explains many of the imbalances and disconnects that have developed over the past few decades.

As long as the chips stay in the casino and are not allowed to inordinately contaminate “real money” in the real economy, inflation can be contained. It’s become part of monetary policy to “manage” that contamination either through interest rate manipulation or releasing chips -- to encourage economic growth or maintain price stability. Its ability to do so over an extended period is, however, being seriously questioned. One statistic that puts this in perspective is that the value of trading in casino chips is now about 18 times more than the value of goods and services traded in the real economy in a year.

It explains widening income disparities, jobless economic growth and the absence of a tangible “trickle down” effect, where the demand for goods and services by the rich should be passed on to others in the form of wages and salaries – what’s happening in Wall Street, it is said, is not happening in Main street.

Low employment financial services form a major part of GDP in many developed countries. It is 25% in the United States, compared with 15% in high employment manufacturing. There are just too few who benefit from these activities to have a tangible effect on demand for goods and services – that’s if they are willing to part with their chips elsewhere but in the casino.

It explains too the disproportionate growth in profit relative to the wage and salary share of wealth. Shares are part of the casino, pushing many share prices to inordinate levels unwarranted by the subdued economic environment. In turn this inflates shareholder expectations of earnings to beyond reasonable price/earnings ratios with the inevitable outcome of containment, including labour’s share of wealth.

There are many more. It may not be the most suitable analogy and avoids the complexities of how the casino itself operates. But then, what else do you tell your friends at a braai?

Their guess at the outcome is as good as mine – indeed as good as those who profess to know.

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