BEST OF DOUG NOLAND
February 27, 2003
An Important Essay by Doug Noland
It feels rather silly nowadays to refer to the eighties as the "Decade of Greed." Like NASDAQ, the GSEs, mortgage finance, and shopping malls, we appreciate today that what appeared at the time gross excess ended up looking quite feeble in comparison to the "blow-off" excesses that were to follow. But our focus on Fiat Money and Credit Inflation in America demands that we return briefly to the 1980s. Of course, we should really commence our analysis with the sixties ("guns and butter") inflation, the consequent collapse of dollar gold-convertibility, and the resulting 1970’s ("garden-variety") inflation surge. But, for our purposes this week, let’s set our sights on the cutting-edge, uncommonly seductive ("non-garden…") strain of Credit inflation that began to take root in the period 1984 to 1989. Over this six-year period, total Credit Market Debt outstanding surged 72% to $12.8 Trillion. Importantly, this bout of Credit inflation was all-encompassing and uniform. We see that Total Mortgage Debt jumped 69% to $3.56 Trillion, Non-financial Corporate debt 67% to $2.4 Trillion, and Federal Government debt 65% to $2.25 Trillion. Structured Finance was in its thriving infancy, hardly stymied by its prominent role in the ’87 Crash.
And despite brief fears of a potential post-’87 stock market crash depression, subsequent (Greenspan, along with the Japanese and global central bankers) "easy money" propelled the U.S. and global industrialized economies into a robust late-decade inflationary boom (to which the Japanese are still suffering and the U.S. eagerly sustaining). With the advantage of hindsight - and after witnessing the extraordinary developments transpiring since – we now realize that the general economy had not by late (post-crash) 1987 suffered from the type of prolonged period of maladjustments that create vulnerability to economic depressions. Additionally, and of momentous importance, the Credit system had not regressed to the type of derangement capable, over a period of years, of creating the colossal and fragile debt structures susceptible to collapse. Monetary Processes dominated by speculative financial flows were not yet indelibly entrenched.
Yet by 1990, previous inflationary distortions, that culminated with the rampant Credit inflation and financial excess of 1988/89, had left the financial system and economy acutely susceptible to severe problems. Facing an insolvent (and imploding) S&L industry, a collapsing junk bond market, the coastal real estate inflations turning problematic busts, the residual of the oil patch inflationary boom and subsequent bust, and an increasingly impaired banking system, there was (as we have often discussed) real risk of financial and economic collapse in the early nineties. The economy was already at this point desperate for another inflationary jolt, but the banking system was in dire straits and largely incapacitated. Not to worry. With Alan Greenspan quite eager, the rapidly ascending Wall Street Money and Credit Inflation regime was more than willing to capture and resolutely clutch the monetary reins. An historic inflationary jolt was delivered – more powerful and intoxicating than anyone could ever have imagined.
The Roaring Nineties can be viewed as the Decade of Structured Finance. From the beginning of 1993 through 2002’s third-quarter, GSE assets were up $1.9 Trillion, or 345%, mortgage-backed securities $1.8 Trillion, or 143%, and asset-backed securities $1.89 Trillion, or 465%. Since the end of 1992, ballooning broad money supply doubled to $8.55 Trillion. As a percentage of GDP, total "Structured Finance" financial claims/Credit creation (GSE assets, and outstanding ABS and MBS) jumped from 35% to 75% ($2.23 Trillion to $7.84 trillion). Inarguably, we have witnessed truly one of history’s great Money and Credit Inflations. Its unusual nature allowed it to run rampant and unchecked; instead of repressed, it was celebrated as a New Era. Indeed, this strain of inflation had all appearances (and propaganda) of unleashing a quantum leap in sophisticated finance and risk management, combining powerful new computing technologies with sophisticated statistical analysis and modeling. Behind all the "sophistication" and "complexity," however, there has been an old familiar bottle and a liberated genie of virulent (electronic) Credit inflation.
Now bear with me, as I interrupt our analysis with excerpts from Fiat Money Inflation in France, a brilliant and provocative little book originally written in the 1870’s by American "historian, educator, and diplomat" Andrew Dickson White (with a wonderful forward in the 1959 publication by eminent economist and statesman Henry Hazlitt). White begins: "Early in the year 1789 the French nation found itself in deep financial embarrassment: there was a heavy debt and a serious deficit. The vast reforms of that period, though a lasting blessing politically, were a temporary evil financially. There was a general want of confidence in business circles; capital had shown its proverbial timidity by retiring out of sight as far as possible; throughout the land was stagnation… There was a general search for some short road to prosperity: ere long the idea was set afloat that the great want of the country was more of the circulating medium; and this was speedily followed by calls for an issue of paper money." (pages 23/24) What began with a 400 million issue of assignats (government issued fiat currency) fully backed by property (confiscated for this purpose), ended six years later with "forty-five thousand millions of assignats. The nation in general, rich and poor alike, was plunged into financial ruin from one end to the other."
From the following extracts (and we highly recommend this timeless classic in its entirety!), I hope readers will capture the essence of the powerful allure of monetary inflation and how, once commenced, it takes on a precarious life of its own. Unless quashed, it will lurch to ever more dangerous extremes. And the longer it runs unchecked, the more distorted the system, thereby the greater the dislocation and hardship required to return to monetary and economic order. The larger the mistakes made by the monetary authorities, the more likely they will accept greater, increasingly desperate inflations as their only option. The recurring folly of monetary "management."
Money and Credit Inflation is, all the while, seductive, misunderstood, too easily misinterpreted, and held as seemingly to the great betterment of many and the benefit of virtually all. Importantly, the inflation expedient feeds and emboldens speculation like an expanding snowball set loose from a mountaintop. It can be captivating, exhilarating, and even entertaining, but the final uncontrollable avalanche wreaks absolute havoc on things both real and financial. How monetary inflation seems to work wonderfully – like magic – so manageable, similar to the ease of adjusting the thermostat. Then one day, somehow, it’s at the same time too hot and too cold; then it’s boiling hot in one room and freezing in the next. The small adjustments that always did the trick before have become impotent. Major alterations only exacerbate the extremes; and then things fall into disarray and beyond control. History may not repeat, but, at times, the rhymes are darn right eerie.
"What chiefly strikes today’s readers is the astonishing similarity of the arguments put forward by our own contemporary inflationist to those of the inflationists of eighteenth-century France… But these parallels strike us so forcibly today, not primarily because White underlined them for his hearers in 1876, but primarily because the course of inflation everywhere – economically, psychologically, politically, and morally – does in fact follow the same pattern… The most striking parallel between the events recorded in Andrew White’s essay and the situation in the modern world is psychological. It is the persistence of delusions." Henry Hazlitt 1959 (pages 8/9/11)
"What the country needs is more ‘purchasing power.’ And as this remedy fails, and quite different results follow, the sole solution of the inflationists is still more money, still more ‘purchasing power.’ The broad patterns of all inflations, historic and modern, is the same. The first result is commonly the ‘recovery’ that the inflationists, like others, are seeking. It is not until later that its disappointing and poisonous effects become apparent." Henry Hazlitt 1959 (page 11)
"It would be a great mistake to suppose that the statesmen of France, or the French people, were ignorant of the dangers in issuing irredeemable paper money. No matter how skillfully the bright side of such a currency was exhibited, all thoughtful men in France remembered its dark side. They knew too well, from that ruinous experience, seventy years before, in John Law’s times, the difficulties and dangers of a currency not well based and controlled. They had then learned how easy it is to issue it; how difficult it is to check its overissue; how seductively it leads to the absorption of the means of the workingmen and men of small fortunes; how heavily it falls on all those living on fixed incomes, salaries, or wages; how securely it creates on the ruins of the prosperity of all men of meager means a class of debauched speculators, the most injurious class that a nation can harbor – more injurious, indeed, than professional criminals whom the law recognizes and can throttle; how it stimulates overproduction at first and leaves every industry flaccid afterward; how it breaks down thrift and develops political and social immorality. (page 29)"
"In vain did Maury (a prominent Assemblyman) show that, while the first issues of John Law’s paper had brought prosperity, those that followed brought misery; in vain did he quote from a book published in John Law’s time, showing that Law was at first considered a patriot and friend of humanity; in vain did he hold up to the Assembly one of Law’s bills and appeal to their memories of the wretchedness brought upon France by them…" (page 46)
"France was now fully committed to a policy of inflation; and, if there had been any questions of this before, all doubts were removed now by various acts very significant as showing the exceeding difficulty of stopping a nation once in the full tide of a depreciating currency." (page 48)
"The great majority of Frenchmen now became desperate optimists, declaring that inflation is prosperity… The nation was becoming inebriated with paper money. The good feeling was that of a drunkard just after his draught; and it is to be noted as a simply historical fact, corresponding to a physiological fact, that, as draughts of paper money came faster the successive periods of good feelings grew shorter." (page 51)
"’It is true that at first the assignats gave the same impulse to business in the city as in the country, but the apparent improvement had no firm foundation, even in the towns. Whenever a great quantity of paper money is suddenly issued we invariably see a rapid increase of trade. The great quantity of the circulating medium sets in motion all the energies of commerce and manufacturers; capital for investment is more easily found than usual and trade perpetually receives fresh nutriment… If…the new paper is of precarious value, as was clearly seen to be the case with the French assignats…it can confer no lasting benefits. …this prosperity would necessarily collapse and be succeeded by a crisis all the more destructive the more deeply men had engaged in speculation under the influences of the first favorable prospects." (page 56/57)
"A still worse outgrowth was the increase of speculation and gambling… For at the great metropolitan centers grew a luxurious, speculative stock-gambling body, which like a malignant tumor, absorbed into itself the strength of the nation and sent out its cancerous fibers to the remotest hamlets. At these city centers abundant wealth seemed to be piled up. In the country at large there grew a dislike of steady labor and a contempt for moderate gains and simple living." (page 59)
"From this was developed an even more disgraceful result – the decay of a true sense of national good faith." (page 63)
"It will doubtless surprise many to learn that, in spite of these evident results of too much currency, the old cry of a ‘scarcity of circulating medium’ was not stilled; it appeared not long after each issue, no matter how large. But every thoughtful student of financial history knows that this cry always comes after such issues – nay, that it must come – because in obedience to a natural law, the former scarcity, or rather insufficiency of currency, recurs just as soon as prices become adjusted to the new volume, and there comes some little revival of business with the usual increase of credit." (page 83)
"None felt any confidence in the future in any respect; few dared to make a business investment for any length of time, and it was accounted a folly to curtail the pleasures of the moment, to accumulate or save for so uncertain a future. This system in finance was accompanied by a system in politics no less startling, and each system tended to aggravate the other." (page 91)"From the early reluctant and careful issues of paper we saw, as in immediate result, improvement and activity in business. Then arose the clamor for more paper money. At first, new issues were made with great difficulty; but, the dike once broken, the current of irredeemable currency poured through; and swollen beyond control. It was urged on by speculators for a rise in values; by demagogues who persuaded the mob that a nation, by its simple fiat, could stamp real value to any amount upon valueless objects. As a natural consequence, a great debtor class grew rapidly, and this class gave its influence to depreciate more and more the currency in which its debts were to be paid. The government now began, and continued by spasms to grind out still more paper; commerce was at first stimulated by the difference in exchange; but this cause soon ceased to operate, and commerce, having been stimulated unhealthfully, wasted away. Manufacturers at first received a great impulse; but, ere long, this overproduction and overstimulus proved as fatal to them as to commerce." (page 106)
"Out of the inflation of prices grew a speculating class; and, in the complete uncertainty as to the future, all business became a game of chance, and all businessmen, gamblers." (page 108)
"And, finally, as to the general development of the theory and practice which all this history records: my subject has been Fiat Money Inflation in France: how it came; what it brought; and how it ended. It came by seeking a remedy for a comparatively small evil in an evil infinitely more dangerous. To cure a disease temporary in its character, a corrosive poison was administered, which ate out the vitals of French prosperity. It progressed according to a law in social physics which we may call the ‘law of accelerating issue and depreciation.’ It was comparatively easy to refrain from the first issue; it was exceedingly difficult to refrain from the second; to refrain from the third and those following was practically impossible." (page 110)
"All this vast chapter in financial folly is sometimes referred to as if it resulted from the direct action of men utterly unskilled in finance. This is a grave error. That wild schemers and dreamers took a leading part in setting the fiat money system going is true; that speculation and interested financiers made it worse is also true; but the men who had charge of French finance during the Reign of Terror and who made these experiments, which seem to us so monstrous, in order to rescue themselves and their country from the flood which was sweeping everything to financial ruin were universally recognized as among the most skillful and honest financiers in Europe." (page 85)
"Never was theory more seductive both to financiers and statesmen." (page 28)
Returning to our analysis of contemporary Fiat Money and Credit Inflation in America, we see evidence of some profound developments. First, we have reached the point where enormous Credit Inflation provides only minimal stimulation. Moreover, the maladjusted financial and economic systems function sporadically and poorly with only "minimal stimulation." As such, we’ve reached the intractable "too hot here and biting cold there" syndrome.
Second, dissimilar to the eighties variety of "all encompassing and uniform" inflation, recent (and foreseeable) inflation is overwhelmingly in the mortgage and government sectors. Investment, sound or otherwise, will no longer be a prominent "manifestation." We are left to ponder how major a role this will play in future consumer goods/services pricing pressures. For the first three quarters of 2002, Non-financial Corporate Borrowings expanded $40 billion, or 1.1% annualized; Federal and State and Local Government borrowings increased $251.4 billion, or 7.0% annualized; and Total Mortgage Borrowings surged $620 billion, or 10.9% annualized. Why would we not expect today’s strain of inflation – virtually devoid of "supply side" spending/investment in goods and service-producing enterprises – to harbor disparate inflationary manifestations compared to those that we (and the markets) have become comfortably accustomed?
Third, the massive leveraged speculating community - that really received its critical impulsion from Greenspan’s powerful early nineties inflation to "recapitalize" the impaired U.S. banking system and reflate the faltering economy (and then again from the Mexican bailout inflation, the post-Russia/LTCM inflation, the pre-Y2K inflation, the bursting NASDAQ Bubble inflation, the post-9/11 inflation, etc.) – is an increasingly distorting and destabilizing influence demanding of continued rampant inflation (rising securities prices and continued speculative gains).
Furthermore, with previous stock and corporate bond Bubbles having burst, the "good old days" when herds of leverage speculators were anxious acquirers of securities has evolved into a much less "cohesive" and market-friendly environment that includes a significant component of selling and shorting stocks and bonds. And, of course, the halcyon days of King Dollar have ended. Speculators from near and far will no longer ponder only what type of U.S. securities make for the best bets, now having the world of currencies, commodities and markets in which to explore for trading gains. At the same time, the enormous global financial conglomerates that were beating down the door to play the great American securities inflation are in dollar retreat.
Nonetheless, chairman Greenspan and Wall Street have good reason to confidently indulge in blind faith for the future success of the latest round of inflation. It’s worked repeatedly in the past. And, in the final analysis, aren’t we just dealing with debit and Credit entries on some enormous electronic ledger? And we’ve, after all, over the years watched myriad companies, industries, governments, markets and entire economies rescued by the magic of journaling some more entries - Credit "reflation." And what is the recourse for the over-borrowed, susceptible to an overdue bout of frugality, American household sector? Well, just a minor adjustment to the thermostat and let the warmth of a refi boom temper nipping debt service to a comfortable level.
But if it all seems too good to be true… The Catch has been - is today and always will be - that it takes unending Money and Credit Inflation to keep this sordid Game going. And the system better not skimp on quantities of new Credit, especially in the enormously distended mortgage sector. As always, over time the source, nature and consequences of the created purchasing power (Money and Credit Inflation) transform, mutate and diverge. For now, we see the distinct inflationary manifestations of massive trade deficits, dollar vulnerability, heightened pricing pressures, and general pricing disorder. Today’s Credit inflation is both extreme and aberrant; manifestations, necessarily, will be likewise. The alluring nineties manifestations – surging stock and bond prices, rising perceived wealth for virtually everyone, plush government revenues, booming investment, an historic technology growth cycle, and consequent enormous foreign-sourced (investment and speculative) financial flows – were sure a lot more enticing than a faltering dollar, economic stagnation, and general "stagflation."
But no amount of Fiat Money and Credit Inflation in America will bring back the glorious nineties inflationary boom with its favored manifestations. It’s simply impossible. As students of the history of inflationary booms and busts, we appreciate that the old medicine has not only lost its magic, it’s evolved into a strain especially poisonous to the diseased patient.
I’ll conclude with a couple of final extractions from Henry Hazlitt’s Introduction (1959):
"It begins to be believed that the value of the monetary unit is going to continue to fall – that it will be less next year than this year, less next month than this month. Once such a belief has taken hold, the decline in the value of the monetary unit is anticipated. The value of the monetary unit begins to fall faster than the supply is or can be increased. The monetary managers are from then on in a necessarily losing battle. The more they increase the supply of money, the more public opinion anticipates still further increases…" (page 19)
"Inflation, in its final stages, always ends in prostration, in what modern economists call a ‘stabilization crisis.’ The explanation of this stabilization crisis is not mysterious. During the inflation…prices do not respond in simple proportionality to the increase in the money supply. Some prices race beyond this, anticipating a further inflation. Even if inflation is halted at some point and no deflation sets in – that is, even if the increased supply of money is merely locked where it is and not reduced – the stabilization crisis sets in because these anticipatory prices collapse. The stabilization crisis, like the drunkard’s hangover, is part of the price that must be paid for every inflationary orgy." (page 20)
Thanks for reading! |
