The Illusions of Modern Economic Theory

Anatole Kaletsky is the Principal Economic Commentator and Associate Editor of that venerable publication, The Times of London. It is evident that neither his exalted status nor the pedigree of the newspaper that publicises his opinions provides assurance that the views expressed are dependable.

It now appears to Kaletsky, although he gives no reasons why it should, that “…the net global cost of the bailouts (by the various governments) will be zero”. How so? How is it possible that the global cost of an adventure which, measured in nominal terms, amounted to several trillion dollars, can in fact be zero. Kaletsky owed it to his readers to explain this extraordinary conclusion.

Can it be that the trillions created by the US Federal Reserve (including an undisclosed amount for quantitative easing) by a method that the boastful Ben Bernanke once proclaimed as the panacea to the threat of deflation, can have been undertaken at a global cost of zero? It is true, of course, that Bernanke claimed that the printing press “or its electronic equivalent” could produce money at essentially no cost. This does not mean however that there is no global (universal) cost to be borne by the various individuals that comprise society, the most obvious of which is the risk of inflation.

Although the threat of inflation is now said to be remote, even a formidable currency like the US dollar can reach a tipping point, beyond which recovery becomes practically impossible. So long as the policy makers promise to do “whatever it takes” to ward off the threat of deflation, the danger that the methods employed will lead eventually to hyper-inflation, or even hyper-inflationary stagnation, cannot be disregarded.

There is, in addition, this unresolved issue that can fairly be called a cost. The bailouts in the United States were so structured as to burden the taxpayer with a contingent liability in respect of the failed obligations which were taken as security in exchange for the funds advanced. The recipients of this largesse were the banks and other financial institutions, including the infamous Freddie Mac and Fannie Mae, as well as the motor manufacturers, which could no longer compete on equal terms in the market place.

This cost has already corrupted the balance sheet of the US Fed, where the bloated valuations attributed to the toxic assets creates a false and even fraudulent valuation of the security held in exchange for the bailouts undertaken. In the United States the entire financial system is at risk because institutions are now permitted to attach a fictitious “mark-to-model” valuation to assets that have no real value. This is done with official approval to avoid the inevitable insolvency that would ensue, in many instances, if the appropriate “mark-to-market” valuation were employed.

To sustain a sense of public confidence in the efficacy of the measures taken, generally accepted accounting practices have been abandoned to create the illusion of a non-existent financial stability. Does Mr Kaletsky contend that there is, and will be, no global cost resulting from such conduct?

What of the cost to the savers, the elderly and those dependent upon a fixed stream of income, of the manipulated interest rates on short-term obligations that yield almost zero percent interest? The interest payable on longer dated securities is not significantly higher. Can the income lost to these individuals be counted as zero? Or do they, the many millions of them, not count as part of the global economy? If so, then the Keynesian method, of which Kaletsky is an enthusiastic exponent, is far less compassionate than its supporters would contend.

Perhaps Kaletsky meant only that with the fiat money system the inevitable loss in the value of the dollar (and of the pound sterling, which participated in the experiment to a lesser extent), there is an equalising process, whereby the devaluation of one currency involves an implicit revaluation of all the others.

But this cannot be because the revaluation of, especially, the currency of an economy dependent upon exports, represents an economic loss, and not a gain. The clearest evidence of this phenomenon, in practice, is the recent contrived devaluation of the Japanese yen against the dollar as well as threats of similar conduct by several other countries. The danger of a cascading competitive global devaluation remains high, and the Japanese action has increased its probability. Would this not represent a global cost, if not a global catastrophe?

What of the skewed benefits that accrued to the politically connected and financially formidable Wall Street banks that were considered “too big to fail”. They have emerged more prosperous than ever, but with ever the same sense of entitlement their management awarded themselves multi-billion dollar bonuses within months of the raid on the public purse. There may be an equalising effect here: the billions taken by the bankers could possibly offset the billions lost by the newly unemployed.

How are these bankers, with their sense of immunity, expected to conduct their affairs in future? Their disdain for public opinion has been clearly demonstrated, so the restraint that is proposed is additional government regulation, with all the imponderables that such interventions entail. Whatever the eventual outcome, and not counting the moral hazard of future egregious conduct, the cost is unlikely to be zero.

Perhaps the greatest cost of all is the cost to political and fiscal integrity which must inevitably be suffered when the government becomes, and is seen to become, the counterfeiter in chief; the counterfeiter with a self-proclaimed indemnity or, to put the matter colloquially, the fox in charge of the hen house.

Author: Rex van Schalkwyk is a former judge of the Supreme Court of South Africa and author of numerous articles and three books. This article may be republished without prior consent but with acknowledgement to the author. The views expressed in the article are the author’s and are not necessarily shared by the members of the Free Market Foundation.

FMF Feature Article / 26 October 2010