Saturday, December 31, 2011

Let’s Take It Backwards – Ruminations for a Foresight

Sometimes one has to take a step back to move forward.

As we end this year today and enter into a New Year one could be excused of being curious how this New Year would shape. I am certainly of the opinion that the world is witnessing some serious structural changes that would hopefully make it a better place in a decade or so but in between that period we would witness unforeseen chaos. Ofcourse no one has an authority over predicting the future however I guess most of believe one simple law that the “nature ultimately corrects the anomalies and take us to the point of sustainability”, to see where this point might lie “let’s take it backwards”.

The main anomaly/fragility I find in the world today is:
-         -  The unnatural government monopolized fiat currency system

From this very anomaly flow two other anomalies/fragilities:
-          - Universities across the world conditioning young minds with wrong economic concepts
-         -  Reward of labour taken away from the productive sector of economy and given to the unproductive sector

The Unnatural government monopolized fiat currency system:

Back in 1776 when Adam Smith wrote “The Wealth of Nations” he talked about the selfish motive of individuals that ironically leads to a functioning of a well functioning economy. This thought in my opinion is absolutely correct and also formed the bedrock of the modern economic machine. However in this context where do the governments fit in?

Surely they are also a part of the society and thus following the analysis of Adam Smith the people in government are also driven by their self interest. So what really is the self interest of people in government?

Well in my opinion again it is “power”; the power to control the destiny of others and the sovereign currencies is one of the most important tools by which they exercise this power. To give an instance, under the presidency of Abraham Lincoln a civil war broke out between the North and Southern states of America, to fund the war Lincoln needed money; ofcourse taxation would have been a way but it would have been grossly unpopular so his advisor asked him to fund the war by simply printing fiat dollar (which has become a norm across the world now). However Lincoln had his doubts, he asked his advisor how do I make people accept this fiat money, the solution was very simple… ask the people to pay their taxes in this fiat currency.

This fiat currency is the instrument by which the government controls not just the economic activity but also as we are seeing now our social lives. Unfortunately we have been brought up to think this cocktail socialism that has carried on since the abolition of gold standard in 1971 and went berserk ever since Alan Greenspan became the Central Banker as free markets. The only way to bring an end to this is by denationalising currency, i.e. bringing it out from the control of government and the few big banks.

Because of this power to siphon off your hard earn wealth without most people even noticing we find the governments becoming too powerful and entering other aspects of our lives and this where the other two points of fragilities come into play.

Universities across the world conditioning young minds with wrong economic concepts:

Teaching a wrong idea is more dangerous than teaching how to pull a trigger, as a misfired can affect lives of a few people but a wrong idea can stray an entire generation onto the wrong path.

A few days back Larry Summers , who happens to be the dean of Harvard, an ex-treasury secretary and was until very recently was heading Obama’s economic team said that “It’s ironic that the solution to the problem of too much debt and consumption is again too much debt and consumption”, listening to this I should have probably thanked my stars that I didn’t go to Harvard but that doesn’t matter as even in Indian colleges the course content is simply copied from such universities which happens to contain lot of macroeconomic gibberish of Keynesian and Monetarist variety (and ofcourse not to mention the financial statistics and option pricing). Ever since leaving college I have found these tools specially Keynesian, as a total waste in understanding the economic machine. I can go on to say that the two years spent in the study of these concepts was a waste of time and I had to spend extra effort unlearning them than I would have spent otherwise. The only purpose that these tools serve is to construct an analytical relationship between a set of variable at a “given point of time” (notice the quotes). However this is of no significant value in a dynamic world.

So the question is why these thought processes become so widespread, simple because under the garb of these economic views the government can have the authority with fiscal and monetary interventions. So the government essentially employs economists with these thought process and since the primary objective of the universities is to provide employment, a person equipped with these ideas find greater chances of employability.

Reward of labour taken away from the productive sector of economy and given to the unproductive sector:

Perhaps the biggest problem the world is facing today is misdirection of resources. The true reason why free markets flourished while socialism collapsed was one “incentives”; free markets gave rewards in lieu of your contribution to society. Aren’t our scientists, engineers, doctors the real people who improve the productive capacity of this world and make it a better place and then shouldn’t they receive the greatest rewards for their labour. However again because of this monopolized fiat monetary system we see that a few banks are hoarding on the wealth and adding very little value to the society and this is giving rise to serious imbalance in this world. Because of this a lot of talented people are going into this sector, the work where demands people of far less talent instead. To give a simple example:

If I want to buy a house and no one in the economy has more than 1 million dollars, the price of the house can never exceed that number. However now come our great banks that are actually nothing but agents spreading the government control of money; through the magic of fractional reserve banking they simply print 9 million dollars out of thin air and give it to an individual at 10% interest. This causes the value of the house to jack up to 9 million dollars and for this useless activity of printing money the banks garb a cool million dollars.

So in short without adding any productive value in this society the banks have accumulate a million dollars; what a waste of resources!!! And they can do it because they have the access to the government money first over any other individual and then on the top of that they have the license to exercise fractional reserve lending; which is nothing but a complete fraud and if done by any common individual can land him into jail.

The first Great War was fought when almost the entire world was captured by few powers and the conflict was the only option to gather more resources. Today as the world population has grown and evolved the need for resources has never been greater; however with the government interventions through monetary and fiscal stimulus, the brazen monopoly of credit by banks and the policy of too big to fail has led to stark misallocation of resources. These are the changes that would be brought about ultimately and probably in this very decade, however if history is any guide then no one likes to relinquish authority by will. While I would resist making any predictions and leave it at the judgment of the readers, all I would like to say is that as we enter into this New Year we are really entering interesting times and if during the course of the year any one wants to understand where the world is headed my suggestion would be to “Take It Backwards”…….


Jagdish said...

Great article Himanshu !
During the housing boom, the banks in the US raised money from foreign investors. It was easy to do that since US $ is the global reserve currency. What do you think will be the future of US $?
In case Euro or china become more stable and bigger than US, what would they do for their currency?

Stochastic Process said...

Hey Jagdish, Happy New Year!! Hope you are doing fine.

You are right when you say that because of the global reserve currency status of US it was able to sell its debt, mortgages, equities etc. to foreign investors.

However now what I see is an end to the fiat national currency era across the world, simply because of its very construction as the only way we avoid a collapse of this fiat money system is by keep on increasing debt; the capacity for which is coming to an end (probably I will write about it more some days later) or by printing money (which is what happening). So you can see both ultimately are roads to perdition.

However the thing is that throughout history the currency systems survive for 30-50 years and then they change, the same thing will happen here but before this happens; the analogy that I give is that of a star which before collapsing goes supernova and shines at its brightest and same would happen to the system. Since the debt to be repaid are so huge you may find the demand for currency increasing (the system ironically strengthening) for short term before it ends. What system replaces it I am not sure, however what I would like to see is a denationalisation of currencies i.e. they moving out of government control into the hands of private enterprise as I discussed in this article.

Jagdish said...

Happy New Year !
thanks for your blog :)