Linear Thinking in a Chaotic World

If some is good, then more is better.  That’s the way simpleminded people think.

Think of alcohol.  A little is good, but past a certain point, more is bad.

I think about central banking the same way.  Until recently, quantitative easing seemed to stimulate the economy, but each increasing dose has done less.  The last one seemed not to work at all, and long rates rose amid buying of bonds by the Fed.

The same applies to running deficits.  Perhaps the Keynesian solution works when there is adequate borrowing capacity in the private sector, but when many cannot borrow more, running high deficits may scare businessmen and consumers, because they wonder whether the system is stable or not, how the books will eventually balance, etc.  Inflation, deflation, higher taxes, currency depreciation… there are so many possibilities.

The leaders in simple-mindedness are Ben Bernanke, and Shinzo Abe of Japan.  Add in George Bush, Jr., and Barack Obama — deficits don’t matter.  They are like Fat Freddy with a hammer; every problem looks like a nail, and he will whack it with his hammer.  BAM!  It’s better, right?

Economies are complex because people are complex, and groups of people are even more complex.  The simplistic tools of neoclassical macroeconomics do not work in situations where there is too much debt, but the ideologues display confidence to the watching world.

When this pattern breaks it will be ugly, and I don’t know when or how it will be ugly.  It all depends on whether policymakers move to inflate or deflate.  You might say, “Of course they will inflate.”  Many thought that in the Great Depression, and they were wrong.

My main point here is that we all know less than we think about the future.  We have no idea as to what might finally derail the policy monoculture of the dominant nations — large deficits and loose monetary policy, but it will derail, and how it will resolve is a mystery.

So diversify your asset allocation into things that benefit from inflation and deflation — maybe you will keep something after the crisis hits.  After all, the looser monetary policy is, the worse the adjustment when the tightening comes, and monetary policy has never been looser than this since 1790.

1 Comment

  • Greg says:

    Based on thousands of years of human history, when times are really bad, the crooks — I mean political leaders — inflate.

    When times are disastrous and debt levels are already higher than what younger generations can afford … default becomes inevitable.

    IBM canceled their pension a decade because they could not recruit younger workers to pay for promises to retirees. Whomever can complain or babble about promises or contracts — but those promises were not made by recent grads. The people who actually made the promises did not properly fund them (neither management nor workers).

    What possible reason do generations X, Y and millenials have to honor the unfunded promises of the baby boomers? We either work 120 hours a week for minimum wage — the fruits of our labors going to pay debts and promises we didn’t make… or we let the status quo collapse on itself. We have no horse in the race (we get 401Ks or IRAs **IF** we fund them ourselves — social security is bankrupt and our pensions were canceled decades ago).

    If (when) the status quo collapses, it hurts the people who benefit from the status quo … not the the people who have to pay the bills.

    If the debt was a lot smaller, I would agree that inflation was inevitable. But based on thousands of years of human history — default seems just as likely if not more so.

    There are plenty of examples where the global super power (with ability to print currency) collapsed under staggering debts. I cannot think of any examples where a nation state buried in unfunded promises and debt did not end up collapsing.

    Cue the chorus singing “this time will be different!”