I Have a Very Bad Feeling About This

August 18, 2023

Unexpected things tend to happen when the real source of problems are papered over and then suddenly reality intrudes.

What an interesting juncture we've reached. We're constantly assured all is well with what matters--the economy--as the all-powerful Federal Reserve has managed not just the hoped-for "soft landing" but a resurgence of growth: yowza, no recession.

The list of good things is striking: unemployment is low, wages are rising, the wealth effect from explosive increases in housing prices has fattened the home equity of households and the soaring stock market has pushed the economy to giddy heights of wealth and confidence.

The spot of bother with inflation has receded and everyone anticipates interest rates will soon follow inflation back towards zero. China has entered a rough patch but it won't affect us. And so on.

Despite all this uniformly good news, something about the situation is setting off alarms: I have a very bad feeling about this.

Perhaps the root of the feeling that danger is far closer than we discern is the universal confidence that finance can always fix any and all real-world problems. Whatever the problem, central banks can solve it by lowering interest rates and flooding the financial / banking system with liquidity, i.e. monetary easing, making it easier and cheaper for enterprises and households to borrow more money.

On the government-spending side, the central state can fix any and all problems by borrowing and spending however many trillions are needed--fiscal stimulus.

In other words, we don't need to suffer any inconvenient sacrifices or systemic changes, we simply need to borrow more and spend more. This is certainly a tidy solution to all problems: borrow more and spend more. Everything in the real world can be fixed with monetary and fiscal easing and stimulus.

What's interesting about this solution is there is no feedback at all: it's a clean trajectory: borrow and spend more, and real-world problems go away. There is never any feedback from the real-world--for example, borrowing and spending don't actually solve the problem-- nor is there any consequence for continually borrowing more and spending more: we can keep borrowing and spending more without any limit or consequence.

But does this confidence in financial fixes actually map reality? In actual lived experience (as opposed to happy narratives and cherry-picked data), there are problems that aren't solved via borrowing more and spending more, and consequences of borrowing more and spending more.

But the real-world consequences of relying on finance to fix everything are given short shrift in the "everything's wunnerful" narratives and policies. In the real world, flooding failing systems with trillions in borrowed money doesn't actually solve problems, it makes them worse--much worse. Insiders are incentivized not to fix the problems but to skim the "free money" and keep the problem active, so the 'free money" keeps flowing.

Throwing more money at the problem generates diminishing returns and unintended consequences as the endless flood of "free money" distorts incentives and extinguishes the discipline of scarcity required to force actual solutions rather than paper them over with PR.

Complexity is easily added--more layers of management, more compliance, more regulations--and throwing more money at this source of inefficiency and decaying productivity only causes it to expand even more.

Then there's the funny thing that comes with borrowing: interest payments. The more we borrow, the mnore interest we have to pay as the hill of debt grows into a mighty mountain. This rising cost of debt service crowds out other spending, forcing us to borrow even more (perish the thought of tightening our belts and cutting expenses!) and to invest less and consume less.

In other words, relying on borrowing more so we can spend more eventually makes us poorer. That's impossible, of course, because all this borrowing and spending is "investment" that magically "grows the economy" so we "grow our way out of debt." It's a very pleasant thought, but as the borrowed money increasingly goes to paying interest and consumption rather than investment in productivity, the economy stagnates rather than grows.

The "one weird trick" to solve this problem is to lower interest rates to near-zero so debt service takes only a modest slice of income. But all this ever-expanding borrowing more and spending more eventually generates inflation, i.e. money and wages lose purchasing power. Once inflation arises from its slumber, the "one weird trick" goes from being a solution to the source of the problem.

Then there are the perverse incentives generated by reliance on easy money and deficit spending: credit-fueled asset bubbles inflate as most of this "free money" flows to the top of the pyramid, where the top 10% use the low-cost money to buy assets that will increase in value as more and more stimulus is dumped into the economy. As assets soar in value, the not-yet-wealthy are outbid and left in the dust as neofeudal serfs.

This asymmetric distribution of the easing and stimulus straps a rocket booster under wealth and income inequality. Since those who've become much, much richer run the economy, this strikes them as a remarkably positive result.

But beneath the happy-story surface (since I'm doing great, everyone must be doing great), soaring wealth and income inequality is dismantling the foundations of society: the social contract, the ladders of upward mobility, the legitimacy of the government and financial system (it's all rigged to benefit the few at the expense of the many), and the legitimacy of the media and institutions that are supposed to be objective (if we tell you everything's wunnerful, then believe us, because your compliance benefits us.)

The rich not only get richer and the slice of the wealth owned by the poor shrinks, moral hazard is optimized: since there will always be more "free money" available, there's no incentive to limit risk, as the consequences of higher risk will always be offset by more central bank / central state "saves," stimulus, backstops, etc.

So go ahead and make incredibly risky bets, and leverage up those bets: if you win, the winnings are yours to keep (with a slice deducted for taxes, of course); and if you lose, the Fed and / or government will bail you out. What's not to like?

These distortions become problems that borrowing more and spending more only accelerate. The supposed "solution" becomes the "problem" that the "solution" cannot solve.

Unexpected things tend to happen when the real source of problems are papered over and then suddenly reality intrudes. One thing that always surprises the top 10% who own 90% of the income-producing assets is markets suddenly crashing after years or decades of lofting higher on the endless easing and stimulus. After all, everyone knows that assets never go down for long, they only loft higher.

This is true until the easing and stimulus that inflated the assets become the problem. The feedback loops that were ignored or diminished with financial trickery suddenly become self-reinforcing, and all the tricks that worked for decades now push the system into instability and chaotic collapse.

So by all means, retain supreme confidence in the empire of debt and deception and its one "solution," borrow more, spend more. Some of us have a very bad feeling about this, and we're no longer kneeling at the altar of the Fed or mumbling prayers to the false idols of easing and stimulus. When the idols fall, the world they supposedly rule crashes around them.

An economy that's dependent on financial "fixes" is fatally distorted. Beneath the artifice, it has lost the capacity to actually solve real-world problems.

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