Recalling John Law

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“There are good reasons to think that the nature of money is not yet rightly understood.” John Law, 1720 (with the collapse of the Mississippi Bubble)

“Irredeemable paper money has almost invariably proved a curse to the country employing it.” Irving Fisher, 1911

 “There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose.” John Maynard Keynes, 1920

“Since the time when President Richard Nixon broke the final tenuous link between the dollar and gold in 1971, no major currency, for the first time in history, has any connection to a commodity. Every currency is now a fiat currency…” Milton Friedman, 1991

“We very much believe that, if you have a debased currency, that you will have a debased economy. The difficulty is in defining what part of our liquidity structure is truly money.” Alan Greenspan, 2000

I included the above quotes back in a March 2000 CBB titled, “John Law and Alan Greenspan – The Great Inflationists.” I could not have imagined at the time that his successor would make Mr. Greenspan appear a most responsible central banker. The monetary theorist John Law introduced paper money to France in the early eighteenth century. As an historic monetary expansion and speculative Bubble ensued, Mr. Law was revered. But when he lost control of his experiment – when his Mississippi Bubble scheme and the French economy later collapsed – Law was run out of the country. The effects of this monetary fiasco lingered for decades. I have argued for years now that the U.S. and world are trapped in another historic monetary experiment run amuck. I believe this framework helps to explain a lot.

“Fiscal cliff” negotiations are in disarray and time is running short. Washington remains conspicuously dysfunctional – almost beyond belief. For much of the past several years, the political process throughout Europe has been dysfunctional. In Japan and elsewhere, there has been similar dysfunction. So why have global policymakers all seemingly been infected with incompetence? While it goes undiagnosed, I strongly argue that the world is suffering from the inevitable ill-effects associated with years of unsound “money.”

Thursday, an exasperated Maria Bartiromo pleaded with policymakers to get a deal done so investors could do what they clearly wanted to do, buy stocks. Interviewing a Congressman, Bartiromo pounced: “Are you guys just incompetent or what? If you can’t do what the American people pay you to do why don’t you step aside and put someone in there that can get a deal done?” 

Our nation is deeply divided. It is, indeed, more divided than yesterday but less divided than tomorrow. There is no bill or series of legislation that will resolve our nation’s very serious fiscal problems. Of course, our speculative financial markets just want a deal – and, apparently, any deal will do. The markets are about to complete another strong year – so what’s the problem? 

The reality is that years of unsound “money” and Credit have done their dirty work. The Great Credit Bubble has created a badly maladjusted economic structure. Our economy’s capacity to create real wealth has been badly diminished, while our debt load just spirals out of control. As a society, we’ve over-promised and do not have the capacity to deliver. Yet we still believe issuing additional financial claims improves the situation. Not unpredictably, we’ve reached the late and precarious stage of an inflationary cycle where more monetary inflation just demands more monetary inflation. 

Yes, incredible fortunes were made. Meanwhile, much of our population saw the great boom reduce their standards of living and future prospects. It has left an unsettled society sharply divided, with no clear understanding of the root of the problem - let alone a path to a solution. With such a backdrop, it is virtually impossible to come to a consensus as to the best course of action – let alone passing requisite legislation. The “fiscal cliff” issue is somewhat bringing things to a head. 

There are two philosophically irreconcilable views of how to deal with our nation’s problems. It doesn’t hurt to try to appreciate – perhaps even empathize with – the positions on both sides of this highly-charged debate. Both believe passionately in the soundness of their views, from an analytical, ideological and moral standpoint. We can amicably resolve the U.S. fiscal issue and then move on to religion and world peace.

On one side, you have those arguing that the system has for too long inequitably distributed economic rewards. The government must play an activist role to ensure that every American gets a fair shake. The wealthy, having so benefited from the boom period, must now contribute more to help support the unfortunate. Large deficits are not only justified, they are critical to jump-starting economic recovery. The market system has serious weaknesses that a large and assertive government sector must work to address. 

On the other end is the philosophical view that big government is the problem. While the boom was unsound, this was largely because of the flawed policies of the Federal Reserve. They believe massive deficit spending is in the process of bankrupting this great country. After doubling the federal debt in four years of unprecedented fiscal stimulus, they are convinced that there is simply no alternative than to reduce spending. Future fiscal obligations are unmanageable. Tax increases hurt private-sector investment, while feeding the insatiable appetite of the government monster. Government expansion must be checked, to ensure free enterprise is allowed to grow the real economy. Federal Reserve money printing is devaluing our currency, weakening our nation’s moral fiber, and essentially financing the federal government’s takeover of the economy.

From my Credit Theory perspective, this was all too predictable. Unsound “money” and Credit invariably fuel Bubbles replete with economic malinvestment, inequitable wealth redistribution and economic wealth destruction. The other side of a major Credit boom is a festering political and societal nightmare. I’m sickened by the inequities and improprieties of the Bubble period. It is not unreasonable to expect those that most benefited from the boom to step up. I’m sympathetic to the view that the government does have a limited counter-cyclical role to play. The problem is we’re now year five into the greatest monetary and fiscal stimulus in history. Washington must stand down. There are very difficult decisions that must be made in order to stabilize our fiscal crisis before it’s too late. And there is today no short cut to the pain associated with financial and economic restructuring. The inflation palliative has become poisonous.

My thesis has been that Washington would cling tightly to fiscal profligacy until the day markets had finally had enough. But in a regrettable replay of mortgage finance Bubble dynamics, dysfunctional markets are more than content to finance perilous borrowing excesses. For me, it gets back to the root of the problem - unsound “money” and Credit and derelict monetary management. Surely, Washington and the markets will not take this dire predicament seriously so long as the Fed is determined to aggressively expand its debt monetization operations. And the more conspicuous the consequences from years of unsound finance, the more determined the Fed is to print more “money.”

It’s difficult not to be pessimistic on how this will all play out. I assume they’ll figure out some stopgap measure to dodge around the “cliff.” I have faith in our democracy, although I worry about post-boom misunderstandings, animosities and deep divides. At the same time, I have lost all confidence in our central bank. Their flawed doctrine is my biggest worry, as they operate unchecked and outside the democratic process. Our nation – and the world – is in this state of instability, uncertainty and confusion because contemporary money and Credit is so unsound and poorly managed. Admittedly, this sounds archaic. The root of the problem is not well understood. And, regrettably, the Bernanke Federal Reserve is in the process of only making the problem worse. Markets cheer.

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About Douglas Noland