How is Wealth Created; By the Fed Printing Money or By Labor and Savings?

By David Stockman

It is hard to believe that in these allegedly enlightened times this question even needs to be asked. Are there really educated adults who believe that by dropping helicopter money conjured from thin air, the central bank can actually make society wealthier?

Well, yes there are. They spread this lunacy from the most respectable MSM platforms. And, no, I’m not talking about professor Krugman and his New York Times column. At least, he pontificates from a Keynesian framework that has a respectable, if erroneous, intellectual heritage.

What I am talking about here is the mindless bunkum issued by so-called financial journalists who swish around Wall Street and Washington exchanging knowing tidbits with policy-makers, deal-makers and each other. Call it the bubble finance “narrative”, and recognize that its gets more uncoupled from economic facts, logic and plausibility with each passing day in the casino.

The estimable folks at The Automatic Earth put a bright spotlight on this crucial matter this morning, even if not by design. Their trademark daily vintage photo was a 1911 picture of a family including all the kids picking berries in the field; they were making GDP the old fashioned way.

In its usual manner, the site’s “debt rattle” list of links to timely reads followed, and the first was a Bloomberg View opinion piece called“QE For The People: Monetary Policy For The Next Recession” by one Clive Crook. It was actually a case for literally dropping central bank money from the skies to enable policy-makers to better “support demand and keep their economies running”.

In thoughtfully supplying a photo of a helicopter in full flight to accompany Crook’s discourse, the Bloomberg graphics department crystalized the essential economic issue of our times. Namely, whether wealth is made by the Berrie Pickers or the Money Printers.

Needless to say, The Automatic Earth’s vintage photo reminds us how GDP is actually made. And, no, its not about child labor. I grew up in a family farm labor force of five kids and ended up no worse for the wear. But we did produce something—lots of strawberries, raspberries, tomatoes, peaches, grapes and apples.

Lewis Wickes Hine Whole family works, Browns Mills, New Jersey 1910

Not surprisingly, the house organ of the Bloomberg empire—the very offspring of bubble finance—- says wealth can be made by dropping trillions of dollars of unearned money from helicopters. Back in the day, even berry-picking kids wouldn’t have believed that.

It used to be that “helicopter money” was a sort of metaphor—-certainly the great libertarian, Milton Friedman, did not literally mean that the state should engage in airborne redistribution through the aegis of the central bank when he famously coined the term. No longer. Here is what Bloomberg’s apparently lapsed Onion contributor said this morning:

Sooner rather than later, attention therefore needs to turn to a new kind of unconventional monetary policy: helicopter money…. (or) how about “QE for the people” instead? It has a nice populist ring to it — suggesting a convergence of financial excess and the Communist Manifesto…… “Overt monetary financing” is closer to what’s required, but something even duller would be better.

Whatever you call it, the idea is far from crazy. Lately, more economists have been advocating it, and they’re right.

The logic is simple. If central banks need to expand demand — and interest rates can’t be cut any further — let them send a check to every citizen. Much of this money would be spent, boosting demand just as Friedman said.

Uncle Milton must be rolling in his grave. Yet, in a way, he asked for it. He erroneously taught the world that capitalism can catastrophically fail if the central bank allows money and credit to be liquidated too intensively and extensively.

To be sure, he did not believe this was an everyday risk on the free market; he was talking about the Great Depression of 1930-1933, but he had his causative factors upside down. During the period in question, excess bank reserves—–the stuff the Fed creates—-soared by 13X, while money market interest rates fell close to zero. So the banking system was actually awash with liquidity, meaning that a Bernanke-style bond-buying spree would have amounted to pushing on a string, exactly as has been the case since the Lehman meltdown.

Instead, the problem in October 1929 was 15 years of massive, Fed-fueled credit creation—first to finance the Great War and then the Wall Street boom in foreign bonds and domestic stocks during the Roaring Twenties. The result of that era’s financial bubble was a massive, unsustainable expansion of US export capacity in agriculture and industry alike——along with bloated levels of industrial inventories, capital goods production and big ticket durable goods (autos, radios and refrigerators).

When the music stopped, the washout in these sectors resulted in a $35 billion drop over the next three years—or 75% of the total plunge in nominal GDP during the 1929-1933 period. Not surprisingly, therefore, this contraction of bubble-fueled economic activity triggered massive insolvencies in the export-oriented agricultural and industrial districts and in the speculative precincts of Wall Street and their wire house affiliates all across the country.

In short, the Great Depression did not represent a catastrophic failure of capitalism nor was it the result of a giant error by the central bank. And most assuredly, it was not owing to a deficiency of some mystical economic ether that the Keynesians were subsequently pleased to call “aggregate demand”.

Plain and simple, the Great Depression was caused by massive insolvencies of banks, businesses and households in the agricultural hinterlands and the new auto, steel and industrial export belt of the upper Midwest and mid-Atlantic. The four-year decline of nominal GDP from $100 billion to $57 billion did not represent the disappearance of “aggregate demand” that could be reincarnated by the state and its central banking branch. As I detailed in the Great Deformation, it represented the liquidation of malinvestment and phony GDP, jobs, production and residual war-time inflation that had never represented real wealth in the first place.

Nevertheless, statists have lived off the false proposition that capitalism is catastrophe prone and is chronically lapsing into recessionary slumps and under-performance ever since. But at least until the Greenspan era, the primary tool of state intervention to purportedly keep the macro economy off the shoals and on the path toward “full employment” was fiscal—–that is, deficit spending and tax cuts.

And that kind of state action to improve upon the alleged inferior performance of producers, consumers, investors, entrepreneurs and speculators on the free market entailed at least some outer boundaries. To wit, hereditary fear of too much national debt kept the politicians from outright free lunch economics—even after the Reagan era destroyed the will of the old guard GOP budget balancers.

As it happened, it was Greenspan who confected the bridge from fiscal stimulus by the unruly and inconstant processes of political democracy to central bank based monetary stimulus based on the purported wisdom of an unelected monetary elite. Slowly at first, and then with a rush during his post dotcom interest rate slashing campaign, Greenspan converted the old  counter-cyclical doctrines of the first generation Keynesians, who made a stagflationary hash out of the US economy during the late 1960s and 1970s, into the bubble finance economy which prevails today.

Clive Crook is simply the archetype of today’s swarm of financial journalists who were house-trained on Dr.Greenspan’s doctrine of statist economics. Always and everywhere, both the old-style fiscal Keynesians and the new style Greenspan/Bernanke/Yellen money printers, postulate that the macro-economy suffers from a deficiency of “aggregate demand”.

And why wouldn’t they argue just so?  If the family in the figurative berry patch pictured above is not spending enough to meet the policy-makers’ arbitrary growth targets—whether because it does not produce enough income or chooses to save a purportedly “excessive” portion—-then what economic agency can pour more spending into the nation’s economic bathtub until it is full up to the very brim? Why the state, of course.

But here’s the insidious thing.  There is no such thing as “aggregate demand” which is separate and apart from production and income. The only way an economy can spend more than it produces is to finance excess consumption from artificially conjured credit.

Now, admittedly, that works——but only so long as balance sheets have available runway and the servicing cost of higher leverage does not overtax the carrying capacity of current incomes. In other words, credit expansion has temporal and economic limits; its not a feature of some mythical, timeless,  dynamic stochastic general equilibrium!

Well, those limits have been reached and we are therefore in a new, post-Keynesian ball game. The US economy hit “peak household debt” at the time of the crisis. Accordingly, central bank fueled credit expansion has been exposed as the one-time parlor trick it actually was.

During the decades leading up to the great financial crisis, household leverage levels were ratcheted higher and higher during each stimulus cycle, causing income based household spending to be topped-up with incremental outlays from higher borrowings. But now the process has been reversed: household leverage ratios are falling, even as they remain far above their healthy and sustainable pre-1970 norms.

So household consumption is once again tethered to current income and savings preferences, as it must be on a long-run basis. You couldn’t have an economy based on the inevitable normalization of interest rates and, say, 400% debt to wage and salary income ratios, too. So the credit fueled boom of 1970-2008 wasn’t the normal capitalist condition; it was a trick of the state.

Household Leverage Ratio – Click to enlarge

To be sure, that monetary financing trick did generate the illusion of growth. But it wasn’t sustainable. Accordingly, the tepid growth rate since the pre-crisis peak——that is, just a 1.0% annualized gain in real final sales for the last eight years—-simply represents the limits of a production and supply-side constrained economy.

During the 40 years leading up to the year 2000, nominal wages in the private economy grew by 7.5% annually, while CPI inflation averaged 4.5% per annum. So real wages grew by 3.0% and with some help from the ratchet in household leverage and total credit relative to GDP, real GDP growth averaged 3.6%.

By contrast, from December 2007 and up to and including this morning’s personal income and spending report for April, private sector wage and salary growth have decelerated sharply—-to just 2.5% at an annual rate for the last eight years. Even if you credit the BLS’ undercount of actual inflation, which has posted at 1.5% per annum during the same period, real wages have grown at just 1.0% per annum or by one-third of their historic trend. And with a discount for actual real world inflation, real aggregate wages have grown hardly at all.

In short, we now have a 1% growth economy, not the 3.6% economy of the Keynesian yesteryear. Households are spending at levels constrained by the tepid growth of their production and incomes, not because some magic ether called “aggregate demand” has gone missing.

It goes without saying, of course, that if you want to expand a supply constrained economy at a higher rate, the answer is to reduce the state’s barriers to enterprise and labor input, not to expand the central bank’s balance sheet and further falsify money market prices and inducements for rent-seeking speculation. For instance, abolish the 15% payroll tax barrier to low-skill labor and abolish the FOMC interest rate peg which subsidizes carry trade gamblers.

None of this will happen, of course. So the bubble finance narrative will roll on awhile longer. Indeed, having been house-trained on the Greenspan wealth effects doctrine, financial journalists like Crook are now taking the intellectual dead-end of state sponsored “demand” stimulus to an absurd and dangerous extreme. Namely, to an out-and-out case for anti-democratic governance by a Wall Street-beholden posse of central bankers.

The real objection is political not economic. Sending out checks is a hybrid of monetary and fiscal policy — public spending financed by pure money creation. That’s why it would work. Politically, this is awkward…….The real case for central-bank independence isn’t that monetary policy is non-political; it’s that central banks are better than politicians at economic policy.

There you have it. Start with the sheer Keynesian myth that there is deficient aggregate demand; spend a lifetime in the Wall Street/ Washington corridor drinking the Kool-Aid; and you end up not knowing the difference between Berry Pickers and Money Printers.

David Stockman is the former Director of the Office of Management and Budget during part of the Reagan Administration, from 1981 to 1985. He is the author of The Great Deformation: The Corruption of Capitaism in America and The Triumph of Politics: Why the Reagan Revolution Failed.

 The above originally appeared at David Stockman's Contra Corner and is reprinted with permission.