1. Executive summary
Many people are wondering how the current problems came about. The world's politicians are desperate to reassure the general public that the current difficulties can be resolved quickly and that they do not have to worry. In desperation the British Government is preparing to take on more liability on behalf of the private sector and to try and borrow its way out of a problem of its own making. The underlying problem is hidden monetary inflation brought about by the need of western governments to keep their economies moving forward. The actual methodology and the benefit to the State of inflating the money supply is explained in detail below. The current crisis is seen to be a global one. This is because all the governments of the Western Nations were all trying to keep up with each other by playing the same game because they all have the same problem. Namely their populations are becoming increasingly less productive and the number of elderly and dependent people is increasing in an unsustainable manner.
A fundamental premise of Keynesian economics is that the State should interfere in all the financial activities of the nation. Where possible consumption should be stimulated as this means that society can spend itself to riches. Consumption is encouraged by creating jobs so any capital investment is good and this is helped by the State setting artificially low interest rates. Finally, the State should spend more than it taxes in order to stimulate investment and consumption.
Keynesian economics is all about government management of the economy, full employment, low interest rates meaning cheap money, deliberate government deficits, and stimulating largely unproductive growth. In a nutshell, the Keynesian economics that Gordon Brown proclaims to believe in is based on simple monetary inflation. Increasing the money supply and maintaining inflation is vital for all modern western economies or more correctly their governments. Inflation provides the State with a massive injection of income as it prints ever more money. Politically this means that one group of politicians can transfer financial liabilities to another group further down the line.
Monetary inflation is always a wonderful thing for any Government as it allows the borrowers to walk away from their responsibilities. Inflation is also a very important source of revenue for the government, which is why it is not stopped. According to Keynesian economics, people who hold their wealth in the form of money are sheep to be shorn in an inflationary period. Governments, businesses and people who borrow money all benefit from inflation. The losers are those that save. Pension plans, savings deposits, and life insurance companies are what less wealthy savers invest in. It is the wealth of these people that the Government can go after most easily. Governments also have mechanisms for locking money into investments such as gilts, pension funds and investment markets. None of these have any great benefit for the financial structure of the country other than to give the State a method for acquiring the finance that it needs. Government deficits are only possible when there is monetary expansion. Without monetary inflation Government deficits would cause higher interest rates and deflation. Low interest rates and lots of available money always occur when the money supply is expanded very rapidly. The lack of real growth in the UK economy for the last decade meant that the British Government had no option other than to print money, which has diminished the wealth of the country, and to borrow money and to pay interest which has also diminished the wealth of the Nation.
The Government is the beneficiary of an enormous scheme to remove wealth from those who were careful and saved it so that it can be given to those who are unproductive and profligate as well as to support the apparatus of the State. In the last twenty years, the older members of society, who saved money for their old age, have watched its potential to yield a return diminish year on year. The reason for this is that the State has to quarry every potential source of wealth that it can so that it can keep up with its ever increasing obligations. Since Labour came into office the level of obvious taxation has risen with more and more taxes being introduced but even this was not enough to cover the funding shortfall. The only way to keep 'growth' going was to encourage investment in property, stocks and shares, and in personal debt. This way the new money was taken out of circulation as fast as it was printed. The current collapse in the stock market, in property prices and the rise in personal debt is exactly what is to be expected with an over inflated economy. As money wealth expands so interest rates should rise in response to inflation. However if governments and central banks hold the official rate of inflation down the money wealth will expand unchecked. This is why the World economies are in the state that they are today. All that has happened is that the Western Governments 'turned off' the normal control mechanisms that should have worked in a period of rapid monetary inflation. There is nothing strange or unexpected in what is happening now - it was entirely predictable.
The profusion of paper wealth constitutes an enormous reservoir of inflation. Paper wealth comes in many forms but debt is a good example. Paper wealth is not real wealth. Real wealth consists of land resources, productive plant, durable goods and people. In contrast, money wealth also includes debt such as mortgages and pension obligations. The wealth of a nation is not increased just because there is more paper money in circulation. Unfortunately paper wealth acts as if it is real wealth. Government debt then grows excessively but private debt gallops ahead. If too much money causes inflation then inflationary prosperity causes too much prosperity. If the prosperity is not based on anything tangible then it is so much waste.
When a country has massive debt there are only three ways that the Government can reduce it. The first is to walk away from it. The second is to raise taxes to pay it off. The third is to inflate and to dilute the debt. Of course, the problem with inflating is that it becomes an upward spiral. Each year there has to be more inflation than the year before just to stay in front of the game. All the features of the Western economy in the last ten years, like a rapid increase in the value of the stock market and increasing house prices are typical of an inflationary bubble. There was a lot of money in circulation and nowhere for it to go. In 2000 interest rates should have gone up in response to this trend but then the British Government and US Government committed the most astonishing piece of financial irresponsibility. Instead of raising interest rates to control inflation, they lowered them and took all the controls off borrowing. This had exactly the effect that they wanted. They could print even more money and the additional inflationary currency was pumped into buildings and the stock market which took it out of circulation. To avoid hyperinflation in a period of high inflation it is necessary to convince the general public that inflation is in fact very low. The underlying realities will always be overlooked as long as the Government can persuade the public that the discussion is about the price of food and consumer goods, and not about monetary inflation. This is only possible if most of the materials consumed in the country are imported from low cost economies. This is what western economies, and the British Government in particular, have been doing for the last decade.
The current difficulties only came about when the Government lost control and let inflation run unchecked for too long. The last ten years have seen a massive increase in the quantity of money in circulation which can be seen by the increase in the value of homes and the stock market, as well as the rise in personal debt. If there had not been a massive level of inflation over the last ten years then gross business turnover in the West would never have grown to the extent that it did. In fact, gross business profits would probably not have grown at all in the last ten years. This in turn would have meant lower tax receipts for the Government. Similarly GDP would not have grown by very much, if at all. Creating the illusion of progress and a year on year improvement in the economy is vital for any government so again inflation is a vital tool of the British Government to keep trends always going upwards.
There has been no real growth in the British economy over the last ten to fifteen years, just ever increasing borrowing made possible because of a high level of money inflation. Now reality has to return and the first way that this will happen is that values will fall back to where they were before the start of this inflationary cycle. House prices in the UK will drop to half of what they were in 2007. The price of stocks will fall back to the same levels as the mid 1990s. However, disposable income will also have to drop back very fast as will the general standard of living. This will hit people's quality of life in the West but also that in manufacturing countries like China that were using the accumulated wealth of the West to create a whole new infrastructure and way of life for themselves
There would be a problem if there was deflation but this is highly unlikely as over half the GDP of the UK is now the responsibility of the State and this proportion is destined to keep on rising. However, the Government will still award public workers annual pay rises and hand out ever more money to the increasing number of people who are dependent upon it. With this driving force behind the economy there is no chance of deflation. The British Government is now borrowing so much that it has no option but to inflate at an enormous rate. All that is necessary is for the Government to massage the data and few people will work out what is going on, and the printing presses will keep on rolling. With no checks and balances in place the Government can do what it likes - or so it thinks.
A study of all the great inflationary periods in the last century tells us that when inflation reaches its terminal stage there will be failing prosperity, a shortness of wealth, a falling stock market, rising taxes, ever larger government deficits and yet still more money expansion except that it will be accompanied by soaring prices. None of the traditional remedies will then be effective. Everyone pays and no one benefits. This will be the outcome of the current recession.
Published: January 2009