Confessions of an Economic Witch Doctor

I just read about Jeffries economist Jim Zervos’ note to clients on BI, in which he admonishes the “Austrian economist types” and “perma-bears” for being so gloomy, for likening this current bull market to a “sugar high”. Because in his opinion, the policy handlers (like Bernanke and the central banks) have all of this under control and it’s full steam ahead.

What cheerleaders like this fail to address are questions like “for how long?” and “then what happens?” If you push them for answers they either have to admit that they don’t know what happens when the unsustainable stops sustaining, or they wait until it happens and scream for another short-term-fix to kick the can down the road again.

Weisenthal compliments Zervos on his “apt medical analogy” in which a car crash victim is given the choice between “modern medical science” (I assume he means the Modern Monetary “Realists”, et al) which can bring down the inflammation in his head now, but leave him hooked on painkillers, which the friendly doctors can help him kick “cold turkey” later; OR he can take treatment from those nutty Austrian “witch doctors” which would recommend skull trepanation.

The problem with this analogy is that it’s a bad one.The situation we’re in today hasn’t been caused by an unrelated accident of circumstance. The global economy didn’t get into a “car accident” (i.e. asteroid hit). The global economy got itself into a credit bubble. A credit bubble is quite simply too much debt. And elegant analogies and rationalizations aside, you cannot cure a debt bubble with more debt.

The far more appropriate analogy is the alcoholic (a topic near and dear to my heart) who is trying to avoid hangovers by staying drunk. It’s a lot simpler, and a lot more meaningful in this context. You could even try to roll off of alcohol and into heroin or cocaine (I’ve seen it attempted) and in the short to medium term, it may appear to “work”.

But when the music stops, trust me, you don’t want to be anywhere near the guy who’s attempting it.

So the drunk has to, you know, stop drinking at some point.

In economics you have to face the stark reality: you have to produce before you can consume; and for various reasons you have to produce more than you consume.

It is possible to reverse this, for awhile, using that marvelous financial abstraction called debt and debt can be very useful to facilitate economic activity. But beyond a certain point the fallacies take over:

You can consume first, and produce later.

You can consume more, and produce less.

You can keep increasing the consumption and postponing the production.

And eventually you arrive in a quagmire where it’s too painful to stop accelerating the increasing consumption and it’s too hard or not possible to raise the production to support it.

We are in that phase now, and the next step after this phase is when the unsustainable stops sustaining. What I do find amazing is that we got back here so fast. In the lead up to the 2007-2008 financial crisis, the naysayers were widely decried as “economic witch doctors” and publicly ridiculed.

You have to also keep in mind that much of the “proof” that the cheerleaders point at as indications of successful economic policies are either heavily massaged (employment numbers) or illusory (stock market highs in nominal terms). You have to ask yourself is this stock market bull cyclical or secular? (Hint: it’s a cyclical bull within a secular bear, there will be a test on this later).

Sometimes friends ask me “Mark, if we had done things after the meltdown the right way, wouldn’t it have been painful? Wouldn’t it have been a really bleak period?” and I always answered “Yes. But we wouldn’t wind up going through that again for another thousand years.”

Instead we’re right back there in 5.

The question to ask isn’t “why are these kooky Austrians and bears always on about fiscal responsibility and money printing, blah blah blah”. The question is really this:

What does it mean if Ben Bernanke and Modern Monetary Realists, et al are right?.

Nobody asks that because the answer is absurd. IF this economic policy actually “worked” – long term, and without a meltdown at the end then why can’t the Fed just monetize everything, forever?

In short, why can’t we just print up enough money to pay off everybody’s debts and make everybody rich? Surely that would spur consumption and demand because we’d all be flying around in our own personal Gulfstream jets, pigging out on caviar and wearing a new pair of Pradas every day! It would be a virtuous consumptive circle that would never end!

It’s the same logic as the PHB in Dilbert cartoons who figures out he can cost cut his way to profitability, Modern Monetary Theory posits that we can run up debt forever and never pay it off (if you actually look into the guts of MMT or MMR, they actually posit that taxation provides the release valve for inflation, sucking the “excess money” out of the system and providing a floor under the demand for the newly printed money).

I once had a physics teacher who told me “I decided to study physics the day I realized I couldn’t just hook up a generator to a motor and have a perpetual motion machine”.

Either fiat, edict and monetary policy can overturn these seemingly straightforward rules of reality or they can’t.

If they can, then an economic perpetual motion machine has been invented, and we can all quit our jobs and become rich.

If they can’t, then

LOOK OUT.

(also see: The Tragedy of Contrarianism)