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My last article touched upon the different schools of thought in economics.
I discussed how mainstream economics is taught in schools without challenging its assumptions.
We barely question them.
We’ve come to accept economics as it is. We don’t go back to the drawing board to test the very same models that governments and central bankers rely on.
Those that seriously question our current economic system are pushed to the fringe.
We face an issue today.
Our system is run on a particular economic model which we aren’t challenging. It’s leading to all kinds of problems. The average person is clueless. Kids from a young age are taught economics with a narrow framework.
My main argument in the previous article is how modern economics, Keynesian economics, is pushed to the forefront of schools and universities because the incentives make it so.
What do I mean by this?
Let’s go back to remind ourselves what Keynesian economics is.
Keynesian economics is based on the premise that the government should intervene to help smooth out the economic business cycle. By fuelling the demand-side of the economy (i.e. increasing consumption), the economy can grow again.
The business cycle is made up of the booms and busts that we come to experience over the years. The “natural” ups and downs from a credit-based system.
Notice the quotation marks.
It’s only natural because we accept credit as a necessary fuel for our economic engine.
When times are good, you borrow to spend and invest more which fuels growth. But once the economy slows down, the reverse happens. You have to tighten your belt. You have to cut back on your spending to repay the debts you took on during the good times.
Whenever you take on debt, you’re borrowing from your future income.
You’re choosing to spend more today and spend less in the future. Unless your income grows (i.e. you become more productive), you’ll need to reduce spending at some point in the future.
The same happens with nation states.
Austerity measures, i.e. when governments reduce government spending and increase taxes, are a result of too much debt. The government previously borrowed a lot of money. It wasn’t able to increase its productivity, and therefore income. The debt has to be repaid by collecting more money from taxpayers and cutting down spending on public services.
It becomes a cycle between good times and tough times.
Good times never last.
But for some states, the tough times get tougher and tougher and become harder to get out of.
Some nations however, have an advantage over others.
Take the US for example. It has its own currency and its own central bank.
When times get tough, what do you think happens?
Some politicians call for austerity to reign in debt growth and pay back previous debt, but that never happens. You can’t win votes that way.
I previously mentioned how the US debt ceiling, i.e. the maximum amount of debt US Congress allows the US government to borrow, keeps having to be raised.
The media keeps on covering this story year after year. Weekly headlines show up pretending that the government will default on its debt because it can’t borrow more money to repay old debts.
What a joke.
The US debt ceiling keeps being raised. The members of Congress initially throw a tantrum but in the end they come to a resolution: the debt ceiling is increased. Yet again.
There’s no alternative.
Debts have to be repaid and the only way to pay them back is with more debt.
If you told your financial advisor that you need to borrow more money to pay back previous debts, they’ll look at you like you’ve got a problem. They’ll tell you to sort your life out. That you need to tackle the root cause. They’ll focus on helping you cut back on your spending. To repay old debts. To make sure you don’t take on any more debt.
But that’s not happening with the US.
The short-term solution is to borrow more.
So politicians promise more spending to protect jobs. And as a nation, if you have your own currency, you have autonomy to print more money.
Not only that, but the US has an advantage that no other country has.
The almighty American dollar.
Every country wants and needs dollars.
Most trade between countries happens in dollars. Most savings are kept in dollars.
If you’re the governor of a central bank and have tens of billions of savings. Where do you stash this money?
Which market is deep enough to absorb this much liquidity?
That’s right. The US dollar.
US treasuries (i.e. US government debt) are probably the most liquid investment instruments in the world.
It’s seen as the safest place to put your money.
It’s also seen as great collateral if you wanted to borrow against it.
Although this is questionable as we’ve recently come to learn.
Silicon Valley Bank, a VC-focused bank in California, had invested a large amount of its deposits into US treasuries. This was before the US central bank, the Federal Reserve, increased interest rates. As rates went higher, the market value of these US treasuries dropped significantly. That caused a huge asset-liability mismatch in the bank.
Depositors got scared and started taking money out. There was a run on the bank. It had to close.
But for the most part, US treasuries are pretty safe. You don’t have to fear that the US government isn’t gonna pay you back. For now…
Not only is it backed by the strongest economy in the world but also by the strongest military in the world.
Now what does this mean for the US?
The government can borrow without much impunity. The whole world is ready to buy US treasuries that the government issues.
The world’s appetite for US dollars makes it so that the US can keep borrowing money. No other nation has the same advantage.
There’s a lot of talk of “de-dollarisation” about the US dollar being replaced but that’s all clickbait. It’s not happening anytime soon.
And if in the off chance there aren’t enough buyers, the Federal Reserve can step in and buy these bonds directly with newly printed money.
So as a US politician, why would you promote austerity? Why wouldn’t you get the voters on your side by promising to spend more to fix the recession? You can issue US treasuries that will be pretty much gobbled up by either the market or the central bank.
Keynesian economics sounds like a plausible economic model.
You can prevent a severe deep recession. Less people have to suffer now. You can save jobs.
Which heartless person will say no to that?
Me.
Now I’m not saying the government shouldn’t help when a population is suffering from a recession. I do care about humanity. Even if I work in finance…
The issue lies in the inability for most people to conduct second-order thinking. Or they do, but they just ignore it.
First order thinking will have you think about the problem and solution in this way:
Sounds like a nice story, right? How could you disagree? Which inhumane person would prevent such a solution? Are they just heartless creatures?
No.
It’s not so simple. It’s never black and white.
We’re talking about an economic system. Solving the recession problem is complicated.
We have to employ second-order thinking to understand what the implications of government intervention is.
It should make you feel uneasy when the solution to an economic problem is more debt.
The Keynesian model can only work by a nation state willing to live beyond its means.
To do so, it needs to be able to have more money than output produced.
How?
By printing it.
If the currency is not backed by anything, i.e. gold, its supply is limitless. There is nothing stopping the powers that control the currency to increase its supply.
In order for the government to borrow more money during an economic crisis, it will have to do so from the central bank.
The bank can create new money and use that to purchase government bonds.
This only works in a fiat monetary system. Because the money isn’t backed by any assets.
We saw this in 2009 during the Great Financial Crisis and most recently during the Covid-19 pandemic.
In the short-term, borrowing more to prevent a deep economic crisis sounds reasonable.
But what happens later on?
Well we are experiencing it now.
Inflation is roaring and the central banks are having a tough time taming it.
It’s only natural that if the number of goods and services available in an economy are fixed but you increase the money supply, you have more money chasing the same number of goods and services. What happens then?
Prices will have to increase.
That’s inflation.
When inflation was increasing throughout 2021 and 2022, many were blaming it on supply-side issues. As manufacturers and logistics companies were still suffering from Covid restrictions, it became more expensive to produce and transport goods. This led to an increase in their prices.
True, this is one reason. But it’s not the only one.
Covid restrictions have all been lifted and we are still experiencing inflation.
Central bankers will have you believe that inflation is due to a number of reasons. But it’s never because of their own policies which led to a stupid amount of money being injected in the system.
You have to ask yourself, why?
Why are they not talking about the issue that is on everyone’s mind? Why can’t they face the problem head on that excessive money printing is inflationary?
The issue runs deep.
Our economic system is reliant on debt. Economic growth is based on credit creation.
The Keynesian model is based on consumers consuming more to fuel economic growth.
How do you get people to spend more?
With debt.
That’s the issue with this economic system.
It was a great idea initially. Franklin D Roosevelt’s New Deal in the 1930s was monumental in passing government reform to help push the economy out of its deep recession.
But when does it stop?
Now recent inflation numbers are showing a slow-down in inflation in the US.
Let’s see if this lasts.
It’s another story in the UK where inflation is still rampant and the Bank of England has to keep raising rates.
We’ve dug a hole for ourselves where we have to borrow to keep the economy growing.
Borrowing is the politician’s favourite tool.
They have no skin in the game. They won’t be personally liable for their decision to borrow more money today. They can let future generations deal with it.
Their intentions may be genuine. They may think that the economy will grow to repay such debt. But if that’s the case, then they are just naive.
The amount of debt in the system is only going up especially since the money we use is no longer backed by anything. Backed simply by the trust in our government.
So those running the system know that we’re reliant on debt. We need more debt to grow. We need more debt to pay back previous debts.
Why would they want to discuss other economic schools of thought that disagree with this philosophy? Why not just teach people that this is the status quo? That this is how economics works?
This system works well for those in power. For those that control money.
In order for Keynesian economics to work in full swing, money has to be controlled by the government. If they control its supply, they can better manage the issuance of debt and overall government intervention in the economy.
The banks are happy as well. If they have free reign to create money, they’re also happy to keep the system as it is.
The incentives align perfectly for politicians and heads of financial institutions to stick to Keynesian principles. It’s an economic system based on debt. The more debt issued, the more votes they can win. The more power they can take. The more money they can make.
The issue is that we can’t get out of our debt-addicted system.
We’re told it’s not an issue.
As long as we can print more money, we can issue more debt to repay old debt.
But as debt grows, so does the cost of the debt. The interest payments start ballooning.
What happens when the interest payments on debt become greater than what an economy produces?
That’s when things become serious.
Central banks may try to bring interest rates down to lower interest payments but that becomes hard to do if inflation is high.
The more debt in the system, the harder it is to manage all these moving parts.
It’s all an experiment.
No one has a clue what will happen.
But I can comfortably say, it’s not looking good.
I manage a $100m private investment fund and I explore Islamic finance and economics through a personal lens. I help simplify financial markets from a Muslim perspective.
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