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Socratic Economics VIII: The Blue Screen of Death

by JakeS Sun Apr 27th, 2008 at 04:48:55 AM EST

I'll start out by admitting my ignorance: I never "got" stagflation. I don't understand what it is, and more importantly, I don't understand why economists are so scared of it. The best description I've read so far is that stagflation is "Economics' version of the Blue Screen of Death." The only solution known to man (or at least the man I've talked to) is to "reboot" the economy by deliberately plunging it into recession and then working from that using the ordinary economic tools.

So I'll attempt to tap into the collective wisdom of European Tribune to answer the following questions:

  1. What is stagflation?
  2. Why is it so scary?
  3. What causes it?
  4. What to do about it?
- Jake

Diary rescue by Migeru


[editor's note, by Migeru]

Socratic Economics is an occasional series of questions posed in a Socratic effort to understand economics. Previous entries: Other diaries which should have been added to the series...

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For a start you can read the wikipedia entry.

Lenders fear inflation because the money they get back will be worth less. Borrowers like inflation because the loan will be easier to pay back.

Since lenders are the ones with the power and money, policies are designed to support their interests over those of borrowers.

So high inflation is a "bad thing". When this is combined with a non-growing economy it also means that stock markets aren't appreciating either, so the investor class is locked out of both markets (bonds and stocks).

During the 1970's many wealthy turned to things like antiques and art works to try and hedge against these conditions. As I say in my current essay on this site, this only works if others agree on the value of what you are trying to sell.

Policies not Politics
---- Daily Landscape

by rdf (robert.feinman@gmail.com) on Fri Apr 11th, 2008 at 01:39:11 PM EST
But inflation hurts the the workers as well as the lenders, unless wages are inflation-indexed. And the harm done to the worker class seems more severe than the harm done to the lender class. So why is inflation bad for the lender class? It isn't like inflation directly affects the amount of stuff available in society - just the distribution of said stuff. And that's a zero-sum game. So if both the lender class and the borrower class lose, who gain?

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Fri Apr 11th, 2008 at 01:54:14 PM EST
[ Parent ]
There is no lender and borrower 'class'. RE owners profit from inflation.
And inflation hurts the lenders only shortly. You can redistribute once. But in the next round of lending the lenders will ask for higher interest with higher real interest rates. There is a reason why some people are worried about the current Fed policy, despite the US has more dollar denominated debt than credit. The long term interest may shoot up badly or hyperinflation may follow, with prices for some products of inf - not sellable for dollars. Depending if the printing press will be used or not.
Of course you can make every now and then a currency reform, but then you'll get a massive capital flight problem.

Der Amerikaner ist die Orchidee unter den Menschen
Volker Pispers
by Martin (weiser.mensch(at)googlemail.com) on Fri Apr 11th, 2008 at 02:06:47 PM EST
[ Parent ]
Martin:
There is no lender and borrower 'class'.

Quite so. If there were only "lenders" and "borrowers" there would be no new money.

Banks create credit and lend it as new money into circulation, and it is simultaneously redeposited.

Some of this new credit is used to create new productive assets, which is fine - without this there can be no development.

Unfortunately a very large amount of it is used to purchase productive assets once they have been developed. This is where asset price inflation and "bubbles" come from.

Credit has no "cost" when created, and through the cycle its cost comprises operating costs, default costs and bank profits.

Productive Capital (ie property in assets with a value in use) also has a "cost" or market price and this has come down from 25% pa in Babylonian times, through 10% pa in medieval times to 5% before the Industrial Revolution.

"Financial Capital" (ie Debt and Equity) then kicked in and funded the Industrial Revolution and everything since. The result is that the world is now awash in productive capital to the extent that the "Cost" is probably now less than 1% pa.

Interest rates are purely arbitrary and bear no relationship at all to either the cost of Credit or this Cost of Productive Capital.

Inflation is IMHO caused by a combination of:

(a) deficit spending by governments (other than on productive assets);

(b) the deficit basis of Bank created credit; and

(c) the "profit" motive.

The problem is that because our Money is Credit then we have essentially conflated Capital and Credit within a parasitic overlay of "Financial Capital" upon the productive economy.

The rates of return demanded by investors take into account the inflation which is inherent in the system itself.

Productive assets are not only inequitably shared among the population, but the system leads inevitably to the concentration of "Wealth" in fewer and fewer hands. Which is how it has evolved as it has developed organically under the control of the rich.

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Fri Apr 11th, 2008 at 04:38:06 PM EST
[ Parent ]
Don't confuse the question of whether workers would be better off with no inflation, if everything else was the same, and the question of whether workers will tend to be better off if we do the things that are proposed as the correct way to "fight inflation".

"Fight inflation" policies boil down to "slow down the economy":

  • raise interest rates, to reduce spending on infrastructure, productive capacity, and consumer durables
  • cut government spending to cut economic activity to produce the goods and services the government is buying
  • raise taxes, to reduce disposable incomes and cut purchasing power.

Now, if the cause of the inflation is effective demand that is outstripping the economy's ability to produce goods and services, then much of the above, done prudently, is quite sensible economic policy.

However, that is not the cause of the inflation that we have been experiencing ... its part of the cause of the inflation experienced by China, but in the US and EU its mostly driven by costs of energy and food.

So why take policies that make sense for an economy being stretched to its limits, and apply them when quite obviously that is not the problem?

Well, it depends on whether you are more concerned with preserving the living standards of the majority or the wealth of the wealthy. Cost push inflation is a reduction in the actual income available to a nation in terms of goods and services.

  • You can protect the level of economic activity, at the cost of tolerating a higher level of inflation which will tend to reduce the wealth of those holding large portfolios of financial assets
  • You can protect the wealth of those holding large portfolios of financial assets, by deflating the economy to offset the cost-push, which will tend to reduce the income that can be earned by those working for a living.


I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.
by BruceMcF (agila61 at netscape dot net) on Sun Apr 27th, 2008 at 06:08:49 PM EST
[ Parent ]
Before we move on to compound issues, what were the results from Socratic Economics I and IV?
by nanne (zwaerdenmaecker@gmail.com) on Fri Apr 11th, 2008 at 04:34:23 PM EST
LOL!

And III, too?

When the capital development of a country becomes a by-product of the activities of a casino, the job is likely to be ill-done. — John M. Keynes

by Migeru (migeru at eurotrib dot com) on Fri Apr 11th, 2008 at 04:39:22 PM EST
[ Parent ]
  1. Stagflation is inflation in the absence of economic growth.  

  2. A) Stagflation is scary because there is no way to combat it using either fiscal or monetary policy (Back in the 1970s, the US government would actually allow itself to have fiscal policy--that is, to act specifically with economic consequences in mind.)--policies that suppress the inflation will tend to further suppress economic growth; conversely, anything that helps the economy is likely to accelerate the inflation.  

  3. B)  It signifies of tailspin, a downward cycle of increasing poverty (for most people).  Political unrest, at minimum, can be expected to follow.  

  4. C) It conflicts with Capitalist Teaching, in which such economic states cannot happen.  That which can neither be explained, nor explained away, must be made to not exist.  But stagflation was tenacious as crab grass, so perforce the best that could be achieved was to pretend that it did not exist.  This pretense did not come easy.  

  5. A)  Stagflation is caused by the shortage of real resources that are essential--as opposed to discretionary or optional--for real economic activity.  Specifically, in the 1970s it was caused by the (then unadvertised) fact that US oil production had peaked, combined with a political crisis in which foreign producers were unwilling (because of particular American behaviors) to sell, and thereby make up the difference.  As global oil production peaks, and no suitable, large-scale substitutes for oil are found, stagflation is pretty much guaranteed for the entire world.  

  6. B)  The shortage of a real, essential resource is not the whole of it, but acts through the fact that debt-based money and interest-bearing loans both require that the money supply forever increase, but unless the real economy can also increase, the increase in the money supply literally means inflation.  This is the cancer-tumor aspect of Capitalism:  It can only grow forever, or else the disconnect between money and reality destroys the whole system, and, mere stability will not serve at all--only growth, forever and ever.  

  7. A)  What to do about stagflation?  Abandon Capitalism.  It is doomed.  Interest on debt used to be called usury--and was both a sin and a crime--for good reason:  No sustainable economy can allow the practice.  The entire system of banking and finance will have to go--and is going to go, regardless.  

  8. B)  Can a sustainable economy have a form of money--abstract markers or tokens of real economic value, a medium of exchange?  We should not assume the answer is yes, but we might well consider what constraints a yes answer would have to meet.  It must be simple and transparent enough that corruption and cheating are not easy; so much is clear.  But more, the systemic purpose of money is to move goods and energy from where they are to where they are needed, and to meet this purpose money must flow readily through all levels and parts of the system without accumulating or clogging up.  Wealth, as it is modernly understood, is prima facie evidence of a non-sustainability in the economy because it means precisely that the flow of the economy is clogging up or breaking down.  Money must therefore carry an automatic, built-in penalty against holding or accumulating, and conversely must reward being distributed or given away.  How this is achieved must be simple and obvious--whatever it is.

  9. C)  A society free of stagflation is as society with social coherence:  The well-being and continuation of the society itself is a shared goal coming with higher priority than individual desires, specifically the desire for invidious advantage within the society.  This puts constraints on how money works:  Do we know of money-using societies in which the money itself does not encourage selfishness?  Because that is precisely the attribute we are seeking--that the structure of the money should itself encourage socially-oriented action.

  10. D)  It must be obvious from what I have written so far that an effective anti-stagflation policy will never be supported by Capitalist elites.  When stagflation happens, they will not try to end it, but only mask it, while profiting from it as best they can.    


The Fates are kind.
by Gaianne on Mon Apr 14th, 2008 at 12:21:30 AM EST
great comment, Gaianne.

a diary in itself!

'The history of public debt is full of irony. It rarely follows our ideas of order and justice.' Thomas Piketty

by melo (melometa4(at)gmail.com) on Mon Apr 14th, 2008 at 11:29:10 AM EST
[ Parent ]
  1. A) I still don't understand why stagflation is scarier than a normal recession? After all, stagflation was resolved by "rebooting" the economy through an ordinary recession. So why is stagflation scarier than the recession that follows it, which is quite ordinary?

  2. B) Or are you saying that the recession that follows it isn't an ordinary recession in some respects, or that the cause for the end of stagflation isn't the "reboot" but the re-opening of supplies of whatever strategic resource was lacking during the stagflation?

  3. A) As an aside, Mig claims that there are simple technical measures that could be taken to combat inflation that are less likely to push the economy into a recession, but which are painful to bankers and therefore not taken. But the technical lingo involved escapes me at the moment.

  4. B) Something about increasing the amount of "real money" banks must have when they create fiat money, or somesuch. Would this work?

- Jake

Friends come and go. Enemies accumulate.
by JakeS (JangoSierra 'at' gmail 'dot' com) on Mon Apr 14th, 2008 at 03:05:22 PM EST
[ Parent ]
the oil taps.  That was then.  

Who can open the oil taps now?  

Recession may come, but will it go?  Your typical recession is due to imbalances in the financial system that find no other resolution.  The recession itself provides the resolution, taking some of the fantasy wealth off the table and allowing the remainder to resume functioning.  At that point the recession ends.  

But when a recession is caused by real, rather than symbolic problems, then the real conditions have to change.  If they cannot change, the recession does not end.  Ever.  

That was 1. A) & B).  

2.  Under the fractional banking system, banks are allowed to loan money they don't have.  This reduces stability by creating a positive feedback loop--which is sought.  This is the methedrine rush of Capitalism, the giddy feeling that everyone is getting rich that comes when easy loans create economic activity leading to more easy loans.  And, like ordinary street junkies, everyone likes this.  But when there is trouble, the same feedback loop amplifies into (a very methedrine-like) panic and depression, as loans are called in to pay loans that are called in made with money that never ever existed in the first place.  

The cure for this is to reduce the amount of loans banks can make with money they don't have.  This is done by raising the fractional reserve, the amount of assets they have to show per amount of loan they make. Everyone finds this makes finance boring.  How can you get rich?  They don't like it.  

The Fates are kind.

by Gaianne on Mon Apr 14th, 2008 at 05:23:56 PM EST
[ Parent ]
Thanks. Those're the parts I was missing.

But. If you're right about that, doesn't it mean that rather a lot of common economic wisdom is a load of horse manure?

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Tue Apr 15th, 2008 at 11:33:28 AM EST
[ Parent ]
The totality of conventional economic wisdom is horse manure because it is based upon horse manure assumptions.

These are many, and have been well documented here.

In particular, it assumes as "Value" something that is in fact its complete opposite - a "Claim over Value" created by Banks and based upon a small amount of "Regulatory Capital".


"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Sun Apr 27th, 2008 at 06:05:29 AM EST
[ Parent ]
"doesn't it mean that rather a lot of common economic wisdom is a load of horse manure?"

I think that's a bit strong. Conventional economic analysis is based on a coherent set of assumptions about the way the markets behave. If you're happy with the idea that the strong, smart, criminal, hard-working people will control everything, the analysis works just fine. It's only when you apply concerns about equity and compassion that the system breaks down.

Do you think that the multi-millionaires who own (not "hold mortgates on") several mansions in various countries will be in trouble in a real estate market collapse? They will simply hold on to their property. Do you think that the CEOs of the defense industry will be in trouble if there are revolutions about food? They will simply adjust their factories to make more machine guns. Do you think that the rich in your town will care if there are street riots (as recently advocated by our foremost American talk show host, Rush Limbaugh)?
http://www.upi.com/NewsTrack/Top_News/2008/04/25/limbaugh_says_hes_dreaming_of_dnc_riot/4093/

No, they will simply call in the SWAT teams to break heads. "Let them eat cake" is, I believe, the motto of the capitalist leadership...

by asdf on Sun Apr 27th, 2008 at 12:03:14 PM EST
[ Parent ]
We can see how difficult the US find it to subdue Iraq. I do not believe for one minute that they could subdue a recalcitrant US population in which the (armed!) middle and working classes had actually rumbled what had been done to them.

"The future is already here -- it's just not very evenly distributed" William Gibson
by ChrisCook (cojockathotmaildotcom) on Sun Apr 27th, 2008 at 01:04:47 PM EST
[ Parent ]
... and scarier than an expansionary inflation because instead of damaging the value of some portfolios of some wealthy, as either a recession or an expansionary inflation will do, it damages the value of almost all portfolios of almost all wealthy.


I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.
by BruceMcF (agila61 at netscape dot net) on Sun Apr 27th, 2008 at 06:12:12 PM EST
[ Parent ]
I have to say that I found this comment breathtaking in its clarity and logic.

Gaianne:

Can a sustainable economy have a form of money--abstract markers or tokens of real economic value, a medium of exchange?  We should not assume the answer is yes, but we might well consider what constraints a yes answer would have to meet.  It must be simple and transparent enough that corruption and cheating are not easy; so much is clear.  But more, the systemic purpose of money is to move goods and energy from where they are to where they are needed, and to meet this purpose money must flow readily through all levels and parts of the system without accumulating or clogging up.  

This gets to the nub of the problem that was the focus of a recent workshop I attended in Seattle.

Credit (aka "Time to Pay") - and not "Money" - is necessary for the circulation (ie exchange) of "Money's Worth" in goods, services, energy etc.

The problem is that we are used to seeing Money as an Object, and specifically as an IOU. Our Money consists of interest-bearing Debt aka Bank-created Credit.

Some - CH Douglas's Social Credit was such a proposal - saw the solution as the issue of Money as Credit by government directly with suitable mechanisms to address inflation. "Community Currencies" - such as LETS - are based upon a money as Credit created within a closed community.

But Credit is in fact only a small part of the financial system. It is the bloodstream, not the body. While Credit is implicit in a monetary system, it need not - indeed should not be used as money, interest bearing or otherwise, because credit alone is not enough.

IMHO Money exists only in the transient moment of exchange and is implicit in a monetary system. A monetary system exists wherever a barter network/ clearing union incorporates "trade credit" from seller to buyer.

I think Money is best described as "Dynamic Value". The analogy of money = Dynamic Value with kinetic energy is almost exact.

Credit is necessary for the deployment of "money's worth" to create productive assets. ie "Property" of different types, such as land, knowledge, buildings, machinery.

When created to acquire existing assets (eg through mortgage loans) the result is everywhere and always asset price inflation.

These productive assets constitute "Capital" - which I see as "Static Value" (analogous to potential energy) which produces "money's worth" in units of production which have a Value in exchange.

These productive assets are the subject of the financial claims (legal protocols) of "Equity" (shares in a Corporation) and secured Debt (eg mortgage loans) which together constitute what some call "Finance Capital".

Note here that one of the great mistaken assumptions of both conventional Economics and Marxism is that only "Labour" and not "Capital" is productive. This anthropocentric assumption is as accurate in understanding the real world as was the assumption in Ptolemaic cosmology that the Sun goes around the Earth.

This anthropocentric assumption - that only Labour has Value - justifies taxation policies based upon Income, rather than upon "Wealth" and particularly upon the privilege of private Property over Commons that encloses that Wealth.

But to return to the point, I believe that it is possible to replace the "deficit-based" but "asset-backed" value units which constitute our deficit-based Money with entire new classes of "Redeemable Units" denominated in energy, and land rental value, in particular.

We may do this simply by using a new legal "enterprise model" - already in increasing use, simply because "it works" - to invest in these assets and to enable new "Units" of production.

These Units will be fungible (ie acceptable in exchange) and capable of circulating as "asset-based" currencies which are redeemable in "money's worth" which is relevant to most people (eg Kilowatt Hours; Square Metre Years), and which is why they will accept them in settlement of credit obligations.

This circulation requires credit = time to pay, and that credit in turn requires trust. This trust currently comes from a Bank guarantee (which is the true value a Bank provides as a credit intermediary)but could equally be a mutual/ community guarantee backed by a pool of "Community Capital" - resources in community ownership - rather than the bank's pool of "Regulatory Capital" in private ownership.

I believe that we may avoid Stagflation only if we are able to replace (finite) non-renewables with (infinite) renewables).

This requires massive investment in a "Green New Deal" - achievable by monetising energy on the one hand, and using "energy partnerships" on the other - to create the productive Capital necessary.

The US is capable of leading this global Capital creation - but not of "owning" it.

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Sun Apr 27th, 2008 at 07:39:18 AM EST
[ Parent ]
Don't we know just one stagflation? How can we decide what it is in general, and how much (or little) can be done with it?

I see "stagflation" more as an ideological bogeyman (from the libertarian or the fat Wall Street side) than an actual phenomenon. There were once special circumstances and a limited reaction, nothing more. If the Fed would had worked as hard and relentlessly then...

If people are eager to cooperate and live in prosperity, what is stopping them to do that kind of cooperation in crises times? Is it some stupid disbalance of money distribution or circulation?

If we imagine that the civilization is catastrophically split into small groups of some 200-300 people, what would be the role of money within those groups? All exchange values and necessary activities could be sorted out without money tokens in small groups. Yet with money emphatically present, games of domination would start.

Valuation of goods is just one function of money. The other function (whether we want it or not) is status determination. With total mutual relations getting too complex in large societies, distribution of money gives power distribution as well, especially when power holders like that. This "lefty" me can be comfortable with some power inequality, determined somewhat by money as well. If we have to propose something different, we either have to define status determination independent of money, or make money work for just social relations.  

But isn't it remarkable that money being the universal determinant of individual prosperity and influence in this civilization, easy or unfair money making is emphatically being left unchecked? Anyone with a heap of money is eventually in high respect, no matter how he got that money, and governments can allow hardships on any work but not on money manipulation... Something funny must happen with this.

by das monde on Sun Apr 27th, 2008 at 08:32:09 AM EST
[ Parent ]
das monde:
Valuation of goods is just one function of money. The other function (whether we want it or not) is status determination. With total mutual relations getting too complex in large societies, distribution of money gives power distribution as well, especially when power holders like that.

I think you are confusing Money and Wealth here.

The money we use is not "Wealth": it is a claim over it created by credit intermediaries.

Sure - when  Money is such interest-bearing Debt/Credit then it is "Wealth" in the hands of the account holder. However, I think most people can see - if they consider it - that such Money is mathematically unsustainable in a finite world, and indeed this deficit-based monetary system is slowly melting down around us now.

The function of Money should  never IMHO be as a "store of wealth". It is "Property" in productive assets that comprises such a "store of wealth", and this is indeed concentrating in fewer and fewer hands as is inevitable in the current system.

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Sun Apr 27th, 2008 at 01:00:39 PM EST
[ Parent ]
When it comes to power representation, claimed credit money is no less consequential as real money in the current system. Who gets help in the current crisis? Surely not end-of-chain borrowers, but debt "investors" in the middle or at the top.

Compounded money claims give actually even more power over other people or institutions, and there probably lie rich intentions. The common economy may meltdown completely, and predators would loose their profits and "imaginable wealth"; but who cares if they reach total power over the rest. Having most of material wealth and all population working for them, the top few hundred of world's rich won't need mass economy; cozy aristocratic friendship will do just fine.

by das monde on Mon Apr 28th, 2008 at 02:31:44 AM EST
[ Parent ]


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