14^th July 2014

Growth verses Austerity

Why the busted credit card is the wrong analogy

Channel 4 News interviewed the billionaire Nick Hanauer here on his views that wages should rise. Whilst this argument has been made by others the news value is that it is a billionaire making it. His reason was very much in self-interest but aside from the mention of pitchforks it followed a Keynesian line. Whilst Keynesian policies were in place during much of the prosperous mid-20th century it has now fallen out of favour with our leaders and the public who seem to have bought into the maxing out the credit card argument. Whilst it may at first appear be common sense it can also be wrong.

The credit card argument plays to our personal experience of housing keeping and balancing the books where debts usually have to be paid back by cutting out luxuries. So paying more instead may sound counter intuitive but the mistake is to see this in monetary terms. In real life we may cut out on going to restaurants and cooking meal at home instead. We may grow fruit and veg in the garden to eat and make preserves. We can also undertake some DIY around the house or make our own cloths. By taking these steps we may end up working a little harder but then we may not see such a fall our quality of living. We can translate this domestic to the national scene. Our monetary income and outgoings represent the exports and imports but our efforts about the house translate as the domestic service economy. Why should we be surprised that the more we work the better off we become because wealth is ultimately an expression of human effort. At this point someone will pipe up with 'where's the money coming from'. To extend the analogy the members of the household will generally take on these tasks for the common good but perhaps just to formalise it or if there is a suspicion that someone was not pulling their weight they could issue IOU's or some other token. These would not have any worth outside the household but then it does not place any limits on how many can be created. Crudely these tokens can be taken as a domestic currency and the income and outgoing expenses as foreign exchange. Of course the interaction of currencies is a little more complex than this and governments are wary of issuing worthless IOUs but this has not stopped Quantitative Easing.

We can also understand austerity in these terms. Instead of supplementing any income with DIY and home grown food, the household just cut back. In the short this may lead to a little hardship but as it continues cloths will wear out and the house will start to fall down. The saving will run out quicker and then they will have to sell off the family silver to pay for the repairs, perhaps from the enterprising neighbour who has taken to DIY. It could be made worse if the family tries to keep up appearances. One could go on developing this analogy but I am sure you get the point.

Put in these terms no one would willingly choose the latter but balancing the books still seems to win the argument. There is a dichotomy here and it relates to our view of money. The argument is too involved for this article and can be found in my book Wealth Creation and Wealth Destruction but essentially money is a representation of wealth, where that wealth can wear out, money hangs around effectively forever. This plays out as inflation but we find it difficult to accept money loses it value even if the volume of wealth that it represents is not maintained. As wealth decays so should any debts associated with them but that this cannot happen with a low interest economy.

These consequences of austerity are playing out for Britain. After 4 years the infrastructure is creaking but the much vaunted rebalancing of the economy has not happened. But nor are we cutting back as we still imports way more than we export which is paid for overseas buyers of our property and companies. There is a sense of denial with a high exchange rate being seen as a good thing even although it encourages imports at the expense of local industry. This is not all the governments fault as there are powerful self-interest groups namely the high finance that is play a part. To those gaining from these selling offs everything appears to be hunky dory but what happens when there is nothing left to sell?