I have to say – it’s nice to see the IMF admitting fault in misunderstanding the negative effect of austerity over the years. I like to say that it’s “only in being wrong that we can learn to be right”. So, what have we really learned from the last 5 years?
Let’s step back and review the last 5 years in 180 seconds. We had a huge housing bubble which resulted in very high levels of private sector debt. This was sustainable as long as the economy remained strong and incomes could support these higher debt levels. When house prices started to fall (for varying reasons) the economy weakened, incomes declined and a falling rock had triggered an avalanche. Our monetary system is one which is built mainly on two things – inside money (bank deposits created by loans) and the flow of this bank credit throughout the system (all in the pursuit of creating goods and services and hopefully higher living standards). So when this crucial piece of the puzzle cratered the economy collapsed and capitalists stopped acting like capitalists because their revenues collapsed. And their revenues collapsed because their customers had stopped spending as much money in an effort to focus on repairing their busted balance sheets. The result was this great big mess we’ve been in for years.
That’s where we’ve been. Those of us who understood this dynamic knew that this was the kind of environment that could easily result in a depression or something close to that magnitude. Why? Because the private credit markets don’t seize up very often. So when they do the economy tends to undergo an incredibly large shock. It’s a lot like a heart attack. And when you have a heart attack the human body generally needs assistance. It doesn’t just fix itself by pulling itself up by the boot straps. But this is essentially the economic policy that many people recommended for the USA and for Europe. They like to believe that economies are self reinforcing systems that should never be manipulated by its participants (never mind that its participants are constantly trying to manipulate the system for personal benefit).
Anyhow, understanding all of this, it’s crystal clear that when the private sector shuts down due to a massive debt bubble, that there is only one entity that can fill this void. Remember, the economic system is a lot like the human body. When the “flow” shuts off the system dies. So when the “flow” died in 2009 you had two options. You could attach the artificial heart or you could let the system go and just hope it recovered. Many countries attached the artificial heart in the form of government spending. You see, the government in the USA can always keep the “flow” going. That is, they can always tax or harness the domestic banking system to spend money into the economy (the US government can’t “run out of money due to the institutional design of the monetary system). This keeps the “flow” going. Granted, the government’s “flow” isn’t always ideal, but at a time like 2009, anything is better than nothing because nothing is certain to cause death.
And that’s exactly what we saw coming out of this crisis. Those nations where austerity was implemented experienced massive depressionary results. Spain and Greece and many of the European nations have 25%+ unemployment, stock markets that are off 70-90% STILL, and economies that remain mired in contraction. Yes, the USA hasn’t exactly been going gangbusters, but by comparison, the country is far better off. Why? Because we were wise enough to implement one of the most powerful tools man has ever created (government) at a time when we desperately needed it.
I’m a capitalist through a through. But a good capitalist must also understand the system we’ve designed and how that system can be good and bad. And there are times, like 2008, when capitalists are powerless to fix the problems that could cause even greater long-term problems for them if an outside entity doesn’t help. I like to say that capitalism makes socialism possible. But 2009 was a rare instance where socialism made capitalism possible. And the USA is better off for it.
So, again, what have we learned in the last 5 years?
- Hopefully, this crisis has forced more of us to better understand the monetary system. See my paper on the monetary system in case you haven’t.
- Private debt matters!
- Autonomous currency issuers don’t “run out of money”. Ie, public debt is different than private debt!
- Being an autonomous currency issuer matters. This highlights a key flaw in Europe’s monetary design.
- Some government policies can have a distorting effect when misunderstood.
- Government is a tool created by us and for us. It’s not always bad!
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.
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