Sunday, November 17, 2013

The Beginning of the End, Deflation and Deficit.

Can you eat gold?

The Austrian says their theory is the only correct economic theory, they say the Great depression as the proof of the soundness of their theory and they say that the present "recession" is to be treated by their prescription - austerity and them advise you to keep gold as a hedge against the coming depression. So are they right? Is keeping gold as a bet helps? It will if you can eat gold!!
So then why their method worked in the great depression and it does not work now? Because they do not see the short term and are blind to the changes that occurred in the world. They do not know that the world, along with the economic system has changed drastically.
So, are the Keynesians correct? Shall we follow their prescription, shall we call for more debt and spending. Yes, that should help, but the higher we go, the more terrible will be our fall. We will fail eventually and if there is any chance for an escape that will be lost by the eventual fall.

So what is Austrian economics? In a nutshell, Austrians say that all the cause of inflation and bad business is money printing. They say that the money printing can change the economic climate and give a false hope to entrepreneurs who in turn will invest in a business where there is no chance of a win lured by easy money. And when the money availability is tightened the business will fail.
They say the great depression was because the low-interest rates and lavish printing of money(hereafter, inflation) and the eventual failing of all the business that started because of the easy availability of money. So they say the depression was good that they eliminated all the bad businesses and helped the promotion of good businesses. They further say that today the Keynesians are not allowing for the dissolution of the bad business hence the world is not recovering as happened after the great depression.
The Keynesians, on the other hand, does not accept that theory. They say depression is a part of the economy and it cannot be prevented and to get over it, one has to create inflation. They say second world war created such a situation helped by FDR's welfare programs and govt spending that ended the great depression.
So, who is right and who is wrong?
The irony is that they both are right and wrong at the same time. How come?
We will discuss. What actually happened after the great depression?
Was FDR the first one to start Govt spending? No Wilson started it before FDR.
So what actually happened? World war preparation started. The Austrians wanted to ignore this. They say war only causes destruction and war have nothing to do with the end of the depression. I agree war is not good, but I do not agree that war didn't help at all.
So what did war do?
1) It created jobs. Jobs are the primary driving factor of any economy. Without jobs, people will not have money to spent. Without money no economics work.
2) It created technology. Research works increased for war preparation. Though the technologies are primarily directed towards war after the war the same technologies were used for civilian purposes which boosted production and jobs. Production increased very much which increased general well being which further fueled an increase in research and a further increase in technology. So when people came back from the war they had money to spend and jobs to find, both together ended the great depression.
Along with these, there was a further boost by FDR in public works, which increased jobs.
So as technology progressed and as spending increased more jobs were created and the population too increased as there were more jobs and money and leisure.
So as the Keynesians say, the govt spending helped and as Austrians say the bad business were dissolved that paved the way for further good business. But Keynesians were wrong that it was govt spending alone that ended the depression and Austrian's were wrong to say govt spending and war has no role.
But is it applicable to today's world?
The govt spending increased, but from where did they get the money? Yes from the future. It was no problem then, every time a new bond was issued then, as is now, there are people to buy it. So what changed?
The technology.
People got everything they wanted. There is no further increase in technology. The earlier technologies created robots that increased jobs, but now the technology is creating machines that take over work and hence decrease jobs.
But something drastic happened. As machination increased, urbanization increased. Population density increased, the population started to stop growing. As population growth decreased, demand and hence the need for products decreased and hence the need for jobs.
And computers became ubiquitous and a new type of economy was created and the older 'industrial economy' gave way to "service economy".
As service economy progressed and as computers became more powerful, jobs decreased. As jobs decreased, the population growth is further decreasing.
So because of the new technology, nothing can stimulate job growth. And because of urbanization, nothing can stimulate population growth.
So next time when the government issues a bond, there may not be enough people to buy it - deficit cannot be covered.
When there are no jobs, people cannot spend, and hence demand decreasing and prices will come down - deflation.
From there, there will be a downward spiral. Neither Austrians nor Keynesian has anything to propose and neither of their medications is effective. Austrians propose a total abstinence from governmental spending. That will be like removing life support from a terminally ill patient. Keynesians say government spending as a miracle drug, but that will not produce more jobs or after a time will not even keep the existing jobs. Then the burgeoning problem of government debt too will rise and there will be an eventual collapse. What we are witnessing is the beginning of the end of human civilization as we know it.
So what will happen to the gold you stored. Everyone has lost their jobs together. Everyone want food and is not will to exchange whatever food they got with any amount of gold in the world. What will you do?

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