Econothermodynamics

I confess that I don't quite get it. Money is supposed to be a representational medium - it stands in for wealth, but paper currency (other than the value of paper as fuel for a Franklin stove or maybe as wall insulation after the gas service is shut off) is not intrinsically valuable itself. I realize that this contradicts the ideas of the so-called Modern Monetary Theorists or Chartalists - if I understand the ravings of this quasi-cult, they are convinced that the creation of money out of nothing, whether or not offset by debt, is a useful economic tool in and of itself. Further, I was not aware, until I read some of his recent columns and blogs, that Paul Krugman has apparently come under the sway of the MMT people, although he likes to draw specious, irrelevant distinctions between his particular brand of cash conjuration and the MMT cult.

Just as an aside: the Op-Ed pages of the New York Times are in a real sense dominated by cultists. Thomas Friedman, the porn-'stached (h/t: Matt Taiibi) major domo of the columnists there, is a globalization freak, for example. It doesn't matter that globalization does not work toward the well-being of the United States. All that globalization has ever done is to enrich the U.S.-based multinational corporations who use it to arbitrage cheap labor and environmental destruction, at the expense of the American middle class. Nevertheless, Friedman, who is taken seriously for reasons I have never remotely understood, is so ga-ga over flat earths, and plug-and-play platforms, and taxi drivers in Bangalore who explain to him how international trade works, that he keeps the global meme coming, book after poorly-written book.

And now Krugman, whose colossal intellectual arrogance is such that he looks with pity on any other analyst who fails to see that America's economic problems are not even necessary, that they all result from the universal failure to appreciate that he (and he alone) is right -- declares that salvation for America and Europe is at hand, through the simple mechanism of money creation by the central banks. He's at a loss to understand why everyone can't see that this is so clearly the way to go.

As I said, I don't quite get how that works. Economics is certainly not a hard science, I understand that. It's full of "principles" and "laws," but they don't mean anything. In a field such as physics, laws such as those for the conservation of matter and energy have to be observed. For example, let us suppose you decide to drive from Ely, Nevada to Tonopah, Nevada on U.S. Highway 6, a distance of 168 miles. It's desolate out there, but as you leave in your Buick Riviera you are aware that you have one gallon of gasoline in your fuel tank, and your gas-guzzling car gets about 16 miles to the gallon. Moving the mass of the Riviera (and you) requires energy supplied by burning gasoline in the engine. Since you are scientifically inclined, you are aware you can conserve gasoline by coasting on downslopes (so that the engine is at idle RPM) and keeping the speed down, since wind resistance increases on the square of velocity. These sophisticated adjustments allow you to go 18 miles before you run out of gas, which means that your scientific acumen actually placed you two miles farther from help than you otherwise would have been.

At this point, I assume that Krugman and the Chartalists would simply declare the existence of more gasoline and be on their way again. Lesser mortals would have to thumb a ride back to Ely.

When the United States ran out of money in 2008, the Federal Reserve stepped into the breach through the first of its quantitative easing episodes. The "quantity" in question was the monetary base, which at the time was about $800 billion, almost all in the form of Treasury securities held by the Fed. The Fed decided to "purchase" mortgage-backed securities to the tune of about $1.2 trillion, not by exchanging the Treasury notes and bonds in its vaults but by declaring the existence of money sufficient to take the MBS off the owners' hands. The Fed further "purchased" about $300 billion of Treasuries through "POMO" operations, that is, Treasuries purchased mostly from Primary Dealers on the secondary market. In QE II, the Fed extended the POMO operations and "purchased" another $600 billion in Treasuries on the secondary market. These exercises in artifice increased the "monetary base" of the Fed to its present roughly $2.7 trillion.

Krugman and the other Keynesian Kultists have been taking relentless victory laps because of the failure of Weimar-style inflation to break loose in the United States, and because the interest rates on U.S. Treasury securities have remained very low. Of course, one needs to point out that even the Fed's roughly $1.3 trillion in mortgage-backed securities represents only about 10% of the total American mortgage market of $13 trillion. By physical analogy, if one were to pour 8 fluid ounces of sulphuric acid into an Olympic-sized pool 50 meters in length (with an average depth of 2 meters), and allowed time for dispersion and dilution, it is doubtful that any harm would come to any swimmers using the pool.

I think this is why we have "gotten away with" wholesale money conjuration by the Federal Reserve. Compared to the total capital stock of the United States (about $50 trillion), the money which Bernanke has pulled out of his silk top hat is not a lot of cash. It's heavily diluted by the preexistence of all the money and credit aggregates already in existence; however, if fiat creation becomes a standard way of doing business, it will, at some point, tip the balance so that anyone swimming in the pool will suffer a third degree burn.

This is why I think cash conjuration is so fundamentally insane. It seems obvious that introducing fake money into the system can have a marginal effect on real wealth, as for example, the "support" which the Fed's MBS "purchasing" program has had on the real estate market. The Fed, by becoming the New American Century of the post-crash era, has created a small secondary market for all the mortgage trash floating on the surface of underwater America. The goal, as with the suspension of FASB 157, which allows banks to pretend that all the worthless encumbrances they hold on real estate (the value of which is less than the loan, or, worse, stand in second place behind an underwater loan), are nevertheless worth 100 cents on the dollar, is always the same. The particular set of politicians and banking chiefs in charge at a given time do not want to be the ones in power when the remnants of the economy spiral down the toilet. Thus, rather than face the music, the goal is to use any means, fair or foul, visionary or extremely short-sighted, to keep the contraption huffing and puffing along on the road to Tonopah for as long as possible.

It stands to reason that creating money out of thin air, and then using it to buy something "real," cannot by definition actually create any new wealth. To the extent that the real estate market, for example, has been slightly levitated by these tricks, this anti-gravity maneuver represents a form of disguised inflation (too subtle for Krugman to see), since the delta between the "real" value and the values maintained by counterfeit money is a form of inflation. Again, this idea is borrowed from physical science: you could call it "negative deflation."

But here's the problem: you can only do this to the point where, by definition, it's not enough to matter. At the threshold of non-triviality, you must introduce so much fake money into the system that in fact you completely debase your currency (pour too much H2SO4 into the pool - I suppose that's acid rather than base), and then Weimar, 1922, does ensue. As soon as the existence of all the extra fake money becomes perceptible, in a tangible way, to the general public, as opposed to the little klatch of insiders who fatten their binary accounts at the Federal Reserve courtesy of the Fed's favoritism, the game is over. However, the charade has the intended effect of extending the game of make-believe a little longer, while meanwhile doling out something of a "moneyish" character (lots of 1's and 0's) to computer entries of Primary Dealers, which are then payable as bonuses. This is the actual "threshold" used: can the Federal Reserve do its magic trick just enough so that the moneyish, digital flow keeps moving to the owners of banks which were in reality bust-o long ago.