Why Things Are Going to Get Worse - And Why We Should Be Glad. Michael Roscoe
figure I considered too high to be believable. However, if we add up the GDP figures for each year going back to 1900 (in constant 2010 dollars), we get a total of around $1,760 trillion. This means that the total wealth ever produced, up to the year 2013, according to GDP figures (in today’s money), is around $1,800 trillion (the figures become relatively insignificant before 1900). Now I’ve already shown that GDP figures are a gross over-exaggeration of true wealth production, because they keep recycling wealth that was created in previous years, and therefore this figure of $1,800 trillion will also be grossly exaggerated. But it does at least explain how we might get that $200-trillion figure as the measure of the debt bubble. In GDP terms, $200 trillion of credit-fuelled growth starts to look quite plausible, as long as we remember the key point that it doesn’t represent real wealth.
Figure 15
If we compare my figure of $1,800 trillion for total accumulated GDP with the earlier figure we had for total private wealth in the world – around $240 trillion in 2013, according to Credit Suisse data – we might begin to understand the relationship between output in terms of GDP, and the amount of actual wealth in dollar terms that ends up accumulating in banks. But in reality, the situation must be more complicated than this. Some wealth must get lost along the way – assets such as property crumble with time – and also private household wealth doesn’t represent all the wealth in the world. What about state-owned wealth? Obviously, I must investigate this matter further. I return to this theme in Chapter 8, but first I must answer another question I think this chapter raises.
So what’s wrong with old wealth?
Because the service sector has expanded to become the dominant force in the economy, based on the recycling of past industrial wealth, the ratio of productive to non-productive GDP has been falling in recent years. I can show this in Figure 16 simply by plotting a line corresponding to the proportion of total global GDP that has come from real industry (in other words, from the primary and secondary sectors of the economy).
One might suppose that wealth accumulated from past industry would be just as good as that created from current industry, but this is rarely the case, primarily because this accumulated wealth tends to end up in banks and other financial institutions as private investment. Unless investment goes towards the development of the real economy (ie, non-financial business) – and most of it doesn’t these days, because there’s far more old wealth held in funds than is required for productive investment – then it doesn’t create jobs. All it creates is debt.
Figure 16
This process of debt creation is at the heart of the world’s economic problems. Not only is it linked to the reduction in real jobs and the resulting impoverishment and inequality in society, debt creation is also harmful in less obvious ways. Because so much economic activity is now based on the spending of credit rather than on genuine wealth that’s already been ‘earned’, it is effectively borrowed from future earnings. There are two negative aspects to this borrowing from the future.
First, even if a debt-fuelled economy sees an increase in genuine production due to the spending of this borrowed money, this production itself is also borrowed from the future, because production is bound to decline as debts are repaid; consumers will have less money to spend in the future.
Second, the debt-fuelled boosting of asset prices gives a false sense of increasing wealth. This new ‘wealth’ has no basis in reality because it is based purely on the increase in credit, and this in turn must have consequences for the value of money, because the value of anything follows a simple formula:
So if money has become less rare while its utility has barely increased (because its utility – its real usefulness – must be a function of its purchasing power, which in turn is related to genuine economic growth, and this hasn’t risen anything like as much as the money supply) then its value must have fallen. To look at it another way, while the amount of real wealth was rising moderately with genuine industrial output, the amount of money being pumped into the economy was expanding much more rapidly.
There is only so much real wealth in the world at any one time and, however much credit banks might create through leveraged lending, or governments might pump into the banks through quantitative easing (more on this in Chapter 12), it doesn’t add one penny to that stock of real wealth. So all it can do is dilute the value of money, like adding water to wine. Just as the wine will be lower in strength, so will the money, and this must inevitably lead to higher prices.
A quick word about inflation
Inflation is commonly understood these days to mean the rise in prices caused by the devaluation of each monetary unit. It would be more correct to say that rising prices are the result of inflation and that the actual inflation is the growth in the amount of money in the economy relative to real economic activity.
An easy way to understand the relationship between the amount of money in circulation and its value is to go back to the commodity analogy.
Say a bushel of wheat has traded for an ounce of silver for several years – this being the accepted market rate, according to the principle of supply and demand – but then farmers start to grow more wheat so they can exchange it for more silver. The effect will be to cause a shortage of silver, raising its price relative to wheat. Each bushel of wheat will then be worth less, when measured in silver terms.
Now try it the other way – an ounce of silver will buy a bushel of wheat. What happens if more silver is mined and gradually finds its way into people’s pockets, via the local market? The demand for wheat increases because people can buy more. Wheat becomes scarcer so prices rise. Farmers might plant more wheat next season to meet the increased demand, but that’s only possible if they have the land. If they don’t, then the cost of wheat stays higher and you have price inflation.
The same thing applies to money supply: if governments print more money than the economy merits, the price of commodities must rise to compensate for the new demand. The money is devalued. Inflation of the money supply beyond genuine economic growth results in rising prices.
Figure 17
The rise in money supply seen in Figure 17 is mostly due to rising wealth and economic activity, and only partly to inflation (this chart is not inflation adjusted). There should be a close correlation between money supply and GDP – otherwise it must mean a change in demand for money relative to output – but the two don’t actually move together. If, for example, we plot US GDP, unadjusted for inflation, against the broadest measure of money supply, which just happens to be very close to GDP in actual dollar terms, we see a close fit (as in Figure 18).
But we see also that the money supply has been rising more quickly in recent years. At the time of writing, we haven’t seen the full effect of this inflation of the money supply, because most of this newly created money is being held by banks and other financial institutions and hasn’t entered the real economy. The high demand that caused the last boom – demand fuelled by credit – has collapsed since the crash, but the supply side of the economy takes longer to adjust. Weak demand relative to supply keeps prices down.
Figure 18