Gold podcast: Blood Meridian
Speaker key:
BS Boaz Shoshan
JB John Butler
BS Hello and welcome to another episode of The Gold Podcast. My name is Boaz Shoshan and I’m an editor at Southbank Investment Research, and I’m joined today by John Butler. John is the chief executive of the Lend & Borrow Trust Company, which deals in precious metals lending and borrowing. I’ve been reading a book recently, you may have read it. It’s been called one of the classic American novels even though it’s relatively recent, it’s called Blood Meridian by Cormac McCarthy.
It’s a very grim, drizzly, grizzly novel, but it takes place in Mexico in the mid-1800s. It’s about this group of bounty hunters, effectively, who have been tasked to kill a load of the Apaches and other Native Americans who have been terrorising some towns. But they’ve been given this remit, they will be paid for every scalp that they deliver to the governor of the town, right.
JB Oh my God.
BS Right, it is a really haunting, very very dark and grisly novel. But this is a case of where it ceases to become the Native Americans that they’re hunting and they’re just getting scalps for the sake of scalps, because they’ll get paid for every single scalp they deliver. So they end up killing all sorts of other people in order to get these scalps that they can then get for money. It’s this idea that when you give somebody this directive that if you achieve X, then we will then give you this, good things happen. And so when you have this metric of more scalps equals more pay-out, all of the stuff around the side ceases to matter.
I was reading a bit on the Vietnam War, where you had Robert McNamara, the defence secretary at the time, as one of these guys who really brought statistics into military policy. McNamara was just going crazy for data being recorded that they could then find some way of using to figure out the correct response. So the taking of the body count of the Viet Cong was prioritised, and similarly with Blood Meridian, what ended up happening was troops killed more people, some of whom weren’t Viet Cong, just to have a higher body count because that meant good things for them, because higher numbers meant a better outcome from McNamara’s perspective.
But it didn’t work out and it was a total catastrophe. But it’s that interesting Goodhart’s law idea, where as soon as a measure becomes a target, it ceases to be a good measure. So in the case of higher body count, be it becoming a target rather than simply a piece of data that is taken from battlefield, when it becomes a target for future battles, all hell breaks loose. So the idea that you’re, by targeting growth, as well as targeting everything else, adding another target, that will somehow lead to a better outcome, that doesn’t seem to be the right perspective from my view anyway.
But in terms of the whole Keynesian thing, neo-Keynesian, and you referred to MMT before we came on air, I think from an outsider perspective, not many people know what all of these things really stand for. We had a discussion on Keynes with Alasdair Macleod, a colleague of yours a couple of weeks ago, how did this all start between the various modern, academic approaches to economics and managing economies?
JB Oh my God, I mean, okay, let’s go back to kind of the beginning of economics itself. Many people associate that with Adam Smith. Now that said, there were many important antecedents prior to Smith coming around. In fact Smith himself, if you get really deep into Smith and don’t just read The Wealth of Nations, but read the text of his lectures that he gave at the University of Glasgow, fine it might be tedious but there’s all kinds of references in those lectures to scholars that preceded him.
So okay, but fine, let’s give Smith some credit for synthesising a lot of ideas in one masterful work, The Wealth of Nations. But what’s going to happen is that Smith will be associated with, and rightly so, this laissez-faire attitude that is that the whole point of economics and understanding economics is basically to understand what happens in the marketplace. Why do people work, why do they save, why do they spend? Why do they invest, what determines interest rates, what determines prices? What determines, you know – The Wealth of Nations is ultimately where he tries to pull it all together.
And when doing so he has this very sort of laissez-faire attitude about it, because he believes that, at least based on everything that he can see, and indeed the scholars that he will cite again in the lectures if not in The Wealth of Nations itself, that the spontaneous and visible hand outcomes generated by the marketplace are ultimately the ones that serve society the best and contribute therefore to the wealth of nations.
Okay, that idea will be challenged initially, and this may surprise many, by Marx. Marx is actually the first economist, if you want to call Marx that, to come along and basically say, well this sounds nice on paper but in practice it concentrates wealth, it leads to inequality, it leads to social disorder. But hey, actually in the long run that’s a good thing because we’re going to end up in this communist nirvana if we just work at it long enough.
Okay, so people think that Marx is super modern in that there was some sort of linear evolution from very very laissez-faire, say on the one hand, to a very aggressive communist outlook on the other. Actually no, I mean, Marx is going to be just about the first guy to really weigh in heavily post-Smith. And then what happens after Marx is this debate. This debate as to whether indeed central planning works or doesn’t work. So Smith said it doesn’t really work, you should let the marketplace work its magic, [allow the] invisible hand. Then Marx on the other hand saying, no, no, we really do need to command economy because capitalism will destroy itself.
Okay, and so the following century, and this leads through the Great Depression, is this debate. Command economy or free market. And to be honest, we’re still having that debate today! And so we go through one iteration after another. And you know, the Great Depression was a major iteration where the command economy people eventually won, because they pointed to the prolonged weak growth in the wake of the various crises, including the stockmarket crash in the United States, but also a series of crises in continental Europe and the UK. They said, hey, no, you’ve got to intervene.
So Keynes kind of wins the argument in that particular iteration. And Keynesianism is born, the idea that when private sector demand is weak it’s the government’s role to step in and spend money. Deficit spending, and to manage economic cycles accordingly. And to prevent things like depressions or even recessions from happening.
But that’s thoroughly discredited with the stagflationary 1970s, when central bankers think they have it all figured out, but they end up with this weak growth but rising inflation situation. In particular in the US and UK, but to some extent other countries.
And then of course we have other crises along the way, 2008 being the biggest one in recent memory. At this point everyone goes right back to the lessons, or what they think the lessons are, of the Great Depression, and they throw an unprecedented amount of stimulants at economies, both fiscal and monetary.
This is the neo-Keynesian synthesis, the idea that yes, you want to try to use the monetary levers as best you can, but the government also needs to be spending money. You should be working both sides to try to manage the economy. Work the monetary side, work the fiscal side, try to coordinate across the gap.
BS Which is really the big command economy idea, really.
JB They say, oh we’re just trying to keep the system liquid. We’re not telling the money where to go, we’re just creating it and making sure there is sufficient liquidity for whoever would want to use it.
BS Can we wind back a bit here, because we are already in the modern time, but why does Keynes have such a huge influence, from your perspective, on modern economic theory? And what do you make of his original ideas?
JB Well this is going to sound a bit cynical but I think it’s a fair position to hold, which is that Keynes was the first modern economist, by modern I mean one who used numbers and equations that a modern economist would recognise. He was the first modern economist to conclude that there is a role for economists.
BS Right.
JB That is that politicians and central bankers can and should manage the economy, and they need to employ lots of economists in order to enable them to do that effectively. Keynes justifies economists’ own existence to themselves, and it justifies politicians mucking around with the economy, for better or worse. It’s self-serving.
BS Creates an industry.
JB There you go. I know that sounds cynical but actually I think it’s a very fair position to hold and I think there’s a lot of evidence to that effect.
BS That’s interesting. But in terms of Keynes and then neo-Keynesianism, what are the principles of Keynes and how have they changed when they get to neo-Keynesianism?
JB Keynes focused on fiscal policy because he looked at the Great Depression when the banking system totally seized up, and he kind of said, look, you can create all the money you want but in the same way you can lead a horse to water, you can’t make it drink. And so he saw in the 1930s lots of liquidity being thrown around by central banks, but not getting any traction. And this is where he thought, aha! The missing piece of the puzzle is that when you get into that so-called liquidity trap, the government just needs to step up and spend.
BS The government needs to start spending.
JB He came up with this famous analogy, pay people to dig holes in the ground and fill them up again. Literally anything that puts people to work and puts money in their pocket, will eventually restart the economy.
BS So it’s sort of similar to the ghost cities in China, right?
JB Yes, right.
BS Just fiscal policy for the sake of fiscal policy.
JB Yes. But he felt that as a temporary emergency measure, that was justified. Now the flip side of Keynes is always forgotten, which is that once the economy does recover, the government should run surpluses.
BS Right.
JB And it should pay down the debt. Maybe not in its entirety but some portion thereof. That’s the part that modern economists conveniently forget.
BS Forget about, right.
JB And they conveniently forget, because of course the politicians they’re advising never want to hear that part, right?
BS No.
JB They don’t want to be the politician responsible for cutting spending, right?
BS No.
JB You know, Savings is a four-letter word to a politician, right?
BS Right.
JB It’s one you don’t use and get re-elected at the same time. So again, this, in my opinion, it may come across a bit cynical but I think there’s an awful lot of evidence to suggest that this really is what explains the rise of initially Keynesianism, and then neo-Keynesianism, which is more Keynesian than monetarist. It does proport to combine the two.
BS All right, so yeah, what’s neo-Keynesianism?
JB Neo-Keynesianism is the idea that you want to use the monetary levers as far as you possibly can, up to and including unconventional monetary policy before the government steps in with fiscal policy. It tries to synthesise that in a systematic way.
BS So what levers would normal Keynesianism not pull? So normal Keynesianism…
JB They would go straight to fiscal policy.
BS Right, as soon as…
JB As soon as the economy showed any evidence of a sharp downturn, they would say, stimulate, stimulate, stimulate.
BS On the fiscal side?
JB On the fiscal side, that’s right.
BS They wouldn’t pull the rates all the way down to zero, and then, you know, QE (qualitative easing) and whatever.
JB Again, a neo-Keynesian would. But a raw Keynesian would say, that monetary stuff, you know, maybe it has a small impact around the margins but really what matters is fiscal policy.
BS Right.
JB Whereas the neo-Keynesian will say, no, no, no, the 1970s and Milton Friedman and the monetarists taught us that money does matter. And so the neo-Keynesians try to synthesise all of it.
BS So they yank the levers all the way down to zero, the QE whatever. And then, finally the cavalry, fiscal stimulus.
JB Yes that’s right. And it doesn’t mean you don’t do any fiscal stimulus along the way. But the idea is that you generally lead with monetary and then follow it through with fiscal.
BS Right. So what’s the monetarist angle then?
JB Well the monetarist angle is that the government should just stay out of it, and that they should keep spending more or less constant. And yes, if you occasionally slip into deficit that’s okay, but it implies you occasionally slip into surplus as well. What really matters is that you simply maintain a relatively steady growth of the money supply, however defined.
Now that’s another problem, back to Goodhart’s law, as you were saying, defining the money supply, good luck with that. There are so many working definitions of the money supply and they’re constantly changing based on the way money is originated and circulates throughout the economy. This was a problem in the early 1980s, Paul Volcker talked about targeting money, it led to redefinitions of what the money supply is. Should we target narrow money, should we target broad money? That opens a real can of worms. But in principle that’s what Friedman was getting at.
BS And by narrow money and broad money we’re referring to, not just notes in circulation but mostly bank deposits, loans, etc.
JB Yes, that’s right. And eventually you get into very broad measures of liquidity that even go beyond money market funds, and include securities for repo and all kinds of things.
BS What’s MMT, Modern Monetary Theory?
JB Yes, this is one step beyond neo-Keynesianism. Actually I think they would claim it’s probably multiple steps beyond. This is the idea that not only should the authorities be prepared to use both monetary and fiscal policy to manage the economy, but that they should explicitly target a growth rate. That is, not just target, say, a price stability the way a central bank does on the one hand, and not just have some sort of vague idea what the potential growth rate of the economy is. But they should actually make a policy.
Right, they should go out and say, okay, we believe that our economy is capable of growing at whatever it is, say 2% a year, in real terms. And we believe that the ideal inflation rate that’s compatible and sustainable with that is, say, also 2%. So we’re going to target 4% nominal GDP growth. And to the extent that nominal GDP growth falls below that, it almost doesn’t matter whether it falls below it for monetary reasons. There is purely inflationary reasons or real growth reasons.
BS Yes, it doesn’t matter.
JB We’re just going to stimulate if we slip below it, and on the other hand if we rise above it, we’re going to tighten policy. Both monetary and fiscal is required. Again, they’ve got lots of data, they’ve got lots of equations. Their dynamic stochastic equilibrium models are super super sophisticated, you’ll need an advanced degree in maths just to even begin to look at the gobbledygook and make sense of it.
BS Right.
JB But they claim that the input they have, their data, leads to this nirvana output, more or less. I mean to be fair, maybe nirvana’s a loaded term. But they really do believe that they’ve built this better mousetrap. Of course that assumes the data’s rock solid and that these relationships are stable over time, when history suggests that’s not true at all, in part because of Goodhart’s law. The moment the financial market senses that the monetary regime is changing, that the fiscal regime is changing, they will position and reposition themselves accordingly. That can lead to asset bubbles, that can lead to foreign exchange volatility, that can lead to all kinds of misallocations of resources.
And this is the sort of thing that economists never look at. They don’t like the unintended consequences, they don’t like the feedback loops. They don’t like the behavioural implications of what should be a, do what our stimulus tells you to do, heavy-handed command economy attitude. They don’t like it.
BS Where do you think the wind is blowing amongst your central bankers, and your academics and economists etc, as to which of these schools of thought they’re going to go towards over time?
JB I think sadly, in part because of the self-serving aspects of what I mentioned earlier, that the free marketeers are still on the defensive following 2008, because sadly it’s very difficult to control that sort of narrative. It’s always easier to say what wasn’t done and say, we should have done more of that, we should have done more of that, we should have done more of that. It’s always easier to say, we should have done more in order to achieve more growth, more this, more that. It’s much harder to say, we should have done less. Because then people think, oh but it would have been even worse had we done less. It’s just a difficult argument to make.
So I think that the free marketers’ side is still on the defensive, and those that favour a more heavy-handed command economy approach to things are still in the ascendant, hence why perhaps the shadow MPC is suggesting moving towards explicit GDP targeting for the Bank of England. However, and there’s a big “however”, the big unanswered question is whether or not inequality is being fuelled by the very sets of policies that these modern command economy types have been advocating. Because there’s a lot of evidence that it is.
BS Oh, 100%.
JB There’s a lot of evidence. And that debate only really started a few years ago, but that’s now in the ascendant. There are a lot of people who believe that all the asset price inflation that has clearly been generated by central bank policy, and excess liquidity and lower rates and all of that, that this is the ultimate source of this rising trend towards inequality.
BS There’s an argument that the reason why these policies didn’t work in the way that they were described or they were intended to work, was because all this wealth was handed to the ultra-rich who have very low propensity to spend such high percentages.
JB That’s exactly right. So basically those who had a lot of assets to begin with saw the value of those assets go up even more, and anyone who simply depends for a typical wage, has seen essentially zero, and in many cases in fact, depending on the country, outright negative real wage growth since the financial crisis of 2008. And central bankers for the most part deny they’re responsible for this, although it’s interesting, there are several retired ones now who in fact do hold this view. And they’re chastising their successors for not paying more serious attention to what might be a central bank contribution to this trend of rising inequality. Which as you say, is down to this asset channel.
BS I heard the other day, there was this great phrase which was, populism is a marking to market of a decline in real living standards over an extended period of time. That’s all that it really is. And because, you know, everyone in their ivory towers in the central banks, the economists and the academics, don’t really measure real living standards, it took them all by surprise when this suddenly happened.
I mean, if this continues, because ultimately policy has not changed regardless of the discussions we’re having about it, the policy has not changed. It sort of implies that we’ve really not seen anything yet when it comes to what is described commonly as populism, whatever that may be. Following that though, do you think there are some people who are going to say, oh well, we’ve given all of this wealth now to the very 0.0001% or whatever, we need to start redistributing this somehow. And when you have the MMT guys, that would obviously increase the power of these people by a huge amount because they would be on the fiscal side and the government, as well as on the monetary side in the central banks. I mean, this would be a huge expansion of the power of these people. Do you see this continuing to the point where the redistribution of wealth is then somehow entered into some stochastic model?
JB Well this is where we really have to be concerned. And this is why Hayek was so concerned. He wrote this famous book in the late 1940s called The Road to Serfdom…
BS Yes, it’s a good one.
JB I mean, it’s a brilliant work, but you can summarise it in the following way: if you intervene in the economy, you end up creating certain negative unintended consequences. And then of course, there’ll be a political push to deal with those negative unintended consequences, so you intervene in a new way in a different area. And then that creates negative unintended consequences and so you get on this Road to Serfdom where you pass one milestone after another on this road, each of which is a new intervention of some kind which is really just trying to solve the problems created by a previous intervention.
BS All the way back.
JS Yes, and so you get into this sort of insidious iterative dynamic that eventually leads you to a socialist command economy, where the free market really can’t function at all. And you lose any and all vital price information that truly helps you distribute resources in a way that actually serves social needs and wants. You end up just with again, a command economy, it might serve very well the interests of those at the top…
BS Oh, I can imagine.
JB So sadly that’s kind of where we are. That is the unintended consequence, call it in this case inequality, let’s just lump it all in there. The unintended consequence of all the massive stimulus, monetary and fiscal post-2008, has created this nasty inequality consequence. And so yes, now there’s a big push for redistribution. But of course that weakens property rights, which is the very foundation of capitalism. So you’re going in a dangerous direction.
BS Certainly. Hopefully not one that ends with a scenario similar to Blood Meridian, I must say that wouldn’t be too great.
JB Some people regard this as a very simple and facile comparison, but let’s not forget that in terms of per capita income, Argentina was as wealthy as most of Europe at the turn of the 20th century. But their economy, one step after another, went in a gradually more socialist direction, and they ended up completely ruining it by the 1970s, 1980s. Venezuela’s going through it today.
BS Oil reserves that were, you know…
JB Yes, Venezuela was a very wealthy country on a per capita basis, in part due to the natural resources. But look what’s happening there. So again, I’m not predicting that we’re going to end up like Argentina or Venezuela tomorrow, however this iterative, insidious policy dynamic sadly, in theory if you take it to its logical conclusion, could eventually get you there. If we don’t wake up and you know, stop it.
BS Right. It is, yes, it’s not a great state of affairs I must say. On that note, speaking of GDP, what do you make of the recent high GDP figures coming out of the States? Because real GDP has actually been pretty high. As we were speaking of metrics and Goodhart’s law with whenever a metric is targeted it loses its value as a metric, GDP is obviously something that, even though it’s not explicitly targeted by central bankers, it’s obviously, politicians love it, you know. Do you think they’re accurate, these figures?
JB Well, I think GDP is actually not a very accurate measure of true economic health any more. I mean, there are certain things it measures well but there are other things it doesn’t measure well. And what it really really struggles to measure are what you would call, sort of, qualitative technological improvements in an economy. It overcounts certain things, it undercounts others. It’s much easier to simply count widgets being manufactured and tally that up as GDP, than it is, you know, all manner of services and tech and software.
It just really is a measure that conceptually originated in the manufacturing-based economies of the early 20th century. There are other proposed ways now to measure the economy, which I think are probably better. But it would take probably a long time for these alternative methods to convince any material portion of the mainstream economic community.
But GDP is misleading. At a minimum, it’s misleading. And also, the way the so-called price deflator or inflation, price inflation, is calculated is also dangerously misleading.
BS Like CPI?
JB Yes. What exactly do you look at, to what extent do you incorporate quality improvements? To what extent…
BS Hedonic adjustments.
JB Exactly. To what extent do you allow for substitution? You know, economists will say they’re being objective in how they create these aggregates, but there is a saying: your aggregate is your theory. In a way, the way you choose to create an aggregate, an economic aggregate, is already applying a theoretical view as to how the economy works. If you’re starting with the wrong view of how the economy works, well then you’re going to end up with an aggregate that really doesn’t tell you what you think it tells you.
BS And aggregates are the inputs to all of these models?
JB Absolutely. Growth inflation, whatever it is.
BS Aggregate demand.
JB Bingo. Yes, absolutely.
BS And the Austrian perspective is of course, say, hands off free markets.
JB Well yes, the Austrian perspective is that…
BS Are there any Austrian aggregates?
JB Well, yes actually. Yes, some of them in fact are extremely useful and powerful in ways that are not generally appreciated. Just quickly, Austrian economics originates in the idea that an economy is at base, an information system. It’s an information system and the most important piece of information is the price. Of something, anything.
Because what you then do is, as an economic actor, individual business, whatever, you are constantly comparing prices. And constantly making trade-off opportunity cost calculations in your mind trying to improve your welfare. And trying to improve your welfare hopefully in a sustainable long-term way, although economies are always full of actors who have so-called high time preference. That is, they prefer to consume everything, you know, today, and don’t have a sense of saving for the future.
But that’s what determines rates of interest, the interplay between those two types of groups. And so basically, an economy is an information system and prices are the information, okay. The moment you start intervening, the moment you start taxing things, the moment you start regulating things…
BS You disturb those prices and those prices stop giving accurate information to all the other economic actors.
JB Bingo, that’s right. And the single most important price in an entire economy is the price of money itself. Because all prices are denominated in money, they’re denominated in the means of exchange. And if you’re manipulating that, you’re manipulating everything.
BS Everything! Yes.
JB And so Austrian economists are very, very concerned when you see these sorts of general monetary stimulus being thrown around. And of course the Austrians therefore were horrified at the response to 2008. They warned, some very prominent Austrian economists warned right then and there, this will create asset bubbles. This will exacerbate inequality, this will ultimately destabilise the economy, and we’re going to have an even larger crisis at some unknown point in the future as a result.
BS So what are the Austrian aggregates?
JB Yes, sorry. Well, Austrians focus on things that you can actually know, that is, things that don’t have to be just estimated. So for example, there’s a definition of money supply called Austrian Money Supply. And what that is, is money that can actually be spent right now. You don’t need to liquidate anything, you don’t need to unwind a position, you don’t even need to go to the bank. It’s money that is in your pocket ready to be spent, if not in paper form, in a readily spendable electronic form.
BS Right. So it’s not M0?
JB No. Because M0 is kind of phantom money supply. It’s bank reserves.
BS Right.
JB And bank reserves are not spendable.
BS Though they can be redeemed by commercial banks for notes?
JB Yes, and they also are available to lend against.
BS Right.
JB But until you’ve actually lent against them, you haven’t created the actual money that can actually be spent. So Austrians are very careful how they go about constructing money supply. I would argue that the way in which Austrian Money Supply is calculated by Austrians, is a better predictor of real economic growth in the medium term, if not within a few months. It’s a better indicator than almost any other indicator we’ve got. If you want to know what the economy will be doing in 18 to 24 months’ time, look at Austrian Money Supply. I think it’s the single best indicator there is.
BS Where would a listener find such an indicator of the Austrian Money Supply?
JB There is an eminent Austrian economist named Frank Shostak who has, some years ago, came up with a definition of Austrian Money Supply, that he then systematically applies to trying to predict the business cycle. And he’s got a pretty good track record. Frank Shostak, great guy, very, very nice guy. Very humble guy, but I think he deserves a lot of credit for the work he’s done in this area.
BS And does he then publish…
JB He does, I believe you do need to pay…
BS Oh right.
JB … for his propriety calculations of Austrian Money Supply as well as the predictive element they have for what he sees unfolding with the business cycle. But for any investor with a serious amount of money to invest, you could argue it’s well worth paying for.
BS Right. Well John, I know you do have to dash off today, and so we will end it there. But thank you very much for joining me. That was John Butler, who is the chief executive of the Lend & Borrow Trust Company. I am Boaz Shoshan, I’m an editor at Southbank Investment Research. Thank you very much for listening to this episode we hope you tune in next time. If you do have any suggestions or you’d like any future guests, do send me an email at [email protected].