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A High Wall

Solomon once wrote, "A rich man's wealth is his strong city, and like a high wall in his own imagination," and surely he was right.

Like many, I had a perfunctory understanding of Keynesian economics for years from my college days. However, in reading his landmark work, The General Theory of Employment, Interest, and Money, it became clear that Keynes, though in a much different way, also well understood the human condition. After reading his work and several books by Dr. Murray Rothbard, a prominent economist from the Austrian school of thought, it has become increasingly apparent that much of what has been taught regarding economics is built on an illusion. While this may sound offensive to some, I ask that the reader allow me to explain.

Inflation has been around for decades. We have come to accept it as a natural outgrowth of our capitalistic society. We even believe that asset price increases are a good thing. But is this growth of the money supply, for that is what inflation is, a byproduct to hard work, innovation, and free enterprise, or is it attributable to expanding government programs, higher taxes, and greater debt?

In order to understand how we got to our current circumstances of rampant (though understated) inflation and a credit and real estate bubble, we must look back and understand the role of the consumer in the Keynesian system.

Keynes believed that it would be boon to the economy to break away from the prior generations' thinking on savings. He saw savings as a hindrance to consumption and therefore a hindrance to economic growth. "The excess of income over consumption, which we call saving, is a mere residual." He held that if we were to grow and prosper as a country, the emphasis would need to be on consumption. "In accordance with this principle, the conception of the propensity to consume will, in what follows, take the place of the propensity or disposition to save."

To Keynes, consumption was the highest moral good in that it was an investment in the economy. In fact, making sure people continued to consume was so important, he believed the state must ultimately exercise control of consumption for the benefit of the people. "In conditions of laissez-faire the avoidance of wide fluctuations in employment may, therefore, prove impossible without a far-reaching change in the psychology of the investment markets such as there is no reason to expect. I conclude that the duty of ordering the current volume of investment cannot be safely left in the private hands." (Italics mine) I can sum his views no better than the cover of the book. "For Keynes, enlightened government intervention in a nation's economic life was essential to curbing what he saw as the inherent inequalities and instabilities of unregulated capitalism."

Of course central banking had gone on years prior to Keynes 1936 work and had played a major role in inflating our money supply (as discussed in my article titled, "When the Big Boys Buy"), but here was the academic mouthpiece to help the failed policies of central bankers rise from the ash heap of the depression. In 1944, Keynes expanded his influence and eventually the supply of money worldwide as he formulated most of the Bretton-Woods Agreement, doing away with the obstacles that the gold standard presented. In many ways the government followed his tenets well in not leaving consumption to the whims of the private sector. Bureaucracy begets bureaucracy, and bureaucracies always need more money.

Over the last 60 years the role of government and bureaucracies has continuously grown. The following charts courtesy of Michael Hodges of The Grandfather's Economic Report shows the incredible extent of government expansion.

How did we let it go this far? Subtly, while Americans were busy raising our families, working hard, and saving, we began a multi-generational shift towards an "entitlement" mentality. As each successive generation experienced a higher standard of living, our baseline expectations grew as well. The mentality goes something like this, "You deserve a 'comfortable' retirement, the best medical care, a 'safe' bank for your money, a good airline system for travel, and, of course, your own home." We began to place more and more reliance on the state to provide rather than each other, the free markets, and the God who created us. While we certainly enjoy having these things, we must stop and think, "So how do we pay for all of these things that are 'our right'"?

The government can cut benefits, raise our taxes, or print more money. The first two options are quite unlikely for a public who votes for the politician who promises to deliver the most. So we are left with the last option, paying for today's debt with tomorrow's promises. Yet history teaches that this game of printing money, backed by nothing except a government's promise to always pay its bills, has been tried since the early 1700's and John Law's Mississippi Scheme, and that it ultimately breaks down.

If all of this makes sense, your next question is, "when will this major change in the money game take place?"

To answer this, we need to leave our discussion of history and turnto science for a moment and the market. We need to understand a term in trading known as a parabolic spike. This trading term means that a line, representing price, is picking up speed and is moving more vertically than horizontally. This is a terminal sign of a change of direction. Often, the movement in the opposite direction is rapid.

For example, if a pilot flies a plane horizontally and then starts climbing vertically, eventually he will stall the plane and start to free fall.

If a government entity were to speak to a group of pilots and told them that they had overcome the laws of nature, the pilots would laugh in their face. However, when it comes to printing unlimited amounts of money and stacking debt on debt, the public plays along thinking the plane can fly straight up indefinitely.

Having watched the cost of money, as measured by the Feds Funds rate, fall from 19% in 1980 to 9% in 1990 to 3% in 2005, how can anyone say the movement of markets is just some random set of events? After reviewing these parabolic spikes, that appear to have unlimited upside, review the past parabolic spikes below, noting their outcome once gravity finally caught up with them.


Complacency has crept in. Many of us, content to enjoy our "expanded inalienable rights", do not even consider how all of these benefits the government provides for us will be paid for. Believing that all of these perks can go on forever, we've grown comfortable with our nation's debts. If there are any problems, we depend on the Federal Reserve to step in and add "liquidity" to the system to solve them. This moral hazard has allowed the central bank to print more money to pay for past liabilities with ever burgeoning, and increasingly burdening, debt loads.

As Michael Hodges' charts reveal, we have slowly moved away from our capitalistic roots to a more socialistic society. Ironically, in the same year that Keynes came to the center of the financial world with his socialistic views, history records these words from a well-known Austrian economist. Ludwig Von Mises, Rothbard's mentor, penned the following in 1944. "Government control of business, it is claimed by the advocates of authoritarian management, looks after the nation's well-being, while free enterprise, driven by the sole aim of making profits, jeopardizes national interest." How different might our circumstances be if the two had changed places?

So, does cutting interest rates and making credit ultra-accessible in the desperate pursuit of keeping the consumer spending, sound like a story that ends well? Every investor should be learning as much as possible and preparing for the downside of these parabolic spikes. If you are interested in learning some of the questions investors should be asking, visit our website at www.bestmindsinc.com. Without preparation, no high wall in our imagination is going to help us escape the impact of what lies ahead.

Sources: Books and Websites
The General Theory of Employment, Interest, and Money, (1936); John Maynard Keynes, pgs 64, 65, & 320.
Bureaucracy, (1944); Ludwig Von Mises, pg 27.

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