I think I must have written about this many times already in this blog, but everyday I see this phenomenon being sustained and justified as if we have found the policy panacea that would prevent the economy from ever having to fail anymore. Have we really found sustained prosperity for the world without ever there be any more adjustments in the economy and that somehow we can just simply go on like there is no tomorrow - not like there is no more future? It is really true that we do not have to fear economic adjustments anymore?
Classical economics was the economics of poverty. Human societies in general were deprived and there was more demand than the world could produce. The focus of the study of economics was the economics of production, where we subject the production frontier to the market in order to produce the most at the least cost. It coincided with the Industrial Revolution. Adam Smith saw this and promoted the economies of scale and the liberation of markets in order to bring more goods and services to more people so that more people could enjoy the newfound prosperity of the scientific method. Say's Law applied: Supply will find its own demand. There was the silver/gold standard so that the quantity of money (well, the monetary base) was more or less stable and adjustments to the monetary circulation was by way of the reserves as well as bank credit, supplemented by trade credit. The element of trust was important in order to bypass the limitation of the monetary supply and the rate of interest was at a decent 7% or 8% per annum which encouraged savings and generally a sense of frugality among the wealthy while there was a constant search for new products and production method in order to bring about a decent rate of return to pay interests and wages and still earn a decent profit. This was already a fairly sophisticated economic system compared with rural production. In a rural economy, all output would be consumed either by workers (as wages) or by the farmer (as earnings) while a certain portion of the output would be put aside for the production period. This was a fairly self-sustaining system unless there was a shock to the system like bad weather or flooding. In the commerce-oriented (and money-using economy, gold standard), there was a constant need for investment which would be needed to absorb the extra output equivalent to the expected rate in order for the economy system to sustain itself. This system worked fairly well only because there was empire provided natural resources which would be processed by the industrial machinery as well as the market to provide that required profit.
The economic system took a dramatic turn with the rise of the US and the swinging twenties and the jazz age introduced liberalism to the economy and particularly the financial markets which made Al Capone and everybody else very happy. (Al Capone made his first million by working as a telephone operator eavesdropping on stock speculators.) The expansion of the monetary supply with the increasing number of small banks and credit expansion gave rise to speculation on the stock market which eventually crashed when the small banks went bankrupt. This led to the depression, when banks started foreclosing businesses and farmers as the banks faced the backlash of the credit crunch. But this was nothing more than a tornado trying to unwind itself, rather than die down, as banks tried to restore their balance sheets. The banking system was trying to destroy the quantity of money in order to restore the value of money.
The classical economists advised for time for the markets to adjust but did not realise that the markets were themselves being destroyed. Expectations were destroyed and the trust was gone. It was when Keynes came in and argue for the restoration of the markets with the government running a major deficit in order to cover the deficit in the balance sheet of the banking system. Keynes' advice worked and this policy recommendation has been employed since WWII, and probably created it, as it led to the production of a product that destroys other things and hence could logically go on indefinitely unless something came in to give way. In some respect, the decline of the US economy started in WWII as it went on a global-destruction mode which probably wasn't all that great for economic efficiency.
While the beginnings of the expansionism of Keynes' idea was tempered by monetary restraint, with the treasury acting as a countervailing force against the spend-thrift populist government, that need for monetary restraint was romanced away by the saxophone-blowing jazz central banker called Alan Greenspan, away arguing that sustained monetary expansion was needed for an innovative US economy that never really was. The way to encourage the US economic efficiency was the Washington Protocol which dismantled all checks and controls on the US financial sector as well as the US economy itself. That openness allowed terror to enter the economy in reality to its war shenanigans outside its borders. That terror attack sent the US economy into a reversal through tight controls and hence killing off an opportunity for growth which it did not really have a chance to exploit. The policy of sustained monetary expansion was passed on to Bernanke who used it as the only tool it knows how to solve a crisis. As the last series of crises were bank-related and as banks and financial institutions were now bankrupted, with big holes in their balance sheets, it was no more possible to issue US government bonds to US banks, while private investors were (and are) looking in the face of a weak US currency. The only way out was to issue US bonds to the central bank which is now happily printing paper money in the name of Quantitative Easing. Beneath all the economic rhetoric espoused by the clever Americans, the reason why they could so far get away with their economic inefficiency (and be a champion of the world) is because as the international currency where countries are happy to hold the paper money, they are happy to print it until such time as when the world has no more confidential in the US dollar as it abuses the seigniorage of the US dollar. That time is about now.
To some extent, the so-called rampant inflation around the world is partly a reflection of the long-term decline of the US dollar as well as the rise in the fight for global resources as China and India choose not to let its people go hungry again. Countries suffering from persistent inflation problems are those who currencies are linked to the US dollar. These countries too may be suffering from economic inefficiency as they failed to respond to the rising economies of China and India.
The only way that the adverse impact of the US dollar on the world economy can be solved is by refuse to use the US dollar as the international reserve currency. Which means that the Chinese renminbi must step it, probably in conjunction with the yen - in order to ensure that there is sufficient of world reserve money to serve a growing international trade. The need for the renminbi as international reserve may be reduced if, as we all believe, that the future of the growth of the Chinese economy depends on its own international consumption and therefore there is no need for an expanded international trade. The Chinese are reluctant expectedly because they could want to source their raw materials from the rest of the world, and they really have to balance their economic and political balance in the world especially in Africa especially when the US probably is beginning to develop a reversal of their superiority complex. It is, I think, this changing of the guard at the international monetary system which will be the major adjustment in the world economy in order that balance and growth can be reestablished for the marglinalised economies in the world. After all, the sustainable prosperity of China requires a world that is at peace with the China. Zheng He's descendents, if any, may need to be pressed back in services, hopefully not in the form of junk bonds.
My little thoughts to while away a boring afternoon, as Alice would say.