California's 'Drought' Has a Monetary Metaphor
Most people would rather skip right to the end because it is easiest to comprehend in what comes out. In the current emergency about a shortage, in what seems to be a never-ending line of them, we are left wondering if California will be as dry as Arizona, or even Nevada in shrinking Lake Mead. The funny thing about western water supply is that, even the possibility of the super-drought considered, there is plenty of water out west and the "shortage" only applies when trying to satisfy every possible and existing use.
That starts with agriculture, which has become hugely inefficient in terms of hydrology. By now you have probably heard about how agriculture in California accounts for 80% of water use but only 2% of GDP, which is a condition mostly known as high-grade inefficiency. It doesn't end there, though it should have, as there are also enormous golf enclaves in the middle of the desert and beyond, all of which use an extraordinary amount of the stuff.
The only reason that such transformations can take place is that there is no system available by which to reduce all possible uses to the most efficient or cost-effective. Already, some are doubting the necessity of such tasks as water is treated as a basic human right, and with good reason. There is no doubting that necessity, only that there has to be a manner in which everyone has a chance to assert their own rights. Governments are uniquely unsuited to that task, even and including elected versions.
Usually, such things progress through market processes, where prices and the ability to pay and keep paying establish who gets what. In California, the condition of the water array is such that rice farmers are now finding it far more profitable to sell their water than grow rice - which more than suggests doubt about whether rice should be on the agenda in the first place. As it is with agriculture there, there has been a multi-decade flood of it that has left the curious "market" distortions where, as Alex Tabarrok put it at MarginalRevolution, "In short, we are spending thousands of dollars worth of water to grow hundreds of dollars worth of almonds and that is truly nuts."
The overflow of scarcity isn't really scarcity at all, as it is the drought that is just revealing these huge inefficiencies. In the flood of ready availability everyone got what they desired without any pause about whether it was sustainable (not in the environmental sense) and effective. It is the deflation of water that has marked out exactly these deep and systemic fault-lines - to the point now that the California state government will now ration your shower if you happen to be there.
There is, obviously, a monetary metaphor in there.
Scarcity is always a problem in true economic situations, and in some respects marks the starting point of all human endeavors. From the authoritarian perspective through government, inherent to government, scarcity is a liability to be overcome by sheer force of will - and taxes and carve outs. From the capitalist perspective and tradition, scarcity is opportunity.
Thus any discipline that views only scarcity from the perspective of a liability is missing the essential piece of the equation. While government may take all its means as really a rearranging and sorting of liabilities, capitalism properly asserted (if allowed) moves way beyond that zero summation and into the creation and enhancement of assets. The true genius is that almost all of the time there is no attention exactly paid to the liability at all, as what progress "gets done" is done so quietly and inattentively beyond even the noticeable background.
As the book Superfreakonomics chronicled, The Times of London in 1894 estimated that population growth would bury the city 9 feet deep in excrement, human and otherwise, while in New York officials were certain that the horse variety would rise three stories tall all over Manhattan by 1930. Governments would set about cleaning up the liabilities, usually through restricting usage, while capitalism "solved" each problem without anyone actually noticing it. Without much heraldry, everyone was better off for it though not all at the same time and to the same degree.
John Maynard Keynes once wrote,
"The outstanding faults of the economic society in which we live are its failure to provide for full employment and its arbitrary and inequitable distribution of wealth and incomes."
To alleviate these conditions, loaded with descriptive qualifiers of "arbitrary" and "inequitable", Keynes proposed genocide in economic terms. In the final chapter of his General Theory he wrote that low interest rates would do the trick. The destruction of returns on what he termed "rents", would lead to, "euthanasia of the rentier, and, consequently, the euthanasia of the cumulative oppressive power of the capitalist to exploit the scarcity-value of capital."
This was well-within the "grand" tradition of the underconsumptionists and Fabians where the wealthy saved entirely "too much." Their "capital" would be better put to work not buying bonds and holding cash "idle" but in being redistributed to those that would spend it on anything for the sake of spending on anything. Efficiency was left out of the equation quite on purpose because, as Keynes would also declare, in the long run we are all dead.
To accomplish this trick requires a flood of money; well, not money certainly, as it no longer exists, but rather the modern incarnations of chains of successors. The wholesale "dollar" has proved the exact pliable tool by which the central adherents to essentially Keynes' doctrine could put to work his suggestion of financial destruction. If an economy is thought headed towards recession, no amount of "capital" should be left idle as anything and everything should be deployed lest contraction take hold and lead to further "arbitrary" and "inequitable" outcomes. To that end, a central bank introduces varying degrees of repression upon the price of risk.
In general, however, the repression has not much varied and certainly not in the 21st century - it only seems to pass in one direction. That is arguably true of the early part of the 2000's and is absolutely true of everything after 2008. There has been constant pressure put upon the supposed idle nature of the capitalist's tendency toward Keynes' version of waste, and the more that pressure is applied the less that the economy has gained. The more "they" attempt to stimulate "aggregate demand" via textbook dogma the less of it that the economy generates.
The manner of actual mechanics is not itself very straightforward at all, which helps cloud the diagnosis. Mainstream convention assumes that the Federal Reserve "prints money" which allows banks into more fractional reserve lending. That just isn't so, and hasn't been in quite some decades, as the level of bank "reserves" throughout the entire housing bubble to 2007 was almost nil - the week before the Lehman bankruptcy there were just $9.02 billion in "reserves" on account, a level that had not varied much through the decades, breaking above $20 billion only rarely. The entire part of increasing funding for the credit explosion that has occurred since the 1980's has been through the wholesale model.
Here the Federal Reserve's presence was, prior to 2007, implicit as the FOMC had only "promised" to "guarantee" whatever liquidity was necessary to maintain its monetary target in the form of the federal funds rate. And even that was clunky and archaic, as the actual means of open market operations worked around maintenance periods where the functional end of monetary policy would anticipate funding needs in advance of each. The Open Market Desk would then adjust levels of holdings in and out of its SOMA portfolio in the calculated amounts to inflict its targets.
In reality, that was all a magic trick as the open market operations really had minimal impacts if any at all. If there was anything holding the federal funds rate to its target it was wholesale dealer operations that were unwilling to challenge the Fed's reach and actually test their resolve. In other words, the wholesale model far outgrew the capacity by which the FOMC and its Open Market Desk believed existed - it just simply worked to that point because it worked (tautology intended). By 2007, the wholesale model holding the federal funds target together had so far outgrown any belief, in quantity and variation, that the Fed was simply overwhelmed right from the start of the crisis.
The drought of the panic revealed the inefficiencies that had been building for decades. The significance of the housing crash was really that so much of the financial means to inflict Keynes' "euthanasia" were not able to withstand even a minor change in their cost structure. The panic in 2008 was treated, and in many ways is still treated, as a shortage but it was anything but. Like California today, the problem wasn't that there was "too little" but that there had always been this drive to allow as much as possible beforehand. Systemically, there just wasn't enough "liquidity" to fund every possible use anymore, which had been the driving impulse of the housing bubble itself.
And that was the economic expression of Greenspan/Bernanke, as well. Their concerns were distilled Keynes, in that their task, as they saw it, was to "un-idle" resources that would be, to their centralized plans, better put to use in more economic growth. To them, the housing bubble was better than the alternative, so long as GDP was "behaved" there wasn't any attention to efficiency because in the long run we are all dead - efficiency is apparently a problem for our children and grandchildren to sort out after the economy starts booming again.
The problem with repressed rates is obvious in the further context of where it all headed. The flipside of that is how expensive, relatively, that makes "capital." In other words, Keynes was, unsurprisingly, entirely wrong about "rentiers." The choice for them was not between un-idling resources or to continue taking unearned rent out of the economy, it was the manner in which they would do the latter. The great deal of focus in innovation and technology in the past thirty or forty years has been in expanding the means to do so, and the capacity by which "our" central bank has taken to attempt economic management has seen to it that such focus heighten exponentially.
In other words, the attempt to do Keynes bidding opened the door to the opposite, as "rentiers" were not extinguished as he suggested but enhanced in ways and manners he never could have dreamed. Wall Street as a tool was put "to use" in finding ways that appeared to accommodate both tasks - "rentiers" could find alternate expressions for their paper wealth, often with much more embedded and poorly understood risk, while the creation of those expressions would eventually (and inefficiently) leak back to the real economy fulfilling the policy idea that resources were indeed unduly idling.
The point of using California as an establishing parable is that I have no idea how much water the state needs, and neither do you or anyone else. It is entirely unknowable. The same holds true of the "money supply", namely that it cannot be determined in advance because it is entirely too complex, too dynamic and never actually stable (nor would we want it to be). But like the water arrangements out West, we can determine that the "money supply" these past four decades is not a "market" factor by what is revealed during the "drought."
By attempting to manage the "rentiers" in the economy, the central bank removes the market for money and replaces it with an abomination. Like artificially cheapened water, the similar arrangement in credit production leads to the exact same specification where efficiency is no longer a priority - except that in the economy long run health and sustainability are derived from efficiency almost alone. In that sense, the central bank attempt at management is nothing more than rearranging liabilities as if that was all that mattered, while actual scarcity in monetary definitions had in the past placed emphasis on assets.
In Karl Marx's Das Kapital, he wrote, "In proportion as capital accumulates, the lot of the labourer must grow worse. Accumulation of wealth at one pole is at the same time accumulation of misery, agony of toil, slavery, ignorance, brutality, mental degradation at the opposite pole." That is essentially the idea of liabilities above all else, as the government or centralization of the economic power structure seeks to alleviate that imbalance. And that was always the great weakness of Marx's critique of capitalism, in that rebalancing would occur not through redistribution but through the creation and innovation into new assets and the efficiency with which that would happen.
And so we see, especially of the 21st century, exactly that which Marx wrote in the passage above - labor in the past two decades has stagnated if not reversed (both in terms of reduced real earned incomes and labor utilization; the lower participation since 1999 actually shows an economy that has shrunk overall) while financial repression has not "euthanized" anyone financially instead making finance the dominant economic force. None of these outcomes have anything to do with an actual market for money attended to scarcity and true value.
This point is easily established by examination of the state of wholesale "money." The US "dollar" system is awash in "reserves" yet actual liquidity conditions have so degraded as to produce a series of "anomalies." Even JP Morgan's chief, Jamie Dimon, commented recently on the state of liquidity by calling October 15 (finally someone is getting around to recognizing just what October 15 actually was) an "unprecedented move" and "an event that is supposed to happen only once in every 3 billion years or so." But even that isn't accurate, as desperate as the first half hour of trading on that day was, as October 15 was followed by similar events in the European part of the "dollar" system on January 15 (which led to the Swiss National Bank abandoning its peg to the euro because it was making the "dollar" far too "expensive" for Swiss banks that are still heavily exposed in "dollars").
The regularity of these problems is an indication of exactly this non-market state to which liquidity exists - which is the true elements of the "money supply" under the wholesale model. These problems and the patterns that emerge from them relate not to market dysfunctions but rather monetary policy itself. The massive intrusion in the middle of 2013 is a prime example, where what was really a funding crisis originated in derivatives and bank balance sheet function - another condition that looked as if a shortage of currency (with currency in this case being bank balance sheet capacity for absorbing "risk") but was really the fact of dealers being heavily over-extended in interest rate swaps due to nothing but QE3! The fallout from that, after the word "taper" was introduced, was another huge market rout in MBS trading due to lack of liquidity, a visible asymmetry that, like golf courses proliferating in the desert, demonstrates the fissionable existence of inefficiency. By way of comparison, there were $1.8 trillion in bank "reserves" the week of May 1, 2013, and $2.8 trillion the week of October 15, 2014.
It is not the existence of capital and savings that produces hated "inequality" it is rather the attempt to manipulate and manage them that does so. The significance of "secular stagnation" as an economic idea is that it moves even monetarists and certain persuasions of "saltwater" economists closer to recognizing that fact. At its core, secular stagnation relates the assumed "equilibrium interest rate", as Bernanke himself terms it, to the natural state of the economy, when in fact it really pertains, conceptually, to bubble inefficiency - how low non-market, central bank targets and interest rates have to go just to maintain this "flood" of finance without it imploding because of the enormity of that inefficiency.
I have spent years expanding on pretty much this one point, with example after example from not just 2007 or 2008 which more than suggest that there isn't an actual market for "money" anymore and that is by design. I will never know exactly what there is for organic demand for money and credit or the "proper" supply to meet it, but I can tell you with a great deal of certainty this isn't even close. If money is a tool in economic allocation, and there is no doubt that is its primary role, the fact that the economy could go so awry and stay there while the attempts at managing Keynes' doctrine were proportional to that is top-tier evidence markets were left behind long ago - as was the actual practice of capitalism. True American capitalism, reaching back to its Anglo roots, would never produce a Japan-style "lost decade." The Great Recession started in 2007, so we are already more than seven years toward one, but in many respects (again, labor and income) it has been closer to fifteen or sixteen.
Those that claim this is all a shortage are those that also say redistribution is a positive economic force, that purposefully assigning through largely political means winners and losers is the path to economic health. There is no monetary shortage, even in the context of the global "dollar" short - which is an expression, again, of inefficiency rather than an actual, market condition of its supply. The terms "loose" and "tight" simply do not apply as the condition of finance right now is that of rice farmers in California or its golf courses in the desert. The claim that the economy needs to still be boosted by more money still pervades, somehow, when in fact the global economy needs to be relaxed first by the "right" money, which nobody can detail or perceive of their own.
