– Joseph Schumpeter
It was about a year ago when IMF Director Kristalina Georgieva took part in a panel discussion hosted by CNBC. This may have been a fairly common occasion. The conversation, however, was entirely uncommon.
Typically, central bankers are illusive in their remarks. They speak in code. They avoid potentially inflammatory words like recession. Most certainly, they never use the D-word – as in depression.
They also generally avoid taking any responsibility for their mistakes. What’s more, they position their failures as successes.
Ben Bernanke’s ‘courage to act,’ for instance. What a bunch of baloney.
Deep inside central bankers must know the folly of planning an economy by stretching the money supply. Still, they want to maintain the perception that they’re masters of the universe – and so, so much smarter than you.
With this in mind, it was in a moment of uncommon candor where Georgieva conceded that central banks globally created the inflation mess that exploded upon the world economy in 2022. She also elaborated that this was because they printed too much money and didn’t think of unintended consequences:
“I think we are not paying sufficient attention to the law of unintended consequences. We take decisions with an objective in mind and rarely think through what may happen that is not our objective. And then we wrestle with the impact of it.
“Take any decision that is a massive decision, like the decision that we need to spend to support the economy. At that time, we did recognize that maybe too much money in circulation and too few goods, but didn’t really quite think through the consequence in a way that upfront would have informed better what we do.”
Georgieva may have acknowledged a past mistake. But she’s still not ready to throw in the towel and call it quits. Instead, she thinks with some additional focus and attention central bankers will be able to foresee and minimize the unintended consequences of their actions. More from Georgieva:
“We act sometimes like eight year olds playing soccer. Here is the ball, we are all at the ball. And we don’t cover the rest of the field.
“Our ability to deal with more than one crisis at one time is very, very limited, and we have to zero in on the really big things that could determine the future and keep our attention on them.”
Georgieva, as you can see, completely misunderstands what unintended consequences are. That they are outcomes of actions which are not intended or foreseen. Additional focus will not somehow abolish the law of unintended consequences.
The folly never ends. Because now, to correct the unintended consequences of flooding the world economy with massive amounts of printing press money, central bankers have been hiking interest rates. To use Georgieva’s analogy, inflation is the ball central bankers are focused on; the rest of the field goes ignored.
Unfortunately, central bankers can never quite clean up their past mistakes. Rate hikes, like printing press money, also come with other unintended consequences. Such as, systemic bank failures.
But that’s not all. Sooner or later something else will go boom too.
Several weeks ago, for example, Patricia Borges was on the job as a machine operator at a Pennsylvania chocolate factory, when something went boom. Then flames quickly consumed the building.
“When I began to burn, I thought it was the end for me,” said Borges. But when the floor gave way, she inadvertently base jumped into a vat of dark liquid chocolate. This extinguished her burning arm and saved her life…though she broke her collarbone and both heels. Seven of her co-workers were not so lucky.
Here’s the point…
“Something is Going to go Boom”
Last week IMF Director Georgieva was at it again. Speaking with uncommon candor. This time at an event hosted by an outfit called the Meridian International Center. Georgieva provided the following insight:
“There is simply no way that interest rates would go up so much after being low for so long and there would be no vulnerabilities. Something is going to go boom.”
Georgieva didn’t specify what exactly would go boom. But with a little imagination we can come up with a few ideas. Maybe more banks will fail. Or a big public pension fund will blow up. Or, perhaps, the dollar itself will take a deep dive.
The important thing to recognize is that ‘something is going to go boom.’ And when it does, a lengthy depression could follow.
Some people may even have to lose their jobs, so they can later find better ones. This, however, shouldn’t be something to fear.
A depression is precisely what’s needed to level set the economy and financial system. The slate needs to be wiped cleaned so the next generation of entrepreneurs can rebuild upon a solid foundation.
At this point, it’s widely observable that something ain’t right with the economy…and it has nothing to do with a supposed failure of capitalism. Instead, it has to do with the abundance of lard – excess debt and excess mistakes – courtesy of the Fed, which is now weighing things down.
An economic depression is all part of the normal course of the business cycle. Moreover, the actions of central planners to tame the business cycle only stretches it out and magnifies the booms and busts.
Certainly, a discussion of the business cycle is not complete without mentioning Austrian economist Joseph Schumpeter. Here are the four phases of the business cycle he identified: prosperity, recession, depression, and recovery.
In summary, economic growth, as noted by Schumpeter, begins with the innovations of entrepreneurs. Then demand from new businesses increases the price of production, including labor.
This, in effect, has a negative impact on existing businesses. They must operate in a condition of higher prices. They may also find that their market share has declined because of competition from the new, innovative businesses.
Over time, as consumers move to products that include the more innovative technologies, demand slips away from the old products. Prices then fall. And the big growth period is over.
The immediate impact of the innovation saturates the marketplace. A shakeout occurs, where the economy consolidates the new businesses. A depression may even set in.
The Creative Process of Government Destruction
According to Schumpeter, the depression stage is both useful and creative. It brings the economy into equilibrium through forced adjustments. The level setting during the depression then encourages new innovations that take shape in the next stage of recovery.
This process, where new and innovative companies destroy the value of established companies, is what Schumpeter called creative destruction. No doubt, it’s disruptive to the existing order of industry and employment, and can result in mass layoffs of workers with obsolete skills. Nonetheless, it is necessary for sustaining long-term economic growth.
Innovation is what provides new opportunities for workers in more creative and productive businesses. It also delivers better and lower priced products to the market.
This is simply how the world works. Dinosaurs like Kodak, Pan American Airways, Bethlehem Steel, Montgomery Wards, Blackberry, and countless other extinct businesses die out as new, more nimble and creative enterprises are born.
But it’s not just companies that are at risk of extinction, governments are at risk too.
For over a century, economic growth masked the fact that idiots in Congress were making idiotic decisions. So, too, economic growth overcame the hindrance of government agencies, and their silly regulations and forms, and their overzealous paper pushers.
When the economy slipped in 2008 and again during the government mandated coronavirus lockdowns in 2020-21 it quickly revealed Uncle Sam’s failings. Money had corrupted the government.
Everyone now knows that Washington doesn’t represent the people. It represents a legion of investment banks, lobbyists, and special interest groups. The question is no longer about who is pulling Joe Biden’s strings. Rather, it’s who’s not pulling his strings.
On top of that, Washington’s legacy costs are now destroying the economy as government debt swallows up productivity.
Perhaps, with the forthcoming depression, creative destruction will cut off the source of the government’s corruption. One can only hope that a disruptive transformation will produce Uncle Sam’s smaller, freer offspring.
Don’t hold your breath.
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for Economic Prism