Thursday, October 18, 2012

A R J Turgot and Quantitative Easing

In the aftermath of the 2007 financial crisis, various central banks around the world have embarked on various policies to which they have given different names like quantitative easing, operation twist, LTRO, economic stimulus etc. etc. If you tear the linguistic veil surrounding these policies, then, you will find that, these policies are nothing but creation of money out of thin air i.e., inflation. Today's bankrupt mainstream economics profession, especially Keynesianism, believes that by simply printing truck load of money governments can get economies out of recession. They simply don't bother to understand that why there is this recession in the first place, and whatever explanations they offer are all wooly-minded and basically no explanations at all e.g., Keynesian 'animal spirit' argument. US Federal Reserve chairman Ben Bernanke is an epitome of this line of thinking and policy making. Despite repeated failures of his money printing policies, he is trying the same thing over and over again while expecting different results every time. You know such behavior is called, insanity. But that doesn't deter him from destroying the US and world economy via inflation.

Now, those who have studied economic history must be knowing that such inflationary policy of printing huge amount of fiat paper money is not new. The most famous case of such policy is in the early 18th century France when Scottish banker John Law created the great Mississippi bubble (more here) and destroyed the French economy. What John Law did in 18th century France, Ben Bernanke and other central bankers are doing today. John Law and various French kings tried to support their profligate expenditures via money printing and heavy borrowing, and they failed. Today's governments with the help of their central banks are trying the same - various governmental debt and money printing is going through the roof - and they will also fail in the end. But, I digress. The reason why I am writing this blog is to let you know about the brilliant French economists named Anne Robert Jacques Turgot (more here), who briefly worked as a finance minister of Louie XVI. As I just mentioned, Turgot was appointed as a finance minister of one of those ill fated French king, Louie XVI, and during his brief stint as a finance minister, Turgot tried very hard to reverse the French government's profligate policies of borrowing and spending to bring the economy back on the healthy course. He failed in his attempt, but his warnings, which comes to us via his various writings, is very relevant for today's similar events all around the world. What he said then is applicable today also, and this is the reason why it is important for all of us to know and understand what Turgot said about the consequences of such policies. Below I reproduce excerpts of his important letter to Abbe de Cice, which is famously known as the Letter on Paper Money (here, pp. 69-78). In this letter Turgot responded to the arguments in favor of John Law's paper money system and a thought that it is okay for the state to go into debt. Turgot said:

Observe, that the king derives no interest from the money he borrows: he needs it either to pay his debts, or for the expenses of the kingdom; consequently he is able to refund it only by taking from his domain, and it follows that he ruins himself if he borrows more than he owns...

The state, the king, the clergy, the provincial estates, whose needs consume their loans, necessarily ruin themselves if, every year, their revenue is not sufficient to pay, besides their current expenses, the interest and part of the principal of what they have borrowed in times of exceptional needs. (bold mine)

Tugot warned against profligate state debt, and he said, if governments will do so, then, they will ruin themselves! Today's governments are doing the same, and they will also ruin themselves and their countries in the end. Turgot warned against the replacement of Silver, the real money, with a paper money which is issued by the king. Remember today's governments have replaced gold/silver money with their phony paper money long ago in 1971. Even today they are doing nothing but printing more and more paper money creating inflation in that process e.g., various QEs. Here is Turgot:

L’Abbé Terrasson thinks very differently. According to him “the king can greatly exceed the proportion of tenfold to which merchants and private persons are bound.”...If the bill is worth money, why promise to pay? If the bill takes the place of money, it is no longer credit. Law was conscious of this, and he states that his circulating paper is really a type of money; he maintains that it is as good as that of gold and silver. “These two metals,” says l’Abbé Terrasson, “are only the tokens which stand for real wealth, i.e., commodities. An écu is a bill conceived in these terms: Any seller will give the bearer the produce or commodity which he needs to the amount of three livres, for that same value of another commodity which has been given up to me, and the effigy of the prince takes the place of a signature. Now what does it matter whether the token is silver or paper? Wouldn’t it be better to choose a material which costs nothing, which does not have to be taken out of commerce where it is used as merchandise, which is indeed manufactured in the kingdom and which does not necessarily make us dependent on the foreigners and proprietors of mines who profit greedily from the enticement  which the glitter of gold and silver holds for the other  nations; a material which one can increase according to need, without ever fearing its deficiency, which, indeed, one would never be tempted to put to any use other than circulation? Paper has all these advantages, which make it preferable to silver.” If all these reasonings were correct, this would be as good as the philosophers’ stone; for there would never be any shortage of either gold or silver to buy all sorts of goods. But was it permissible for Law to ignore that gold, like everything else, lowers its price by its increase? If he had read and studied Locke, who had written twenty years before him, he would have known that all the commodities of a State are always balanced among themselves and with gold and silver, in accordance with the proportion of their quantity and their vent; he would have learned that gold has no intrinsic value which always corresponds to a fixed quantity of merchandise; but that, when there is more gold, it is cheaper, and more of it is given for a fixed quantity of merchandise; that gold, therefore, when it circulates freely, is always sufficient to meet the needs of the State, and that it matters little whether there are 100 million marks or one million, if all commodities are purchased more dearly in the same proportion. It would, be ridiculous to imagine that money is only token wealth, the repute of which is based on the stamp of a prince.

This stamp is only there to certify its weight and standard. In their respective relation with commodities, uncoined silver is at the same price as coined silver, the legal value is purely a name. This is what Law ignored when he established the bank. (bold mine)

Turgot then goes on to discuss the effects of this inflationary policy. Unfortunately his whole letter with full analysis is lost, but whatever he has said above can be applied to the inflationary policy of Ben Bernanke and other central bankers. Ben Bernanke is also trying to convert paper currency notes into a philosophers' stone via his quantitative easing programs. He (falsely) thinks that, because economies are in trouble due to lack of aggregate demand [sic], so by printing and handing out money to people he can increase that aggregate demand, which then will bring the economy out of recession! But as Turgot said, like John Law, Ben Bernanke and other central bankers are ignoring the fact that, like everything else, paper currency will lower its price by its increase i.e., creation of money out of thin air will only reduce the purchasing power of every fiat currency note in circulation (i.e., inflation); it will buy less goods now than before various QE programs began. Overall demand and consumption won't increase as long as production is not increasing.  Later on, building upon the works of people like Turgot, Ludwig von Mises showed comprehensively that such money printing policies will ultimately result into a 'crack-up boom' and the final collapse of the whole monetary system.

Looking at today's events one feels that the history is again repeating itself. Time and again governments have resorted to money printing to fund their endless expenditures, and in that process have ruined their economies. Louie XVI and his government didn't listen to Turgot at that time, and finally the king lost his life in the bloody French Revolution. I wish things don't turn that bad today. I won't get surprised though if things get really ugly in future. I am not delusional about the realities today, and it is better to prepare ourselves for any dire eventualities.

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