Richard Cantillon

Of Money Printing and Covid Vaccines

I recently wrote a piece for livemint.com, explaining why the central government should ensure that free vaccination against covid is available even for those in the 18-45 age bracket, and why the principles of free market do not work in this case.

In this piece, I carry the argument forward.

One of the arguments being made is that the companies making the vaccines should be allowed to price the vaccine at a price they deem to be appropriate because they need to be compensated for the risk that they are taking on.

In a normal situation, I would completely agree with that. But this is not a normal situation. We are in the midst of a health emergency of a kind India has not seen in a long time. Also, more than that, allowing companies to decide on the price of the vaccine is bad economics. (I had explained this in the livemint piece and I make a new point here). 

Let me explain. There are two companies which are supplying vaccines, Serum Institute and Bharat Biotech. They have access to the entire Indian market for the next few months, before the foreign competitors come along. Of this, Serum Institute has been supplying 90% of the vaccines up until now. Basically, it has more or less got a monopoly over the Indian market.

This is a very important point that needs to be taken into account. As per India Ratings and Research 84.19 crore out of a total population of 133.26 crore are now eligible for the vaccine, basically people over the age of 18. This is something that the central government needs to keep in mind.

Even if these companies made Rs 100-150 per dose of the vaccine, there is a lot of money to be made, running into thousands of crore, and that is an adequate compensation for the risk involved. Also, it is worth remembering that Serum Institute did not develop the vaccine. It is a contract manufacturer. These points cannot be ignored. 

Other than letting the vaccine companies decide on a price, the central government has also decided to let state governments procure vaccines directly from these companies. The price fixed for the state governments by the Serum Institute is Rs 400 per dose. Bharat Biotech has priced it at Rs 600 per dose.

For the private hospitals, the price has been fixed at Rs 600 per dose and Rs 1,200 per dose, respectively. Of course, these are wholesale prices, and the price eventually charged in the private hospitals, will be higher than this, as those entities need to take their costs of administering the vaccine into account and make a profit as well.

Over and above this, central government will continue to buy vaccines from these two companies and continue supplying them to state governments for free, so that those over the age of 45, can continue to be vaccinated for free, at government vaccination centres.

What will this do? Multiple price points for the vaccines in the midst of a health emergency is bad strategy to say the least. It will encourage black marketing, with black marketers sourcing vaccines from the cheapest source (central government supplying to state governments for free) and selling it for a higher price in the open market. This, especially at a time when there is a shortage of vaccines. 

Hence, it makes sense that central government continue to buy the vaccines from the manufacturers and allocate it to the state governments. This does not mean that the private hospitals should not be involved in the vaccination effort. They should be because the aim is to vaccinate as many people as fast as possible. 

But at the same time it needed to be ensured that the government vaccination centres vaccinated everyone for free, and not just those over 45. This would have ensured that the private hospitals could not have charged a very high amount to vaccinate. This would have keep prices in control and those who wanted to pay could have paid for the vaccine, as well. 

Many state governments have declared that they will vaccinate those in the 18-45 age group, for free. While this is a good move, it needs to be said that this is something that should have happened at the central government level. The central government has many more ways of raising money than a state government. Also, the central government had allocated Rs 35,000 crore towards vaccination in the budget, with a promise to raise the allocation if required. 

Over and above this, there is a more important point. But before I explain that. Let me deviate a little here and talk about an Irish-French economist called Richard Cantillon, who lived in the seventeenth century. Cantillon came up with something known as the Cantillon effect.

He made this observation based on all the gold and silver coming into Spain from what was then called the New World (now South America). When money supply increased in the form of gold and silver, it would first benefit the people associated with the mining industry, that is, the owners of the mines, the adventurers who went looking for gold and silver, the smelters, the refiners, and the workers at the gold and silver mines.

These individuals would end up with a greater amount of gold and silver, that is, money. They would spend this money and thus drive up the prices of meat, wine, wool, wheat, etc. Of course, everyone in the economy had to pay these higher prices.

How is this relevant in the world that we live in?

When central banks print money as they have been doing regularly since 2008, in order to drive down interest rates, they do so with the belief that money is neutral. So, in that sense, it does not really matter who is closer to this money being printed and who is not. But that’s not how it works.   

The Cantillon effect has played out since 2008. When central banks printed and pumped money into the financial system, the large institutional investors, were the ones closest to the money being printed.

They borrowed money at cheap rates and invested across large parts across the world, fuelling stock market and bond market rallies primarily, and a few real estate ones as well.

The larger point being that if a central bank prints money and throws it from a helicopter, those standing under the helicopter, get access to this money first. 

The important word here is access. With state governments and private hospitals being allowed to buy vaccines directly from the two companies, access becomes very important. When vaccination for those between 18-45 opens up on May 1, demand will go through the roof. But the supply will not go up at the same speed, with companies taking some time to scale up. So, how will the vaccine companies decide who to sell how much to?

Should they fulfil the demands of state X first or should they sell more to state Y? Or should they sell more to private hospitals, because the price is higher in that case. In this scenario, access becomes very important. This is the Cantillon effect of vaccines. The phones of the CEOs and the top management of these two companies won’t stop buzzing in the months to come. 

What will also happen is that many corporates will look to vaccinate their workforces (in fact, they already are), so that everyone can get back to work fast (Please remember everyone can’t work from home. India has large banks and many service businesses, in which people can’t work from home). In this scenario, private hospitals will have to decide whether they should vaccinate individuals or should they vaccinate corporate work forces, first.

Corporates might decide to pay a higher price for vaccination simply because it might be more profitable for them to have a vaccinated workforce going out there and doing their work, than not. 

The current structure of vaccination at multiple price points makes the issue of access to vaccination very important and that shouldn’t be the case. The central government shouldn’t be propagating inequality in access to vaccines.

Hence, the central government should have bought vaccines directly from the manufacturers and supplied it to the states.

Nevertheless, this is not going to happen simply because that would mean that the strategy of multiple price points was a mistake. And the government doesn’t make mistakes, especially even when it makes them.

A 400 year old economic theory that the world has forgotten about

yellen_janet_040512_8x10Vivek Kaul

The Federal Open Market Committee (FOMC), which decides on the monetary policy of the United States, had its last meeting for this year scheduled on December 16-17th, 2014. After this meeting, Janet Yellen, the Chairperson of the Federal Reserve spoke to the media.
Everything Yellen spoke about during the course of the press conference was closely analysed by the financial media all over the world. The gist of what Yellen said at the press conference was that she expects that the Federal Reserve will start raising the federal funds rate sometime next year.
The federal funds rate or the interest rate at which one bank lends funds maintained at the Federal Reserve to another bank, on an overnight basis, acts as a benchmark for the short-term interest rates in the United States. The last time the Federal Reserve increased the federal funds rate was in 2006.
In the aftermath of the financial crisis, the Federal Reserve decided to print money and pump it into the financial system by buying government bonds and mortgage backed securities. The Federal Reserve referred to this as the asset purchase programme. The economists called it quantitative easing. And for those who did not want to bother with jargons, this was plain and simple money printing.
This was done to ensure that there was enough money going around in the financial system and interest rates remained low. At low interest rates the hope was that people would buy homes, cars and consumer durables. This would drive business growth, which in turn would drive economic growth, which would create both jobs and some inflation.
While this has happened to some extent, what has also happened is that a lot of money has been borrowed by financial institutions at very low interest rates and has found its way into stock markets and other financial markets all over the world. This has led to bubbles.
The economic theory explaining this phenomenon was put forward by Richard Cantillon, an Irish-French economist who lived during the early eighteenth century. He basically stated that money wasn’t really neutral and that it mattered where it was injected into the economy.
Cantillon made this observation on the basis of all the gold and silver coming into Spain from what was then called the New World (now South America). When money supply increased in the form of gold and silver, it would first benefit the people associated with the mining industry, that is, the owners of the mines, the adventurers who went looking for gold and silver, the smelters, the refiners and the workers at the gold and silver mines. These individuals would end up with a greater amount of gold and silver, that is, money. They would spend this money and thus, drive up the prices of meat, wine, wool, wheat, etc.
This rise in prices would impact even people not associated with the mining industry, even though they hadn’t seen a rise in their incomes, like the people associated with the mining industry had. This was referred to as the Cantillon effect.
Interestingly, Cantillon was also an associate of John Law. In 1705, John Law published a text titled Money and Trade Considered, with a Proposal for Supplying the Nation with Money. Law was of the opinion that money was only a means of exchange and that a nation could achieve prosperity by increasing the amount of money in circulation.
The problem of course was that when it came to gold and silver coins, only so much currency could be produced. But this disadvantage was not there with paper money. Law firmly believed that by circulating a greater amount of paper currency in the economy, commerce and wealth of a nation could be increased.
His theory was in place. But, like a physicist or a chemist, it could not be tested in a laboratory. Law needed a nation that was willing to let him test his theory. And France proved to be that nation. In 1715, France was the richest and the most powerful country in the world. But at the same time it was also almost bankrupt.
This was primarily because the country did not have a central bank of its own like the Dutch and the British had. Law’s idea was to create a central bank which would have the right to issue paper money which would be a legal tender. He also wanted to create a company which would have a monopoly of trade. This would create a monopoly of both finance as well as trade for France and the profits thus generated would help pay off the French debt.
Law went around establishing a bank called the Banque Royale and formed a company called the Mississippi Company, which was given a 25-year-long lease to develop the French territory along the Mississippi River and its tributaries in the United States. The Banque Royale was allowed to issue paper notes guaranteed by the French Crown.
Cantillon was an associate of John Law and observed the entire thing very closely. As Bill Bonner writes in Hormegeddon—How Too Much of a Good Thing Leads to Disaster: “Cantillon noticed that Law’s new paper money backed by the shares of the Mississippi Company—didn’t reach everyone at the same rate. The insiders—the rich and the well connected—got the paper first. They competed for goods and services with it as though it were as good as the old money. But by the time it reached the labouring classes, this new money had been greatly discounted—to the point, eventually, where it was worthless.”
This was the Cantillon effect. As analyst Dylan Grice told me during the course of an interview: “Cantillon, writing before the days of Adam Smith, was the first to articulate it. I find it very puzzling that this insight has been ignored by the economics profession. Economists generally assume that money is neutral. And Milton Friedman’s allegory about the helicopter drop of money raising the general price level completely ignores the question of who is standing under the helicopter.”
The money printed by the Federal Reserve in the aftermath of the financial crisis has been unable to meet its goal of trying to create consumer-price inflation and getting consumer spending up and running again. But it has benefited those who are closest to the money creation. This basically means the financial sector and anyone who has access to cheap credit. They were the ones standing under the helicopter when the money was printed and dropped.
Institutional investors have been able to raise money at close to zero percent interest rates and invest it in financial assets all over the world, driving up the prices of those assets and made money in the process.
It has also left these investors wondering what will happen once the Federal Reserve decides to end the era of “easy money” and start raising interest rates. In October 2014, the Federal Reserve brought its asset purchase programme to an end. This did not lead to a panic in the financial markets simply because the Fed made it clear that even though it would stop printing money, it would not start immediately withdrawing the money it had already printed and pumped into the financial system over the years.
But that is going to happen one day. Yellen is trying to get the financial markets ready for interest rate hikes starting next year. At least, that is the impression I got yesterday after watching her press conference.
Once the Fed decides to start withdrawing the money that it has printed and pumped into the financial system, and which in turn has found its way into financial markets all over the world, interest rates will start to go up. That will happen sooner rather than later. Maybe 2015. Maybe 2016. Who knows.
And once interest rates start to rise, the arbitrage of borrowing at low interest rates and investing money in financial markets all over the world, won’t be viable any more. It is difficult to predict precisely how exactly the situation will play out.
Nevertheless, Bonner summarizes the situation well when he says: “What exactly will happen, and when it will happen, we will have wait and find out. But it will be bad, that much is certain. We will hit rock bottom.”
All I can say to conclude is—Watch this space.

The column originally appeared on www.equitymaster.com as a part of The Daily Reckoning, on December 19, 2014

References:
M. Thornton, “Cantillon on the Cause of the Business Cycle,” The Quarterly Journal of Austrian Economics 9, 3(Fall 2006): 45–60 

J.E. Sandrock, “John Law’s Banque Royale and the Mississippi Bubble.” Avail­able online at http://www.thecurrencycollector.com/pdfs/John_Laws_Banque_Royale.pdf

C. Mackay, Extraordinary Popular Delusions and the Madness of Crowds (Project Gutenberg, 1841). Available online under Project Gutenberg.

A 400 year old economic theory explains who really runs the Indian stock market

 helicash

Vivek Kaul

On September 12, 2008, the Bank of England, had total assets worth £83.8 billion on its books. In the six years since then, the total assets of the British central bank have gone up by a whopping 385.6% to £ 404.3 billion, as on September 17, 2014.
Things haven’t been much different in the United States. The Federal Reserve of United States had assets worth $905.3 billion as on September 3, 2008. Since then it has jumped to $4.45 trillion, as on September 17,2014. An increase of close to 392%.
The total assets of the Bank of Japan have more than doubled since the start of 2011. In January 2012, the total assets of the Japanese central bank had stood at 128 trillion yen. Since then, it has more than doubled to 275.9 trillion yen at the end of August 2014.
Since the start of the financial crisis in the middle of September 2008, Western central banks have printed money big time. This money has been pumped into the financial system by buying bonds. These bonds have ended up as assets on the balance sheet of central banks.
The idea behind this, as I have often mentioned in the past, was to drive down long term interest rates, leading to people borrowing and spending more at lower interest rates. This would, in turn, lead to economic growth, the hope was.
When central banks started printing money, the Cassandras (which included yours truly as well) started to point out that the era of high inflation was on its way. The logic offered was fairly straight forward. With so much money being pumped into the financial system, it would lead to a lot of money chasing the same amount of goods and services in the economy, and that would drive prices up at a rapid rate, and lead to high inflation.
But that did not turn out to be the case. The Western world had already taken on huge loans before the financial crisis broke out and was in no mood to borrow and spend all over again.
This lack of inflation has been used by central banks to print and pump more money into the financial system. The hope now is that with all the money that has been pumped into the financial system some inflation will be created. This inflation will lead to people spending more. The logic here is that no one wants to pay a higher price for a product, and if prices are going up or likely to go up, people would rather buy the product now than wait. And this will lead to economic growth. That in short is the gist of what the policy of the Western central banks has been all about over the last few years.
The economist Milton Friedman had suggested that a recessionary situation could be fought even by printing and dropping money out of a helicopter, if the need be, to create inflation.
And this is what Western central banks have done since September 2008, in the hope of reviving economic growth. While they may not have been able to create “some” conventional inflation as they wanted to, there is a lot else that has happened. And that needs to be understood.
When central banks print money, they do so with the belief that money is neutral. So, in that sense, it does not really matter who is standing under the helicopter when the money is printed and dropped into the economy. But the Irish-French economist Richard Cantillon who lived during the early eighteenth century, showed that money wasn’t really neutral and that it mattered where it was injected into the economy.
Cantillon made this observation on the basis of all the gold and silver coming into Spain from what was then called the New World (now South America). When money supply increased in the form of gold and silver, it would first benefit the people associated with the mining industry, i.e., the owners of the mines, the adventurers who went looking for gold and silver, the smelters, the refiners and the workers at the gold and silver mines.
These individuals would end up with a greater amount of gold and silver , i.e., money. They would spend this money and thus drive up the prices of meat, wine, wool, wheat, etc.
This rise in prices would have impacted even people not associated with the mining industry, even though they wouldn’t have seen a rise in their incomes, like the people associated with the mining industry had.
This is referred to as the Cantillon Effect. As analyst Dylan Grice puts it : “Cantillon, writing before the days of Adam Smith, was the first to articulate it. I find it very puzzling that this insight has been ignored by the economics profession. Economists generally assume that money is neutral. And Milton Friedman’s allegory about the helicopter drop of money raising the general price level completely ignores the question of who is standing under the helicopter.”
The money printing that has happened in recent years has been unable to meet its goal of trying to create consumer-price inflation. But it has benefited those who are closest to the money creation. This basically means the financial sector and anyone who has access to cheap credit.
Institutional investors have been able to raise money at close to zero percent interest rates and invest it in financial assets all over the world, driving up the prices of those assets and made money in the process.
As the economist William Bonner put it in a column he wrote in early 2013: “The Fed creates new money (not more wealth… just new money). This new money goes into the banking system, pretending to have the same value as the money that people worked for. And people with good connections to the banks take advantage of the cheap credit this new money creates to aid financial speculation.”
This financial speculation has led to massive stock market rallies all over the world. As I wrote in a piece last week “The Dow Jones Industrial Average, America’s premier stock market index, has rallied more than 30 percent since October 2012. This when the American economy hasn’t been in the best of shape. The FTSE 100, the premier stock market index in the United Kindgom, has given a return of 15 per cent during the same period. The Nikkei 225, the premier stock market index of Japan has rallied by 53 per cent during the same period. Closer to home, the BSE Sensex has rallied by around 43 per cent during the same period.”
Let’s take a closer look at the Indian stock market over the last two years. The foreign institutional investors have invested Rs 1,82,789.43 crore during this period (up to September 19,2014). During the same period the domestic institutional investors sold stocks worth Rs 1,07,327.65 crore.
It is clear from this that foreign money borrowed at low interest rates has been driving the Indian stock market. The domestic investors have continued to stay away.
So, even though a lot of domestic investors may talk about the India growth story being strong, they really don’t believe in it. If they did, they would invest money and not simply talk about it.
Hence, even though the economic growth through large parts of the world continues to remain subdued, the stock markets can’t seem to stop rallying. The explanation lies in the access to the “easy money” that the big institutional investors have.
And this access to easy money will continue in the days to come. The Bank of Japan, the Japanese central bank is printing around ¥5-trillion per month and is expected to do so till March 2015. The European Central Bank is also preparing to print €500-billion to €1-trillion over the next few years. All this money will be available for big institutional investors to borrow at very low interest rates.
The Federal Reserve of United States has made it clear that even though it will go slow on printing money in the days to come, it is unlikely to start pumping out all the money that it has put into the financial system any time soon.
Hence, the stock market bubbles around the world are likely to continue in the days to come. As Claudio Borio and Philip Lowe wrote in the BIS working paper titled Asset prices, financial and monetary stability: exploring the nexus  “lowering rates or providing ample liquidity when problems materialise but not raising rates as imbalances build up, can be rather insidious in the longer run. They promote a form of moral hazard that can sow the seeds of instability and of costly fluctuations in the real economy.”
The worst, as they say, is yet to come.
The article originally appeared on www.FirstBiz.com on Sep 27, 2014

(Vivek Kaul is the author of Easy Money trilogy. He tweets @kaul_vivek)

Why the helicopter economics of NREGA doesn't work

helicash Vivek Kaul 
The Down to Earth magazine has done an excellent expose of how village heads in Bihar have been siphoning off money from the various government run social scheme primarily MGNREGA (or Mahatma Gandhi National Rural Employment Guarantee Act). “More than 100 mukhiyas are learned to have become millionaires in the past five years. They have amassed wealth by siphoning off money from development projects related to MGNREGA, solar lights, rural roads, Indira Awas Yojana and the public distribution service (PDS),” the magazine points out.
The magazine gives the example of Sunil Verma, village head of Dakkin panchayat who has assets worth more than Rs 3.75 crore, investments over Rs 35 lakh in insurance policies and nearly 14 bank accounts. Village heads whose earn around Rs 8000 per month are purchasing guns, SUVs and appointing private guards for their security.
There are examples of village heads who were earlier construction labourers now driving around in SUVs. “We have discovered only the tip of the iceberg,” Director General of Police (DGP), Abhyanand, told the magazine. The MGNREGA scam is estimated to be around Rs 6,000 crore.
What is happening in Bihar and other parts of the country(which a simple Google search will reveal) as well is an excellent example of the “cantillon effect”. And to understand what it means we need to go back in history.
During the 16th century, the Spanish discovered gold and silver in huge amounts in the “New World,” the continent now known as South America. With all this silver/gold coming into Spain from the New World there was a sudden increase in money supply and that led to inflation in Spain.
Richard Cantillon, an Irish-French economist, who lived in the late 17th and early 18th century, studied this phenomenon and made some interesting observations.
What he said was that when money supply increased in the form of gold and silver it would first benefit the people associated with the process of money creation, the mining industry in general and the owners of the mines, the adventurers who went looking for gold and silver, the smelters, the refiners and the workers at the gold and silver mines, in particular. As Cantillon wrote “If the increase of actual money comes from mines of gold or silver… the owner of these mines, the adventurers, the smelters, refiners, and all the other workers will increase their expenditures in proportion to their gains.”
These individuals would end up with a greater amount of gold and silver i.e. money, before anyone else. This money they would spent and thus drive up the prices of meat, wine, wool, wheat etc. This new money would be chasing the same amount of goods and thus drive up prices.
This rise in prices would impact people not associated with the mining industry as well, even though there incomes hadn’t risen like the incomes of people associated with the mining industry had.
The situation that Cantillon talks about is very similar to what western central banks around the world have been up to over the past few years. They have been printing money and pumping it into their financial systems in the hope of keeping interest rates low, so as to encourage people to borrow and spend money, and in the process kick-start economic which has come to a standstill.
But this money printing has benefited those who are closest to the money creation. This basically means the financial sector and anyone who has access to cheap credit. Institutional investors have been able to raise money at close to zero percent interest rates and invest them in all kinds of assets all over the world, leading to huge bubbles. In the process, these investors have made a lot of money, while the overall economic growth continues to remain slow.
The modern terminology for this mode of operating is “helicopter money” i.e. the government and the central bank printing money and dropping it from a helicopter. So that people pick up the money that is being dropped, spend it, and thus help to revive economic growth.
But what this theory does not take into account is the fact that everybody can’t possibly be standing under the helicopter. Only a few people can. And those people who are standing under the helicopter are the ones who are likely to pick up the money being dropped and thus benefit from its purchasing power.
MGNREGA is no different from helicopter economics. The government has decided to spend a huge amount of money to guarantee jobs to citizens of this country. But there are very few checks and balances to figure out whether the money is actually being spent for what it is meant for. Turns out it is not and is being siphoned off in various ways.
Sanjay Dixit, a member of the Central Employment Guarantee Council (CEGC), explained the modus operandi of the scam while claiming a Rs 10,000 crore MGNREGA scam had happened in Uttar Pradesh. As he told India Today “This includes payment of wages against fake job card holders and fake construction works; creating fictitious purchase invoices, payment to ghost firms against the procurement of various items including hybrid seeds, calendars and publicity material; purchase of instruments used by labourers for construction works and purchase of photo copy machines and computers.”
The village heads in Bihar would have operated along similar lines. The people MGNREGA is benefiting the most, are the village heads and government officials, who are standing right under the helicopter from which the government is dropping money.

The article originally appeared on www.firstpost.com on September 25, 2013
(Vivek Kaul is a writer. He tweets @kaul_vivek) 

What the humble electric toaster tells us about the global financial system

kitchenaid-kmtt200-toaster
Vivek Kaul
Tim Harford writer of such excellent books like The Undercover Economist, The Logic of Life and Adapt, once wrote a blog discussing the perils of a design student trying to make an electric toaster from scratch.
Harford discusses the experience of Thomsan Thwaites, a postgraduate design student, who decided to embark on what he called “The Toaster Project”. “Quite simply, Thwaites wanted to build a toaster from scratch,” writes Harford.
The toaster was first invented in 1893 and is a household good in Great Britain and almost all other parts of the developed world. It costs a few pounds and is very reliable and efficient. But building it from scratch was still not a joke. “To obtain the iron ore, Thwaites had to travel to a former mine in Wales that now serves as a museum. His first attempt to smelt the iron using 15th-century technology failed dismally. His second attempt was something of a cheat, using a recently patented smelting method and a microwave oven – the microwave oven was a casualty of the process – to produce a coin-size lump of iron,” writes Harford.
Next Thwaites needed plastic. Plastic is made from oil. But Thwaites never made it to an oil rig. He finally settled at scavenging plastic from a local dump, which he melted and then moulded into a toaster casing.
More short cuts followed. As Harford writes “Copper he obtained via electrolysis from the polluted water of an old mine… Nickel was even harder; he cheated and bought some commemorative coins, melting them with an oxyacetylene torch. These compromises were inevitable.”
A simple toaster has nearly 400 components and sub components which is made from nearly 100 different materials. So imagine the difficulty if everything had to be procured and made from scratch. As Thwaites told Harford “I realised that if you started absolutely from scratch, you could easily spend your life making a toaster.”
Thwaites finally did manage to make an electric toaster, but it was nowhere as good as the ones easily available in the market. As Harford writes “Thwaites’s home-made toaster is a simpler affair, using just iron, copper, plastic, nickel and mica, a ceramic. It looks more like a toaster-shaped birthday cake than a real toaster, its coating dripping and oozing like icing gone wrong. “It warms bread when I plug it into a battery,” he says, brightly. “But I’m not sure what will happen if I plug it into the mains.””
So dear reader, you might be reading this piece sitting in the air-conditioned comforts of your office on an ergonomically designed chair (hopefully). Or you might be sitting at home reading this on your laptop. Or you must be travelling in a bus/metro/local train hanging onto your life and reading this on your android smartphone. Or you must be waiting for your aircraft to take off and must be quickly glancing through this on your iPad.
The question that crops up here is that how many of the things mentioned in the last paragraph, would you dear reader, be able to make on your own? The answer is none. So then where did all these things that make life so comfortable come from?
Dylan Grice answers this question in the latest issue (dated March 11, 2013) of the Edelweiss Journal. “So where did it all come from? Strangers, basically. You don’t know them and they don’t know you. In fact virtually none of us know each other. Nevertheless, strangers somehow pooled their skills, their experience and their expertise so as to conceive, design, manufacture and distribute whatever you are looking at right now so that it could be right there right now.”
Estimates suggest that cities like London and New York offer ten billion distinct kinds of products. So what makes this possible? “Exchange. To be able to consume the skills of these strangers, you must sell yours,” writes Grice. It is impossible for a single human being to even make something as simple as a toaster from scratch. But when many people specialise in their respective areas and develop certain skills, only then does a product as simple as a toaster become possible.
Let me take my example. I sell my writing skills. With the compensation that I get I buy goods and services that I need for my existence. From something as basic as food, water and electricity, which I need to survive or comforts like buying a washing machine to wash clothes, a refrigerator so that I don’t need to cook on a day to day basis, hiring a taxi to travel in or catching the latest movie at the local multiplex.
At the heart of any exchange is trust. As Grice puts it “we must also understand that exchange is only possible to the extent that people trust each other: when eating in a restaurant we trust the chef not to put things in our food; when hiring a builder we trust him to build a wall which won’t fall down; when we book a flight we entrust our lives and the lives of our families to complete strangers.”
So for any exchange to happen, there needs to be trust. But trust is not the only thing that facilitates exchange. There is another important ingredient. And that is money.
Money has been thoroughly abused all over the world in the aftermath of the financial crisis which broke out officially in September 2008. Central banks egged on by governments all over the world have printed money, in an effort to revive their respective economies. The idea being that with more money in the financial system, banks will lend more which will lead to people spending more and that will help revive the economy.
But all this comes with a cost. “So when central banks play the games with money of which they are so fond, we wonder if they realize that they are also playing games with social bonding. Do they realize that by devaluing money they are devaluing society?” asks Grice.
Allow me to explain. In the aftermath of the financial crisis, government expenditure all over the world has shot up dramatically. This expenditure could have been met by raising taxes. But when economies are slowing down this isn’t the most prudent thing to do. The next option was to borrow money. But there was only so much money that could be borrowed. So the governments utilised the third possible option. They got their central banks to print money. Central banks used this printed money to buy government bonds. Thus the governments could meet their increased expenditure.
When a government increases tax to meet its expenditure, everyone knows who is paying for it. It’s the taxpayer. But the answer is not so simple when the government meets its expenditure by printing money. As Grice puts it “When the government raises revenue by selling bonds to the central bank, which has financed its purchases with printed money, no one knows who ultimately pays.”
But then that doesn’t mean that nobody pays.
With the central bank printing money, the money supply in the financial system goes up. And this benefits those who are closest to the “new” money. Richard Cantillon, a contemporary of Adam Smith, explained this in the context of gold and silver coming into Spain from what was then called the New World (now South America).
As he wrote: “If the increase of actual money comes from mines of gold or silver… the owner of these mines, the adventurers, the smelters, refiners, and all the other workers will increase their expenditures in proportion to their gains.” These individuals would end up with a greater amount of gold and silver, which was used as money, back then. This money they would spend and thus drive up the prices of meat, wine, wool, wheat etc. This rise in prices would impact even people not associated with the mining industry even though they wouldn’t have seen a rise in their incomes like the people associated with the mining industry had.
So is this applicable in the present day context? The money printing that has happened in recent years has benefited those who are closest to the money creation. This basically means the financial sector and anyone who has access to cheap credit. Institutional investors have been able to raise money at close to zero percent interest rates and invest them in all kinds of assets all over the world. As Ruchir Sharma writes in Breakout Nations – In Pursuit of the Next Economic Miracles:
“What is apparent that central banks can print all the money they want, they can’t dictate where it goes. This time around, much of that money has flown into speculative oil futures, luxury real estate in major financial capitals, and other non productive investments…The hype has created a new industry that turns commodities into financial products that can be traded like stocks. Oil, wheat, and platinum used to be sold primarily as raw materials, and now they are sold largely as speculative investments.”
While financial investors benefit, the common man ends up paying more for the goods and services that he buys, something that is not always captured in the inflation number. As Grice puts it: “So now we know we have a slightly better understanding of who pays: whoever is furthest away from the newly created money. And we have a better understanding of how they pay: through a reduction in their own spending power. The problem is that while they will be acutely aware of the reduction in their own spending power, they will be less aware of why their spending power has declined. So if they find groceries becoming more expensive they blame the retailers for raising prices; if they find petrol unaffordable, they blame the oil companies; if they find rents too expensive they blame landlords, and so on. So now we see the mechanism by which debasing money debases trust. The unaware victims of this accidental redistribution don’t know who the enemy is, so they create an enemy.”
And people all over the world are doing a thoroughly good job of creating “enemies”. “The 99% blame the 1%; the 1% blame the 47%. In the aftermath of the Eurozone’s own credit bubbles, the Germans blame the Greeks. The Greeks round on the foreigners. The Catalans blame the Castilians. And as 25% of the Italian electorate vote for a professional comedian whose party slogan “vaffa” means roughly “f**k off ” (to everything it seems, including the common currency), the Germans are repatriating their gold from New York and Paris. Meanwhile in China, that centrally planned mother of all credit inflations, popular anger is being directed at Japan.”
This is only going to increase in the days and years to come. As Grice writes in a report titled Memo to Central Banks: You’re debasing more than our currency (October 12, 2012) “History is replete with Great Disorders in which social cohesion has been undermined by currency debasements…Yet central banks continue down the same route. The writing is on the wall. Further debasement of money will cause further debasement of society. I fear a Great Disorder.”
The article originally appeared on www.firstpost.com on March 21, 2013 
Vivek Kaul is a writer. He tweets @kaul_vivek