This has not affected these primary producers significantly yet, because their costs haven’t risen all that much (the cost of equipment and labor and so on). But at some point there has to be a readjustment. It is inevitable that prices will rise, because although the value of money has fallen, the value of the earth’s natural wealth hasn’t changed – except in so far as resources have become scarcer, which will itself also cause prices to rise.
There might not appear to be any particular law that governs the relationship between the value of natural resources and money – supply and demand is hardly a scientific equation – but there ought to be a general consensus that links the scarcity of resources to the price, which must eventually feed through to the markets.
Figure 19
It’s true that markets aren’t actually all that good at valuing commodities, partly because of the influence of speculation – betting on future prices influences those prices, just as betting on a racehorse changes the odds. There’s a tendency towards a herd instinct that pushes the trend too far upwards, followed by an overreaction when it becomes obvious that prices have risen too much, sending the price too low, much the same as happens with stock markets.
One might suppose that the true value of something like oil, for example, shouldn’t vary greatly, both demand and supply being fairly constant. The former rises and falls with changes in the real economy, but not by all that much relative to the total quantity produced, as shown in Figure 20. Supply is depleted gradually by extraction, and can be temporarily reduced by production problems in a certain region – a war in the Middle East, for example. It can also be boosted by new fields coming into production. But these are not wild variations compared to the overall quantity of oil available from operational fields.
Figure 20
If we look at the oil price over the last half-century, as shown in Figure 21, we see that the price hardly varied until the dollar, and therefore oil, lost its link to gold in 1971, at which point producers began raising prices to compensate for the fall in the dollar’s value. Unrest in the Middle East added to the uncertainty and caused price spikes in 1973 and 1979. Prices fell as production increased in the 1980s and 1990s, then rose sharply in the boom up to 2008, driven by speculation as well as rising demand. So the price is obviously not governed purely by the true value of the product, and in fact might bear little relationship to it.
But ignoring these wild fluctuations, the trend for commodity prices is bound to turn upwards. Global demand will keep increasing as long as the population keeps rising and emerging economies continue to grow, while many commodities are gradually being used up. At the same time, money is more abundant than ever.
Figure 21
Easy money is cheap money
I look more closely at the subject of prices in Part Two, but for now I want to return to the debt problem. The credit bubble hasn’t really gone away: it only deflated slightly, and has since blown up again in a different form. With the government bailout of the banks, some private-sector debt has been converted into public-sector debt, which has hit a record level, greater even than was experienced at the end of the Second World War, even though there was nothing this time that remotely resembled the global crisis that made such debt unavoidable in the 1940s.
This has serious implications for the wealth of future generations, because surely public-sector debt is merely private-sector obligations carried into the future, in the form of future tax revenues. We talk about public and private sectors as if they are quite different things, but in the end the state is just the people; a collection of individuals. And unless it has somehow become possible to get something out of nothing, debts always have to be paid, one way or another.
Whether all this means we are in for another major financial shock, or whether the difference between perceived wealth and actual wealth can somehow be reconciled more gently over time, I wouldn’t like to guess, though if I were a gambler I’d put my money on another crash.
Figure 22
One thing, however, seems fairly certain: the amount of real wealth in the world today is considerably less than the figure suggested by Credit Suisse or any other financial institution, because the banks are measuring assets in terms of money that has been devalued by the credit bubble and subsequent inflation of the money supply, even though that devaluation hasn’t yet fed through into the economy.
Why hasn’t all this new money fed through into the economy? Because the banks aren’t doing anything with it. With interest rates effectively zero, the banks aren’t lending because there’s no profit in doing so. They have been building up their reserves instead, which is a good thing, but doesn’t alter the fact that money has been devalued.
The idea that governments should stimulate demand by keeping interest rates close to zero is self-defeating. The lack of demand isn’t caused by the cost of borrowing. How could it be, when interest rates are already so low? The lack of demand is caused by the reduction in the real wealth of the majority of the population, which is linked to the shortage of real jobs and the related decline in real wages.
The credit boom boosted demand with debt-based consumer spending – the growth in GDP was artificial, as I’ve shown. So the answer can’t be to increase demand through more borrowing. The answer is to accept lower demand, because this is the real level of demand, and concentrate government policy on creating jobs instead of creating more debt.
There is a fundamental relationship between money and work: when we exchange money, we are ultimately exchanging our labor, and although this doesn’t necessarily apply in practice in the modern world, the principle is still relevant, for reasons I shall explain in Part Three.
But there’s an even bigger issue behind all this, connected to the increasing dominance of accumulated wealth over produced wealth, as seen in the rise of the financial sector relative to real industry. It is this rise that led to the increase in lending, encouraged by ever-lower interest rates – a glut of cheap money that in turn led to the credit and house-price bubbles, and I think this has major implications for the future of the global economy, and for the future of civilization in general.
Representations of wealth, such as money, must be linked to the real wealth created by industry. Money has no other claim as a measure of wealth. Government promises mean nothing if the government cannot back the promise with real wealth. The rise of the financial sector to a position of economic dominance over real wealth-creating industry poses a serious threat to the value of money everywhere, and to the economy in general.
The whole concept of making money from assets such as property and other financial investments, rather than from real industry, is deeply flawed. No real wealth can be created this way; all that happens is wealth is transferred from the borrower to the lender, which usually means from the middle classes to the