“Stagflation On The Horizon” By Paul Brodsky

Stagflation on the Horizon

Logic and current trends suggest that declining output growth accompanied by higher prices will begin hitting economies and facing policy makers in the coming years. Markets should begin sniffing out this stagflationary macroeconomic setup this year.


We have published data showing global output growth is in decline and have argued this trend will continue. Indeed, a long term graph of US Real GDP growth implies a change in complexion since 1999, from credit-induced boom-bust economic cycles to a secular trajectory of decline (red lines on graph 1).

Graph 1: US Real Gross Domestic Product: Percent change from preceding period is in secular decline


This trend is especially troublesome following the debt-induced wash-out recession in 2008/2009, subsequently offset by zero-bound interest rates and central bank asset purchases. Since then, real GDP growth, characterized by middling output and low consumer inflation, has languished on a low plane, bouncing between 2.5 percent and 1.6 percent (shaded box on graph 1).

The US Bureau of Economic Analysis will not release its initial GDP estimate for Q1 2017 until April 28, but credible high frequency reports suggest real US output growth is in the process of falling below its low plane. The Atlanta Fed’s GDP now forecasts growth of only 1.3 percent in the first quarter. Among the factors weighing on the updated outlook are softer projections for household spending and non-household capital expenditures. Even more ominous is that this estimated slow growth included a month (February) in which the average temperature was ten degrees above normal – the hottest in sixty years.

Weak output growth is a far cry from the Fed’s official 3.1 percent forecast based on broad econometric models. This more optimistic forecast has more influence over the Federal Open Market Committee, which establishes and executes monetary policy. Accordingly, the Fed has communicated it will hike rates today and hinted it will again two or three more times in 2017.

Declining secular growth stems from the downside of pervasive debt assumption, which retards capex and consumer spending. Unperturbed, policy makers are doubling down. GaveKal Capital published the following two graphs showing how critical Treasury debt issuance has become to US growth. The first shows how debt assumption is increasing far more than GDP ($1.05 trillion of federal debt vs. $632 billion of GDP in the latest quarter). Clearly, it takes a lot of government debt assumption to drive output growth.

Graph 2: Diminishing Impact of Federal Debt on Nominal GDP: 2007 – 2016


To prove its point, GaveKal notes a close correlation: “In the first three quarters of 2015, debt growth was held in check by the debt ceiling and fiscal conservatives in Congress. Notice the negative effect on GDP growth in this period as growth slowed each quarter. Then in the fourth quarter of 2015, the debt ceiling was suspended and the flood of federal debt began again. Predictably, growth picked up too.”

GaveKal then extended the same graph back 35 years and expressed the time series annually. We can see from Graph 3 below that output growth regularly outpaced debt assumption when a dollar of debt produced more than a dollar of output; which is to say when the US economy functioned properly. This was real economic growth – growth that was not borrowed and that was expected to be repaid someday.


Graph 3: Diminishing Impact of Federal Debt on Nominal GDP: 1980 – 2016


 As always, Treasury must service its debt by issuing new debt, and raising the debt ceiling has been a constant source of conflict among US legislators. Last week, Treasury Secretary Mnuchin asked Speaker Ryan to persuade the House to raise the ceiling as soon as possible. If Congress does not raise it above $20 trillion, experts say Treasury would default on its debt by late summer or early fall 2017.

We are of the view that Congress will once again raise the debt ceiling, but that it will come at a significant cost. One of the major sources of the recent rally in equities and higher Treasury yields has been enthusiasm over Donald Trump’s economic initiatives. If raising the debt ceiling is delayed or tied to legislation that triggers future debt retirement, then expectations for future US growth would decline, as would US equities and Treasury yields.

Even if raising the debt ceiling goes smoothly, we think global output will continue to drop. Using debt to promote output growth is playing out across the world. Despite massive debt growth, output is static or declining in Europe…






…and even India:


Where is the global driver of output growth? Which geography or segment of society has a balance sheet large enough and un-levered enough to support a return to a debt-fueled boom-bust economic cycle?

Are we to believe that changes in US fiscal, regulatory, immigration and trade policies would have the power to persuade businesses and consumers around the world to reverse course – to not care about the exchange value of their currencies – so that they produce and consume for the benefit of American output and labor? Even if President Trump succeeds at raising US GDP to 3 percent, which would be no easy feat, how sustainable would that be and would it even matter for US multinationals that must grow abroad?

Investors should take note of what should logically be one of the highest-frequency leading indicators for the onset of a recession – retail spending. S&P retail sector stocks, as expressed in the XRT ETF, have declined 13 percent over the last six months in spite of a very strong stock market, and for good reason. Table 1 shows that in the last two quarters profit margins in the retail sector have crashed:

Table 1: Leading Indicator of Recession: Retail Sector Profit Margins are crashing


Watching US market ebullience in the face of a tiring, highly-indebted US economy that lacks an obvious new outlet for credit growth is like watching a slow motion car crash. We expect continued disappointing consumption, corporate profits and real growth rates to continue in 2017, in the US and around the world, and expect it to be followed by declining global trade and economic malaise.


We expect rising inflation to accompany falling output, and to understand why we offer a wonky but practical discussion of inflation.

Classic economics suggests demand and inflation should track each other higher and lower. Such a correlation, however, is not as tight in real life as it is conceptually. Super-economic factors associated with the exogenous management of global trade and credit greatly affect supply in ways often unintended by policy makers. From time to time supply shortages arise independent of the economics of production and demand. This creates significant economic dis-equilibria, leading to substantial inflation.

The last time this occurred was in the 1970s. OPEC oil exporters, bothered by the unknown future purchasing power of the new fiat dollars they were being forced to receive in exchange for their crude, limited its supply and drove up its price. Since energy was needed for manufacturing and transporting goods and services, the general price level rose across economies, even as demand and the need for labor fell. So, policy-induced supply disruptions led to slowing output and rising prices – stagflation.

Since then a global monetary regime that prices oil and most other trade goods in fiat dollars has been in force. US policy makers have maintained a generally stable dollar and, as importantly, strong dollar-denominated assets, which have provided global suppliers with an attractive destination for their wealth.

A stable dollar and generally rising US financial assets have created a fairly stable level of perceived wealth creation across the world. Were the dollar’s exchange rate or capital markets to fall, then US dollar and asset holders (foreign and domestic) would have great incentive to liquidate their holdings. Thus, the perception of the US as the global hegemon is the key to stability in the global economy.

What would cause capital flight out of the US? The obvious answer is the general perception that the dollar and the US economy will weaken more than those of other major economies.

This does not seem to be the case today, at least in relative terms. Following the financial crisis, the Fed acted aggressively to de-leverage the US banking system and was then first to taper and stop quantitative easing. US dollars and capital markets attracted global wealth. More recently, the Fed was also the first among major central banks to begin raising benchmark interest rates, which has further boosted the exchange value of the dollar vis-à-vis other major currencies. The recent enthusiasm over President Trump’s economic initiatives has provided a further boost to US corporate equity. All seems copacetic presently for dollar and US asset holders around the world.

Graph 4: DXY Index: a strong US dollar


Imminent Problem: A Scarcity of Dollars

Not so fast. Relative strength in the dollar stems from positive interest rate differentials and the natural demand for dollars to service, rollover and repay dollar denominated debt. Total US credit market debt totaled over $60 trillion (before the Fed stopped publishing it last quarter), which is five times M2 and fifteen times base money – the amount of deliverable dollars available to repay it. (The $60 trillion figure does not include off balance sheet obligations like Social Security, which would boost the multiple further.)

Graph 5: US dollar Leverage


There is also a scarcity of dollars held in foreign hands relative to the scale of the global economy. This will lead to a decline in dollar reserves held abroad. Recall that global trade volume is mostly based in dollars. A decline of dollars held in reserve limits global trade, pushing global output down. This, in turn, speeds incentives to raise the status of other major currencies to compete with the dollar.

To date, US bond issuers have had an easy time servicing their obligations because the dollar has been strong and they have produced sufficient revenues in dollars. The more pressing problem may arise from non-US issuers of dollar credit, which has doubled over the last ten years to $10 trillion. This credit also has to be serviced, rolled over and repaid in dollars. We anticipate increasing pressure among non-US dollar creditors to obtain dollars as the Fed hikes US interest rates, strengthening the dollar further.

The most pressure will be felt by emerging market sovereigns, banks and other companies that have issued about $3.2 trillion in dollar bonds. While further dollar strength would increase exporters’ profit margins, it would also reduce gross trade volume. Top line output of EM economies would suffer and they would likely raise consumer prices to maintain nominal growth rates. Inflation.

A discussion of the US dollar and dollar assets (including US real estate) without a discussion of dollar denominated liabilities is like trying to clap with one hand. Depending on how one counts, 25 to 95 percent of US dollars have liabilities attached to them. To service or repay these liabilities, more dollars have to be created. Simply liquidating assets to service or repay them will not work because for every liquidation there must be a buyer and the buyer must have dollars (that do not exist) to settle the trade.

Interest rates attached to liabilities ensure that the gross amount of liabilities will grow at a compounding rate, and higher interest rates ensures liabilities will grow faster. This, in turn, puts further pressure on assets to generate returns in excess of the negative return from liabilities. Eventually, this pressures policy makers to make sure asset prices rise more than the compounding rate of liability growth.

Ultimately, helping to maintain the appearance of rational asset valuations and decent commercial fundamentals becomes secondary to policy making institutions principally charged with protecting the dollar-centric global monetary system. We are currently far along on this spectrum.

We argue the US economy, US assets, the Fed and US fiscal policy makers are displaying obvious signs of late-stage fatigue associated with protecting the current global regime at all costs. As in the 1970s, the triggers for goods and service inflation within a slowing global economy will be currency related and a dearth of supply flowing through the trade channel, but rather than oil, this time the world will lack an adequate supply of increasingly scarce dollars needed for debt service.


The Political Solution: Dollar Inflation

Milton Friedman famously noted “inflation is always and everywhere a monetary phenomenon”. In the post-Bretton Woods monetary system, the pricing and supply of money and credit are not determined by production, but rather by monetary and currency exchange policies. Central banks and treasury ministries manufacture inflation through policy administration.

This is easy to see in extremis. During the financial crisis central banks were able manipulate the general price level higher to counteract the onset of deflation. We learned from the 2008/2009 experience, however, that central banks cannot determine where new money and credit mostly flow – to production or to assets. Central banks can directly manipulate only bank balance sheets, and banks, in turn, tend to lend more to issuers and buyers of assets when the organic need for production is not increasing.

The organic need for more production in the US (and everywhere else) is falling, as evidenced by declining global output growth. The only lever US policy makers will soon have left to pull, if they want to maintain the USD-centric global system, will be coordinated currency dilution (i.e., devaluation).

Oil is still very important to manufacturing and transportation, but oil exporting countries no longer have the same influence over global pricing, thanks to Russia’s ability to compete in global trade and the more recent fracking revolution in the US. The exogenous influence that would produce global economic dis-equilibrium and bring about stagflation today would be money itself, specifically US dollars.

To produce consumer inflation coincident with declining or contracting output, there must be an exogenous influence over prices outside the reach of central banks. We believe that influence is actually – and ironically – contracting production. The less production in an economy, the less influential that economy’s factors of production are in the global economy, and the less influence its central bank has over the global supply of goods and services.

The Fed has already recognized, and communicated to the public in its statements over the last two years, that its monetary policies also consider the strength of the dollar, trade and the global economy. We think it will have to soon recognize declining global output growth and the impact a strong dollar has on it. Our guess is that the Fed would like to hike rates as much and quickly as possible over the next two years so that it can then reduce them – to weaken the dollar – as global output sinks deeper.

In the end, the Fed will not be able to protect unilateral US dollar hegemony. Officials at the Fed and other major central banks, working bilaterally and with the BIS, IMF and WTO, would have to try to bring the purchasing power value of all currencies down together in relation to the real value of global production. Doing so successfully would be a monumental bureaucratic undertaking. We imagine it will be messy from social, political, economic and, especially, financial perspectives.

The Fed will have to turn on the spigots and create dollars for US and foreign creditors and, if they are lucky, debtors too. Stagflation will appear. The markets should begin getting a whiff of this soon.


Cuándo Trump olvidó a Ricardo y a Keynes. Comentario de Ignacio Diez. CS Gestion SGIIC

La Fed reiteró su intención de subir tipos gradualmente a medida que el mercado laboral siga mejorando. El primer meeting del año de la Reserva Federal sonó ligeramente más optimista, ya que reconoció una mejora de la confianza del consumidor y de las empresas, así como del mercado inmobiliario. Los inversores se centrarán ahora en el dato de empleo del viernes para tomar posiciones tras la incertidumbre creada tras la investidura de Donald Trump en sus dos primeras semanas de mandato.

La Fed no hizo mención alguna a planes de reducción de balance. Continuamos pensando que habrá posiblemente dos subidas de tipos este año. La primera podría llegar más de cara al tercer trimestre, salvo que haya un repunte de la inflación por encima de lo esperado en el primer semestre. No obstante, estaremos muy atentos a las noticias en referencia al plan de estímulo fiscal anunciado por Trump.

La reacción del mercado a la decisión de la Reserva Federal se concentró principalmente en su divisa que se depreció contra el euro hasta niveles próximos al 1,08. La curva de tipos apenas se movió, ya que no hubo sorpresas.

“Simplicity does not precede complexity, but follows it.”

– Alan Perlis

“Stop trying to change reality by attempting to eliminate complexity.”

– David Whyte

Esta semana vamos a reflexionar sobre el acierto o no de los aranceles a la importación y la política fiscal expansiva . Vamos a tratar de ver las consecuencias de la política económica que es posible que acometa Trump.

Nos  gustaría desarrollar una falsa idea que corre por los medios basada en el cálculo del PIB por la vía de la demanda y como no  se puede incidir en él de forma aislada interviniendo un componente como las importaciones . El PIB, es la suma de la Demanda Interna de un país (Consumo Privado, la Inversión Bruta y el Gasto Público más la Demanda Externa (Exportaciones de bienes y servicios menos las Importaciones de bienes y servicios). Debido a que el PIB sólo calcula los productos producidos en el país, se deben restar las importaciones. Las exportaciones deben añadirse, porque una vez que abandonen el país, no se añadirán a través de gasto de los consumidores. Para tener en cuenta la importación y exportación, toma el valor total de las exportaciones y resta el valor total de las importaciones. A continuación, agrega este resultado en la ecuación. Si las importaciones de un país tienen un valor superior a sus exportaciones, este número será negativo. Si el número es negativo, resta en lugar de agregar. Aquí es donde nos gustaría centrarnos. El déficit de la balanza por cuenta corriente de bienes y servicios se compensan con la balanza de capital. Si se pretende por parte de la Administración Trump que una caída de las importaciones genere un superávit en la balanza por cuenta corriente no se da cuenta que el PIB caerá ya que producir en USA hará que los productos sean más caros, la inflación elevará los tipos de interés y se contraerá el Consumo y la Inversión.

Tipos más altos atraerían capitales y el dólar se apreciaría agudizando la caída de las exportaciones.  El mundo es global y no es posible revertir esta tendencia. Ya se intentó en los años 80 con el sector de autos y todos sabemos cómo acabó la industria en Estados Unidos.

Con el fin de no incurrir en errores, es importante saber que en el pasado a la hora de presentar los datos de balanza de pagos de los distintos países, y en la mayor parte de los libros de macroeconomía todavía en la actualidad, cuando se hace referencia a la balanza por cuenta corriente ésta incluye las transferencias de capital que en la actualidad se suelen presentar en una cuenta independiente.

Sin embargo; siguiendo la metodología recomendada en la actualidad por el FMI y seguida por la mayor parte de los países, la capacidad o necesidad de financiación vendrá determinada por la agregación de los saldos de la balanza por cuenta corriente y de la cuenta de capital.

Un desequilibrio por cuenta corriente no es en sí ni bueno ni malo, de modo que en ocasiones puede ser interpretado como beneficioso para el país en cuestión, mientras que en otras ocasiones se considerará perjudicial, dependiendo de las circunstancias económicas concretas del país.

Existe una identidad contable básica en economía internacional según la cual, la balanza por cuenta corriente a nivel mundial debe estar equilibrada, o lo que es lo mismo, deberá cumplirse que la suma de los saldos en cuenta corriente del conjunto de países debe ser cero. Por tanto, el saldo por cuenta corriente de los países superavitarios (que determina la capacidad de financiación a nivel mundial) deberá coincidir con la suma de los saldos en cuenta corriente de los países deficitarios (que determina la necesidad de financiación a nivel mundial).

Así, la contrapartida al aumento del déficit por cuenta corriente de Estados Unidos y al consiguiente aumento en las necesidades mundiales de financiación ha sido la expansión de los superávit en otros países.

David Ricardo (Londres, 18 de abril de 1772 – 11 de septiembre de 1823) fue un economista inglés de origen judío sefardí-portugués, miembro de la corriente de pensamiento clásico económico, y uno de los más influyentes junto a Adam Smith y Thomas Malthus. Es considerado uno de los pioneros de la macroeconomía moderna por su análisis de la relación entre beneficios y salarios, uno de los iniciadores del razonamiento que daría lugar a la ley de los rendimientos decrecientes y uno de los principales fundadores de la teoría cuantitativa del dinero. También fue un hombre de negocios, especulador exitoso, agente de cambio y diputado; logrando amasar una considerable fortuna.

El modelo de la ventaja comparativa es uno de los conceptos básicos que fundamenta la teoría del comercio internacional y demuestra que los países tienden a especializarse en la producción y exportación de aquellos bienes que fabrican con un coste relativamente más bajo respecto al resto del mundo, en los que son comparativamente más eficientes que los demás y que tenderán a importar los bienes en los que son más ineficaces y que por tanto producen con unos costes comparativamente más altos que el resto del mundo.

Esta teoría fue desarrollada por David Ricardo a principios del siglo XIX, y su postulado básico es que, aunque un país no tenga ventaja absoluta en la producción de ningún bien, es decir aunque fabrique todos sus productos de forma más cara que en el resto del mundo, le convendrá especializarse en aquellas mercancías para las que su ventaja sea comparativamente mayor o su desventaja comparativamente menor. Esta teoría supone una evolución respecto a la teoría de Adam Smith. Para Ricardo, lo decisivo en el comercio internacional no serían los costes absolutos de producción en cada país, sino los costes relativos.

De la teoría ricardiana sobre el comercio exterior solamente la teoría sobre los costes comparativos fue introducido en los libros de texto. La teoría de los costes comparativos sostiene que el comercio entre dos países es beneficioso para los dos países incluso en el caso que un país es más eficaz que otro en la producción de todos los productos.

El comercio internacional es beneficioso para todos ya que conduce a una mejor asignación de los recursos y una especialización orientada a mejorar el PIB per capita de cada economía. Trump debería darse cuenta que el PIB en Estados Unidos ha crecido gracias a la tecnología, biotecnología, shale oil y shale gas y otros sectores más productivos que ha hecho que en sectores con menos rentabilidad se haya trasladado el empleo a otros países. El comercio es el componente del PIB que más pesa en USA y este se ha disparado gracias a una mayor renta disponible como consecuencia de la bajada de precios de muchos de los bienes importados.

David Ricardo:

“En un sistema de comercio perfectamente libre, cada país, dedica su capital y trabajo a los empleos que le son más beneficiosos, utiliza más eficazmente las facultades peculiares y distribuye el trabajo más eficaz y económicamente. Con esto difunde el beneficio general, une por medio de los lazos del interés y el intercambio, la sociedad universal de las naciones, ya que es más fácil importar aquellas cosas que cuestan más producir y exportar aquellas que podemos producir más cómodamente (más beneficioso aplicar todo el capital a aquello en lo que somos buenos produciendo, que a aquello que nos cuesta más).”

En On the principles of Political Economy and Taxation David Ricardo explica esta teoría en media página de 350 páginas. Se puede decir igualmente que menciona este aspecto, sin darle gran importancia. Es otro ejemplo más para un fenómeno que podemos ver muy a menudo. Algo bastante irrelevante en la obra original llega a ser la afirmación central y aspectos mucho más importantes caen en el olvido. Es algo parecido a como se está desvirtuando a Keynes. Su política de expansión fiscal iba dirigida a períodos de contracción, no de picos de ciclo. No tiene sentido argumentar que la actual política económica estadounidense es keynesiana.

Ricardo es recordado por su profundidad intelectual y la forma excepcionalmente moderna con la que abordaba los problemas económicos, con un elevado y riguroso nivel de abstracción a pesar de que carecía de formación universitaria reglada. Igualmente todavía hoy Keynes, sigue siendo un economista ‘muy actual’, con reflexiones que aún hoy siguen haciéndonos reflexionar mucho sobre el ahorro y la política económica.

El keynesianismo es una teoría económica propuesta por John Maynard Keynes, plasmada en su obra Teoría general del empleo, el interés y el dinero, publicada en 1936 como respuesta a la Gran Depresión de 1929. Está basada en el estímulo de la economía en épocas de crisis.

Este control se ejercía mediante el gasto presupuestario del Estado, política que se llamó política fiscal. La justificación económica para actuar de esta manera parte, sobre todo, del efecto multiplicador que, según Keynes, se produce ante un incremento en la demanda agregada.

Las escuelas monetarista y austríaca han intentado refutar el keynesianismo, sin embargo, éste sigue aplicándose en la mayor parte del mundo, y cierta parte de los economistas más influyentes del mundo son reconocidos keynesianos, como Paul Krugman y Joseph Stiglitz.

Al igual que establecer aranceles como hemos podido explicar es un error y lejos de crear empleo lo va a destruir, hacer una política fiscal expansiva en la parte final de uno de los ciclos más largos, es un error mayor que desembocará en un fuerte incremento de tipos, una recesión más profunda y un ajuste mucho mayor. Lo crea o no Trump el mundo sigue siendo Global, Digital y Renovable.

“Con un proceso continuo de inflación, los gobiernos pueden confiscar, secreta e inadvertidamente, una parte importante de la riqueza de sus conciudadanos (…) Pero cuando los fenómenos son tan complejos, los pronósticos no pueden señalar nunca un solo camino, y se puede incurrir en el error de esperar consecuencias demasiado rápidas e inevitables de causas que acaso no son todas las aplicables al problema.”

J.M. Keynes

“Economics in general has a problem. It wants to be seen as a true science, on the level of physics or biology or chemistry, rather than one of the soft sciences like sociology or history. At various times, economics has been called “political economy” or “philosophical economy.” Political economy was, in the words of Adam Smith, “an inquiry into the nature and causes of the wealth of nations,” and in particular “a branch of the science of a statesman or legislator [with the twofold objectives of providing] a plentiful revenue or subsistence for the people… and to supply the state or Commonwealth with a revenue sufficient for the publick services.”

John Mauldin

The Great Gatsby and the Fed Mises, by Louis Rouanet

Even the most innocent novel can give its reader a fresh perspective on the economy during the author’s time. Economic writings and economic conditions often inspired great writers who, in turn, allowed us to contemplate either a glimpse or a detailed picture of economic reality. Stendhal was influenced by Malthus, Flaubert by Bastiat, and Ayn Rand by Mises. Other novelists faithfully described the economic times of their lives. Émile Zola, for instance, brilliantly accounts for the French 1882 financial crisis in his novel L’Argent (1891) and unconsciously exhibits the evils of fractional reserve banking.

Just as Zola’s L’Argent, so too F. Scott Fitzgerald’s The Great Gatsby (1925) is a product of the business cycle. Some have interpreted Fitzgerald’s novel as an indictment against capitalism. It is not. It has been said that Gatsby is a product of alcohol prohibition, but Gatsby is also the unfortunate product of the Federal Reserve’s expansionist monetary policy. The “constant flicker” of the American life described by Fitzgerald in his celebrated novel is no less than the artificial boom driven by the Fed during the roaring twenties.

Inequality and the Fed during the Twenties

The Franco-Irish economist Richard Cantillon was among the first to notice the redistributive effects of monetary creation. Cantillon observed that the first to receive the newly created money saw their incomes rise whereas the last to receive the newly created money saw their purchasing power decline as consumer price inflation came about.

Under modern central banking, money is created and injected into the economy through credit on financial markets. Thus, the economics of Cantillon effects tells us that financial institutions benefit disproportionately from money creation, since they can purchase more goods, services, and assets for still relatively low prices.

One of the most visible consequences of this growth of financial markets triggered by monetary expansion is asset price inflation. Increases in asset prices will mainly benefit the wealthy for several reasons. First, the wealthy tend to own more financial assets than the poor in proportion to income. As the wealthy’s net worth increases, securities with continuously rising prices can be used as collateral for new loan requests. Second, it is easier for the richest individuals to contract debt in order to buy financial assets that can be sold later at a profit. Since credit-easing lowers the interest rate and therefore funding costs, the profits made by selling inflated assets bought on credit will be even greater. Finally, asset price inflation coming with the growth of financial markets will benefit the workers, managers, traders, etc., in the financial sector.

Not surprisingly, the development of ostentatious wealth and extreme inequality is one of the main themes in The Great Gatsby — which was published and written during the boom that would finally lead to the Great Depression. In his bestseller on the causes of the “Great Crash” of 1929 and the subsequent Great Depression in the United States, John K. Galbraith mentions “the bad distribution of income” as the first of “five weaknesses which seem to have had an especially intimate bearing on the ensuing disaster.” The cause of this rising inequality is to be found in asset price inflation.

The responsibility of the Fed in the asset price bubble of the 1920s cannot be doubted. Indeed, as late as 1927, Benjamin Strong, who was then governor of the Fed, told the French economist Charles Rist that he was going to give “a little coup de whiskey to the stock market.” Similarly, the former chairman of the Fed, Marriner S. Eccles, points to the rising inequality financed by credit expansion during the 1920s, when, “as in a poker game where the chips were concentrated in fewer and fewer hands, the other fellows could stay in the game only by borrowing. When their credit ran out, the game stopped.”


 Money in The Great Gatsby is either inherited or derives from the mysteries of high finance or comes from crime or is made on the sports field. Involuntarily, Fitzgerald unfolds the Cantillon effect before our eyes. Indeed, the artificially stimulated financial sector, Fitzgerald shows, creates a distinctive geography and urban space. Whereas Manhattan and Long Island benefit from the redistributive effects of money production by the Fed and the Wall Street banks, the rest of America suffers from them. Thus, in the first chapter of the book, Nick Carraway explains that “Instead of being the warm center of the world, the Middle West now seemed like the ragged edge of the universe — so I decided to go East and learn the bond business.” Under central banking, money is first of all where it is artificially produced rather than in the hands of the most talented entrepreneurs. Nick followed the money.

Easy Money and Consumerism

The Great Gatsby describes a society that had gone beyond industrialism to become driven by leisure and consumption. But this too was at least partially caused by the Fed’s policies. As Dr. Guido Hülsmann writes in The Ethics of Money Production (p.187): “The spiritual dimension of these inflation-induced habits seems obvious. Money and financial questions come to play an exaggerated role in the life of man. Inflation makes society materialistic.”

No surprise then that the romance between Gatsby and Daisy is fashioned by materialistic concerns. Daisy’s love for Gatsby is conditioned by his great wealth. Daisy’s emotions are “materialistic”:

Suddenly, with a strained sound, Daisy bent her head into the shirts and began to cry stormily.

“They’re such beautiful shirts,” she sobbed, her voice muffled in the thick folds. “It makes me sad because I’ve never seen such — such beautiful shirts before.”

Consumerism is a function of monetary inflation because easy money policies create the illusion of wealth and thus lead individuals to consume more than they would otherwise. Because consumption increases, the capital stock will decline and society will ultimately be poorer than it would have been. This naturally leads us to depict the cultural consequences of easy money which are so visible in The Great Gatsby.

The Cultural Consequences of Inflation

The cultural effects of inflation have perhaps never been clearer than during the 1920s. As H.L. Mencken writes in 1925 in his review of The Great Gatsby, “To find a parallel for the grossness and debauchery that now reign in New York one must go back to the Constantinople of Basil I.” Mencken then adds with typical wit and gusto:

The thing that chiefly interests the basic Fitzgerald is still the florid show of modern American life — and especially the devil’s dance that goes on at the top. He is unconcerned about the sweatings and sufferings of the nether herd; what engrosses him is the high carnival of those who have too much money to spend, and too much time for the spending of it. Their idiotic pursuit of sensation, their almost incredible stupidity and triviality, their glittering swinishness — these are the things that go into his notebook.

By meddling with money, the Fed created an illusion of wealth and contributed to the creation of an all-pervasive world of illusion. It is Paul Cantor, that patron saint of Austrian literary criticism, who has noticed the link between inflation and the distortion of reality. Under fiat money, reality is confused with illusion and inauthenticity becomes a prevalent trait among the people. As Paul Cantor writes:

In a paper money economy, one does not see gold anymore, but the currency gives the illusion of the presence of wealth. The increasingly mediated character of the modern economy, especially the development of sophisticated financial instruments, allows the government to deceive its people about the nature of its monetary policy. When a government tries to clip coins or debase a metal currency, the results are readily apparent to most people. By contrast, the financial inter-mediation involved in modern central banking systems helps to shroud monetary conditions in mystery.

This inauthenticity of the characters in The Great Gatsby is obvious. From the beginning, everyone is speculating about Gatsby’s true identity. “Somebody told me they thought he killed a man once” says one; “it’s more that he was a German spy during the war” answers another. Gatsby himself lies about the fact that he was educated at Oxford. Worse, Daisy’s love for Gatsby is revealed to be phony as she finally realizes that her allegiance is with her husband Tom.

For the reader who knows his monetary history, nothing is clearer in The Great Gatsby than the cultural decline for which the artificial inflation of the money supply is responsible. Central banking, today as in the 1920s, led formerly good Americans to lie, commit fraud, and desert hard work. As Nick Carraway narrates the first night he goes to Gatsby’s mansion:

I was immediately struck by the number of young Englishmen dotted about, all well dressed, all looking a little hungry, and all talking in low, earnest voices to solid and prosperous Americans. I was sure that they were selling something: bonds or insurance or automobiles. They were at least agonizingly aware of the easy money in the vicinity and convinced that it was theirs for a few words in the right key.

In an inflationary environment, one must dream of becoming an overnight success because the slow steady way of amassing a fortune by working hard simply will not work. Hard-working people are systematically screwed. George Wilson, the garage owner and the figure of the hard-working American is, with Gatsby himself, the great loser of the novel. Not only is his wife Tom Buchanan’s mistress but she ends up dead. In The Great Gatsby, the Cantillon effect holds true even for love and women. Fitzgerald, however, somehow anticipated the bust that inevitably follows the boom. Gatsby dies. Nick returns to the Middle West.

One disappointing aspect of The Great Gatsby is the lack of contrast between the nouveaux riches who got wealthy thanks to fraud and financial speculation and the entrepreneurially talented bourgeoisie. This contrast, for instance, was made much clearer in Émile Zola’s book L’Argent. In Fitzgerald’s world, on the other hand, all the rich people are immoral and disgusting creatures. To this extent, Zola was much more successful, more than 30 years before Fitzgerald, in accounting for the corruption of entrepreneurial values and the debauchery caused by modern finance under fractional reserve banking and central banking.

One reason why Fitzgerald was incapable of elucidating different categories of rich was his insensitive ignorance of the financial sector itself. Contrary to Garet Garett’s novel The Driver (1922) which precisely describes the inner workings of the financial sector, Fitzgerald is sloppy and particularly unknowledgeable when it comes to describing the stock market. Thus, there probably is a germ of truth when Mencken writes that The Great Gatsby is “no more than a glorified anecdote, and not too probable at that.” Nonetheless, the moral decay on display in Fitzgerald’s novel serves, not merely as titillation for the reader, but as an object lesson in the evils of both central banking and prohibition.