Is this the world's most important debate?

Last week the Bernanke Fed recommenced its interventionist tendencies and announced QE3. The world’s most important central bank will be able to buy its previously targeted range of securities to the tune of $40bn a month.

The Fed probably felt newly empowered by the ECB’s recent promises to action, and the deliberately awe inspiring words of ‘Super’ Mario Draghi. The world’s most systemically important central banks are building their balance sheets and with it an even bigger hand in the world’s most important financial game of poker.

The financial system gets more ‘managed’ every day, as the stewards at the helm implement their policies and ideologies.

What the debate is all about

There has been hot debate since the unfolding of the Financial Crisis in 2008 about the actual causes, the symptoms and necessary prescriptions.

The Neoclassical economists, who maintain numerical ascendancy in educational and research posts, central bank committees and political inner-circles, are convinced that we need to stimulate, borrow and spend more to prevent catastrophe, increase aggregate demand and monetary velocity, and generally protect and create jobs and wealth. This mainstream view, dominated by Keynesianism, is generally echoed in journalist circles and the mainstream media, and is still just about believed by the electorates in the Western hemisphere who hope the political and financial establishment can deliver on their ever increasing promises.

The Classical school of economic thought thinks that this way of thinking is a sham, and that the crash of 2008 was firm evidence that the intellectual emperor of the status quo had no clothes. Hedge fund manager Kyle Bass echoed these sentiments succinctly when he urged that: ‘Alan Greenspan traded the tech bubble for the housing bubble’. Concerns that central bankers trigger bigger and less manageable bubbles run high in this intellectual camp – you might have heard it referred to as the Austrian school of economics.

These Austrians argue that Keynes’ multiplier is generally illusory and that his theories were special theories not general ones. They argue that monetary velocity is the joker in the pack, and cannot be controlled as Monetarists like Milton Friedman would hope. This way of thinking, that real wealth is created by hard work and enterprise – not by debt and spending, has real concerns with the current modus operandi of our political establishment and central bankers.

Jim Rickards’ argues in his best-selling book, Currency Wars: The Making of the Next Global Crisis, the Fed has engaged in ‘the greatest gamble in the history of finance… by printing money on a trillion dollar scale’.

Looking up at the Lords of finance

Back on Main Street and it all feels highly disconcerting.

The alternatives each side presents to its proposed way forward to the buzzwords of ‘growth’ and ‘prosperity’ are highly undesirable, and the differences of opinion (eg – on gold and money) are marked. It feels like we are ants looking up at giant protagonists in the US Congress, European Parliament or UK Houses of Parliament, with storm clouds circling overhead.

What is difficult to ignore is that public debts continue to build (even if some private sector deleveraging has taken place), currencies continue to be printed and debased, confidence is weak, banks remain highly leveraged, financial repression tactics are openly pursued by central banks, economic growth and activity are worryingly sluggish (imports and exports are down), unemployment levels are high, and gold prices are still rising.

This debate must be about the biggest and most pressing one going, as the implications and costs of being wrong are so huge. Our futures, jobs and livelihoods are collectively at stake.

The next years, maybe decades, will be key to deciding the outcome. It feels like we are living through the run up to an unavoidable reckoning for economics, and we should carefully note what both sides have argued before 2008 (look decades further back to – perhaps to 1971), continue to propose now, and will argue as the Financial Crisis continues to unfold.

Whilst we have our own preferences that we often cover in these pages, now is not the time to rehash them. What we would say is that one side is likely to be proved more right than the other.

Economics being a social science (and suffering from ‘physics envy’ as George Soros beautifully termed it), covering a subject matter whose actions are difficult to measure and can affect the results, means that one side will not be indisputably correct. Economics is not like maths, where calculations are right or wrong and a bi-polarity of correctness exists.

Which snowflake causes the avalanche?

However, one of these different paradigms of economic thinking will shine or be sullied.

Debts grow, and money is being printed, at staggering rates. This might be compared to the falling of snowflakes, by the classical economists, akin to the piling up of snow prior to an avalanche.

Or, Neoclassical thinkers, and Messrs Bernanke, Draghi and King, might tell you this can continue almost indefinitely until economic recovery and growth return, bringing improved tax receipts and rosier public balance sheets.

Whilst this might not be a comfortable era to live through, the results and changes to how we manage our economies will be fascinating. Will currencies collapse as confidence evaporates? Will predicted economic recoveries, and growth rates materialise? Is the founding collateral the financial system operates from irrevocably impaired?

We may understandably be suffering from issue fatigue, have become prone to tune out from the chatter of ‘talking heads’, and perhaps be drifting down the path of apathy and cynicism. Yet, amidst all that do take a moment to generally understand what the proponents to the debate would have you believe.

We’re all aboard a roller-coaster ride, and it may continue for some time yet. We are living through a truly unique moment in financial history. The forces of inflationary stimulation are doing battle with the financial system’s apparent desire for debt destruction and deflation. The outcomes might be shocking, but be sure to to stay awake to see who got it most right… or least wrong.

If you want to keep in touch with this debate, the financial crisis and our research, follow us on Twitter or Facebook. You can also subscribe to our RSS feed: Gold Investment news.