Aggregate Demand. The holy grail of economics.

Humanity has a liking for both philias (in Greek, obsessive mental love) and phobias (in Greek, aversion, hatred). After all, if the Darwinian human evolution theories are correct, herd thinking preceded individual thinking  (my apologies to Adam and Eve believers). Philias and phobias are great for crowds. No subtle or complex thinking is required. You just follow the herd with simple binary answers. And now the herd is convinced that printing money is good. GDP growth (even prostitution and drug traffic induced) is good. Money should be lent for free (why pay the saver?). Deflation is bad (it’s better to degrade the purchasing power of your salary). Salaries should be as competitive (read low) as possible. Profits must soar to help equity price bubbles. Nowadays surely everyone must know that everything must be done to ensure the continuity and growth of the holy Aggregate Demand. If they don’t, they must be autistic (thanks Dustin Hoffman. What a film on the subject you made). They are sick -do not listen to them.

SPAIN-RELIGION-GRAILAggregate demand (AD) is the new new Holy Grail. It’s a better asset than gold, crude, water, or land. Pressed to choose an asset, I’d rather own the sovereignty of 500.000 citizens with substantial purchasing power, than a nuclear energy generation complex. All kinds of corporations would try to sell their products and services to my citizens. I’d make them pay for that. And, rest assured that they would pay me every time they tapped my  AD. Regardless of the fact they made a profit with it or not, and regardless of their nationality. AD is the best long term asset, if you learn to profit from it. Your bargaining position is exceptional.

Keynesians learnt this a long time ago. The rest of the economists were also aware of the importance of AD, but innocently thought it was the constant and gradual supply side improvement that would support it. That was naive; improving AD old style was heavy lifting. Nobody likes heavy lifting any more. Surfing in Hawaii is the new fad. So Keynesians  set up an altar to the AD god (goddess now that I think of it) instead, and prayed to the new god daily. Millions of economists and ordinary people converted to the new religion. We, non-converts, have all been declared heretic. Being burnt alive is our final destiny.

Needless to say, Keynesians are not (all) stupid. With their prayers they also offered the new god some action: daily sacrifices. Good for masses. True enough -no more ritual sacrifices of virgins at an altar. Too messy. Instead, they used monetary and fiscal policy regardless of the effects. Debt soared due to fiscal deficits, and somebody is allowed to starve every other day. After all starving by some is only an inevitable side effect. Same thing with crushing a  new generation with debt. Both effects are something like a war casualty – inevitable.

TH22-STARVATION_NIG_131517eIf money printing doubles the price of petrol, wheat, or corn … “Sorry, we didn´t want that to happen, may I offer you our condolences” , Janet would politely say. “But we had to print, or AD would not grow”. If future generations need impossible primary surpluses to pay off that debt, well … ¡bad luck, you should have been born before -you’re late to the party! You can always pass the problem on. It’s really a musical chairs game. Just make sure the music does’t stop on you, and you will be Ok. Ask Chuck Prince.

Every religion has its acolytes. Central Banks worship Aggregate demand. Their board members are the archbishops in this particular church. It is in the holy name of AD that they print and party every day. And they are famous, wealthy, and powerful vicars. The last Mohicans of the true Borgia clan with italian medieval roots. Forget Elvis Presley or Michael Jackson, they were popular, but had no power. Janet and Mario are the new gods of mount Olympus. It is through their infinite wisdom that we will access the “sanctum sanctorum” (or the nirvana for buddists). Whenever you see a central banker remember to kneel down and kiss his honourable hand (not if he’s been in Africa of late).

Of course, even Goebbels would need some substance underneath, if he was to uphold and support any popular belief. In this case we are talking about a God that has drawn some presumably intelligent people to its worship. So there must be something to AD that generates such kind of unconditional addiction.


Inevitably, some economic theory is needed when we get to this point. If AD is so sexy it means it es very valuable. It has to be valuable if we are willing to sacrifice the poor and our children literally “for god’s sake”. And what makes something valuable to society? It is scarcity and usefulness that drives value. Even fashion calls are finally subject to using one of those two pedestals. When something is very useful it doesn’t have to be scarce to be of practical value. But if it can be found or built easily, and unless some kind of oligopolistic structure is set up, it’s price will tend to equal the marginal cost of production. The supply side will be able to sell it, but it’s unlikely it will be esteemed by society as “valuable”. So something is unlikely to be top value unless it is scarce, expensive to build, or has solid entry barriers to entering the supply side.

Solid Aggregate demand can certainly not be found or produced easily above the level implied by Says law, unless a couple of million of well off Martians moved over to live in your city. And, don’t forget, they would be unwelcome unless they brought their savings with them to spend. If they can’t spend, you don’t want the martians for more than a polite conversation over a cup of coffee.

ATreatiseOnPoliticalEconomySo AD is scarce because it’s not easy (or long term viable) to generate it outside Says law. When something is scarce, like diamonds, pricing is supply and demand driven. With some occasional manipulation up in the Netherlands. Manipulating market prices is as addictive as sex. Remember Michael Douglas? He had to cure his sex addiction in a Barcelona clinic. I wonder how they get to do that. But, back to the point again, scarcity is what makes gems so expensive.

Aggregate demand is the new gold. It is scarce, will remain scarce, and it of utmost (happy with the wording Mr Jordan?) need for the economic development of the world. New entrepreneurs, new goods, new services, all need AD to prosper. Try to sell a first class product where there is no purchasing power; hopeless. In Spain, we learn that the hard way every single day. Unless your customers have a Bankia super “black beauty” special credit card, you have a tough time selling, even if your product or service is excellent. Healthy AD makes mediocre entrepreneurs thrive. Take it away, and some of the fittest and smartest do not survive. You can find alternative locations to produce your goods, and you can use different energy providers, but you need accesible AD somewhere in the world if you are to survive as a corporation.

tractorsIn one of my first posts, written in spanish, I explained what pushed the developed world into the actual state of affairs. Succinctly, my thesis is that humanity improved its standard of living steadily (in a Say compatible way) as it was able to increase productivity per worker. The supply side kept improving and one man has ended up being able to harvest what only 100 men could harvest long before (with no tools and old methods). Right up to the industrial revolution, productivity increases were badly distributed, but intense. With industrialization, and the subsequent union movement that restored some wealth distribution equilibrium, standards of living improved substantially.

At the beginning of the twentieth century it became apparent that there was a limit to the rate of improvement. If humanity’s road to opulence was Says law, it was going to take hard work and a long time. What a sweat! So we looked around for shortcuts. We had to generate AD in amounts substantially higher than the supply side natural evolution was able to provide. And we found debt. Private debt and, less so, fiscal deficit induced, public debt. 1929 is a known fact. Markets take only that much abuse. We rediscovered debt half a century later but that,s another story.

After the Second World war Bretton Woods (1944) agreements began to function. Keynes’s contribution was not respected. Only the gold standard prevented a wild abuse of foreign trade using “beggar thy neighbour” policies. And we all know how the gold standard ended. Funnily enough, it was the US that wanted to leave that door open. And other countries have used it against them repeatedly. Germans, Japanese and lately the Chinese profited from this possibility. There is a superb post on this issue by Michael Pettis.

BeggarThis way, the second shortcut to the J. B. Say law was enabled. No heavy lifting to generate AD. Just beggar thy neighbour, and surf and suntan in Hawaii. Who cares about the supply side? Over time, a covert currency and global trade war was inevitable. See my post “star wars“. Or have a chat with the chairman of the Riksbank or the SNB. Make sure whisky is abundant in order to ease “omertà” constraints.

The last surfer shortcut to the supply side long slog at generating sustainable AD, has been the welfare state. It’s simple. You subsidize workers, pensions, sick people, unemployed, and poor (food stamps) and you make up for the lack of AD generated by the obsolete supply side. So much for good old Jean Baptiste. Good riddance to… Debt is passed on, and we just ask Goebbels to convince everybody that debt is going to be paid.debt

Ditto. Please repeat to everyone you know. Debt will be paid, and Central Banks will not allow disruptions in the financial markets. That’s the missionary’s statement in the massive global common knowledge game (hat tip: Ben Hunt, Epsilon Theory).

Thanks, we are doing fine up to now, central bankers would undoubtedly say. “AD is not great but it keeps chugging along. Nothing to write back home about, but we have things under control. Considering debt and unemployment levels, AD is great! We´ve done an stupendous job. Yeah, it would be fantastic if we could fix a couple of issues in the supply side, but there’s politics you know. It ain’t easy”. In the meantime, lets stimulate again with some more fiscal deficits (debt), said the IMF two days ago. Thanks Christine. You are gifted people and always come up with “avant-garde” proposals we hadn’t even thought of.

But beware. The common knowledge game is showing some seam cracks, and some evangelists are jumping ship. Bad news is no longer good news. Where are the omnipotent central banks to be found? A loss of faith is perceptible. Faith does not spring eternal. Ask the catholic church about that. Wait and check constantly if the music keeps playing.

Bad news for the economy is good news for asset markets if investors feel that the policy response will  be effective in stimulating both activity and asset markets. When investors see no effective policy response on the growth side, at most another dose of QE, which is both politically unpopular and widely viewed as marginally effective, they buy bonds as the all-weather safe haven, basically on the view that there will be more liquidity but not much else.


The news flow isn’t any worse in aggregate than it has been in recent months and indeed over the last couple of years, but perhaps investors are realising that we’re very soon to be in a world without US QE and therefore bad news can actually be bad news for markets rather than in more recent times when bad news was often good news due to the extended liquidity it might bring

Deutsche Bank

And you know the ship is in trouble when rats are jumping ship. No mistake on the first author of the next quote reproduced. What is super dove Jeffrey worried about all of a sudden? Where can we find the “super long history” of his dissents as an FOMC member? Because if he says this now, it must mean he opposed the measures when they were being implemented. ¿Or not? Anyway, better late than never. Welcome back to the real economy Mr Lacker.

Modern central banks enjoy extraordinary independence, typically operating free from political interference. That has proved critical for price stability in recent decades, but it puts central banks in a perpetually precarious position. Central-bank legitimacy will wane without boundaries on tools used for credit-market intervention.

Since 2009 the Fed has acquired $1.7 trillion in mortgage-backed securities underwritten by Fannie Mae and Freddie Mac , the mortgage companies now under government conservatorship. Housing finance was at the heart of the financial crisis, and these purchases began in early 2009 out of concern for the stability of the housing-finance system. Mortgage markets have since stabilized, but the purchases have resumed, with more than $800 billion accumulated since September 2012.

Such interference in the allocation of credit is an inappropriate use of the central bank’s asset portfolio. It is not necessary for conducting monetary policy, and it involves distributional choices that should be made through the democratic process and carried out by fiscal authorities, not at the discretion of an independent central bank.

Jeffrey M. Lacker and J. Weinberg. Wall Street Journal Europe.

As I have said many times before, it is my firm conviction that inflation or interest rate hikes will not signal the end of this bubble. This bubble will end because money printing ultimately disappears or is not kept at sufficient levels, or because popular faith in the common knowledge game falters. If people realize debt might not be paid it is the end. Money printing is being questioned, but printing machines are still on. People must retain faith both in the holy priests of the central banks, and the sustainability of AD using current surfer methods and shortcuts. As Voltaire once said:

“La foi consiste à croire ce que la raison ne croit pas.”