The Inevitability Of Unintended Consequences

This is true even in exceedingly simple situations, which we've written about at length here at Peak Prosperity (the uncontrollable nature of the straightforward Beer Game detailed in this post on the Bullwhip Effect outlines this well). And it's one of the truisms that gives us the most confidence that the world's central planners will eventually lose control of the global systems they are trying to manage via increasingly heavy-handed intervention.

History is full of examples where governments' best-laid plans failed in spectacular fashion, exacerbating the very problems they were intending to solve. Here are a few of our favorites:

Hoy No Circula

In the late 1980s, the air pollution in Mexico City had reached concerning levels. City planners decided that reducing the number of cars on the roads would have a material impact on improving air quality via reduced emissions, so they launched the Hoy No Circula ("today [your car] does not drive") program.

Hoy No Circula mandated that only certain cars could drive on certain days of the week. The rules were based on the last digit of a car's license plate. If your license plate ended in a 5 or 6, you couldn't drive your car on Mondays. If it ended in 7 or 8, Tuesdays were out. And so on.

The expectation was that people would commute via public transit more and, on any given day, there would be 20% fewer cars on the road. 20% fewer cars meant 20% fewer emissions, leading to improved air quality.

But… that's not quite how things worked out.

People, being people, didn't want to change their behavior. Having to find alternate transportation plans every few days proved a frustrating inconvenience. So how did the public respond? By buying a second car, with a license plate ending in a different digit than their primary vehicle.

This was bad for several reasons. Not only did it prevent the number of cars driving on the roads each day by dropping by the expected amount, but these secondary cars were predominantly cheaper, older "beater" cars — which were much more pollutive automobiles.

Even those who chose to commute instead predominately took taxis instead of public transit (Mexico City had, and continues to have, insufficient options for public transport). Most of the taxis in use when Hoy No Circula was first implemented were Volkswagen Beetles, one of the worst-emitting vehicles in circulation at the time.

So air quality actually in Mexico City worsened after the implementation of Hoy No Circula. And traffic congestion, which was already bad, got worse, as well.

The Cobra Effect

Such misguided policy-making isn't anything new. In our recent book Prosper!: How to Prepare for the Future and Create a World Worth Inheriting we share a fine example dating from the Crown rule in India era:

During British colonial rule of India, the government became concerned about the large number of cobras in Delhi. So it issued a bounty on the poisonous snakes, paying a ?xed sum for each dead cobra brought in by the public. It didn’t take long for things to start going sideways on this plan. In order to receive more payments, enterprising residents began breeding cobras.

 

Clearly this was not what the British rulers intended. Once they discovered how their program was being abused, they terminated the bounty scheme. And what happened next? Yep, with no incentive left, the breeders set their now-worthless snakes free. And the cobra problem in Delhi skyrocketed to much greater heights than before the bounty program began. The “solution” had the exact opposite effect as intended.

(Source)

An Inexhaustible Supply

Sadly, the inability of the central State to recognize its vulnerability to the law of unintended consequences is mighty. Each generation of policymakers refuses to learn from the errors of the preceding ones, and remains confident that as long as it has good intentions (at least publicly), success is inevitable.

But instead, we get bungle after bungle.

The economy is slowing? Fill the banks newly-printed capital! They'll lend it out, thus increasing the velocity of money, spurring consumer spending and re-igniting economic growth. This was the thinking in the wake of the 2008 slowdown — but what happened? The banks realized it was much safer to hold on to that new money, lever it up and buy 'safe bet' instruments like US Treasury bonds — thereby making risk-free profits. The money that the banks did deploy largely went into the assets that most favored the banks and their richest clients, resulting in the widest wealth gap our country has ever experienced in its history.

Money velocity still not perking up? Take the bold step of charging negative interest rates on bank deposits! That's sure to get money out into the larger economy, where it can seek a positive return. This is what a growing number of countries are experimenting with today; but like Japan and the EU are realizing, imposing negative nominal interest rates actually boosts demand for cash, gold and safes to store them in. Turns out, desperate and bizarro-world tactics like NIRP cause investors to prioritize return OF capital higher than return ON.

Workers not able to get jobs paying them enough to live on? Double the minimum wage! This sounds noble, but places a heavy cost burden on the already-beleaguered small employer. As we've recently discussed, dramatically boosting the minimum wage without any commensurate relief for small and medium-sized businesses simply adds to the incentive for these companies to shed as many jobs as possible and to invest in long-term non-human solutions like automation. We are permanently destroying the supply of jobs available to our workforce.

The point here is that in many cases (if not most), governments' cures are often worse than the disease they are treating. Or as my favorite de-motivational poster puts it:

Conclusion

And very likely compounding these unintended consequences is the basic principle of uncertainty. In his article Why Our Central Planners Are Breeding Failure Charles Hugh Smith opined on how unknowable much of the results of current monetary policy will be, despite the Fed et al's assurances that they have everything well under control:

As noted above, any policy identified as the difference between success and failure must pass a basic test: When the policy is applied, is the outcome predictable?  For example, if central banks inject liquidity and buy assets (quantitative easing) in the next financial crisis, will those policies duplicate the results seen in 2008-15?

 

The current set of fiscal and monetary policies pursued by central banks and states are all based on lessons drawn from the Great Depression of the 1930s. The successful (if slow and uneven) “recovery” since the 2008-09 global financial meltdown is being touted as evidence that the key determinants of success drawn from the Great Depression are still valid: the Keynesian (or neo-Keynesian) policies of massive deficit spending by central states and extreme monetary easing policies by central banks.

 

Are the present-day conditions identical to those of the Great Depression? If not, then how can anyone conclude that the lessons drawn from that era will be valid in an entirely different set of conditions?

 

We need only consider Japan’s remarkably unsuccessful 25-year pursuit of these policies to wonder if the outcomes of these sacrosanct monetary and fiscal policies are truly predictable, or whether the key determinants of macro-economic success and failure have yet to be identified.

It's this concern about the failure of the current strategy our central planners are pursuing, paired with the tremendous magnitude of the impending cost of that failure, that motivated Chris to issue our report The Consequences Playbook last year, which begins:

What’s really happened since 2008 is that central banks decided that a little more printing with the possibility of future pain was preferable to immediate pain.  Behavioral economics tells us that this is exactly the decision we should always expect from humans. History says as much, too.

 

It’s just how people are wired. We’ll almost always take immediate gratification over delayed gratification, and similarly choose to defer consequences into the future, especially if there’s even a ridiculously slight chance those consequences won’t materialize.

 

So instead of noting back in 2008 that it was unwise to have been borrowing at twice the rate of our income growth for the past several decades — which would have required a lot of very painful belt-tightening — the decision was made to ‘repair the credit markets’ which is code speak for: ‘keep doing the same thing that got us in trouble in the first place.’

 

Also known as the ‘kick the can down the road’ strategy, the hoped-for saving grace was always a rapid resumption of organic economic growth. That’s how the central bankers rationalized their actions. They said that saving the banks and markets today was imperative, and that eventually growth would return, thereby justifying all of the new debt layered on to paper-over the current problems.

 

Of course, they never explained what would happen if that growth did not return. And that’s because the whole plan falls apart without really robust growth to pay for it all.

 

And by ‘fall apart’ I mean utter wreckage of the bond and equity markets, along with massive institutional and sovereign defaults. That was always the risk, and now we’re at the point where the very last thing holding the entire fictional edifice together is beginning to give way. Finally.

When credibility in central bank omnipotence snaps, buckle up. Risk will get re-priced, markets will fall apart, losses will mount, and politicians will seek someone (anyone, dear God, but them) to blame.

In The Consequences Playbook (free executive summary; enrollment required for full access) we spell out what will happen next and how you should be preparing today for what might happen tomorrow. If you haven't yet read it, you really should. Suffice it to say, a tremendous amount of wealth will be lost if (really, when) the central banks lose control. And standards of living for many will be impacted. A little preparation today can make a huge difference in your future.