Ever since I can remember, free market theorists have been advocating ‘pure and perfect competition’ (PPC). This ideal state, that is, PPC hinges on the over-simplifying assumption of a large number of buyers and sellers (incapable of distorting prices individually), any number of firms entering/exiting the market without any imposed restrictions or transaction costs and every market participant knowing everything at all times. The end objective, of course, is to provide goods and services to maximum number of people at minimum cost. While this is the best outcome for consumer markets, it would kill the ‘animal spirits’ in the producer markets, thereby curtailing supply and pushing up prices for consumers, thereby destroying the very crux of PPC.
Hence, in reality, we have all kinds of market distortions in the form of natural or artificial barriers. We have tariff as an international trade barrier, capital as a barrier in many heavy industries, brands and distribution as barriers in certain consumer industries, cartels in commodity markets, immobility and immigration laws in labour markets, traders who hoard produce etc. This is what keeps the animal spirits alive and the supply going. In essence, the term ‘animal spirits’ has an inherent dichotomy wherein it needs to be kept alive, while not being allowed to run amok. Curiously, ‘animal spirits’ are best flamed by cheap money and in the past decade, central banks have more than played their part.
Lender of first resort
The helping hand extended by most major central banks globally post-2008 seems to have created severe distortions in the capital market. An unprecedented, almost unquantifiable stash of liquidity has been unleashed as if money can actually create oil, minerals, alluvial soil, clean air and water etc. The fact is that money can only buy these things, not create. (It’s a different matter that money can’t even buy love, honesty, health, etc – but that’s for another day). It seems that so much liquidity has been artificially created that virtually everything on this planet can be bought, and still some surplus liquidity will be left over. And this should really imply inflation on a massive scale. Inflation rate very simply is more money chasing less goods and services. Clearly, money supply has increased without any increase in real demand