The first of these is a report from the IMF, which said the following:
'In its bleakest assessment yet of rapidly worsening global prospects, the International Monetary Fund predicted that industrial economies as a whole will shrink through next year by 0.3 per cent, in the worst such slump of the postwar era.It might be noted that the IMF reports are progressively becoming more downbeat. The reaction from stock markets was predictably negative, in yet another case of a rally of optimism being dented by economic reality.
The IMF said that the toll imposed by the downturn across the West would sap the strength of the world economy and cut global growth next year to an anaemic 2.2 per cent. That is down 0.8 points from its last forecast, made only a month ago, and is below the 2.5 per cent threshold at which the world economy is judged to be in the grip of global recession'
Meanwhile the Bank of England has slashed interest rates in an attempt to turn around the economy. For regular readers, they will be aware of my lack of support for central banks setting interest rates, but I have argued that, if they must, they should have cut rates a long time ago. For those that are unaware of the mechanism by which interest rates are 'set' (targeted), I have copied an explanation of this from an earlier post:
'interest rates are set (as a target) to govern the money supply in the economy (through open market operations in the UK primarily through the London Interbank Offered Rate). The control of the money supply is managed by either buying or selling securities such as second hand government debt (e.g. bonds), or by lending to or borrowing money from banks.'The trouble is that the banks are not playing ball, and are holding interest rates higher than the rate targeted by the Bank of England. The real problem here is that the same article details that the banks are now being pressurised to accept lower interest rates in their lending. This is what the article had to say:
'John McFall, chairman of the Commons Treasury Committee, told The Times:“These guys came in with some pretty big begging bowls asking for taxpayers’ money. They are displaying an alarming lack of social conscience. They should pass on the cuts in full.”
Yvette Cooper, Chief Secretary to the Treasury, said that ministers expected banks to pass on the cuts as fast as possible. “The Government has stepped in to make the banking system safe, to support the banks,” she said. “It is right now that the banks do their bit to support everybody else.”'
The absurdity of this position is that the reason for the banking crisis was the mis-pricing of risk, which has led to huge losses for the banks. Having been scathing about the banks for doing this, now that the banks are (rightly) being cautious, the government is now using its newly acquired whip hand to force the banks to return to mis-pricing of risk. This is exactly one of the many problems that I predicted would arise as a part of the government bailout of the banks. It also sows the seeds of further troubles for the banks in the future.
The reason for such pressure is the belief that banks need to start lending again, as there is still a fundamental belief that everything can be solved through borrowing. This attitude is implicit in many commentaries, and just one example can be found in a commentary on the problems being faced by Barack Obama:
'America is looking to its new president for a string of answers: how to stop the US economy shrinking at its fastest rate for seven years; how to stop unemployment, already at a five-year high of over 6pc, rising even further next year; how to rebuild consumer confidence, which suffered its steepest drop in October since records began in 1952; how to kick-start consumer spending, which represents two thirds of the US economy and fell in September for the first time in many years.'
It is the last part that is most telling. The key to the revival of the economy apparently lies in getting consumers spending again. Note that there is no mention of increasing wealth generating business and activity, but instead the answer lies in consumers going shopping. The question of shopping with what is not discussed, but the reality is that what they really mean is shopping with borrowed money. That is why governments are urging the banks to cut interest rates and pressuring them to lend. Whatever way you look at it, it is increasingly clear that governments view the solution to all the problems is increased consumer spending, and they do not care whether that spending is generated through increased consumer debt. Even were such a solution to succeed (which it will not), at what point would the unsustainability of such a proposition become evident? How much debt can consumers actually shoulder? In this foolish conception of economics, apparently consumers can go on borrowing for eternity.
This does make me wonder whether governments have any idea of what they are really saying. Surely, even when dressed up with economic jargon and euphemisms, the thrust of what they are suggesting must be apparent to them.
Note 1: There have been some very interesting and insightful commentaries on the blog, starting with Lemming, who says the following:
'Mark, I'm still thinking along the lines of a comment I made a few months back in which I asked whether the financial system is so broken, that only some sort of 'reset' can get things back on track. It seems to me that nothing has gone greatly wrong with the world's ability to produce sufficient 'stuff' for most people to live adequately, but that capitalism has tied itself into such knots that it cannot be untangled without destroying society in the process. Can we continue with capitalism in its present form?'
The idea of a reset makes sense in some respects. The trouble with such an idea is that it would be a very bitter pill for the creditors to accept, as they would have to write off large tracts of wealth as unrecoverable. In writing off such wealth, it would then cause a complete loss of confidence in all kinds of investment, as investment is built on the trust that there are rules that support a return on investment. If the rules can simply be torn up when it is no longer convenient, and the defaulter suffers no adverse consequences, then on what basis would anyone invest? Would you give an individual, £1000 to open a shop if you were told that he could do anything with the money that he liked, for example using to throw a party, and that if he never repaid the money, then there was nothing you could do about it. You might notice that he owns a house, and a car, but you would have no claim on these things if he failed to repay. You would just be told, 'tough luck'. Would you ever lend again under these circumstances?
What you have in a reset, is an 'unfair' situation and game theory has tested this. In an experiment they sit two people at a table, and say that if the two sides can agree on a division of money, then they will both get the money according to the split that they agree to. In other words they both will win if they agree. Universally, people will not agree if they think that the division of the money is unfair. In these circumstances, they would rather get nothing, rather than get an unfair share. In a reset situation, both sides would benefit, but would benefit unfairly. Game theory shows that the inclination is to not allow an unfair outcome, even at cost to oneself.
Lemming goes on to say the following:
'I think in previous posts you have described how the world economy expanded to such a degree that bottlenecks in the supply of essential raw materials, like oil, caused the expansion to halt, thereby causing an inevitable crash (the economy must expand constantly to keep paying off the interest on loans..?) If a requirement of capitalism is to constantly expand the amount of economic activity towards infinite size (and it sounds as though it is) then the bottlenecks you describe are unavoidable, and no degree of ingenuity can get around them, whatever Adam Smith says. Isn't capitalism just a giant pyramid scheme which collapses as soon as a bottleneck in the supply of energy or raw materials or cheap labour is reached? And like all pyramid schemes can't you point to persuasive evidence that 'it works' right up until it collapses?'
There is an element of truth in this. However, the current circumstances are unique, and that is why the current crisis is unique. It is the scale and speed of the introduction of productive labour into the system, with the emergence of countries like China, that is the problem that makes the bottlenecks so devastating. For example, in China, it is not an inherent fault in capitalism, but a knock on effect that arises from communism. The communist system restricted the productive potential of workers, whilst providing just sufficient resource to keep the numbers of workers expanding. When the communist system was abandoned, the workers were allowed to start reaching their productive potential, and the speed of this development reflected the strength of the capitalist system. It demonstrated the actual potential of the workers. However, in doing so, it provided a supply shock that has only recently become apparent in the evident lack of commodity to supply their new found productivity. As such, the shock is not the result of capitalism, but the removal of a distortion caused by communism. Whilst the capitalist system is flexible, this has stretched the flexibility to a literal breaking point.
The shock is evident in the current crisis, and as I described before, the world has run towards the commodity brick wall, bounced back, and will in due course start running at the wall again. Whilst the wall is moving forwards too, the runner will keep catching up and bouncing back. In other words the capitalist system is responding, but it can not respond fast enough.
DZ followed up Lemming's comment with this:
'If a society deals with interest, then like lemming said, we have to assume infinite growth. However the world is not full of infinite resources. So it becomes a pyramid scheme with the initial lenders gaining the lion share of resources and the guys at the bottom working to pay of ever increasing debt until they give up, which cause market crashes to reset things.
However, take away the "interest on loans" concept away and you are left with trade. Trade is all about dealing in resources so you will have winners and losers but the economic system then doesn't depend upon infinite growth. Instead we rely on increasing productivity to maximise usage of finite resources.'
DZ is right that there are not infinite resources, at least not for everything. However, at the moment resources are still there to meet growth, they have just not yet been harnessed. In principle there is potential for the world to rise up to an overall higher standard of living by better harnessing and extraction of resource. For example, huge areas of Russia are not fully exploited for agriculture (I read about this in the Economist some time ago, but must apologise that I do not have time to find the article). The availability of resources such as oil is more questionable, but the dominance of oil is in part due to its availability. There are arguments that when oil starts to run down that the economic incentives to develop alternatives will be compelling and will therefore spur alternative solutions/structures. This is all debateable, but I personally buy this argument.
With regards to charging interest, what happens if you are a productive person and generate a surplus. Without an incentive to utilise that surplus, why would you use it in any way? Interest allows you to use that surplus to improve the economic activities/performance of other individuals. It also allows people to lend into consumption, which is not always obviously beneficial. However, that comes down to a point of view of whether you believe individuals should be free to accumulate debt. For example, although housing has been confused with investment, for owner occupiers it is also a form of consumption (consumption of a mode of shelter, as well as social status, comfort and so forth). Would it therefore be acceptable to restrict borrowing for this kind of consumption? If this is acceptable then it is hard to find a reason to restrict other borrowing towards consumption.
I hope that I have addressed the points in the comments. There were some other comments I would like to have addressed, but I have run out of time. As a general point, it is really good to see such thought provoking comments on the blog.
Note 2: I have just made one of my regular visits to the New York Times and it makes bleak reading. Retailers are reporting shcocking falls in sales, another report tells of stock market falls inspired by negative news such as General Motors struggling to keep its head above water, and poor figures on unemployment. The 'Obama bounce' is rapidly disappearing, as the hard economic news onces again bites optimism.
Perhaps the greatest concern is that the Chinese economy is also showing signs of strain. Regular readers will be aware that I have always had mixed views on what would happen to the Chinese economy in this crisis, but erred towards the possibility that the economy would hurt, but not as badly as others. This is becoming less and less certain. We have yet to see how the Chinese government might deploy the substantial reserves to support the economy, but the negative side of that for the Western countries is that there is less and less chance of China using the reserves to prop up the world economy. There is also the problem that, if China draws on the reserves, in particular the $US reserves, this will also bring about a collapse in the value of the $US and thereby destroy some of the value of the reserves. It is a very tangled web.
The real worry is that, if the Chinese economy slows sharply enough to bring about hardship, the potential for unrest in China remains high. There have been many reports over recent months of simmering discontent with the government, and my own sources within China are suggesting that there is some anger over government behaviour in general. The consequences of unrest in China are very, very disturbing, so we should all hope that China can ride out the problems without too much damage.
Note 3: I have not posted this link for a while, but for new readers, I would recommend that you read this post if you would like to understand why we are really going through the current financial crisis.