Sunday, December 28, 2008

2009 - The Year of the Fall of the West

As 2008 comes to a close and we head into a new year, I thought that (for once) I would follow convention with a brief review and predictions. For new visitors to this blog, I should mention that much of what I write is referenced to reputable sources, but for today I will only reference in a limited way, relying on my previous posts for my analysis. If you are new to the site, you may want to browse through some of the previous posts (see links to the left).

In November of 2007 year I wrote the essay that was the precursor to this blog, 'A Funny View of Wealth', and that has been the bedrock of the thinking of this blog. In the essay, I presented an argument which completely diverged from the thinking of mainstream economists. I pointed out that, in the UK (and the same could be said of the US), there had been no real growth in what I considered to be wealth creating assets over the last ten years which could explain GDP growth; manufacturing, commodity extraction, export of services, and tourism (no net growth).

Instead I pointed to the growth in debt, and asset inflation (real estate) as the source of all of the GDP growth of the last ten years. This debt, in conjunction with the multiplier effect, along with upwards levers such as immigration, created an illusion of growth in wealth. It led to the 'post industrial', 'service economy'. My argument was that this was completely unsustainable, and that a collapse in asset prices would signal a self-reinforcing downward spiral in the economy, driven by a collapse in consumer sentiment (a massive belt tightening) leading to the collapse of the service economy, higher unemployment, more belt tightening and so forth into a downward spiral. I concluded that essay with the following:
'The situation overall will be a massive contraction in the UK economy, a contraction that will see the UK step back in time in terms of economic development. The contraction will need to be deep and severe enough to reverse the illusory gains of the previous ten years (or even longer), and will require that the UK restructures its economy from top to bottom. It will, in effect, be the most significant crisis to hit the UK since the World War II. The only way out of the crisis will be to alter the fundamentals of the UK economy back to producing more goods and services for export led growth, and away from debt based growth in services. It will be a long, and very painful adjustment that will see the UK lose its place as one of the worlds’ leading economies, and recovery from the crisis will take many years.'
Perhaps the most important prediction within this paragraph is that I suggested the UK economy would contract back at least ten years. Since I made the predictions for the economy, mainstream economics has slowly been catching up. I watched as week by week the Economist magazine's weekly poll of forecasters ticked down GDP growth predictions by 0.1 % increments, all the while still predicting growth in the economy - at least until the full savagery of the current crisis was staring at them square in the face. The reality of the scale of the crisis is now sinking in. This sub-head from the Telegraph a few days ago:

The 2009 recession could be so severe it sets Britain's economy back five years, according to the most chilling warning yet on the scale of the looming slump.

In other words, they are catching up with my prediction, but not there yet. They will finally accept the reality of the scale of the contraction only when it is right before them. My prediction was that UK economy would one of the worst hit in the world, if not the worst. One of the key transmission mechanisms of the collapse of the UK economy that I identified would be a collapse in the value of the £GB. We have this from the Times:

This year, however, Britain – with a GDP per head of $43,859 (the pound buys fewer dollars) – has been o v e r h a u l e d b y t h e U S ($46,993), France ($45,088) and Germany ($44,245). Only Italy, ($39,641) and Japan ($38,692) remain behind.

Worse is to come, according to the Oxford Economics projections, because of the recession and the sliding pound. “UK GDP per capita in 2009 will be 24% lower than in America and will be over 15% lower than in Japan, Germany and France,” said Adrian Cooper, managing director of Oxford Economics.

“It will even be 7% lower than GDP per capita in Italy, where economic performance has been very poor over the past decade.

It had become fashionable amongst many commentators to discuss currency strength in disparaging terms, talking about it being a matter of 'virility', rather than being a substantive issue. If I remember correctly, the example I gave to illustrate the nonsense of this view was a person with a preference for Belgian beer. If the £GB weakens, then that beer will cost the individual more, and that individual is therefore poorer. If the individual's income does not buy as much beer today as it did yesterday, how can anyone argue that the individual has not become poorer?

The simple reality is that, as each day goes by, as the £GB slides further, every single individual holding and earning in £GB becomes a little poorer. The £GB has a long way to fall yet....

In order to understand why the £GB has so far to fall, it is first necessary to explain why it continued to ride high for so long. One element is the irrational element of confidence. However, underlying this confidence is good old fashioned supply and demand. The key question here is; why was there so much demand?

The answer is rather scary. First of all, we have run consistently large trade balance deficits for many, many years. There is therefore minimal demand for the £GB to buy our products and services. Tourism sees a negative balance, with more spent overseas by British tourists than others spend in the UK. For commodities, our major source of commodity wealth, North Sea Oil, peaked a few years ago and is in decline. The real source of demand for the £GB is very scary indeed.

We are now all aware of the massive expansion in debt in the UK over the last 10+ years. Much of that debt has been financed from overseas. In order to lend to UK consumers, business and government, overseas investors had to buy £GB in order to then loan that money. This is a huge source of demand. In other words, a large part of the demand for the £GB was demand that was driving the UK into ever deeper debt....Our creditors, such as China and Saudi Arabia, are now turning off the supplies of credit, and are no longer buying the £GB to lend to us. Demand from this source will continue to evaporate...

A second area of demand was for inward investment, with much of that investment going into inflating assets, and the one area of growth - the service sector. With the downward spiral of the UK economy, only the clinically insane will invest in the UK, excepting the vultures who will pounce upon distressed assets at knock down prices.

As such, there is very little genuine demand for the £GB. To add to the woes of the £GB, we can add the latest in the insanity of government economic policy. The government is borrowing ever larger sums of money, and pouring it into the black hole of a bankrupt banking system. I predicted that when the government bailed out the banks, it was just the start. The banks had lent too much into an economy built on debt, in an upwards spiral of debt driven growth. It was self-reinforcing. The more the banks lent, the more the economy grew, and then the more the banks lent. I predicted that, as the spiral went into reverse, the losses of the banks would just increase. This from the Telegraph:

Britain's banks face up to £70bn of losses on commercial property loans, enough to force some of them into a further round of taxpayer bail-outs.

Investment bank Close Brothers forecasts massive writedowns in light of its forecast 50pc-60pc slump in commercial property values by the end of 2009 compared to the market’s 2007 peak. Most property experts believe such values have already dropped 30pc this year.

Such writedowns could again imperil banks’ capital ratios, potentially forcing them once more to go cap in hand to the Government.

This is just one sector of lending. Consumer debt is going to sour ever more quickly. Commercial lending is already falling off a cliff with, for example, prediction of carnage in the retail sector. The retail sector is just the most visible part of the bust. All of this just means bad news for the banking sector, who will continue to make huge losses.

In amongst all of this, the government is using its stake in the banks, and the fact that they are one of the only remaining sources of capital to bully the banks to keep lending into this mess, rather than making provisions for the next stages of debt delinquency carnage. It is a recipe for ongoing catastrophe. More bad lending into a collapsing economy.

Then we come to the real horror for the £GB, and for the UK economy overall. Everything suggests that the Bank of England and the government are planning to print money as a solution to the deep problems in the UK economy. In a post here, I have detailed how the government is seeking to hide the fact that this is their plan. If you are new to the blog, take a moment to read the post, as it is all referenced, including to Bank of England resources.

A long time ago, I predicted that the UK would default on its sovereign debt, and that default would happen at about this time (we are about a month overdue on my original prediction). As the predicted time for the default approached, there were more and more signals that the markets were less and less willing to fund UK government borrowing, and the debt default became ever more inevitable. I became more and more certain that I was right, and the default was a certainty.

It was at this point that the discussion of money printing suddenly appeared from left-field, with the Bank of England openly discussing the possibility. I was puzzled that such a dangerous policy was being considered, and gnawed at the question of why the Bank of England and government might be considering this. It was at that point that is occurred to me why this was being done. If the bank prints money, and then lends that money into the banking system, the banking system can then use the money to buy up government bond issues, thereby financing government debt. Under the Basel rules, lending into OECD governments creates tier 1 capital, and therefore means that the banks are seen as meeting capital adequacy rules. In other words, the banks return to (apparent) solvency, and the government manages to continue borrowing, and does not default on the loans. In the meantime an Act of 1844 that required the Bank of England to publish the amount of currency issued is abolished, such that the Ponzi scheme can be hidden.

All the while, the excuse for printing money is given as the avoidance of deflation. Whilst this excuse might stack up in the US, where their currency has not (yet) devalued, in the UK the devaluation of the £GB means that we are importing inflation. Whilst there may be deflationary impacts from the contraction of the economy, the imported inflation from the collapse of the £GB makes the idea of deflation very unlikely.

I have explained what money printing actually really means over several posts. The first point is that it does not create value, but transfers value from the existing supply of money. You can not create value out of thin air. If there are 100 units of currency, and you just print 10 more, all you are doing is spreading the value of the 100 units into 110, such that all of the currency is devalued. This is, of itself, highly inflationary. It is also a form of taxation. In transferring some of the value from the currency in supply into the newly printed currency, there is a movement of value to the printer of the money - the Bank of England, and eventually the government. Therefore, whilst the government makes its rather sad and pathetic VAT tax cut, they are quietly taxing ever more money to pay for their borrowing. It is the ultimate stealth tax.

What we have here is a 'double whammy'. As the demand for the £GB is in decline, the government is increasing supply. In so doing, the only possible outcome is inflation, and capital flight. The UK is now on course for hyper-inflation.

What does hyper-inflation mean? The first problem is that it will see the destruction of savings, and investments. The massive destruction of debt that comes with hyper-inflation may seem to be a good thing in a nation sinking under mountains of debt. However, when no one any longer trusts to lend, there is no investment, there is no prospect of return to growth. All of those who have been responsible and have saved are punished, and the feckless are rewarded. It is a recipe for long term pain. Meanwhile, the £GB becomes worthless, and every single holder of the currency just becomes that much poorer. As capital flees the country, there is no money left in the economy, nothing left to rebuild the economy.

The real truth is that, when the printing presses turn, we are witnessing one of the greatest debt defaults in history. In printing currency, yes, it is possible to pay the debts, but paying back debt with a debased currency is just another form of default.

How is this all going to unwind for the UK?

It is a very big question. I am not really sure that I know the answer. I am not sure how bad things may yet become. Many months ago, a commentator on a post asked whether I thought that there would be food shortages in the UK in the future. I suggested that this would not be the case, and still think that it will not become that severe. However, I do think that the UK is heading towards that kind of severity, though will never reach that point. There are still enough companies in the UK that can create genuine wealth, that are competitive in the world, but they are too few in comparison to the needs of the country. This has been evident for many years in the ongoing balance of trade deficits.

So what has caused all of this mayhem? Why is the world economy, and the UK economy in particular, in such deep difficulties?

As I progressed my commentary in this blog, I started to unravel the real causes of the problems in the economy. In one of my early posts, 'The Cigarette Lighter Problem', I was grasping my way to the nature of the problem. The problem I was trying to answer was why it was that an identical cigarette lighter costs nine times as much in a Western economy as it does in China. The same distribution, the same manufacturing costs, the same shop service. Everything is the same. How can this additional cost be justified? The only answer that made any sense was to identify massive value adding industries in the West, such that they could disburse this wealth into the wider economy, and that these industries were not to be found in China. It was hard to find any examples that could explain such a differential. In a later post, I identified the differential, and it was that the lighter was being funded by the appearance of wealth, the appearance of value added, that was rooted in debt. In other words, although we might not have directly borrowed money to buy the lighter, if we trace back the sources of economic growth, and the real source of the money, it could be found in debt.

It is here that the problems arise. It returns me to 'A Funny View of Wealth', the essay at the start of this blog. We have had the appearance of wealth, as borrowed money flooded into the economy from real wealth producing countries. We spent that money, created massive amounts of activity in the economy through the multiplier effect, and all the time we were just spending our future wealth. It is this borrowed money, that paid so much of our income, that was being used to support the difference in the price of the lighter between China and the OECD country. In other words, when we purchased the lighter, through the massive input of credit in the economy, we could pay such a high price for the lighter. The sick part of this is that one country lending us the money to pay for the overinflated price of the lighter was China, the manufacturer of the lighter.

What this really means is that the wealth producing countries, the big exporters, have been lending us the money with which to buy their goods. They did so in good faith, in the belief that we were good for our debt. We are not. I have often used the example of an 18th century aristocrat to illustrate the problem. His family has always been rich, and his creditors believe that this is the natural condition. However, the lavish lifestyle led by the aristocrat has, for a long time been supported by credit. His estate no longer produces enough wealth to cover his costs. The creditors will keep lending, but only to the point where they finally realise that they are lending to him to pay back his previous borrowing.....

I have said that the creditors lent in good faith. However, all is not well in this regard. In particular the artificial value of the RMB in particular has been an aggressive and damaging factor in the mix. It is, and has been, a massive export subsidy for companies operating out of China. It has meant that China has enjoyed an export led growth boom, but at the cost of destruction of large swathes of manufacturing in the Western world. Quite simply, it is unfair trade practice, and has contributed to large imbalances in world trade, and sucked foreign currency into China, which has then been lent back to the West.

This is not to say that the only problem has been the problem with the RMB. One of the themes throughout this blog has been the question of labour supply in relation to commodity supply. I first detailed the problem in 'Why do Economists Get it so Wrong?' The argument is quite simple.

In the past ten or so years, the labour force of the world has doubled. There were always the huge numbers of workers available in countries like China and India, but they were previously under-utilised. What changed was that these workers have been given access to capital, to technology, and access to world markets. As this happened, they became a part of the world labour force.

When we look at the entry of the emerging economies in this way, it becomes apparent that we have had a massive supply shock into one of the key inputs of production. At the same time, whilst we have this massive oversupply in this one input into production, there has not been a commensurate increase in supply of another vital input into production - commodities. We saw this shock in the eventual spiking in oil prices. This spike was what finally motivated the pushing over the edge of the Western economies, which were already balancing on a precipice of debt fuelled consumption.

At its most simple, we have a situation in which, about ten years ago, commodities were supplied at a rate of 1.2 units per worker. As the emerging economies seriously entered the world economy, the supply of commodities increased, but not at a fast enough rate to match the numbers of new workers. Eventually, demand outstripped supply, and the commodity prices spiked upwards. In effect we hit the point where there were only 0.8 or 0.9 units of commodity per worker. Whilst the numbers here are made up, I hope that this illustrates the basic principle.

The result of that commodity spike was to expose the impossibility of the ongoing imbalances. The output of the world was being consumed in the West, but increasingly the production was in the East. The East was lending the money for the West to continue to consume a disproportionate amount of world resource, at the cost of the wealth of their own more productive populations. Something had to give.

What gave was the Western economie, and they have taken with them the emerging economies - who built their structures to support Western consumption. Having geared their economies to the West, they now no longer have markets for their goods. The imbalance is correcting in a very painful way.

As world trade collapsed, so did the demand for commodities. I make an analogy here of a man running towards a brick wall of commodities. The wall is moving forwards, but not as fast as the runner. Eventually, the runner hits the wall and bounces back, only to later start to run towards the wall later. We have just bounced back. The running will resume later....

Today, economists are finally starting to 'get it'. However, I think that it may be economic historians who finally grasp what has happened. The simple truth is that the world moved out of balance with the massive input of labour many years ago. The massive boom in debt simply hid the imbalances. It was not complex financial instruments that created the problems, but rather they were the reaction to the wall of credit that flowed into the Western economies from the ever more productive East.

As more and more credit flowed in, there were few opportunities to invest that money into wealth creating assets. The Western economies were bloated in comparison to those of the East, and in many sectors were unable to compete. If you wanted to invest in manufacturing, you looked to the East. As such, there was a wall of money entering the economies of the West, with limited opportunity for investment into productive assets. Instead, the money was lent into consumption, and into asset price inflation. If you have a limited supply of assets, and an increasing supply of money chasing those assets, you will have asset price inflation. When you have a huge supply of money, and limited investment opportunities, the quality of the investment will suffer. The first tranches of money will go into low risk, high return investment but, as the money keeps flowing in, these good investments will disappear, leaving the investor only the option of pouring money into ever more risky investments. This is the source of sub-prime, and the financial instruments that were developed were just a method of hiding the poor quality of those investments. The financial crisis was caused by the imbalance, not the other way around.

In other words, the catastrophic failure of the banking system was simply a result of too much capital with no good place to go. All the while that the money was pouring into black holes of investment, economists, bankers and governments could point to GDP growth to show that their economies were miraculously growing. However, GDP is a measure of economic activity, not a measure of wealth creation. Where that activity is generated through growth in debt, it is not economic growth, but the destruction of future wealth. The delusion was that activity meant wealth creation.

What we therefore had was a massive imbalance in the world economy. The East was increasingly producing goods for the West to consume. Meanwhile, the East lent money into the West so that the West could continue to enjoy a lifestyle of comfort. The East, in other words, worked hard to support the lifestyle of the West....

It was always impossible that such a situation might be sustained. At some point, at some time, the massive imbalance had to be corrected. This is the process that we are witnessing now. The only element still missing is the collapse of the mighty $US.

In this matter I have been wrong. I long predicted a collapse in the $US. It has not happened.


However, if we look at what has driven events, what has caused this crisis, it is apparent that the $US must finally collapse. The US is just one huge deficit, and has long since ceased to pay its way. When I made the analogy of the aristocrat, we can extend this analogy to the US, but in the case of the US, the US is the King. How much more difficult to imagine that the King is broke. After all, the King's head appears on money.

At this moment in time, the $US is the biggest bubble in history. In my previous post I discussed money and the banking system. The important point about fiat money is that there is absolutely no support for its value excepting confidence. At present, as the reserve currency of the world, the $US is holding onto its value, despite ever more issuance of the currency - they are printing money too. With the US as the 'King' it is hard to imagine that it is bust, that the US is in as bad a state as the 'aristocrat' that is the UK. However, the two countries are running paralell, and there is only a difference of scale. If we compare the two economies, they are very similar in all of they key points that I have discussed so far.

As such, the $US will collapse. It is just a question of when.....

When I first started writing on economics, I wrote with the optimism that, once the nature of the problem was recognised, we would take action to reform our economies to meet the challenge, the hyper-competition of the East. The one thing I have not seen since is any single policy or initiative with this purpose. All I have seen is policy that seeks to replace the lost consumer borrowing with ever more borrowing, and an attempt to recreate wealth through the use of the printing press.

There has been a collective burying of heads in the sand. The only possible outcome for this is that, what would always have been a painful adjustment, is going to be agonising.

I am very sorry to say this, but the situation can only get worse. The next stage of the crisis is hyper-inflation, and that can mean only one thing.

What we will witness in 2009 is the fall of the West.


  1. Mark, an excellent summary of the situation which rings very true.

    One thing which interests me is that you have previously described yourself as a free market "purist", or similar, and you often cite Adam Smith, he of the "invisible hand" and all that. But the catastrophe now befalling the world is a direct result of free market practices isn't it? The world economy's tragic response to the debut of the Chinese workforce must surely be just the free markets doing their Adam Smith thing. The self-interest and greed of billions of individuals is somehow supposed to result automatically in the optimum prosperity for all, but it sounds too good to be true, and that's certainly the way it looks, now.

    At a high level maybe it was possible to see the system going wrong, but without a coordinated planned economy or protectionism, or other taboo practices, how could ordinary myopic people - with no clue about sustainable lending, China, exchange rates, the calculation of GDP etc. - be stopped from 'following the money'? Maybe the idea of the invisible hand works more-or-less at the local or national level (but even then isn't it just a hand wavy assertion?), but it is hard to see how it can work globally. On what basis could you prove that billions of dumb 'agents' can collectively stabilise and optimise a system riddled with distortions, delays, random events, incomplete information etc. etc. without some form of higher level control?

  2. Excellent appraisal Cynic.

    Let's face it, we're not going back to pre crunch level, the party's over. (how many times have I read that?)

    You are right when you say the talking heads never saw it coming, the irony is, it is those self same people who are telling us everything will sort itself in 2009

    It is also those self same people who are being entrusted with the reconstruction - you couldn't make it up.

    Brown smells trouble on the streets and is prepared to print as much money as it takes to stop that trouble.

    I have been banging on about hyper inflation rearing its bestial head somewhere down the road ahead, I've dreaded the thought that my life long investment in life itself is about to go down the pan - what a sickener! What an epitaph to one's life.

    The MSM are telling us how much worse it is going to get in 2009, this apparently is known as (para) predictive forecasting, IOW's preparing the masses for the worst. I think the MSM know full well what's coming down the pike, because they're are part of it.

    Have you noticed how the MSM are lambasting those on benefits, how dare they live so well whilst hard working families are up against it, talk about divide and conquer. It was ever thus.

    Watch this space.

    Cynic your playing a blinder, keep chronicling.

    Here's wishing everyone the best in the coming new year, it looks like it's going to be a white knuckle ride.

    PS. My prediction for the coming year. The rise and rise of National politics! Goodbye Lib/Lab/Con.

  3. Great post. Just one thing caught my attention:

    >> I do think that the UK is heading towards that kind of severity... (food shortages) though will never reach that point. There are still enough companies in the UK that can create genuine wealth, that are competitive in the world

    You believe we won't see food shortages. I do.
    The companies that are still competitive in the UK will flight as the situation deteriorates. No point in staying in a country with shrinking individual purchasing power, rising unemployment -so less people can buy your services- and a currency and hard assets -property, machinery- depreciating by the minute.
    The capital will rapidly get out of here as things get tougher. This is already happening as yo u know.
    Politicians will let the capital leave because they'll be either pressured into doing so, or simply because wealthy politicians themselves will benefit of not impeding this massive and rapid capital flight.
    There will also be "noise" by populist politicians and the masses on "spreading the wealth" more evenly, increasing taxes to the wealthy. This will only accelerate the capital flight process. End result: an economy that does not produce anything competitively exportable, where people can't find jobs and small amounts of money change hands very slowly. If we add to this the fact that most western societies are not geared to producing their own food, why can you not see food shortages in the future?

  4. So on the world stage which nations or areas are producing genuine wealth? Will China manage to adjust its production into useful goods away from fripperies for western credit card consumers? Or is there some other region (Russia? India?) quietly beavering away waiting to become 'top nation' afer we fall?

  5. Lemming,

    Economies simply do not operate according to free market principles - there are an incalculable amount of distortions that result from policies that try to 'fix' the market.

    As Mark has said, China has kept its currency artificially low to stimulate exports.

    Western countries too have their own policies that distort the market (eg minimum wage, farm subsidies etc), which are generally accepted as beneficial to society.

    But before being implemented a policy should be thought through so ALL its effects are taken into account; in reality only the immediate effects are noted and numerous other (often detrimental) effects occur.

    This is the central message of arguably one of the best books on economics ever written.
    "Economics in One Lesson" by Henry Hazlitt.
    Its simplicity is why it has continued to be popular since it was written over 60 years ago.

    Having seen you regard yourself as an economic novice I believe you would find it most helpful in improving your understanding of how meddling in markets merely creates more problems that themselves need to be dealt with.

    I purchased mine from the Institute of Economic Affairs as I found this was the cheapest place
    (no, I don't work for them!)

    Good fortune to all in these interesting times.

  6. Interesting to see your thoughts coming together Mark. However, I see the USA crashing before the UK.

    Why? Well, despite the relative strength of the USD vis-a-vis the pound and its status as a reserve currency, I think America's main problem is the sheer corruption of its financial services industry. For example, the UK has yet to see its own Bernie Madoff figure emerge (yet....).

    I think that although the UK financial and political elite have certainly been incompetent, so far there has not been the whiff of brazen criminality as in America - I hear there are ongoing rumours of Hank Paulson shorting Goldman Sachs CDS's for another example.

    Faith in the US system will be destroyed more by this sense of endemic corruption than the recognition of the epic scale of its debts.

  7. I try and avoid naming political parties when I post here as there seems to be an unwritten rule to do so and avoid 'partisan' posts. But the responses so far seem to have let that slip a little and so I'll do the same this one time, since I think some things need saying.

    If Gordon Brown calls a Summer election (unlikely, but who knows?) we might escape total disaster.

    The Conservatives don't seem to yet understand the full nature of the problem (I'm one of them, just a very unimportant one) but they do, at least, have the proper ethos to begin recovery.

    That being: Cut Costs, Avoid Borrowing, Encourage industry.

    Now you could argue they aren't talking 'tough' enough right now. But if they *did* they'd lose the next election because nobody yet believes it. (Except us, here, of course.)

    We'll see things deteriorate into something akin to a disaster that people CAN see. We'll see the Conservatives win government in a landslide because of it. And then we'll (I very much hope) see some light at the end of the tunnel.

    I honestly feel that if we could strip bare the massive waste in the public sector we wouldn't need to borrow. A powerful reformation of taxation towards lower, fairer taxes would encourage business.

    My wish list would include the stripping away of legislation I personally feel was well-meant but crazy, counter-productive or a factor in our inability to compete with the East.

    I think, hope and prey that 'Anonymous' is wrong in predicting a rise in national politics and the death of the parties we know. The system is flawed and needs work, but at its core its a good system. It can deliver if it gets the chance.

    What frightens me the most is the idea that the present government will stick around until late 2010, doing the same thing, but escalating by the month. The damage that would cause might not even be possible to ever fix.

    I'd like to thank Cynicus for an excellent year of posts and the most observant and interesting blogger I have read on the subject.

    Wouldn't it be great if all of us who read and comment here, and Cynicus himself, all turned out to be wrong? I can't think of another time I have so wanted to be incorrect about something.

    Best Wishes for 2009 everyone!

  8. Lemming,

    We don't have free markets - that's precisely the problem.

    We have central banks interfering in a massive way by buying/selling bonds to control the price of credit (the base rate is a target that they achieve by interference).

    If the market was left alone so that the people who could lose their shirt decided the price of credit then I suspect we wouldn't have seen banks falling over themselves to lend without deposits or certified income - and that's just one aspect of their interference!

  9. Hi Jonny

    I have, indeed, read Henry Hazlett's book; I found the text somewhere on the web a few months ago. An enjoyable read, but I remember thinking at the time that it didn't offer any real proof that a true free market 'works', but seemed to take it as a given.

    I think the main point in my earlier comment is exactly the one you're making, in a way: that even if there was something to the "invisible hand" idea, it could never be demonstrated in practice because at every level, from individuals, to companies, to governments, real people try to subvert the supposed principles of the free market. Which is strange, seeing as they are the very people who collectively are supposed to produce the 'wisdom' spontaneously.

    I did think of the example of the RMB you mention, but I don't see that it is, in principle, any different from a company making certain strategic decisions which are designed to wrongfoot rival companies or even a clever advertisement that attracts customers to buy a poor product - all of which would be applauded by free market capitalists. China is, after all, only using the normal market mechanisms to buy and sell currencies isn't it? How do we know what their motives are? If the sacred free market rules allow this to happen, we must accept it as the invisible hand doing its thing.

    I have a question for you: is the patents system compatible with the free market?

  10. A question from a simpleton.

    When you say 'the fall of the West'...what do you mean by that in practical, day to day, terms?

    Your analysis is coherent and credible, but the use of such a phrase without qualification as to what it actually means for ordinary people leaves a vacuum, for me at least.

  11. First time reader from UK. Very impressed.

    Any more info on the author - surely he does more than sit around and flick through the Economist while picking his nose?

    And any tips on how to weather the shitstorm would be welcome!

  12. Hi Lemming,

    Glad you’ve read it. Yes its true it doesn’t really justify a free market but merely starts from the premise that they work; but how else can it start as a free market is really akin to a financial state of nature.

    The currencies market is not free – I believe its been noted from documents released by the Bank for International Settlements that the G10 members admit to interfering in the value of currencies and the gold price to ‘maintain stability’. I see what you mean that keeping the RMB depressed is similar to a company attempting to gain a competitive advantage; however when we look at things on an international level I don’t think the conventional marketplace analogy is suitable as the system becomes far too complex.

    Intellectual property is a matter for lawyers.

    Best wishes.


    Time to invest in vegetables, locally sourced, ie your garden.

  14. Just discovered yr excellent if gloomy analysis.

    "I think America's main problem is the sheer corruption of its financial services industry. "

    The UK has been just as corrupt ... the UK based banks have been producing Balance sheets for years, which could easily have been entered for the Booker prize for Fiction.

    One thing you miss is the way that SME's are going to simply give up in the next 6 /8 months. What incentive have holders of private capital to keep risking their capital whilst the Government steals their capital through all the imposts / taxes placed on them?

    They might as well live on their capital in modest comfort as watch it erode at 30% per annum.

    The result will be twofold ;

    1. Massive redundancy / unemployment

    2. Totally unsaleable industrial property - for which Business rates are now due.

    Those with free capital who decide to exit UK will also be restricted by some form of capital export controls.

    Ludwig von Mises summed it up like this:

    "There is no means of avoiding the final collapse of a boom brought about by credit expansion. The question is only whether the crisis should come sooner as a result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved."

    FWIW I identify the beginnings of the collapse this way

    The total number of motor vehicles licensed at the end of 2006 was 1.4 % up on the end of 2005 at 33.4 million.

    The number of vehicles registered for the first time during 2006 was 3.6 % down on 2005 (cars of all types -4.2%)

    With the exception of taxis there were decreases in first time registrations for all body types. Full DVLA annual statistics -

  15. Very interesting blog. Ever hear of Frederick Soddy, Wealth, Virtual Wealth and Debt. Omni Publications 2nd ed. 1933.

    The economic situation is calamitous. Wonder if any politicians will have the courage to recommend cancellation of personal debt and personal mortgages as a means to halt widespread poverty. Homeless persons are unlikely to riot, but the hungry sure-as-hell will!

    Brian P.

  16. Two predictions:

    1) Every business and every household will retrench until sure the worse is over - so no attempt by govt to avoid the worst will work;

    2) No policy that is helpful will be electorally popular and no policy that is popular will be helpful, so govt can do much that is harmful but nothing that is useful until after an election or a disaster.

    One conclusion:

    The sooner the crash comes, the better.

    Two comments:

    1) This makes it look as tho' democracy is incompatible with wisdom.

    2) But the Chinese system, however you describe it, doesn't look very wise right now either.

    Let's hope this is just a terrible dream, and the great and the good have got everything sorted. Now, children, do you believe in fairies?

  17. How are things going on in America? The fall has started already.

    In Mid-January of 2008, there was a report that a majority of the Wal-Mart gift cards were being used for shopping and groceries, hinting that the Wal-Mart shopper was already feeling the pinch.

    Throughout 2008, we started having banks become insolvent. At first, it was the smaller banks we didn't hear about, then suddenly it was banks figured to be to big to fail. Governments threw their paper at them to supposedly stop the markets from flash-freezing, I'm thinking it just made things go slow-motion.

    Things slowed down enough to shake prices downward. Suddenly what was $4/gallon gas in the US became $1.66 gas in a matter of months. Still, I see the occasional moped parked around the streets of suburban Northwest Indianapolis.

    Xmas stiffed badly, with few places thriving. Even Wal-Mart suffered.

    Coming into the next year, there are predictions that one quarter of our storefronts will close down. Not just Wal-Marts or Krogers, but also lawyers, doctors, masseuses, and colleges. Our governments are so deeply in debt that they're looking for everything of value to sell. Meanwhile housing prices (the reason for the "prosperity" from 2003 to 2007) have dropped, causing many people to owe more on their houses than them things are worth. Meanwhile credit is so drying up that people are bitching that their future has been taken away from them...too bad that we've (I'm from the US, so "we" is the proper pronoun) so dekcuf up the world with our toxic investments (called that when we sold them, may I add...). Justice, I believe the term is, although I most of those affected can honestly say they didn't take direct part in the actual gnikcuf.

    There's still industry in the US. We're trying to save the Automobile industry, despite the fervent wishes of 60%+ of our people. That's right: our biggest industry still in the US, and its own people want it destroyed. Never mind that Toyota and other foreign car companies stated that they'd leave the US if we let the Big Three die; they'd rather watch their own workers lose their houses and stuff than band together to improve themselves.

    As for everything else: Only American Apparel make their clothes in the USA. Little else that consumers might make is made here, and there's plans to outsource foodmaking. Melamine as a staple of the American Diet, anyone?

    To be honest, I'm not sure Obama may be able to print enough paper to do any rebuilding. The yahoos shouting "NIMBY ÜBER ALLIS" and "Lower Taxes, Keep Up My Services!" will probably be able to hold up any Obama rebuilding long enough so that the Chinese and Arabs and Russians will be able to bum-rush in with their excess dollars and buy up everything at rebate-plus prices. America will be able to export grain still, but look for the minerals and slaves elsewhere on the docks. You may also be able to set aside some of that North Sea Oil as Canadian Tar Sands and Gulf Shore Medium will flood the markets for a while. Also don't be surprised if Obama is forced to leave many armed forces behind in Afghanistan and Iraq.

    You might want to make sure you know the way to Mecca. The blood of Jews running from Palestine would probably help your cause, as well.

    As for me...I'm solvent, but I'll go down with "good" ship USA. Too poor to escape, too unskilled to be wanted elsewhere (after all, you can find all your lorry drivers from Turkey or Poland).

  18. An excellent and thought provoking post. There is no doubt that the US, the UK and other Western countries have serious structural economic problems.

    I agree with much of this post.

    But I do have a quick comment about the collapse of the manufacturing sector in the West.

    First, I would draw your attention to this article:

    Luria, Daniel, “Is manufacturing in the United States toast?” Manufacturing & Technology News, Oct 17, 2007

    This appears to show that the news about US manufacturing is not all gloom and doom.

    If one factors in the artificially lower value of the RMB, would the Western manufacturers be able to compete with East Asian manufacturers?

    I would also draw your attention to the writings of Clyde Prestowitz, whose work you may like to read.

    You can easily Google his name to get his writings, but here is an interesting place to start:
    Clyde Prestowitz, “China as No. 1,” American Prospect, February 21, 2005

    He points out that it is simply not just low wages that make China a global leader in manufacturing but government policies (essentially state interventionist or investment incentives attract to Western companies):
    China has become the location of choice for global manufacturing. This is usually attributed to its low wages. Chinese factory workers today earn 50 cents to $2 an hour and often work long shifts, getting minimal time off for weekends and holidays. But low wages are not the only factor; after all, wages in places like Vietnam, Myanmar, and Africa are even lower. China's workers are not just inexpensive but literate, hard working, already reasonably skilled, and eager -- nay, desperate -- to be trained. There is also a sizable and growing cadre of university-educated technologists and professionals. For example, China is now graduating 330,000 engineers and scientists annually, as compared with 398,622 for the United States. China has also invested extensively in infrastructure and now has a very workable system of airports, harbors, communications, and roads. Indeed, your mobile phone will work a lot better in China than in the United States, and you'll get from the airport to downtown in Shanghai a lot faster than in any major U.S. city. ….
    Because Chinese labor is inexpensive, production processes that are capital-intensive in the advanced countries can be “dumbed down” and made much less capital-intensive in China. As a manufacturer, you cut both your wage and your investment costs. On top of that, the Chinese government at local, provincial, and national levels will offer substantial investment incentives -- such as long tax holidays, capital grants, free land, low utility rates, worker training, and other benefits -- to companies willing to put plants and research-and-development facilities in China.
    These investment incentives confound free-trade theory. They are, in fact, distortions of the market, and therefore of questionable legitimacy under the rules of the World Trade Organization. This has never been challenged because other countries have investment subsidies, too.
    (American states offer tax deals to induce companies to invest.) China, however, subsidizes investment strategically to capture new industries at higher levels than anyone else.

    China’s advantage, then, comes not just from the artificially lower value of the RMB and cheap labour, but from an activist and interventionist state with a mercantilist industrial policy.
    If these factors were removed from the cost of production, how cheap would it be to manufacture goods in China for export to the West?

  19. Hmmm... Interesting article here which shows the Bank Of England knew precisely what was going on rather longer ago than perhaps they'd care to admit...

  20. CE

    The last three posts have all been excellent in different ways.

    very illuminating, thought provoking and persuasive -- on regulation of banking especially.

    I have many points and some queries but unfortunately really do not have the time to give you and your commentators contributions the time they deserve for considered replies and in some cases rebuttals.

    so a happy and prosperous and peaceful 2009+ to you all.

  21. Here is a copy of a poster's comment in the Telegraph article
    linked by Kecske December 31, 2008 1:12 AM

    Bank Of England knew precisely what was going on

    Tom 1:37pm Wrote

    "They (The international bankers)are evil psychopaths who want to own and control everything, and they don't want to share it with 6 billion useless eaters. Draw your own conclusions."


    This whole thing was contrived to asset strip the people. The bourgeois champagne quaffing socialists, freemasons, politicians and bankers don't want anyone else on the planet to have a share of the wealth. They want it all for themselves. They want their big poorly insulated palaces, their big limos and their first class travel. There's no limits to their carbon footprint is there? What utter BS global warming is too. It's just another way to fleece the people. They want their fine wines, the best food and they want all the asset wealth and resources of the world for themselves.

    They make Hitler and Stalin look like small fry.

    They control the money supply in every nation. They own most of the important land. They control all the world's important resources. It is a corporate socialist dystopia. Most people are totally asleep and don't realize the world is being run by the most unspeakably evil people, gangsters in Saville Row suits. If Gordon Brown told them the moon was made of Wensleydale, they'd believe it.

    The paper money currency system had to come to an end one day. They've bled most of the wealth away from the people anyway. Only the richest people own their asset wealth debt free.

    It really is MANKIND versus THEM.

    Time is running out.

    The paper money currency system, Bretton Woods II, is going to implode imminently. The consequences for virtually everyone on the planet are going to be beyond awful."

    UK Debt Slave
    December 30, 2008
    07:08 PM GMT

    Useless eater, (good name for a handle) is a term used for members of the excess world's population that it is alleged will be culled (by as much as 80%.)

    As I have said before here, there is too much of this type of material out there to dismiss lightly.

    Fine tune your radar.

  22. It was clear even to me 3 years ago, interest rates were unusually low given the real world, street level inflation of living costs I was seeing around me; the real world wages on offer for various jobs; the regular reports in the papers about first-time buyers being priced out of the market; seeing many of my friends around me, around 20-30 yrs old, all reporting they carried an average of £20-30k of credit card or loan debt like it was normal and encouraging me to do the same to fund what they called “fun stuff”.

    I’m generally not one for conspiracy theories but something about the whole situation seems highly contrived and deliberate. I have been reading your blog with great interest for a while now, as try to understand the strategy of the government in this affair. This is what I have come up with so far:

    Back well before 1997, I remember people growing tired of the Tory government’s new faces and old tricks, which they still couldn't disassociate with Thatcher.

    But, as tired as we were, as ripe for change, election after election they would reappear in defiance of the poles. Socialism seemed the greater of the two evils and we appeared to trust the individual economic prosperity of “speculate and hoard” Conservatism over the shared common wealth of “tax and spend” Labour.

    Unable to gain the majority with only the common vote, Labour reinvented itself to win the richer vote and moved to the middle ground, more like “borrow and spend” New Labour perhaps?

    Well, in any case, they won by a land slide by meeting the demands of self-interest over common good. So they began “borrowing and spending” as the economy they inherited was ripe for “growth”.

    To deliver the social spending requirements, needed to restructure the NHS, education, welfare etc, they had to have the high GDP income expected of an advanced industrial nation. Increased direct taxation of income was a vote loser, so the stealthier taxes on market transactions were the only viable alternative. These would require high volumes to generate income for the government.

    Always being reluctant to remove Stamp Duty tax from stock market equity transactions still baffles most investment experts who have felt it only makes the LSE less competitive and cumbersome among its global peers. Many property experts have argued that the government has been oddly lazy about altering the Stamp Duty Land Tax threshold in line with house price inflation. Similar views are held about IHT and CGT levels by others.

    However, prudence was not shown when it came to any policy that controlled debt based growth, such as keeping interest rates artificially low using false or massaged statisitics; or the new language of spin to help feign prosperity in the face of warning signs, such as the deluge of television and media ads from previously unheard of companies all offering easy “platinum credit cards”, “debt consolidation loans”, “home equity release schemes”, “holiday home mortgages”, “self-certified/pre-approved mortgages” , “buy now, pay later” etc.

    Well, I remember a time when this wasn’t normal, where it was unfashionable to be heavily in debt, or to pay for things by credit, you needed to prove your expenditure over 3 months and your income over a year. Instead, the culture was, if you want something better, work harder or educate yourself into a better pay bracket.

    All change then, with New Labour came a new culture for the British people. “Borrow and spend” your way the American Dream where you don’t need to keep up with the Jones’, because now you ARE the Jones’.

    All this activity seems to have been generated through inflating the credit supply and mainly expressing it as spending power through partial liquidation in the perceived future value of peoples homes. And all through, total reluctance to regulate lending in order to subdue the asset bubble created by the Blair-Brown Project. Switching to CPI over RPI, removing house prices from the measure proves that.

    In essence, it seems the government created a new sector for the economy through house price speculation. Excluding housing from the inflation measure meant they banked that houses could then only go up. The thing that has caught them out is the income gap has not kept up and the Golden Goose of property is starting to fly away. Their response is another stealth scheme (bail-outs) that ultimately focuses less on business and employment, but rather on making banks lend to the property market.

    Ultimately, it is the tax-payer subsidising people who want to buy houses. All reports in the media about government action seemed centred around pressuring banks to pass on interest rate cuts to mortgage holders and lend out the tax bail-outs for more house purchases. This doesn’t make sense as they, as well as the banks, must know the houses are currently over-valued?

    But then we consider the other stealth tax initiated (quantitative easing) is to inflate the currency supply at the expense of the value, the big scare story being deflation (again only really being seen in the property market). Putting both these actions together, the strategy seems a clear attempt to prevent the property market from stalling and to stabilise it at current levels – limiting the bust.

    Otherwise, as next year’s GDP figures will probably have the UK behind Italy in EU terms, Labour won’t make any real money unless they raise direct income taxes. This would make sense as the percentages the government must have made from the acquisition and disposal of equity over the last 10 years must be massive.

    Like many of you, I’m trying to decide what to do with my savings, so have a vested interest in understanding all this. Appreciate any comments, particularly if you think I have this right, or if I’m missing anything.

  23. A farm is like a factory. You put the ingredients in it, you throw some hard work and you get production.

    A confiscated farm looks a lot like a confiscated factory. There is a small difference though.

    You can start a closed factory in days if there is the will to do so. Waiting for a new crop, needs months.

    There could be starvation if there is no caution.

    What is the financial situation of the average UK farmer?

  24. I think you're right, Mark. In regard to the global free market, I'd say that a grand leveling is beginning between the East and the West that will culminate when the factors of production are to the point where trade is a win-win proposition for the participants. The leveling period won't be short and it won't be easy!

  25. "Our creditors, such as China and Saudi Arabia, are now turning off the supplies of credit, and are no longer buying the £GB to lend to us. Demand from this source will continue to evaporate..."

    Could somebody briefly explain the mechanichs of this? How did they lend to us? By buying Government bonds? Sorry, I am not economist. Very interesting post though?

  26. Not read the whole thing, but on a minor point...

    The reason why a cigarette lighter costs so much more in the West is because the consumer end of the supply chain costs drastically more to run. Baumol's cost disease kicks in; tradables drive up value-add, which bids up market wage rates for the non-tradable sector (including profit rates from self-employment), which in turn raises the cost of doing basic functions (i.e. running a newsagent).

    Possibly excessive borrowing bids up wage rates in the domestic economy, but this would lead to a collapse in tradable competitiveness; which, given exports have been ok regardless of sterling's strength these past years, seems unlikely.

    But hey.


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