Friday, January 29, 2010

GDP Growth, Debt and Current Accounts

We should all be celebrating, should we not? The news is that US GDP grew at an annualised rate of 5.7% in the last quarter, and the UK finally moved into GDP growth, albeit that the UK GDP growth is negligible. Should this be a cause for celebration, should we not be singing the praises of those that engineered this 'recovery'? I will apologise in advance for the long quotes that follow, but these are necessary to understand the nature of the 'growth'.

The US

If looking at the source of the surge in GDP growth in the US, AFP provides an explanation:

The big GDP gains came in large part from businesses ramping up production to rebuild inventories, which economists say may skew the picture of overall activity but is a normal part of recovery. Inventories accounted for 3.39 percentage points of GDP.

Stripping out inventory adjustment, real final sales -- a reflection of the underlying pace of growth -- was at a 2.2 percent rate, the report showed.

[and]

Capital spending on equipment and software surged 13.3 percent, another significant contributor. Ian Shepherdson at High Frequency Economics called this a "key upside surprise" but added that "we can't see where this comes from and think a downward revision is likely."

The data showed exports surged 18.1 percent, making trade a positive contributor to GDP since exports increased more than imports, which were up 10.5 percent.

Consumer spending, which is traditionally the key driver of economic activity, rose at a 2.0 percent pace, down from 2.8 percent in the third quarter, and accounted for 1.44 percentage points of GDP.

In the case of the US, it is noticeable that there is some cynicism about some of the statistics, and that the rebuilding of inventories will presumably diminish as an influence. A real positive is that 'export growth was strong at 18.1% which leaves net exports contributing 0.5pp to overall GDP growth.' However, before the US starts celebrating, it is necessary to add a dose of cold hard reality. The chart that follows shows that the 'growth' in exports starts from a low base:

Then there is the imports of goods and services, which is the other side of the coin:

All this give a balance on goods and services trade as follows:

But here is the real problem. As the economy contracted, so did the current account balance. However, as 'growth' commences, a commensurate deterioration in the current account balance follows. In other words, the 'growth' is seeing the US problem of consuming more than it produces worsening as the economy 'grows'. It gives a horrible sense of deja vu...

Observant readers will note that the chart only goes to mid 2009, and does not therefore include this current spurt in 'growth'. I suspect that, once the figures are out, the line will continue the downwards trend. The preliminary figures from the Bureau of Economic Analysis suggests a growth in the current account deficit for the third quarter of 2009.

What we are seeing is the delayed effect of the government's role as a replacement for the loss of consumer debt driven economic 'growth' (the chart is 'Household sector: Liabilities: Household Credit Market Debt Outstanding') .

I do not think anyone needs to see the following chart which shows the massive increase in the government deficits, but will include it anyway.


As a final chart for the US economy, we have the GDP figures that have caused so much excitement.


It is not difficult to see what is taking place when we see these charts. As consumer debt growth tailed away, the economy fell into deep recession, and with it there was an improvement of the position of the current account balance. The current account balance started to move in the right direction as American consumers moved towards living within their means. However, as this took place, the government replaced the consumer as the driver of debt driven consumption, and we are now seeing the return to 'growth' with a commensurate decline in the state of the current account balance. The early decline in GDP reflects the time lag for the wall of government borrowed money to hit the economy but, as it works its way through the economy, 'growth' appears again.

The UK

In the UK this is what national statistics offered as an explanation of the slight GDP growth:

Services output rose 0.1 per cent, compared with a fall of 0.2
per cent in the previous quarter. Distribution, hotels and restaurants contributed most to the increase. Distribution, hotels and restaurants rose 0.4 per cent, compared with an increase of 0.7 per cent in the previous quarter. Motor trades and retail contributed most to the increase. Transport, storage and communication showed zero growth, compared with an increase of 0.7 per cent in the third quarter. Business services and finance showed zero growth in the fourth quarter, compared with a decrease of 0.8 per cent in the previous quarter. Government and other services rose 0.2 per cent, compared with a decline of 0.2 per cent in the previous quarter. Health made the largest contribution to the increase.

Total production output rose in the fourth quarter, increasing 0.1 per cent, compared with a fall of 0.9 per cent in the previous quarter. Manufacturing made the largest contribution to the increase rising 0.4 per cent, compared with a fall of 0.2 per cent in the previous quarter. Mining and quarrying output rose 1.0 per cent, compared with a decrease of 5.7 per cent in the previous quarter. Electricity, gas and water supply fell 3.3 per cent, compared with an increase of 0.2 in the previous quarter.
The same kinds of relationships can be seen in the UK data as can be seen in the US. If we start with the balance of trade, we have this from national statistics:


And then there is the current account balance:

The following is a chart of net lending which, whilst not directly comparable with the US chart, shows a similar pattern.

Just as consumer lending goes into reverse, as in the US, the UK government steps in to replace consumer borrowing with government borrowing:

And finally, there is GDP growth figures:

What we are seeing is the same pattern as the US, but at an earlier stage. Just as the US moved towards growth, and the current account balance started moving in the wrong direction, the same is happening with the UK. Just as the US government replaced the consumer as a borrower, the same has taken place in the UK.

Conclusions

Whilst they are not following exactly the same pattern, there is an uncanny similarity in the relationships between the charts for the US and the UK. What we are seeing is not economic 'growth', but growth in debt. It is not the first time I have said this, but it is worth saying it again. This is like measuring a person with a salary of $100,000 and adding borrowing of $20,000 to suggest that he has an income for the year of $120,000. Sure, his purchasing power has increased, but his income has not. Just as the individual can now spend more than he earns, so can the US and UK. This is reflected in the current account and trade deficits.

None of this is economic growth, but is instead a steady process of national impoverishment. It is the feel good of consuming more than you produce, and the hell with the consequences in the future. It is a road to ruination, and I will therefore not join any celebrations for the increase in GDP. It is the height of irresponsibility.

32 comments:

  1. IMO the big problem is that the "health" of the economy is judged by this single figure "GDP", the distillated figure which is supposed to precisely represent the total of economic activity. It is surely time to change the metrics and use figures which are much more meaningful. As a starter maybe a country's economy should be treated in exactly the same way as a company would be, taking into account

    1. The percentage of fully employed productive workers.

    2. The profit/loss and balance sheet of the country.

    3. The ratio of overheads to productive assets.

    By these measures the UK, the US and a large number of other countries are in a massive mess.

    The GDP historic chart I find remarkable. From 2004 to 2008 there is hardly any movement in the steady two to three percent growth. But look at the yo-yoing current account deficit and the massive surge in loans on property (a significant proportion being enquity release to spend on "good feeling" stuff) over the same period.

    Why wasn't the GDP bouncing around as well? Somehow the effect of the extra debt has been magically massaged into a smooth GDP. The FTSE represents the health of the top 100 companies in the UK, maybe it should be used as an indicator of the health of the economy? We are now back to 1998 levels, and only because of the availability of vast quantities of free money pumping it up, otherwise we could be back to 1995 or earlier.

    From my personal view, I do not feel that the last decade has increased my personal well being. Although electronic stuff has, to a certain extent, "enriched" my life, all the basic living necessities are vastly more expensive, I am paying more taxes than ever before, my savings rate is at an all time low, my company pension scheme is totally underfunded as, indeed, is the state scheme. For me a losing decade, leaving me worried about how I am to fund my existence going into my retirement.

    We stand at the beginning of the next decade, and I honestly cannot see how this can be anything other than another long decline of living standards. We are starting out with a huge mess and terrible fundamentals, which will not be solved in six months, two years of even five years. In the UK there will be no attempt to solve anything for the next six months until the election is behind us. Another six months time wasted and thrown away due to political bickering and troughing at the tax payers' expense.

    But then, in the light of all this, the Nationwide announces they expect a "double digit growth" in house prices. Well, that will certainly save us all.

    Words fail me.

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  2. We are stealing from the future generations in order to consume goods and services now. If we were forced to pay for the level of govt spending from tax revenue alone, and no borrowing, the level of taxation would be untolerably high, and rejected by the electorate.

    Instead we mortgage the efforts of our children to pay for our profligacy now. We have comparable debt to that incurred during WW2. At least then you could argue that it was legitimate for the coming generations to pay, as the people then also paid, in blood. They spent the cash not on themselves, but on winning the prize of freedom, which they passed on to us.

    We on the other hand are a lazy, entitlement driven population, living for the moment, and damning the future. The ME ME ME generation. The I Want It Now generation. All the future will inherit from us is a life of servitude to service the debt incurred for our good times.

    It is unsustainable, as all debt fuelled binges are, and will end in tears.

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  3. A Real Black PersonFebruary 1, 2010 at 9:10 AM

    Today's economic problems in the developed world are a result of culture. Workers in developed countries are competing with developing countries where excellence is expected from birth onwards. Calculus is taught at the sixth grade level in India.
    I doubt any foreign worker thought they weren't learning useful at school as a child.

    Current policy in developed countries favors insourcing. It's far easier than changing culture, values, and expectations.

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  4. What we are seeing is not economic 'growth', but growth in [government] debt. It is not the first time I have said this, but it is worth saying it again. This is like measuring a person with a salary of $100,000 and adding borrowing of $20,000 to suggest that he has an income for the year of $120,000. Sure, his purchasing power has increased, but his income has not.

    Let me give an alternative view. The analogy with private debt is wholly mistaken, for these reasons:

    (1) The government is the monopoly issuer of its own currency; no private individual can print money;

    (2) The government has the power to rollover much of its debt, unlike private individuals;

    (3) The government has access to tax receipts which grow over time, which can effectively mean that the cost of interest servicing falls as the population rises.

    Chartalism (or Neo-chartalism or Modern monetary theory), a branch of post Keynesian economics, provides the best explanation of how our modern fiat monetary systems actually work, and it also blows the tired old analogy between private debt and government debt out of the water.

    I recommend reading Bill Mitchell’s neo-chartalist blog.

    Also, there is this excellent essay on why government spending, if used correctly, is the key to getting the West out of stagnation and recession:

    Can we spend our way out of the recession? Is the fiscal deficit unsustainable? By Eric Tymoigne


    Comment on Sobers

    Instead we mortgage the efforts of our children to pay for our profligacy now.

    Deficit spending on infrastructure, public works and public services is not 'profligacy.'
    It is a worse crime to allow the economy to collapse and allow high unemployment. This prevents the potential economic growth that we would get from full employment from ever happening.

    Future generations will benefit tremendously from public investments made now, particularly education, health care, science and technology.


    We have comparable debt to that incurred during WW2.

    Um, actually, no we don’t. It is certainly high by the standards of the past 40 years, but only about 30% of the debt level the UK government had at the end of WWII.

    The UK public debt as a percentage of GDP is estimated at 71.95% in 2010. After the end of WWII in 1946, it stood at an incredible 237.12%, as you can see here:

    UK National Debt As Percent Of GDP

    According to the “government-debt-will-bankrupt-the-nation” crowd, the UK should have totally collapsed after WWII under the crushing weight of government debt.

    The post war generation should have been reduced to penury and poverty.

    Of course, no no such thing happened, for the 3 reasons I outlined above.

    Instead, the UK went on to enjoy the most prosperous period of economy growth it ever had, probably in the whole modern period.

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  5. Lord Keynes

    I dont think you can compare the situation of ww2 debt with the current situation.

    First, the debt incurred wasn't a normal " commercial " debt and thus repayment / profit was not its motivation. It was provided by the US for the reconstruction of the war ravaged UK.

    Second, as such, the terms were very generous ie 2.5% fixed interest, unusually long and flexible repayment term, the option ( taken on numerous occasions ) to take payment " holidays " when required and the certain effects of inflation which reduced massively the overall debt over such a lengthy term.

    Third, the UK economy was a very different creature to the one today. We were a manufacturing superpower ( albeit declining ) and posted b of p surpluses. We led the world in shipbuilding, aircraft manuf and new technologies amongst others, points that have a very real resonance within the framework of this blog.

    Fourth. The world in general was in an equally weak position, thus the Uk position was relative to the position to our main trading partners / competitors.

    Five. There were no emerging economies or alternative economies of the size and scope that exist today ( China ) to threaten the status quo.

    Your points re Govt debt are dependent on govt ability to roll over their debts. There are many who think that this may not be as easy as you assume given the catastrophic state of the current finances, the structural imbalance of the UK economy and the general malaise so frequently ( and excellently ) discussed in this blog.

    It also seems to me that the govt may be approaching the limits of its ability to print its own money without bringing about the total collapse it is seeking to avoid. In any case, the money printing argument seems to reaching the end of its credibility, to continue in any further substancial measure will surely bring about the wrath of the markets, bond, forex,ratings etc, with all the miserable result that, that entails.

    Similarly, increasing tax reciepts are not a God given certainty, particularly when those reciepts have been financed by massive debt, private, public and corporate, which is and has imploded. It seems to me that the whole premise of this blog is to question where the growth will come from to continue the past largesse and thus tax reciepts.

    I have to confess that I have not followed the link you gave ( its late at night ) but will at some other time. The thoughts above are just an immediate response.

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  6. @Lord Keynes: If we were actually getting something for all the cash being spent, then I might agree. A souped up motorway network, or railway system perhaps? A national water grid? A superfast broadband network? A nuclear power generation system? A health service that doesn't kill thousands of its patients every year through negligence? An education service that teaches the 3 Rs to a rigorous standard and doesn't allow 20% of pupils to leave functionally illiterate? A benefit system that encourages people into work and to be self reliant?

    Can't say we're getting any of those. What we are getting is a a growing underclass dependent on State handouts, an education system that produces badly educated louts, an health system that is riddled with super bugs, and a plethora of unaccountable quangos that produce nothing but reams of unreadable verbiage and new regulations designed to stop the few people still trying to create wealth in this country from doing so.

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  7. US Government Debt as a percentage of GDP: Historically Unprecedened?

    I should also have added that even the US goverment debt as a percentage of GDP is not as large as that after WWII:

    National Debt Graph

    In fact Reagan and Bush senior ran deficits almost as large as Obamas and pushed up the debt to GDP ratio to levels almost as high as those now.

    ReplyDelete
  8. Further thoughts

    In one respect, the high government debt to GDP ratios that have emerged over the past 2 years in the UK and the US are 'profligate' - because most of the government debt has gone to bail out zombie banks, as you can see here:

    Bailouts versus stimulus

    In fact, the US and UK and governments could have nationalised the banks, audited them, wiped out bondholders and shareholders and written off bad debts, and simply bailed out depositors up to a certain amount.

    Then they could have engaged in large stimulus packages - and been left with smaller government debt to GDP ratios.

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  9. Reply to Sobers 2

    If we were actually getting something for all the cash being spent, then I might agree. A souped up motorway network, or railway system perhaps? A national water grid? A superfast broadband network? A nuclear power generation system? A health service that doesn't kill thousands of its patients every year through negligence?

    Fine. Then elect a poltical party that will do that with your money. That doesn't change the fact that efficient government spending on public works or social services is in no sense "profligacy."

    It wouldn't be the useless Tories, but a party like the "Old" Labour of Clement Atlee.

    My argument that decifit spending is vitally important and responsible government policy in times of economic crisis stands.

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  10. @Lord Keynes

    Let me give a counter to your overeducated view of basic economics:

    (1) The government is the monopoly issuer of its own currency; no private individual can print money;

    (1c) The government can continually dilute the value of its currency and thus disincentivise any economic activity dependent on forward valuations of that currency.

    (2) The government has the power to rollover much of its debt, unlike private individuals;

    (2c) The government can create a ponzi scheme and continually pretend to creditors that there'll be another greater fool coming along any minute now.

    (3) The government has access to tax receipts which grow over time, which can effectively mean that the cost of interest servicing falls as the population rises.

    (3c) The government can rape the farm of its crops and then flog the soil to impatient creditors and still expect a bumper yield next season despite the farmhands having eaten each other out of sheer desperation.

    I recommend reading Economics In One Lesson by Henry Hazlitt http://jim.com/econ/

    Also, there is this excellent essay on why government spending ruins every economy known to mankind, it's called HISTORY.

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  11. @Lord keynes: just for future reference, is there any limit to govt spending and levels of debt in your economic theory? If so what is it?

    ReplyDelete
  12. Reply to Adam

    (1c) The government can continually dilute the value of its currency and thus disincentivise any economic activity dependent on forward valuations of that currency.

    Steady but low inflation does the precise opposite: it incentivizes investment and increases it, because you know that not investing your money will see its value fall. On balance, low but steady inflation leads to higher investment and economic growth.


    (2c) The government can create a ponzi scheme and continually pretend to creditors that there'll be another greater fool coming along any minute now.

    Government borrowing is fundamentally different from a Ponzi scheme.
    Here is the definition of a Ponzi scheme from Wikipedia:

    A Ponzi scheme is a fraudulent investment operation that pays returns to separate investors from their own money or money paid by subsequent investors, rather than from any actual profit earned. The Ponzi scheme usually entices new investors by offering returns other investments cannot guarantee, in the form of short-term returns that are either abnormally high or unusually consistent.

    Apart from the fact that rolling over debt may sometimes involve taking money from a new buyer of a bond and giving it to the old one, the similarities end there.

    In fact, stock market trading involves exactly the same thing: a new buyer paying money for a share or stock to an old buyer.

    So by your argument and logic, this makes stock market trading the equivalent of a Ponzi scheme?

    Of course, no one who thinks carefully about it would think anything so foolish.

    Furthermore, government borrowing is utterly different from Ponzi schemes for these reasons:

    (1) The government does something extremely important with the money it borrows: it pays for public infrastructure, defense, social services, funding of R&D, education, and law and order. A Ponzi scheme fraudster does nothing of social value with his investors’ money.

    (2) Government bonds offer quite low returns (not ridiculously high ‘Ponzi’ style returns) compared to other investments, precisely because they are so safe.

    (3) Government often does not roll over debt, but pays back bonds with tax money, its real and guaranteed income, which is growing with the population and economy.

    Your response to my point (3) doesn’t refute it in any way.

    You seriously don’t believe that a growing economy and growing tax base reduce the government debt to GDP ratio of a nation????!!

    If so, would you care to explain this graph
    that shows how US government debt dropped like a stone in the ocean from 1948 right down to 1980, when the “free market” Reagan drove the US into deep deficits?

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  13. Reply to Adam 2 - On Henry Hazlitt’s Economics In One Lesson

    Actually, I have read Henry Hazlitt’s book. I wasn’t impressed.

    I have refuted many of his utterly mistaken and ignorant views on this blog before, including his caricature of the case for infant industry protectionism, his mistaken view on free trade, and his inability to understand how a modern fiat monetary system works.

    You can read many of my refutations here (at the bottom in the comments section):

    The UK and the Silent Bank Run.

    A sample:

    On Henry Hazlitt’s Taxes Discourage Production

    Hazlitt argues that taxes take money away from the private sector and significantly prevent private sector growth:

    the capital available for risk-taking itself shrinks enormously. It is being taxed away before it can be accumulated. In brief, capital to provide new private jobs is first prevented from coming into existence, and the part that does come into existence is then discouraged from starting new enterprises

    Yet again this book fails to convince. In a modern economy, the central bank can increase the money supply in response to demand from private enterprise for investment capital.

    In the US, banks can obtain money through the discount window at the Federal Reserve or the Fed can engage in open market interventions to increase banks’ capital.

    The claim that the money supply is significantly reduced through taxes ignores the actions of Central banks.

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  14. Reply to Sobers

    @Lord Keynes: just for future reference, is there any limit to govt spending and levels of debt in your economic theory? If so what is it?

    Of course there is a limit to the government consumption of real resources (either goods and services).

    That limit is reached when we have full employment, strong economic growth and signs of inflation.

    Then it is time to rein in spending, curtail bank lending by raising reserve limits or soaking up excess liquidity or even introducing a tax based incomes policy.

    When there is a severe supply contraction, on the other hand, government deficits are a bad idea, and should not be done.

    However, in times of depression and severe recession, when much productive capacity is unused, the government can, and should, run large deficits to stimulate the economy.

    The principles are explained here:

    Zimbabwe for hyperventilators 101

    In a depression or severe recession or in times of emergency, the government can just as easily have the central bank purchase bonds if the private sector does not buy them all. In other words, it can 'print money.' This is how Lincoln won the civil war, how Japan got out of the Great depression, and how the US won WWII.

    Historical instances of printing money that then led to hyperinflation were accompanied by massive and severe supply contractions – something which is not an issue for the UK or US today.

    The US, for instance, won World War II by having the Fed print money when necessary..

    Even with the printing of money, the massive war time deficits that reached 30% of GDP in some years and the contraction in the production of consumer goods caused by the wartime command economy, there was no hyperinflation or economic collapse in the US. There was high inflation as the economy was converted back to producing consumer goods, but that was utterly different from hyperinflation.

    And under the 'tap system' of issuing government bonds after WWII, a number of Western countries like Australia for many years actually had their central banks purchase government bonds when they weren't all bought by private bondholders.

    No hyperinflation ever resulted.

    The system is explained by Bill Mitchell of Billyblog:

    [around 1981] the Australian Office of Financial Management was set up as a special part of the Federal Treasury to management federal debt. Previously, bond issues were made using the “tap system”, whereby the government would announce some volume of debt it wanted to issue at a particular rate and then sell whatever was demanded at that yield. Occasionally, given other rates of return in the financial markets the issue would not be fully subscribed – meaning some of the Government’s net spending would be covered in an accounting sense by central bank buying treasury bills (government lending to itself!).
    The neo-liberals hated this system and regarded it providing no fiscal discipline on government. They knew that by linking deficits $-for-$ with private debt they could more easily mount the debt hysteria and maximize their pressure on government to cut deficits and withdraw from the market.


    D for debt bomb; D for drivel ….

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  15. Reply to Anonymous on the UK's Wartime debt

    Public Net Debt-total
    I dont think you can compare the situation of ww2 debt with the current situation. ...
    Second, as such, the terms were very generous ie 2.5% fixed interest, unusually long and flexible repayment term, the option ( taken on numerous occasions ) to take payment " holidays " when required and the certain effects of inflation which reduced massively the overall debt over such a lengthy term.


    I assume you are talking about the Anglo-American loan of 1946?

    This was a loan of to $3.75 billion US to the UK on 15 July 1946.

    In 1945 pounds, that was a loan of £930 million.

    But the total UK government debt in 1946 was £23.6 billion.

    So in actual fact the Anglo-American loan, which was indeed on generous terms, was just 3.9% of Britain’s total wartime debt.

    Yet the total massive debt still fell rapidly in the post-WWII era.

    I will address your other arguments in later posts.

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  16. *sigh* (Surely I should have 'Don't debate imbeciles' tattooed on the insides of my eyelids.)

    >> Steady but low inflation does the precise opposite: it incentivizes investment and increases it, because you know that not investing your money will see its value fall. On balance, low but steady inflation leads to higher investment and economic growth.

    Stealing money out of people's pockets 'incentivizes' them to spend it before it's all gone. The fact that such spending can find its way into all manner of malinvestments should concern no-one because all that matters is the immediate bump in GDP??

    >> Apart from the fact that rolling over debt may sometimes involve taking money from a new buyer of a bond and giving it to the old one, the similarities end there.

    Yup. That's a ponzi scheme.

    >> In fact, stock market trading involves exactly the same thing: a new buyer paying money for a share or stock to an old buyer.

    Nope. That's called a revaluation of an asset.

    >> (1) The government does something extremely important with the money it borrows: it pays for public infrastructure, defense, social services, funding of R&D, education, and law and order. A Ponzi scheme fraudster does nothing of social value with his investors’ money.

    Just like the government, a ponzi-schemer can spend his ill-gotten gains into the economy on land, houses, schools for his children, and all manner of things that require other people be employed to produce things. He could even invest in a shell company (think government dept.) to launder his dodgy paper and make himself appear legit.

    (Are you taking the hint that the group of individuals collectively known as the government are in fact no different from any other (bad) actors in the economy and should be held to a universal moral standard?)

    >> (2) Government bonds offer quite low returns (not ridiculously high ‘Ponzi’ style returns) compared to other investments, precisely because they are so safe.

    Another standard textbook reply. Ask the Chinese how safe they think certain government bonds are.

    >> (3) Government often does not roll over debt, but pays back bonds with tax money, its real and guaranteed income, which is growing with the population and economy.

    Also ask the Germans about Greece.

    >> If so, would you care to explain this graph
    that shows how US government debt dropped like a stone in the ocean from 1948 right down to 1980, when the “free market” Reagan drove the US into deep deficits?

    Was this about the same time the world suddenly 'adopted' a dollar standard thus allowing America to pay off its debt with its own printing press?

    Get your head out of your 'Keynesian Voodoo Economics for Zombies' textbook and start living in the real world.

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  17. Reply to Adam 2

    Thank for your comments. I am happy to respond.

    Stealing money out of people's pockets 'incentivizes' them to spend it before it's all gone. The fact that such spending can find its way into all manner of malinvestments should concern no-one because all that matters is the immediate bump in GDP??

    The actual empirical evidence says otherwise. Savings rates may be poor in the US and have been since about 1985. The historical savings rate in the US from about 1950 to 1985 hovered around 10%, but then plunged to 0% at at time of low inflation, which doesn’t fit your argument at all: if anything the US saving rate should have plunged to nothing in 1970s when we had very high inflation that hurt people's living standards.

    But other countries with fiat currencies and low or even moderate to high inflation have reasonable savings rates. In Europe, average savings rates are about 20%, and in Japan about 25%. The average rate in China is estimated to be almost 50%, yet China also often has problems with higher inflation rates compared with Western countries.

    And, anyway, large investors don’t spend their money on consumer goods, and never have. Nor do people saving for retirement. Steady and low inflation incentivizes investment, especially amongst large investors, because doing nothing with your money simply means it decreases in value.

    If you have steady deflation, on the other hand, there is far less incentive for people to investment money, because it is certain that the value of the money will rise.
    Business people wanting to borrow money are also given an incentive to borrow for productive investments, because steady but low inflation means they effectively pay less than they borrowed back.

    Effective financial regulation prevents asset bubbles and bad loans.

    Apart from the fact that rolling over debt may sometimes involve taking money from a new buyer of a bond and giving it to the old one, the similarities end there.

    Yup. That's a ponzi scheme.


    No, it isn’t. If it was, then rolling over private debt would also be nothing but a Ponzi scheme as well. It isn’t. Nor is rolling over government debt.

    Just like the government, a ponzi-schemer can spend his ill-gotten gains into the economy on land, houses, schools for his children, and all manner of things that require other people be employed to produce things. He could even invest in a shell company (think government dept.) to launder his dodgy paper and make himself appear legit.

    If a fraudster secretly invested his investors’ money in “houses, schools for his children” and other things of social value, he would not have the money to pay back his investors ludicrously high returns.

    By definition, he would not be a Ponzi schemer, but a person guilty of a strange type of financial fraud.

    Government, by contrast, tells us precisely what it is spending our money on in the coming year’s budget. It is not secret. And, of course, you completely forget that people vote governments in and out: so the voting population ultimately determines what their money is spent on. We can vote for higher or lower taxes as well.

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  18. Reply to Adam 3

    Another standard textbook reply. Ask the Chinese how safe they think certain government bonds are.

    The statement that government bonds offer quite low returns (not ridiculously high ‘Ponzi’ style returns) compared to other investments is completely accurate.

    That is precisely why people across the globe fled to US bonds in 2008.

    The fact that the Chinese are worried about the effects of the US monetizing government debt doesn’t change the fact that historically bond yields are generally lower than the returns on other investments.

    Your average Ponzi scheme offers a 20% return or higher. The yield on a 5 year US Treasury bond last month was 2.67%. Most people can see the difference.


    Also ask the Germans about Greece.

    This does nothing whatsoever to refute my comment.

    And, in fact, Greece’s monetary system is fundamentally different from that of the UK or the US. It is a textbook example of why a nation should never give up its currency sovereignty. When Greece joined the EU, it gave up the sovereign power to have its central bank control the money supply, and is effectively forced to borrow in Euros, which is like a foreign currency over which it has no control.

    The UK and the US and most other nations outside the EU have currency sovereign, so they will simply never have the sort of problems that face Greece.

    Was this about the same time the world suddenly 'adopted' a dollar standard thus allowing America to pay off its debt with its own printing press?

    What debt??! The US was a net creditor to the rest of the world for a long period after the Second World War, right down to 1985.

    And even if your statement were true, it would be utterly irrelevant.

    I was talking about the UK government debt (that was the issue here): this was denominated in UK pounds, not US dollars, and the debt was also largely owned domestically, and was paid off through growing tax receipts from real and high economic growth and population growth.

    The fact that you won’t even answer the original question speaks volumes.

    Let me repeat the question:

    You seriously don’t believe that a growing economy and growing tax base reduce the government debt to GDP ratio of a nation?

    A fiat monetary system is not even necessary for this process to take place: you would get the same effect if you had a gold standard and a growing economy.

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  19. is trying to create wealth IN the United States or Britian or any developed country? Who? The genetically modified crop businesses?
    All the "wealth creators" are ,for the most part, foreign born. Engineers and scientists from developing countries aren't staying in Western countries after completing their studies not only because of regulation but because they can make a better living at home. They refer to lower living costs at their native country with phrases like "[we can] live like kings". There is simply less inflation in living expenses in developing countries because
    of real wealth creation and because people there are happy to toil for less than $ 20 a day. Large families take care of what social programs take care of in developed countries. As birth rates fall, the developing countries will have their own versions of social programs but that will be offset by savings in both private and public institutions.

    Cynicus, the masses are slowly waking up.
    http://www.youtube.com/watch?v=eZA0qNsf4m0&feature=pyv&ad=3723781624&kw=housing
    As I've noted, some of them realize there's a cultural demension to it all.


    Lord Keynes,
    Debts held by governments are real. Ask any third world country that has a 3 to 1 debt to GDP ratio debt if their debt impacts their economy. Hint: it does. Debts can't be inflated away. Escalating federal debts can destroy currencies. No government can"roll over debt" and you know they can't. You haven't cited one example of a government that has "rolled over" its debt. Don't try to mention Japan. Japan barely makes anything these days and its population is aging rapidly because everyone was too busy the last 30 years to make babies. Germany tried to" roll over" its debt in the 1920s the only way a government can "roll over debt", by printing lots of money that wasn't backed by anything. Germany did this with no international market for its bonds and that led to a quick collapse of its currency. The current United States government will soon have no more new buyers for its bonds. No buyers for its bond means there will be ,soon if not now, no international confidence in the U.S. dollar's worth. It's only a matter of time.

    The only way government spending could help if it were directed to the military to wage war. War eliminates competition.That's what World War II did for America, It worked in World War II, it's working in Iraq for Iraqis. Destruction and the reconstruction that follows it creates demand for just about everything. As an observer of history and biology, I can only conclude that some people are going to have to die to get the global economy humming again.

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  20. Lord Keynes

    The link below explains how the UK dealt with nat debt post ww2, a tactic unlikely to succeed again in todays world.

    http://www.taxpayersalliance.com/waste/2009/04/repaying-the-national-debt-not.html

    In addition to the US reconstruction loan you mentioned, there was an additional loan for equipement and goods in the UK following Lend lease totalling some 600m dollars and Canadian loans. The billions owed by the UK for war equipement under lend lease was actually written off.

    Two billion pounds was raised through patriotic fervour in the form of war bonds. These bonds had an open repayment term, the capital HAS NEVER BEEN REPAYED to this day and are now virtually worthless to the holders. So much for patriotism.

    I maintain that WW2 debt is a very different animal to the normal commercial gilt market of today. One sniff of inflation being used as a tool to inflate debt away will result in a devastating response.

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  21. Lord Keynes, so much of your argument relies upon a growing population (of economically active people) to provide a growing base of tax receipts for the government. This, for most Western nations will not be the case in the future. The only other way to acheive increases in the tax take is for increased productivity per capita. This is proving problematic with, as outlined numerous times in this blog, the huge increase in labour introduced into the world economy by the developing nations makes comparative advantage and increased productivity harder to acheive and more and more short lived. Ergo the government must learn to live closer to its actual means in the future.
    I appreciate the government does not actually run a ponzi scheme but should it find itself in a situation where it cannot repay its debts without debasing its currency what is the point of semantics?

    ReplyDelete
  22. Reply to Anonymous

    Lord Keynes, so much of your argument relies upon a growing population (of economically active people) to provide a growing base of tax receipts for the government. This, for most Western nations will not be the case in the future.

    Not without encouraging families and creating productive jobs. This can be done through social policies to help families as well as immigration and vigorous industrial policy.

    The only other way to achieve increases in the tax take is for increased productivity per capita.

    I agree completely. And the way to do this is to make large investments in science and technology – through the state.

    This is proving problematic with, as outlined numerous times in this blog, the huge increase in labour introduced into the world economy by the developing nations makes comparative advantage and increased productivity harder to achieve and more and more short lived.

    The rise of China was very little to do with comparative advantage. It rose through aggressive industrial policy.
    The UK and US can use aggressive industrial policy as well to rebuild their manufacturing sectors.

    I appreciate the government does not actually run a ponzi scheme but should it find itself in a situation where it cannot repay its debts without debasing its currency what is the point of semantics?

    It doesn't have to debase its currency to repay its debt. The effect that I am talking about is increasing tax revenues through strong growth to make the cost of servicing interest payments fall.

    The quantity theory of money (particularly in its Friedmanite form), the idea that there is a simple and direct relationship between the money supply and the inflation rate – is a hopeless and ignorant oversimplication.

    Just one example can show how wrong it is.

    Under Ronald Reagan, for example, the US money supply doubled, as you can see in this graph, but the inflation rate fell in virtually every year until 1987, even at a time of deep government deficits.

    ReplyDelete
  23. Reply to a A Real Black Person

    Ask any third world country that has a 3 to 1 debt to GDP ratio debt if their debt impacts their economy.

    Third world countries often have debt denominated in foreign currencies like US dollars, and not in their own sovereign currency. This is insane. It is why Argentina collapsed. Government debt should be denominated in the domestic currency over which the government has control.

    Third World countries are also in a weaker position and are often forced by the World Bank and IMF into catastrophic deflationary policies by neoliberal extremism.

    No government can "roll over debt" and you know they can't. You haven't cited one example of a government that has "rolled over" its debt

    Um... rolling over government debt is a completely common and widespread practice. It happens all the time in virtually every country.

    In case of the US, for instance, all you have to do is read this:

    Statistics on US rolling over of debt

    (scroll down to the middle of the page)

    Japan barely makes anything these days and its population is aging rapidly because everyone was too busy the last 30 years to make babies

    Japan is a manufacturing giant, the 4th largest economy in the world (the 3rd if you don’t count the EU as a country), that just posted a Y545.32 billion trade surplus in December, 2009.

    Germany tried to 'roll over' its debt in the 1920s the only way a government can "roll over debt", by printing lots of money that wasn't backed by anything

    The Germans printed money to pay for government deficits and servicing of the insanely crippling debt imposed on them by the vengeful WWI allies, at a time of severe supply contractions in Germany. They didn't 'roll the debt over.' These are two separate things.

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  24. Reply to Anonymous on UK Debt

    I saw the Taxpayersalliance site you linked to:

    Repaying The National Debt. Not.

    The article is grossly ignorant and wrong.

    Post WWII economic growth (1945-1973) is universally agreed to have been mostly in the productive side of the economy in the tradable goods and services sectors, unlike the phantom economic growth of the neoliberal era, that has been based on asset price inflation and debt.

    Inflation rates were much lower then as well, compared to the last 35 years.

    Strangely, the article acknowledges that the reduction of UK debt in late 1980s and early 1990s was due to 'both of those periods [seeing] exceptionally strong economic growth combined with falling interest rates', but fails to acknowledge the post War period saw better economic growth and low interest rates too.

    The site makes the common error of focusing on absolute numbers rather than on debt to GDP ratios, which is the important figure.

    I maintain that WW2 debt is a very different animal to the normal commercial gilt market of today. One sniff of inflation being used as a tool to inflate debt away will result in a devastating response.

    You mean “inflate away” debt by hyperinflation?

    The hyperinflation scare is just that – a scare.

    The government ability to control the interest rate, the central bank and monetary policy that we had in the post WWII era can be easily restored today.

    And in fact if investors really were concerned about higher inflation they would have stopped buying UK governments years ago.

    The annual inflation rate in the UK between 1973 and 2008 was 6.50%.

    The post-WWII annual inflation rate in the UK between 1946 and 1973 is 4.61%, quite lower.

    Yet bondholders have continued to but UK bonds.

    Two billion pounds was raised through patriotic fervour in the form of war bonds. These bonds had an open repayment term, the capital HAS NEVER BEEN REPAYED to this day and are now virtually worthless to the holders. So much for patriotism.

    Really? And what is your evidence for this? You can cite a reliable source for this?

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  25. The_Rational_MartianFebruary 4, 2010 at 8:06 AM

    " so much of your argument relies upon a growing population (of economically active people) to provide a growing base of tax receipts for the government. This, for most Western nations will not be the case in the future. "

    You might find this explanation for falling birth rates intriguing:

    http://look-think-do.livejournal.com/365.html

    I'd say debt/GDP ratios should be the least of the worries emanating from an ageing population. Students of history will recall that Turkey (Anatolia), the Levant and all of North Africa were part of Europe before massive Arab and Turkic immigration and invasion that a decaying Byzantine Empire could not prevent. The situations then and now are not identical, but it remains a law of nature that empty space will soon be occupied.

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  26. Lord Keynes

    re undated and unredeemed gilts. I owe you an apology, my eyesite let me down and I read ww11 as opposed to ww1 ( very small print ) In fact, there is 1.9bn of undated and unredeemed gilts from ww1. Presumably, ww2 issuance was on a term basis, although I can cant find out much about the source of govt funding at that time AT ALL. If the US supported the UK through lend lease which was written off, what was the source of the rest of the debt, what was it spent on and who lent it to us.

    In response to your point re post war debt levels and relative inflation. I would point to my earlier statement re the very real differences between the UK economic structure, relative position in the world and lack of the imbalances being thrown up by the " developing countries " . Basically, investors will not view the current UK in the same light as their predecessors viewed the credit worthiness of the super / imperial power of the UK of the 1940's.

    This follows on from the point that cynicus has been making re the assumption that the UK can never default, because it never has in the past.

    As the weeks and months have past over the last years or so, this assumption is looking very shakey indeed and the dam is beginning to crack. It is inconcievable that the markets, given the current, well publicised sovereign crises in various countries, will stand to finance ANY further expansionist policies by the UK govt aimed at artificial stimulous of the UK economy.

    Following todays boe suspension of QE, I expect we will get a better indication of just how the markets view the UK over the coming weeks /months. This coupled with the markets obvious targetting now of " insolvent " states such as Greece, Portugal and Spain, indicates that Ireland and then the UK may be next. The common thread amongst these nations is unsustainable budget deficit.

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  27. After the war rationing went on into the fifties unless I miss my guess. Austerity. That's what we had to endure to pay our debts.

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  28. @ Lord Keynes: You gave a typical politicians answer - completely unverifiable and always able to be denied that it has happened. I want a level of govt debt to GDP above which you think it is unsustainable and dangerous to exceed. Not a vague statement of outcomes.

    By your definition, as long as there is unemployment, the govt is entitled to continue to borrow money, and even print it to buy its own debt, ad infintum. Do you really think this is sustainable? Do you think hyperinflation is a figment of historians imaginations?

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  29. Reply to Anonymous

    After the war rationing went on into the fifties unless I miss my guess. Austerity. That's what we had to endure to pay our debts.

    War rationing did indeed continue after the war, but that was because of the disastrous
    collapse in production of food and consumers goods not just in the UK but all over Europe caused by the war, the destruction in Europe, and the necessity of the UK to feed the population of European areas under British control.

    The transition from a war economy to a peace time eocnomy took time, so your claim that it was because of debt servicing its nonsense.

    The rationing ended in 1954 when the debt to GDP ratio was still over 150%.

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  30. Reply to Sobers

    You gave a typical politicians answer - completely unverifiable

    The presence of high inflation in economy an is completely verifiable.

    Are we to assume that you are incapable of recognizing high inflation when you see it???

    The rest of us don't seem to have a problem.

    By your definition, as long as there is unemployment, the govt is entitled to continue to borrow money, and even print it to buy its own debt, ad infintum.

    That is not what I said at all. Read it again.
    I said monetizing debt is an emergency measure, and that all goverments should rein in spending when inflation becomes a problem.









    Of course there is a limit to the government consumption of real resources (either goods and services).

    That limit is reached when we have full employment, strong economic growth and signs of inflation.

    Then it is time to rein in spending, curtail bank lending by raising reserve limits or soaking up excess liquidity or even introducing a tax based incomes policy.

    Do you think hyperinflation is a figment of historians imaginations?

    Hyperinflations usually happen when there is a massive supply shock and irresponsible governments print too much money.

    I already addressed this issue.

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  31. I hope Lord Keynes and CE are still reading this thread. I have had concerns about MMT (Modern Monetary Theory) for some time. I am not an economist myself, but I have spent much of the last few years reading everything I could find on economics. I have read the works of Keynesians, Post-Keynesians, Austrians, Monetarists, Chartalists, and Modern Monetary Theorists. My readings have left me with many misgivings. I am hoping that I can raise them here for debate.

    My first and most general concern is that the economy is an incredibly complex system made up of irrational people yet most economists, pundits, and politicians try and reduce this complexity to a few simple rules. Even in the more sophisticated cases this seems to me like trying to land a jumbo jet by only using the rudder. It ignores or oversimplifies the interplay between the rudder, throttle, the flaps, and the angle of attack. This leaves the public with the impression that economics is more advanced and developed than it really is.

    Now all this being said, Bill Mitchell and MMT provide the best technical explanation for how a fiat currency system works. Most people still think in terms of the gold standard and fractional reserve lending. These notions were correct prior to 1971. When Nixon ended the gold standard everything changed. Very few economists seem to recognize this regime change at all. Bill Mitchell's blog (http://bilbo.economicoutlook.net/blog/) provides extensive information on this distinction and I would advise all to go and read it with an open mind.

    Lord Keynes has provided an excellent defense of MMT and its technical workings in the comments of this post. I do not dispute MMT on technical grounds. My concern with MMT is more abstract. Hopefully I can convey these concerns adequately! Here goes:

    Both Keynsian economics and MMT are highly dependant on an elightened individual(s) to be in control who are capable of guiding the economy. The central banker perhaps? By this I mean that someone or some group of people have to be able to identify inflation and manage it in a fair and impartial manner. This goup needs to manage interest rates and in the case of MMT decide when to pull back from rising inflation. Without this body working indepenently and competently both MMT and Keynsian economics will fall far short of its potential in practice. Keynes himself was an elitist who thought men like himself should run the economy for the betterment of all. I think it should be obvious to all the flaw inherent in this. What happens when we get Greenspan and Bernanke in place of Keynes? What happens when the group of people who are to set the interest rates or track inflation are corrupted by the politcal process? What happens when the measure of inflation itself is subject to poltical 'adjustment' such as CPI has been in the US (hedonic adjustments)? Will the enlightened ones be able to stop the spending when the politicians want to continue their pet projects but inflation starts to rear its head?

    While these theories are brilliant on paper I think that they will suffer greatly when they make contact with irrational men and human failings -- especially of the political variety.

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  32. Another issue I have with Keynesian-ism is the obsession with fiscal spending of any kind. While I agree that spending can be used to jump-start the economy I have many reservations about this that do not seem to be often discussed. This is a great example of the oversimplification I talked about earlier. Fiscal spending is bandied about as if it was the cure for all situations where we need to 'jump-start' demand. It is not clear to me at all that this is the case. The particulars of the spending are often overlooked by Keynesian economists. As an example, oil is a very finite resource. It would seem to be a poor choice to use up large amounts of oil to dig holes to bury money in and then burn more to dig the money up as in Keynes own example. We should be using our existing oil stocks (or any other scarce resource) carefully to advance to the point where it is no longer a limiting factor on growth. (Use gasoline based construction vehicles to build out the infrastructure needed for an oil free economy -- build wind turbines, solar farms, etc.) With a scarce resource such as oil you will only have one shot as it were to use it productively. This would seem to apply just as well to any other project or resource. CE has detailed this on the blog in the past with the examples of unneeded roads or buildings. These projects are a waste of finite and potentially scarce resources.

    The micro matters in these cases if you will. If you use the fiscal spending to directly address the issues or causes that are holding back demand than there is a strong argument for the spending. If however you spend for the sake of spending because Keynes said to do so it would seem that you are under the thrall of a certain dead economist.

    In most of the talk about the recent US stimulus most Keynesians bemoaned the use of half the bill for tax cuts. In general they say that tax cuts are bad for stimulus. This also seems to be an oversimplification. If the point is simply to stimulate the aggregate demand then whether the government spends the money or an individual does should not matter. The point is then raised about the money multiplier or how individuals will just save it. MMT says that the idea of a multiplier is incorrect (see http://bilbo.economicoutlook.net/blog/?p=1623). As for savings, if the primary reason for the lack of demand is private debt, then would it not be more effective to let the individuals pay down their debt and return to a more normal level of demand than to build unnecessary roads and buildings?

    On MMT I aslo worry about the reaction of those who are not educated in it to the idea of governments performing massive spending of issued money (bank account credits really) to pay down their large debts from years of over spending. Economics is not a physical science. The impressions of the irrational beings within the economy matter. If everyone in the market thinks there will be a bond crisis in the UK or US due to too much debt then their will be -- regardless of the mechanics of fiat issued money. The confidence of the partipants is more important in my opinion than any 'law' of economics.

    Finally, not a critique, but a recommendation. One area where I am in full agreement with Bill Mitchell is on unemployment. The fact that we allow such high levels of unemployment is a crime. A massive waste of human captial. The idea of a job guarantee (a living wage plus health care for all who ask for it) in place of unemployment benefits and some welfare benefits is fantastic. A great example of an automatic stabilizer that will help to right the economy whenever it gets too far out of whack. (see http://bilbo.economicoutlook.net/blog/?p=1541).

    I apologize for the length of this post and hope it is clear enough to get my points across. The debate on this blog is amongst the best anywhere that I have read and I am hoping to have some of my concerns addressed!

    Thanks!

    -everson

    ReplyDelete

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