Wednesday, March 17, 2010

The UK as Catalyst for Crisis

The UK Budget

Inevitably, there has been a lot of comment in the UK press regarding the recent budget in the UK. As many commentators have identified, the problem with this budget is that it is so close to an election that it might be meaningless. Everything to do with the UK hinges on the forthcoming election. Perhaps more importantly, the UK may, if the election goes to Labour, may be the big test of the sustainability of massive government deficits, with a UK fiscal crisis potentially creating a broader crisis. It may also be the case if Labour does not win, but there may be a delay in the onset of crisis in these circumstances.

It is interesting that there is now increasing talk of the possibility of a hung parliament, or even outright Labour victory. In a recent post, I commented on the Economist's view that there is a coming battle between those reliant on the state for their livelihoods, and those who generate the wealth that ultimately funds the state. The UK is now in a position in which over 50% of the activity in the economy is rooted in the state. This is a situation in which there are more people reliant on the government keeping the spending taps open at full tilt, and a situation in which self-interest might short-sightedly determine the voting intentions of many of the electorate.

In this context, it is interesting to note the Telegraph column of Ian Cowie, who says the following:
What’s a first-time buyer’s vote worth? If you were longing to get out of rented digs, then a £2,500 tax cut – the most notable feature of the pre-Election Budget – might well be enough to do the trick. Nor is this group electorally insignificant. Official figures show that the number of people in privately rented homes has increased by 1m since 2001 to 3m today.
His argument is very simple - the budget is offering a bribe to one million of the electorate to vote Labour. Another Telegraph commentator quotes Professor Philip Booth of Cass Business School, as follows:
Almost every Budget measure [on Wednesday] involved a spending favour for some small group or other, or some tax relief for a group that the Government hopes to sway behind the Labour Party at the election.
The rest of the budget is simply a denial of the reality of the terrible state of the UK's fiscal position. Perhaps the most humorous addition to the budget was the addition of a so-called 'Green Investment Bank', with a remit to invest in a wide range of projects including 'green' energy investments. Among the targets are wind and solar power, both of which are virtually useless forms of energy generation. Within this provision, it is possible to see another expenditure aimed at a particular group, those who have strong beliefs in global warming, and is aimed at ensuring their votes go to Labour. By contrast, those who are cynical about global warming are not likely to vote against Labour on the basis of this expenditure.

Perhaps the most worrying aspect of the budget is the belief that the UK is about to enter a period of rapid growth. As Jeremy Warner of the Telegraph points out, a large portion of that growth is built upon an assumption of significant growth in exports, with the justification being that similar growth took place after the last £GB devaluation. As Jeremy Warner correctly points out, last time the £GB devalued, the world was not mired in an economic crisis.

Overall, what is apparent in the budget is an attempt to appease the clients of the state, and target narrow sections of the electorate through appealing to their self-interest. This is done with accompanying flimsy justifications, which serve only to allow people to tick the Labour box with no feeling of cognitive dissonance.

As you would expect, the other political parties have attacked the budget, but they still lack the will to really lead the UK and persuade the country of the absolute necessity for root and branch reform of the economic structure of the UK. What they are not telling the electorate is that, whilst Labour can promise to keep the spending taps open, eventually they will not be able to deliver on their promises. In other words, they need to tell the clients of the state that they are, whatever the promises of labour, going to eventually suffer cuts regardless of who wins the election.

The yield on gilts have climbed since the budget, and the head of the UK Debt Management Office (DMO) is yet again having to reassure the markets that gilts will not suffer a failed auction. That the DMO is having to makes such statements is of itself the story, not the statement of confidence. The UK is in deep, deep trouble, and a funding crisis must eventually come, unless serious action is taken to deal with the massive deficits. I have said it before, and will say it again, the current situation is one in which there is an agonising pause in the markets, with the coming election the only thing that is supporting the ongoing purchase of gilts. The gilt market is supported by 'wait and see', and this is a fragile foundation.

The real story, however, is the wider implications of a UK fiscal crisis. As I have often emphasised, there has been a stubborn resistance to the idea that the 'developed world' might be much, much poorer than many imagine. I have compared this belief to a dam, and each new concern about the economies of the developed world as small cracks in the dam. A UK fiscal crisis would represent the kind of crack that finally weakens the dam to the point of catastrophe. The likely outcome of such a crisis is that investors will flee to the illusory safety of the $US, before finally realising that the $US is in the line of the deluge.

Scenarios for the Way that the Crisis Might Resolve Itself

I recently added a comment to my last post, asking if the readers of my blog might be interested in my making a highly speculative post on how the economic crisis might finally resolve itself. Several readers expressed enthusiasm for the idea, and one suggested that I look at a best, middle and worse case scenario. The idea of a best to worst case scenario seemed to be very sensible, right up to the point where I started to write them up. The problem that arose was that, however much I tried to take an optimistic/positive perspective, the same problems started to emerge.

In particular, the underlying problems in the structure of the world economy simply would not go away, and no policy can reverse the underlying problems without considerable pain. The problem that I am referring to is the illusory level of wealth in the developed economies, and the fact that the world economy is still (largely) adapted to servicing wealth that is not really there. I have previously described the underlying causes of the economic crisis, which is to highlight that the entry of labour into the world economy has seen a massive supply shock, in which the labour force with access to the world market has approximately doubled, whilst the available resource for labour to utilise has not seen a commensurate rise (if you have not read it, I suggest reading this version of the argument as an introduction - note, there is a typing error; zero sum 'gain' should read 'game' ).

Interestingly, Alan Greenspan is now subscribing to the thesis that the massive input of labour was the root cause of the economic crisis, but is doing so to justify his argument that monetary policy did not cause the crisis. Whilst happy that somebody from the mainstream has finally noted what I identified long ago, Greenspan can hardly deny that the Federal Reserve also took a problematic situation, and contributed their own major input into the depth and scale of the crisis that followed.

Returning to the argument, the upshot of the change in the structure of the world economy is that we are now seeing a period of hyper-competition, in which wealth is moving from the developed world to the so-called emerging economies (I note that the Economist now calls them something like 'middle income'). However much money is created, however much money is borrowed, there is nothing that will change this process, short of bringing globalisation to a grinding and rapid halt. The essential problem that I was confronted with, when trying to paint optimistic scenarios, was that this change simply could not be wished away.

At its most basic, we can see the problems in the growth of the service sector in much of the developed world, all of which was designed to service debt fuelled economies, and the growth in manufacturing in emerging Asia to supply the debt fuelled economies with goods. Few now doubt that this structure was, in the end, unsustainable. However, there is a stubborn refusal to acknowledge the consequences of this system, and that it shaped the world economy in a way that now must change. Thus we have the policies of massive fiscal deficits, massive monetary easing and so forth. All of these policies are a stubborn denial of what we all know; that an economy can not live on overseas derived credit forever.

Greece is, of course, an illustrative case of what happens when there is a real possibility of having to live on the added value actually generated from within your economy. When the credit taps turn off, austerity follows. The economy in question sees their real level of wealth generation revealed and, as is illustrated by Greece, it is not a pretty sight. Even whilst Greece is trying (possibly unsuccessfully) to confront the underlying limits of their wealth creation, their ability to generate added value for exchange, much of the developed world is still in denial. Even as the signals, market analysis, and other indicators are increasingly flashing warnings, policy makers are clinging to the illusion that the developed world can return to the pre-crisis era.

The problem is that they are seeking to return to an era in which Asian countries steadily emerged as major competitors, but where the consequences of the emergence were hidden by Asian savings being recycled into developed world credit. In order for a return to this past, it is necessary for the credit to continue at pre-crisis levels. If, and it is a big if, they were to do so, the developed world credit junkies will eventually hit a level of debt that simply can no longer be supported. It is the Greek problem.

The problem for all of the scenarios that I played with was the same. At some point, the factories in Asia supplying goods into the developed world will need to restructure such that they no longer are reliant on servicing the credit fuelled portion of the developed world economy. In the credit fuelled countries, all of the jobs and services that are derived from overseas credit must also disappear. As indirect evidence of the problem of structure, I read the following in the Economist, regarding occupations showing growth in the UK:

England’s fastest-growing jobs between the second quarter of 2001 and the same period in 2009 include conservation officers (up 124%), town planners (94%), psychologists (67%), and hairdressers and the like (63%). Further investigation shows a big increase in semi-professional jobs (paramedics, legal associates, teachers’ assistants) rather than professional ones.
The report also identifies that employment in heavy manufacturing is in decline. I mention this story because it represents the last gasp of the credit fuelled economy that must eventually restructure.

The big picture is this; in a post, sometime ago, I made an estimate of the size of the US economy if overseas credit were withdrawn, and came to the conclusion that the economy would shrink by 17%. Again, this is comparable with the situation facing Greece. If we think of the growth in the occupations in the UK, a similar story might unfold in many countries. Many of the jobs that are supported and growing on the back of government borrowing and spending are simply unsustainable.

In trying to consider scenarios, they must all confront these problems, and I simply do not see a positive outcome. The other problem is that, in trying to create scenarios, I kept on bumping up against the ongoing denial of the situation by policymakers. It seems that, whatever happens, they seem to be willing to resort to ever more extreme policy. In the UK, for example, the Bank of England has printed money to buy over a year of UK debt issuance, and there is still the possibility of more money printing to come. The trouble with policy extremes is that the extreme policy of country 'x' does not operate in a bubble, but eventually impacts on the policy of country 'y'.

The more extreme the policy of country 'x', the more likely that country 'y' will see an extreme policy response. An example of this is interest rates and the carry trade. If country 'x' has loose monetary policy in conjunction with low interest rates, this encourages the 'carry trade', in which money from country 'x' goes to country 'y' to benefit from higher interest rates. Money floods out of country 'x', enters into country 'y', potentially causing overheating of the economy, and currency appreciation. The policymakers of country 'y' then have to come up with a policy response to counteract the results of the policy of country 'x', and it will be an extreme response, as the impact of country 'x's policy is extreme. That extreme policy response will not only effect country 'x', but many other countries, who will, in turn, have to respond.

In such a system, although each policy takes a while for the effects to become apparent, there will be a steady ratcheting up of extremes of policy. At this stage, we are starting to see the effects of initial responses to the economic crisis, and the lagging responses in policy as the effects become apparent. The problem is now that there is less and less in the hands of the policymakers with which to respond - the only ammunition left is printing more money. All over the world, there is a massive demand for credit to fund government debt, but how might such a wall of debt be funded? The borrowing of country 'a' impacts upon the borrowing of country 'b'.

In other words, the massive issuance of debt in country 'a' is acting in competition with country 'b', and investors face a beauty contest with many of the entrants looking like the ugly sisters of fairytale fame. The UK is just slightly more ugly than the other contestants. The risk is that investors will look at the contestants, and decide that they are all too ugly to be worth their vote. Within this competition, the uber-judge is China, and China has now added the Euro to its concerns about the safety of the $US. Yesterday's Cinderella is today's ugly sister. And sitting in the middle of the ugly sisters is the UK.

The foolishness, the denial of reality and the extreme policy that the denial has generated, has brought the world to the brink of an economic disaster. For the moment, the Greek crisis is on pause, but a more serious crisis is developing in the UK. If the UK should topple, as is looking increasingly likely as the UK election unfolds, it is very likely that it will commence the final stage of the economic crisis. However much I tried, I found no best case, and no middle case scenarios for the way the final stage might play out.

The pitiful truth is that I am hoping for two things; that the Conservative party wins the coming UK election, and that they have not been telling the truth about their intentions. I just have to hope that they win and take an axe to the deficits, and that they commence a root and branch reform of the UK's economic structure. Even with a collapse of the UK economy the most probable catalyst of wider economic chaos, it nevertheless remains a forlorn hope. There are plenty of other potential catalysts out there.

In summary, there is currently no sign of a best or middle case scenario. Instead, the flashpoints for a savage deepening of the crisis are multiplying. The UK is moving closer to the brink, and we now have to wait and see whether those reliant on the state, those bribed by the state, might stand back and make a hard choice. Is the UK electorate mature enough to demand the necessary hardship? I worry that they are not....

40 comments:

  1. The UK electorate will have to be pulled kicking and screaming towards economic reality. Politicians will never tell the TRUTH because there are no votes in it. What floating voter, not being that economically literate, votes for the candidate offering higher taxes, lower spending and reduced standard of living?

    Not going to happen. A crisis is the only way this will be resolved, and all political parties will try desperately to put off the dreaded day as long as possible. Out of their watch anyway.

    This situation WILL result in catastrophe, its just a matter of when. Could be this year, could be 10-20 years down the line. Just be prepared for it when it comes. It will be a great shock to many if not most of the population. Forewarned is forearmed.

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  2. Comments on the UK Budget

    Perhaps the most worrying aspect of the budget is the belief that the UK is about to enter a period of rapid growth. As Jeremy Warner of the Telegraph points out, a large portion of that growth is built upon an assumption of significant growth in exports, with the justification being that similar growth took place after the last £GB devaluation. As Jeremy Warner correctly points out, last time the £GB devalued, the world was not mired in an economic crisis.

    The world recession and low demand would be a problem even for free market / liquidationist plans for recovery.

    Even if you were to slash government spending and make savage cuts to wages, what then? Who is going to buy your goods in a global recession?

    It hasn’t worked in Ireland. Despite the spending cuts and the fall of wages, the Irish economy contacted by 3% in 2009.

    The only economic policy that deals with this problem is Keynesianism: you need domestic growth for the economy in a time of global crisis, not constantly rely on export led growth.

    Furthermore, there is an obvious place where the UK government could make deep spending cuts: defence. Why does the UK need to flush billions of dollars away on a useless, pointless and immoral war in Afghanistan?

    The explosion of defence spending can be seen below, from less than 30 billion in 2001 to nearly 45 billion today:

    Time Series Chart of UK Public Spending.

    In all the hand wringing about government “profligacy” (usually over stimulus and welfare spending), nothing is said about the ridiculous and unnecessary wars of choice in Iraq and Afghanistan.

    The problem is now that there is less and less in the hands of the policymakers with which to respond - the only ammunition left is printing more money. All over the world, there is a massive demand for credit to fund government debt, but how might such a wall of debt be funded?

    Actually, neoliberal policymakers limit themselves to one weapon: monetary policy.

    That governments adopted limited Keynesian stimulus in the crisis of 2008/20009 means very little when they are still mired in New Classical and neoliberal economic thinking.

    If governments completely switched to a different macroeconomic theory, like post-Keynesianism, they would have a vast range of policy tools such as:

    1. Financial regulation
    2. Nationalization of banks
    3. Complete separation of commercial from investment banking
    4. Breaking up banks too big to fail
    5. Large stimulus programs
    6. Offering state superannuation to provide funds for government spending
    7. Adopting a “tap system” of funding budget deficits
    8. Central bank intervention to control yields and manage the exchange rate
    9. Capital controls if necessary
    10. Direct job creation
    11. Industrial policy
    12. Tax and education policies to support industry
    13. Protectionist measures if necessary to increase production at home and reduce trade deficits
    14. Large R&D programs directing at improving productivity

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  3. Revealed: £12bn hidden costs of Afghan war:

    The soaring cost of Britain's military campaign in Afghanistan is laid bare today, as a comprehensive analysis reveals that the cost of fighting the Taliban has passed £12bn. An Independent on Sunday assessment of the "hidden costs" of fighting since the Taliban was ousted in 2001 reveals that the bill works out at £190 for every man, woman and child in the UK – and would pay for 23 new hospitals, 60,000 new teachers or 77,000 new nurses.

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  4. Thank you Cynicus for a typically thoughtful, articulate post which certainly reflects my thinking.

    I'm reminded of something I read recently (it may have been on this site actually!) where somebody stated that there is no such thing as society when it comes to looking holistically (in this case, the plight of the country). Everyone looks after No.1; we're just loosely bound by a common culture, e.g. enjoying football, watching soaps, Sunday Roast etc.

    My point being that nobody really cares what the country owes, as long as it doesn't affect them - or, crucially - if it *must*, it doesn't effect them *yet*.

    Now I'm not here to make a judgement on individual choices; but the Tories don't stand a chance offering 'pain now' when Labour's (cynical) 'pain tomorrow' seems much more palatable (to so many select groups, as you've mentioned).

    So, we now await the election to see 'what gives'; there will be twists and turns alright.

    And like you (I'm guessing), I'm watching this slow moving car crash with intrigue and insight, but certainly not with any satisfaction.

    Bob

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  5. Hi Cynicus,

    This is a must listen:

    US Empire Will Decline, China Will Rise Rapidly

    http://kingworldnews.com/kingworldnews/Broadcast/Entries/2010/3/27_David_Murrin.html

    Death to Bubble Addicts

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  6. Which is why I bought gold in mid 2007. At least a precious metal won't evaporate and doesn't rely on false promises . People come up with clever-clever arguments about 'useless shiny yellow metal' etc. They are the same people who argue black is white, up is down and have got us where we are with yet more clever-clever arguments. Put ye not your faith in your fellow man - unless you like disappointment.

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  7. 'Clients of the state' - be more thoughtful when you quote this. It is a fact that a large proportion by head count, let alone actual costs, in the public sector are actually either independent contractors or bloated private companies such as Capita, PA Consulting and many more. These folk have grown very rich and fat on the dispensions of the taxpayer and they will also be scythed down (and are now in fact) when the real cuts take place.

    Be careful what you wish for.

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  8. Insightful post as usual Cynicus. You finish with the question ' Is the UK electorate mature enough to demand the necessary hardship? ' but you're making an assumption that the electorate understands the question. None of the main political parties are addressing the issue and the mainstream media is ignoring it, Also our education system hardly encourages financial understanding. To quote the ever excellent dailymash :-

    One, two buckle my shoe
    Three, four, knock at the door
    Five, seven is it? I'm sorry, I went to a state school that felt that arithmetic was not as important as teaching me about lesbians and socialism.

    Sorry I couldn't resist using the quote but satirical news sites make more sense to me these days as they seem to contain more truth and understanding than the regular media.

    fiatpete

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  9. >>The pitiful truth is that I am hoping for two things; that the Conservative party wins the coming UK election, and that they have not been telling the truth about their intentions. <<

    Its funny, CE. As a Conservative I'm hoping the same two things.

    But then there's this other side which almost almost wouldn't mind if Labour won. Don't get me wrong - I know this will create an immense problem which will affect us all and I don't wish the country ill.

    But things are going to get very grim no matter who wins and I don't relish Labour claiming that "recovery had begun and the Conservatives have ruined it" for two reasons. The first, because its so very untrue. The second - because it might lead to another decade of left-wing madness in the UK if people are fooled.

    There are so many people who just don't "get it" on all sides of the political debate. As i've said before it may take a very harsh wake-up call before reality asserts itself. This is very sad and I really wish it weren't true. Maybe people are wise enough to understand the choice they are about to take and how vital it is. We'll know in a month or so.

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  10. Morlock the WarlockMarch 29, 2010 at 7:44 AM

    The worst case scenario is of course protectionism then war.

    The USA defaulting on their debt to China and imposing protectionist measures is a certainty. Whether this results in a war is the real question.

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  11. No one should hold their breath over this one.

    My hunch is that it will be a long drawn out depression/recession - call it what you will.

    The powers that be, all around the world, will keep passing the buck around to have one bail out after another, whilst introducing long term austerity measures which slowly but surely pay down debt, cut public services and countries adapt painfully to economic reality.

    It's in no ones interest for the global financial system to fall apart and so it will be avoided by some way or another. Other countries will go the way of Greece - just enough bail out to avoid financial collapse and not too much austerity so as to cause political breakdown and revolution.

    I think people with talent and capital will move to where life offers them the best opportunities and that won't help Britain dig itself out the mess it has got itself into.

    In fact I suspect the lack of private capital being invested in Britain is going to be a problem going forward. I can't see it being an attractive place to invest for growth to be honest.

    Any recovery will have to be home grown and not export driven, which Lord Keynes suggests. However I believe that will be born out of harsh financial neccessity rather than fiscal stimulus.

    Maybe I'm wrong but I don't either see or sense enough inventive, dynamic engineers, scientists coupled with business expertise that are going to create new technologies and wealth in this country. Without those things I can't see how the country can dig itself out of the state it's in. That will have to be the long term answer or the slide will continue for many, many years.

    Politically, I'm not sure how it will play out but suspect it will either go harder left or harder right as opinions become polarised in the face of adversity. The wishy-washy centre politics of LibLabCon trying to fool all of the people all of the time must be running out of time.

    I suppose the thing to remember is that life goes on no matter what happens - those with talent and money will do o.k. - those without will struggle. That is how life has always been.

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  12. The Tories should listen to Robert Skidelsky, their former chief opposition spokesman in the Lords for Culture and then Treasury affairs.

    His book Keynes: The Return of the Master (2009) should be required reading for all Tories.

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  13. CE, a good post. A major problem, as I see it is that the vast majority of people are ignorant as to what wealth is. Until this term is clearly and explicitly defined, people will continue to dupe themselves that astronomical valuations of assets, whether tulips or houses or gold, make society wealthy.

    I made an attempt to define wealth when trying to understand the origins of the current crisis : Wealth is the sum of hard resources (foodgrains, minerals, fuel etc) and soft resources ( knowledge of engineering, medicine etc) which allow the owners of said wealth to secure and maximize their genetic transmission.

    The reference to genetic transmission might seem strange, see my blog for where I'm coming from: look-think-do.livejournal.com.

    Interestingly, the Chinese seem to have no confusion about this judging by their drive to build great infrastructure and their minerals and crude oil buying spree, while the west seems obsessed with equality advisers and psychologists.

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  14. So let me get this right, Conservatives on this thread are going to vote for them in the hope that they are actually lying?

    Am I the only one who sees the utter futility ( and inherent servitude ) in propping up a political system where essentially you can't be sure that what a party publically says are their actual intentions? So actually you don't know what you're voting for? Jeez...

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  15. Josiah Stamp's GhostMarch 30, 2010 at 7:36 AM

    Like i said before, Cynicus I think Cynicus is often right with his analysis of the problem, but wrong with the solution - a little like a doctor saying to a patient,

    "Well the diagnosis is that your left arm is broken. The cure is to use your right one instead."

    The Tories are the political elite, with the same motives as Labour - but different solutions on how to acheive them. The whole system is corrupt, bent and out of touch with reality.

    The pitiful truth is that I am hoping for two things; that the Conservative party wins the coming UK election, and that they have not been telling the truth about their intentions. I just have to hope that they win and take an axe to the deficits, and that they commence a root and branch reform of the UK's economic structure.

    Just take the logical step and take an axe to the whole system. As my name sake once said,

    "Banking was conceived in iniquity and was born in sin.The Bankers own the earth. Take it away from them, but leave them the power to create deposits, and with the flick of the pen they will create enough deposits to buy it back again. However, take it away from them, and all the great fortunes like mine will disappear and they ought to disappear, for this would be a happier and better world to live in. But, if you wish to remain the slaves of Bankers and pay the cost of your own slavery, let them continue to create deposits."

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  16. I can't help thinking that this so called fiscal crisis is a load of old baloney. From what I have read about modern monetary and fiscal policy the UK does not even need to issue debt, it being a sovereign state with sovereign fiat currency. EMU countries on the other hand can default and become insolvent quite easily. Why not start blogging about that instead? Why the labour government has not woken up to this fact is beyond me. Perhaps the people advising them are just as idiotic as the people advising the Tories and Libs.

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  17. To Anonymous

    You say:

    I can't help thinking that this so called fiscal crisis is a load of old baloney. From what I have read about modern monetary and fiscal policy the UK does not even need to issue debt, it being a sovereign state with sovereign fiat currency. EMU countries on the other hand can default and become insolvent quite easily.

    Absolutely correct. The fiscal "crisis" even in the EU is self imposed insanity.

    A government with a sovereign currency and its own central bank can control yields and support government deficits when they are necessary.

    In emergencies, governments can do what they have always done: have the central bank buy government bonds not taken up by the private market.

    Issues arise in open economies with current account deficits, but these are dealt with by Post Keynesian eocnomics.

    See Paul Davidson, "The General Theory in An Open Economy," A Second Edition of the General Theory, edited by G.C. Harcourt and P. Riach, London, Routledge, 1996.

    Countries with current account surpluses (like Japan, China, Germany, Scandinavia) are in a very good position. Keynesian policies are easily implemented there.

    Another point related to this is that with all the hysterical talk these days of the West collapsing, many Western countries actually have current account surpluses:

    Germany
    Switzerland
    Norway
    Netherlands
    Sweden
    Canada
    Austria
    Finland
    Belgium
    Luxembourg
    Denmark

    List of countries by current account balance.

    If we think of the EU as a whole country: it's doing fine, as it tends to have current account balance, with Germany the export power house as its centre.

    The US has the largest current account deficit, but it's the world's biggest economy and still the largest manufacturer. It could rebuild itself with industrial policy and demand management.

    Our problems are largely self imposed, because of deeply flawed and poisonous neoliberalism.

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  18. i am interested in what annonymous says at 8.45 that we do not need to issue debt being a soveriegn state. Someone said this to me the other day. I have to admit I am stumped as to how we can just print more fiat money but Cynicus you might be able to explain?

    I am with the poster who says they like your analysis but not your solutions. I agree - excellent analysis of where we are but the solutions are as bad as the ills. If we just take a huge axe to the country we will cause a depression anyway. Less people who can spend in the private sector.

    Also think on as to what the public sector even is today. Who empties your bins? Repairs council property? Runs the councils HR/IT services. Implements council regeneration policy? In my council this is all done by contractors/consultants from the PRIVATE sector.

    Then think about the massive private IT scheme in the NHS. The fact that much of the welfare state is now run by and for bloated private and third sector firms, ATOS, Capita, A4E etc etc etc...

    Cynicus your analysis of people being clients of the state is simplistic. The private sector does not merrily provide wealth that the public sector soaks up - more like much of the private sector soaks up state sector subsidies robbing the tax payer blind (the banks being the obvious one but look at the rails too etc). If the public sector bill is to be cut in a way that will not cause a revolution (all those who want benefits stopped etc ought to realise that many know the only thing stopping the UK from severe unrest are those benefits) it will HAVE to fall massively on the private sector.

    Things are so intertwined in our modern economy that these cuts will affect all the sectors.

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  19. Lord Keynes

    Raw statistics don't tell the whole story. I would genuinely like to know how "industrial policy and demand management" could help if a hypothetical country had a couple of generations of workers who were educated and trained to do the 'wrong jobs'. This might have occurred if the country had had a one-off windfall of, say, oil being discovered in its back yard, now running out. Could you guarantee to be able to re-train the workforce to do useful work? If not, how do you support them?

    If the one-off windfall had caused the economy to grow beyond its 'natural' size, is it possible to state that shrewd policies will always maintain expansion even as the oil runs out?

    Are you saying that your policies can overcome *every* difficulty that a hypothetical economy might find itself in?

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  20. Reply to Lemming

    I would genuinely like to know how "industrial policy and demand management" could help if a hypothetical country had a couple of generations of workers who were educated and trained to do the 'wrong jobs'.

    What wrong jobs?

    If the one-off windfall had caused the economy to grow beyond its 'natural' size, is it possible to state that shrewd policies will always maintain expansion even as the oil runs out?

    The UK has a huge 61 million internal market - plenty of room for growth though demand management.
    How else do you think you reduce a trade deficit?
    You start making things domestically instead of importing them. Infant industry protectionism allows industries to become internationally competitive - then you can get growth through exports as well.

    No economic system can solve every problem - but it can minimize them.

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  21. More on what Anonymous said at 8:45 - the need to issue gov debt or not - See this from Billy Blog:

    "there is no financial reason for issuing the debt because the sovereign government retains monopoly control over the currency. The practice of debt-issuance is a hang-over from the gold standard era where governments had to “finance” their spending in order to retain control over the exchange rate.

    The practice has lingered because it is now a convenient ideological cum political tool used by neo-liberals to limit the size of government and to give the corporate sector access to corporate welfare (the risk-free government debt) that they use to create profit."

    find it here: http://bilbo.economicoutlook.net/blog/?p=8986#more-8986

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  22. Just let me know chaps when you plan to start the presses rolling. I'll exchange all my pounds for something a bit more permanent. Something you can't just produce billions, nay trillions, more of at the flick of a switch. Like, ooh I don't know, gold coins perhaps?

    Of course you won't mind as you'll all be perfectly happy to go on holding your pieces of paper. Throughout history people have always wanted pieces of paper, haven't they? I mean they say 'I promise to pay the bearer on demand' on them, that must mean something mustn't it? Otherwise they'd just be bits of paper............

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  23. Hello Lord Keynes

    By 'wrong jobs' I mean estate agents, car salesmen, diversity co-ordinators, interior designers, aromatherapists, kitchen fitters and people on benefits... basically all the people who took a direction in life that allowed them to make a better living off the inflating bubble than mugs like engineers, but whose skills won't get them very far once the borrowing stops. I don't believe that such people can instantly metamorphose into shipwrights, coal miners and steelworkers. Nor can they take a three month course and become industrial designers, systems engineers or other high flying professionals further 'up the food chain' (the usual answer to anyone who suggests that competing with the developing world might be a bit tricky). And presumably all the while we are competing with the rest of the world for energy, materials and food to fuel this growth.

    I presume that, through deliberate policies, your basic aim is to ensure that everyone is contributing to 'wealth generation'. Can you provide a concrete example of how, say, a redundant 50 year old estate agent might be steered into wealth creation? (I don't think it is good enough to say that as the economy will be expanding due to unspecified policies we will need estate agents again, by the way).

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  24. Reply to Sobers

    I assume you are suggesting that hyperinflation is close or would result?

    Plenty of commentators predicted hyeprinflation for 2009 - now look at them, their Austrian school nonsense is totally discredited. Pathetic.

    This mythical hyperinflation won't happen because bank reserves are not inherently inflationary at all - only if they get injected into the economy by banks.

    And banks aren't lending much and are likely to return to conservative lending principles anyway even in an upturn - and even if they did increase lending greatly to stimulate the economy they only have a limited demand for credit from borrowers, not enough to cause hyperinflation.

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  25. Just an observation: I saw a commenter on one blog saying that his standard of living had declined recently, but that electronic 'toys' made life tolerable for him. Personally, I would be extremely distressed to lose my computer or broadband connection. An enforced evening in alone no longer conjures up an image of extreme boredom and depression; the internet just absorbs the hours at a frightening rate, with whatever sort of stimulation takes your fancy e.g. commenting on blogs like this one. In my occasional strolls to and from the pub I notice that there are no young people about in a neighbourhood where once petty vandalism was rife; you can now leave your dustbin at the end of your drive without worrying it will be knocked over by some cheeky tearaway. Where are they all? I'll wager they're at home twotting with each other over the internet. It really does seem to me that as long as everyone has access to a computer and broadband and the barest essentials for living, the docility of the population is assured...

    ReplyDelete
  26. Reply to Lemming

    I presume that, through deliberate policies, your basic aim is to ensure that everyone is contributing to 'wealth generation'.

    No, it is not. You don’t need “everyone”. My aim is create industries that produce wealth (real goods and services) that lower trade deficits and then become internationally competitive. That does not require that 100% of the workforce is employed in them.

    You seem to think that everyone needs to be involved in producing tradable goods and services – this is totally false.

    Even in countries with large trade surpluses, for example Germany, only a limited percentage of people are actually doing "productive" jobs in the sense that they are producing tradable goods and services.

    Take the figures for Germany in 2007:

    29.8% of the workforce in manufacturing
    2.3% of the workforce in agriculture

    Germany: National Statistics.

    So Germany produces a massive trade surplus with only 28.8% of the labour force employed in manufacturing, and actually also is largely self-sufficient in food:

    The food self-sufficiency rate in Germany is 96%, the United States, 125%, France, 132%, and in Australia, it is as high as 280%. As you can see, the food self-sufficiency rate of many industrialized countries is more than 100%. This means that in these countries, the amount of food that is grown domestically (within that country) exceeds the amount of food domestically consumed.

    So many Western countries earn money through a surplus in agriculture – despite the fact that less than 5% of the population is employed there.

    Most other people in Germany are employed in services (about 60% including government and education etc) – yet Germany is a manufacturing powerhouse with large trade surpluses.

    So in fact you can be a very rich country and still have the majority of your workforce employed in services – and that’s just because modern technology allows people in manufacturing and agriculture to be much more productive than in the past.

    This is something that should be celebrated – not feared. To engage in handwringing or cries of horror about it is ridiculous.

    Conservatives scream about governments about creating “make-work non-productive jobs” – despite the fact that even in very rich countries most of workforce is already essentially non-productive in the sense that they do not produce tradable goods and services.

    This does mean that a non-productive job isn’t useful: an aromatherapist who reduces someone’s stress level may increase their health and even productivity. (As an aside, do you really think they are no aromatherapists in Germany?)

    People working in a government infrastructure project like the construction of a harbour or highway can decrease transport costs and increase business profits.

    My advice to conservatives: learn the basic facts about modern labour market structure – stop doing the intellectual equivalent of shovelling horse manure.

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  27. Correction:

    The sentence "This does mean that a non-productive job isn’t useful" should be
    "This does not mean that a non-productive job isn’t useful"

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  28. @Lord Keynes: it doesn't need hyperinflation to steal the value of your hard earned cash, old chap. Even a steady 2% inflation nicks half your dosh in 20 years. Make that 5% and its only 8 years. Your sang froid regarding inflation suggests to me that you may have little savings, or do not rely on a fixed income............

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  29. reply to Sobers:
    Once you read up about MMT - modern monetary theory - it will come as a release from all the fear you are carrying around. MMT says that it is taxation that gives those bits of paper value - since the gov only cares to have its tax demands paid in its own fiat currency. i.e. not gold sovereigns or truffles etc. The point about governments running deficits in MMT is that it should support aggregate demand and the spending should be done for public purpose. i.e. the gov needs to have a clue about what it wants to achieve. Full employment should be the starting point. After that you can take care of what Lord Keynes wants, what you want etc etc.

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  30. Lord Keynes

    I'm still none the wiser as to your view of whether a workforce can, indeed, have the 'wrong' skills and education and training to bring a country out of depression. To take it to an extreme, what if the entire population of a country was currently employed in 'services'? How would your industrial policy address this? As a concrete example, on May 7th, what would you say to the country's aromatherapists?

    I just seem to sense that your starting position is "The economy *will* be expanding because of some unspecified centralised policies" from which flows "There will be more than enough money for all" from which flows "most of the population can continue working in services". If so, this sounds remarkably like the economy of the last few decades, where the starting position of the 'fact' of an expanding economy meant that we didn't have to worry too much about borrowing; we could 'invest' to our heart's content and growth would always swallow our debts.

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  31. Reply to Sobers 2

    it doesn't need hyperinflation to steal the value of your hard earned cash, old chap. Even a steady 2% inflation nicks half your dosh in 20 years.

    What do you do? Hide your money under the bed in an old sock?

    Any normal person puts it in the bank or in a fixed term investment.

    The inflation rate has ranged between 0.7 and 3.6% over the past 15 years. For many years it was less than 2%. In other words, the return you would have got from a bank or from some other investment would have preserved the value of your money and given you a return.

    And don't think a gold standard is any guarantee of zero inflation: the UK was on the gold standard and had persistent inflation between 1897 and 1912.

    It’s often claimed the price level in the United Kingdom and the United States was virtually the same in 1900 as in 1700.

    There’s just one problem with this: no one lived this damn long!

    Average life expectancy was about 40 in the mid-19th century. People never lived to see the price level return to where it was when they were born or when they started to work. In practice, they saw the price level fluctuate during their short lives.

    The deflationary periods saw crippling debt deflation and loss of business confidence, which reduced growth and actually made people poorer, because the growth potential wasn’t reached.

    I’ll keep fiat money and low but steady inflation, thanks very much.

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  32. @LordKeynes
    /quote
    The world recession and low demand would be a problem even for free market / liquidationist plans for recovery.

    Even if you were to slash government spending and make savage cuts to wages, what then? Who is going to buy your goods in a global recession?

    It hasn’t worked in Ireland. Despite the spending cuts and the fall of wages, the Irish economy contacted by 3% in 2009.
    /quote


    I lol at that (im from Ireland)

    you picked a bad example there, first of all the cuts have not been as savage as advertised and in some cases (sadly) reversed, alot more was needed to be cut, the country is still borrowing heavily but rates have stabilized because the buyers have actually fell for the illusion of savage cuts that was painted by the media and of course they got distracted by Greece

    secondly Irish exports have remained steady thruout this crisis, while imports collapsed, we are still a net exporter, and assuming the public sector bill (doubled in decade) and welfare (quadrupled in decade) can be brought under control then we might just about return to export led growth in 5-10 years (would be faster but our government are an incompetent lot of morons)

    most of the economic contraction and job loses are due to construction sector (anything reliant on this sector) which was a massive quarter of economy imploded on itself

    if you dont believe me then go to cso.ie and lookup the breakdown of exports/imports and detailed breakdown of what sectors of economy was most affected (job loses etc)

    ive been a long time reader of this site and posted here before, i realize you always try to contradict what cynicus says, but in this case you are badly misinformed @Keynes

    regards
    Smiley

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  33. Reply to Smiley

    As of the 31 March, the unemployment rate in Ireland at 13.2%, one of the highest in the Eurozone (Eurozone unemployment rate).

    The most recent data:

    [Ireland’s] GDP decline of 7.1 per cent was "marginally better" than the estimate at the time of the December budget of 7.5 per cent. If the decline in new house building was stripped out "GDP was roughly unchanged in the fourth quarter", the minister said. However, some economists were more gloomy. Alan McQuaid, economist with Bloxham stockbrokers, … calculated that the cumulative decline in [real] GDP since the end of 2007 was a "staggering" 12.7 per cent, which he said was more than double the rate of the slowdown in the eurozone …. Unlike in many EU countries, the Irish slowdown was exacerbated by a contraction in government spending, which declined 1.2 per cent following the emergency budget last April. The one piece of good news was that the current account deficit continued to decline and now stands at 0.5 per cent of GNP.

    Even if you implemented more savage wage cuts and government austerity, this would just cause complete collapse.

    Ireland has excessive private debt. If you cut people’s incomes, how do they service it??
    They don’t and both debtors and creditors go bankrupt.

    These deflationary policies will lead to devastating debt deflation (precisely the root cause of the Great Depression):

    Ireland is experimenting with [a deflationary] cure. We are seeing the consequences. Nominal GDP has fallen 18.7pc since the top of the boom, ... Real GDP has fallen by less, 12.6pc. The rest is the effect of deflation. But what matters most for debt is nominal GDP. The same debt load has to be financed from a nominal economy that has shrunk by almost a fifth. That is why deflation can be so deadly, as it was from 1930-1933.
    It is no surprise that the losses of the Irish banks are now proving catastrophic. They cannot be isolated from the Irish state. As Ian Campbell at Breaking Views writes, the country is now at a risk of debt spiral. The budget deficit was 11.7pc of GDP last year, despite spending cuts. Irish GDP fell a further 2.3pc in the 4th quarter. There is no longer any low-lying fruit for the tax authorities. Further austerity would cut deep into the muscle and bone of the Irish welfare system.


    The IMF should impose default on Greece to end the charade.

    You say:

    secondly Irish exports have remained steady thruout this crisis, while imports collapsed, we are still a net exporter, and assuming the public sector bill (doubled in decade) and welfare (quadrupled in decade) can be brought under control then we might just about return to export led growth in 5-10 years (would be faster but our government are an incompetent lot of morons)

    5-10 years!! And actually it would be longer in the absence of state intervention. What you say actually reinforces my statement that “world recession and low demand would be a problem even for free market / liquidationist plans for recovery.”

    The best you can offer your fellow citizens is 5-10 years of waiting for export-led growth despite a debt-deflationary spiral?

    You are like the liquidationists in the Great Depression – and look how that turned out.

    People in Ireland will turn to sane economics long before then – Keynesian demand stimulus and internal growth.

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  34. As of the 31 March, the unemployment rate in Ireland at 13.2%, one of the highest in the Eurozone (Eurozone unemployment rate).


    @LordKeynes, as I said earlier an incredible quarter of Irish economy revolved around construction, now this sector has imploded bringing unemployment (especially among young semiskilled/unskilled males) to highs not seen for 15 years,
    this madness could not go on!

    take a read of this, specifically the breakdown of who mostly ended up unemployed here > http://www.ronanlyons.com/2010/03/30/its-not-raining-men-ireland-at-risk-of-becoming-the-opposite-of-china/



    Ireland has excessive private debt. If you cut people’s incomes, how do they service it??

    by generating real wealth via exports, we had export led boom here in 90s before the country got carried away in the UK/US style credit orgy

    borrowing money at high interest on international debt markets to service lower interest debt is sheer madness, would you take money from a loan shark at 30% to service your 10% credit card bill??


    They don’t and both debtors and creditors go bankrupt.

    the creditors (banks) are bankrupt and were recently all nationalised


    These deflationary policies will lead to devastating debt deflation

    i invite you to come over to our little island, deflation is exactly what this country needs to get back down to reality


    Take Irish GDP and GNP figures with pinch of salt, multinationals wash trillions thru the country in order to avoid taxation



    5-10 years!! And actually it would be longer in the absence of state intervention.

    we be recovering by now if it wasnt for government saddling the next generations with debts for mistakes made by the same government

    see interference by eejits leads to more interference and more bad results



    The best you can offer your fellow citizens is 5-10 years of waiting for export-led growth despite a debt-deflationary spiral?

    the country still makes things and services the rest of the world buys,

    we had export led growth in 90s and thats whats were getting back too

    the whole credit fueled growth has been exposed for what it is, a cruel joke

    people here realize that the only way out is to regain competitiveness


    People in Ireland will turn to sane economics long before then

    lol, yes we will just print our way out, its working out great for US and UK


    Keynesian demand stimulus and internal growth.


    yay we can get abck to selling each other overpriced shoebox apartments that no one wants

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  35. Did anyone hear the Gordon Brown interview on the radio this morning?

    http://news.bbc.co.uk/today/hi/today/newsid_8608000/8608788.stm

    I thought it was very revealing, particularly the first few minutes. It showed that the scope and scale of his ideas are very small and technical. To him, a fixed inflation target was all that was necessary to maintain stability. It never even crossed his mind that the sustained low inflation we experienced might not have been due to his "golden rules" or "prudence" but, in fact, due to external factors such as the rise of China, or simply the unpredictable behaviour of a complex system with time lags and psychology mingling to produce some 'calm before the storm'.

    He obviously thinks that you can measure the instantaneous "performance" of the economy from a few simple statistics and, through feedback, maintain it at its 'optimum' level. And he thinks he knows what the 'optimum' is. To my mind, this is no different from a naive young student who thinks that any real world problem can be solved through the application of feedback. In engineering, such a student soon learns the limitations of that strategy from mathematical theory, and the empirical results of many, many experiments. Clearly such mathematics and experiments are not possible with real economies, so people like Gordon Brown spend their entire careers simply reading about a very small number of economic events (such as the Great Depression) and theorising about what went wrong or right, inevitably drawing over-simplistic conclusions. They then finally get their hands on a real economy...

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  36. It is very interesting to watch this economic chaos because, all one should have read in 1998 was John Gray's book:

    FALSE DAWN: THE DELUSIONS OF GLOBAL CAPITALISM

    Everything is coming up nicely as he predicted.

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  37. Reply to Lemming on Methodology

    If you want a truly ridiculous methodology, then look no further than the Austrian school:

    The Austrian praxeological method is based on the heavy use of logical deduction from what they assert to be self-evident axioms or undeniable facts about human existence ....
    Methodology is the one area where Austrian economists differ most significantly from other schools of economic thought. Mainstream schools such as the neoclassical economists, the Chicago school of economics, the Keynesians and New Keynesians, adopt mathematical and statistical methods, and focus on induction to construct and test theories; while Austrian economists reject this approach in favor of deduction and logically deduced inferences. ....
    Critics of the Austrian school contend that by rejecting mathematics and econometrics, it has failed to contribute significantly to modern economics. Additionally, they contend that its methods currently consist of post-hoc analysis and do not generate testable implications; therefore, they fail the test of falsifiability.


    It is of course true than any valid and sound deductive argument derived from true starting propositions is necessarily true, but the Austrians starting axioms are often questionable and the reasoning not sound.

    The rationalist methodology used by Austrians was employed by early modern philosophers like Spinoza and Leibitz, but it failed dismally.

    The most spectacularly successful branch of modern human knowledge is science, which employs inductive and empirical methodology.

    An economic theory that can never be falsified by empirical evidence is useless and unscientific.

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  38. Quote: 'An economic theory that can never be falsified by empirical evidence is useless and unscientific.'

    What, you mean like Keynesians are never wrong, we just didn't spend enough of someone else's money to make the economy grow?

    ReplyDelete

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