Friday, April 30, 2010

The Lessons of Greece

I have now written several posts on the subject of the Greek crisis, but I thought it might be an appropriate moment to explain why we should all be alarmed at the implications of the Greek crisis. It is not a post about contagion, but about the fundamental problems for all of the countries that are financing huge and growing debts through overseas borrowing.

For regular readers, they will be familiar with the discussion that follows, but I hope they will forgive the repetition for any new readers. The problem that I would like to outline is the problem with the measure so dear to economists, analysts and policymakers; the measure of GDP. The fundamental problem of GDP is that it measures activity within an economy, rather than the underlying size of an economy. As one extreme example of how flawed this measure actually is, if we imagine that a country has an earthquake that destroys a city, the activity that is generated from the rebuilding will possibly see a rise in GDP as the city infrastructure is rebuilt (assuming the loss of productive capacity from the city does not offset the increased activity from the rebuilding). In other words, destruction of assets might give the impression that an economy is growing.

In addition to this problem, there is a more fundamental problem in this rather dangerous measure. This is the inclusion of activity financed through overseas borrowing in the GDP figures. The way this works is simple, and I will give an example to illustrate how it works. Imagine that I go to a restaurant and purchase a meal with a credit card, and the origin of the finance for the card comes from Japan. When I purchase the meal, the activity will be recorded as activity within the economy, and will be reflected in GDP. However, it does not end there. The restaurant will then use that money to pay for a range of expenses, and each payment will also constitute activity in the economy. For example, the restaurant staff will be paid from my borrowed money, and might spend that money in a shop, again creating more activity, then the shop will use that restaurant worker's money and so forth.

What we have is a situation where my borrowed money will not just register as activity in the restaurant, but will also finance considerable subsequent activity. The problem is that this activity is really the result of the output of Japan, as it is Japanese lending that is paying for all of the activity. It is the equivalent of an individual earning £100,000 and borrowing £10,000 and imagining that he actually earns £110,000 per year. Yes, our individual can have a £110,000 lifestyle, but only at a future cost to his diposable income, and only for so long.

In an earlier post, I made a rough and ready calculation of US GDP if overseas funded activity was stripped out of the figures, and came to the following conclusion:

In other words, something like 17% of the US economy is funded by overseas borrowing. You may note that there is a large amount of 'fudge factor' in all of this, and comments and critiques are therefore welcomed (especially from those who are more numerate than myself - which is most people).
There were no critiques, and I would encourage readers to look at the original article, and again encourage critiques. The reason for bring this up in relation to the Greek crisis, and the concern that it should raise for the world economy is relatively simple. If we imagine that Greece does not receive the bailout from the EU/IMF we can see what will happen (I am assuming that there will be no further finance from the markets).

The Greek government will be in a position where it can no longer use the borrowed money to finance activity within the economy, and will have no choice but to enforce extreme austerity measures. As the flow of overseas borrowed money disappears from the economy, the level of activity within the economy will start to fall in an alarming and dramatic way. What will then rapidly follow is that many businesses will find no customers for their goods and services, or a significant reduction, and they will find that they are no longer solvent. Furthermore, many direct employees of the government will be made redundant or have pay-cuts. All of this will lead to less activity within the Greek economy.

The next step will be that a large number of businesses will go bust or start laying off workers, and unemployment will start to rise rapidly. All the while this happening, GDP will be falling off a cliff, and with that falling off, the debt to GDP ratio will be rapidly moving in the wrong direction. Even more worrying is that, as the activity in the economy is falling, the size of the tax base supporting government activity will also be shrinking, causing yet more damage to the fiscal position of the government, which is already in a very poor state. The government will be forced into a further round of cuts.

What we will really see is the actual real output of the Greek economy being laid bare before us. If the ongoing injection of borrowed money is taken out of the economy, many of the jobs accross the economy will simply disappear. In a crude illustration, we might just focus on the amount of activity that is generated by a single civil servant going about their daily life, with their shopping, payment of bills, visits to restaurants and so forth. If the civil servant is made redundant, we can see how the effects of that redundancy will ripple through the economy. Our civil servant will stop their trips to the restaurant, may not be able to pay for their mortgage and put their house on the market, the local shops will lose a customer and so forth. Each of these direct losses of income to businesses will see further downstream losses of income, multiplying the effect of the losses.

It is notable that, within our one rather crude illustration, it is evident that our civil servant will no longer be able to support their mortgage payments. Bearing in mind that unemployment will be rapidly rising over the whole economy, this problem will be replicated over the whole economy. The price of housing will sink, and with it the collateral the banks used for their previous lending. The same will be happening to commercial real estate, as the many businesses that will find that they are in trouble, or going bust, will see a growing flood of commercial properties onto to the market, either for rental or sale. Prices of real estate assets in the country will start to collapse.

That collapse of real estate assets will take away the foundations for bank lending. As businesses go bust, and individuals become unemployed in greater numbers, large numbers of what appeared to be sound loans will become delinquent. The banks will start to make large losses on what had appeared to be prime lending. With the values of property falling rapidly, they will not be able to recover their full losses, and they will be on a fast track to insolvency. As they attempt to protect themselves against their losses, they will hold on to cash. They will not only hold on to cash to protect against insolvency, but also out of the fear that they simply do not know where future losses might originate; after all, prime lending is going sour before their eyes.

What we are seeing is that the assets in Greece have been valued not upon the basis of the underlying output of the Greek economy but upon the foundations of unsustainable overseas borrowing.

With bank lending in decline, sources of potential growth in the economy will be closed off. Furthermore, in the case of Greece, capital flight has already been taking place, but it will accelerate rapidly as the crisis progresses from bad to worse. The discovery of the mispricing of assets will create panic. Access to capital will diminish.

What we are seeing is a downward spiral that is resultant of Greece being forced to live within its actual means. To return to the GDP example, it is like the person who has been living on £110,000 having to move to living on £100,000. They find that they can no longer afford their mortgage payments, the trip to the expensive restaurants, and so forth. Moreover, they are now having to pay back their previous borrowing, and they find their disposable income is collapsing. They have no choice but to live a far, far more austere lifestyle.

The essential problem is this. The more a country borrows from overseas, the more it supports GDP growth (or forestalls GDP decline). As time goes on, the more businesses rely on the overseas borrowing in order for their businesses to be solvent, and the more employment is founded in borrowing from overseas. The more businesses and individuals that are reliant on the income from overseas borrowing, the greater the extent of assets being priced on the overseas borrowing. The greater the extent that assets that are priced on the basis of overseas borrowing, the more the banks solvency is reliant on overseas borrowing. In order for an economy to be kept from collapse, it is necessary to keep borrowing, and the more it borrows, the more the economy is adapted to survival on borrowed money.

The only solution is to break the borrowing spiral as soon as possible.

A long, long time ago I proposed reforms for the UK economy. At the time of writing I argued that the UK needed reform now. The reason for the urgency was the absolute necessity to keep creditors on board whilst the reform took place. My argument was that it was necessary to keep them onboard such that the transition to a more sustainable fiscal foundation could be undertaken with the minimum of hardship. I never pretended that it would be easy or painless, but I always had in mind the scenario I have just painted for Greece. Better to reform with the benefit of credit to ease the transition, than face the imposition of reform and change in a state of shock. I think I made the analogy of falling down a hole, or using a ladder to climb down. You arrive at the same place, but in the latter case without broken bones.

So here we are, about two years after I suggested reform, and no reform has been enacted. This applies to the UK, the US, and a host of other 'rich world' countries. Instead of using the access to credit to allow a transition to a sustainable and realistic economic structure, governments have chosen to use massive borrowing to support their faux economies, and frittered away the chances to make the transition to their real size as painless as possible. We have seen the situation get worse, not better. Rich world economies are now increasingly reliant on overseas borrowing, not less so. In doing so, governments have taken a severe crisis, and turned it into a potential catastrophe.

This is the lesson that Greece teaches us.

44 comments:

  1. As if by magic, I just found this in the Times:

    Pressure continued to mount on Greece yesterday when Moody’s, a leading debt rating agency, downgraded nine of its banks, including National Bank of Greece, because of their “weakening stand-alone strength” due to challenging economic prospects, low business growth and increased loan quality problems.

    http://business.timesonline.co.uk/tol/business/industry_sectors/banking_and_finance/article7113451.ece

    I have also found a fascinating analysis from Buiter reproduced on zerohedge. It is long, but worth the effort:

    http://www.zerohedge.com/sites/default/files/Buiter%204.26.pdf

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  2. The Greek government will be in a position where it can no longer use the borrowed money to finance activity within the economy, and will have no choice but to enforce extreme austerity measures.

    It will have no choice because of its enslavement to the EU and its choke hold of the ECB.

    As the flow of overseas borrowed money disappears from the economy, the level of activity within the economy will start to fall in an alarming and dramatic way.

    I don’t know why you just focus on “overseas” money, because this would be still be a problem if it was just excessive domestic credit.

    The solution for asset bubbles and excessive credit is financial regulation, and government stimulus to take the role of private credit to prevent a collapse in the economy.

    The Greek government will be in a position where it can no longer use the borrowed money to finance activity within the economy, and will have no choice but to enforce extreme austerity measures. As the flow of overseas borrowed money disappears from the economy, the level of activity within the economy will start to fall in an alarming and dramatic way. What will then rapidly follow is that many businesses will find no customers for their goods and services, or a significant reduction, and they will find that they are no longer solvent …. causing yet more damage to the fiscal position of the government, which is already in a very poor state. The government will be forced into a further round of cuts.

    What you are describing is a form of debt deflation. A process that caused the Great Depression.

    What we will really see is the actual real output of the Greek economy being laid bare before us.

    Actually, not at all. Debt deflation will cause savage cuts to real wages and profits which will destroy perfectly profitable and productive industries. What you will do is cause the destruction of whole swathes of the productive sectors of your economy. This is a recipe for a Great Depression.

    As businesses go bust, and individuals become unemployed in greater numbers, large numbers of what appeared to be sound loans will become delinquent.

    Precisely. Why even allow such a disaster to happen in the first place?

    What we are seeing is that the assets in Greece have been valued not upon the basis of the underlying output of the Greek economy but upon the foundations of unsustainable overseas borrowing

    Given that most of Greece’s government debt is held by other EU countries, it is quite false to regard this as “overseas borrowing.”

    This is debt owned with the EU, and it would be more like a US state government having debt mostly owned in other US states.

    This applies to the UK, the US, and a host of other 'rich world' countries.

    Your analysis in no way applies to the US.

    The US dollar is the world’s reserve currency for now and the foreseeable future. The US is the largest economy in the world, the largest manufacturing nation, and has the largest financial markets in the world. It will continue to attract investors.

    The UK might face a balance of payments crisis if it can’t obtain capital account surpluses, but this is utterly different from the government debt, which can be largely funded internally or by the central bank.

    As I have argued in other posts, the solution for countries like the UK is financial regulation and industrial policy. That can be funded without foreign money.


    Rich world economies are now increasingly reliant on overseas borrowing


    A simple look at the statistics shows that the UK has decreased its reliance on overseas borrowing:

    http://news.bbc.co.uk/2/hi/business/8530150.stm

    Japan is in no way reliant on foreign credit. Its government debt is almost completely owned domestically.

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  3. The essential problem is this. The more a country borrows from overseas, the more it supports GDP growth (or forestalls GDP decline). As time goes on, the more businesses rely on the overseas borrowing in order for their businesses to be solvent, and the more employment is founded in borrowing from overseas.

    There appears to be a fatal flaw in your analysis. Most of the Greek debt is owned by other EU banks, mutual funds and insurance funds:

    Jack Ewing, “Already Holding Junk, Germany Hesitates” April 28, 2010

    This is not really “borrowing from overseas”: it’s an internal Eurozone affair.

    Just because the other Eurozone countries lend to Greece in Euros, it does not mean Greece can obtain all the US dollars it needs for funding a current account deficit.

    It still faces that problem. It imports from outside the Eurozone will require US dollars, not Euros.

    Trade within the Eurozone is not like foreign trade at all: the Greeks can purchase other Euro zone goods with Euros, just like any person in California can purchase goods made in New York with US dollars.

    Greek consumption of Eurozone products is good for other Eurozone countries, and means higher employment and output.

    The article I linked to above shows how interwoven the Eurozone really is. It’s already like a single state, but with one ridiculous problem: no federal fiscal policy.

    If the Germans and French do not want to provide a bailout, then their own banks and mutal funds will face huge losses.

    In other words, something like 17% of the US economy is funded by overseas borrowing. You may note that there is a large amount of 'fudge factor' in all of this, and comments and critiques are therefore welcomed

    The US simply does not need this overseas borrowing.

    The US dollar is the world’s reserve currency.

    The “overseas lending” could stop tomorrow and the US government could substitute deficit spending for the private credit.

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  4. Yeva Nersisyan and L. Randall Wray, "The Chinese Are Coming! The Chinese Are Coming! Oh My!" March 27, 2010:

    While most public discussion has focused on Chinese holdings [sc. of US government debt], Japanese holdings had been greater than Chinese holdings previous to 2008—and again surpassed those of China as of December 2009 ... Note also that the most recent data from China indicate that it ran an overall trade deficit; its accumulation of foreign assets must have slowed. It is too early to know whether this will continue—since it probably is due to relatively rapid growth in China in the context of a global recession. If it does, however, Chinese accumulation of US treasuries will probably slow.

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  5. Borrowing from overseas is, I would suggest, just one part of the problem but it is not the core of the problem. The core of the problem is excessive reliance on credit whether provided from within or outside any particular country.

    I am yet to hear a persuasive argument for a national economy being any different in substance from the minuscule individual economies operated by every household and the (usually) less minuscule economies operated by every business. After all a national economy is nothing more than the aggregate of the millions of little economic units within a geographical area.

    Is Greece bust? Yes. Is the Eurozone bust? Not necessarily. Isn't Greece just one little economy within the Eurozone economy just as the FatBigot household is a little economy within the UK economy?

    Borrow more than you can repay and you risk bankruptcy whether you are a household, a small country, a multinational corporation or a large country.

    If I borrow more than I can repay it makes no difference whether the lender is within or outside the UK, I go bust anyway. If the lender is outside the UK the loss falls overseas, so it is arguable that it is better to borrow from overseas if you are a bad risk.

    The core problem is excessive borrowing not the source of the finance.

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  6. CE

    If countries begin to rely on excessive borrowing, why does the Invisible Hand of the markets not correct this before it goes too far? I think you have previously suggested that one reason is that excessive banking regulation gives the illusion of risk-free investment, and I really like that explanation.

    But isn't there also another, seemingly inexplicable factor? As you describe today, GDP is universally regarded as a synonym for "economic output". Debt-to-GDP ratio is regarded as the most important measure of an economy's health, so lending continues to pour into countries whose debt-to-GDP ratio remains below some magic number. But why do the investors believe this? It appears that hard-nosed financiers cannot understand that GDP is a completely elastic concept. Isn't this evidence that the Invisible Hand doesn't work? i.e. that even given perfect information, people cannot - or choose not to - understand what it means.

    I would bet that even if the economy collapses completely, GDP will still be regarded universally as "economic output", and people will stand around scratching their heads as to why some countries with apparently healthy debt-to-GDP ratios imploded.

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  7. The fatbigot said,

    "I am yet to hear a persuasive argument for a national economy being any different in substance from the minuscule individual economies operated by every household and the (usually) less minuscule economies operated by every business. After all a national economy is nothing more than the aggregate of the millions of little economic units within a geographical area."

    The persuasive argument supports the fatbigot's view: the argument is advanced by Mandelbrot who describes fractal economies. That is, the way economies of differing sizes behave is the same, it is simply the scale that is different. (I think the term is 'scale invariant').

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  8. Quote - As businesses go bust, and individuals become unemployed in greater numbers, large numbers of what appeared to be sound loans will become delinquent.

    Precisely. Why even allow such a disaster to happen in the first place?

    You think it's preventable at this stage Lord Keynes? All that can be done is push the eventual debt deflation scenario a bit further into the future and making it worse in the process!

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  9. Quote -
    If countries begin to rely on excessive borrowing, why does the Invisible Hand of the markets not correct this before it goes too far? I think you have previously suggested that one reason is that excessive banking regulation gives the illusion of risk-free investment, and I really like that explanation.

    Or more probably a lack of banking regulation, resulting in uncontrolled lending?

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  10. The core question, for me, is WHY are Western economies in this hole? Our workers are no less able to work. Our fields are no less able to grow. We may not have access to every natural resource - but we are not "resource starved."

    We have turned ourselves into nations which let other people overseas do much of our production. And we've convinced ourselves of "entitlements" and "rights" which only exist in our minds - thus perpetuating the situation.

    It is not too late to turn things around. Actually, is it NEVER too late to turn things around as long as our physical ability remains true. What we lack is the will.

    Take a look at Greece. All these strikes and all this fury from the people who live there just represents a denial of the state of things. They think that if they get angry enough, refuse to work, shake their fists at their government - money will magically appear in their coffers.

    When you rack up debt and run out of money and things get desperate you have three options. You can sit and do nothing and dissolve into misery. You can demand "justice" and rail at the sky, achieving nothing. Or you can tighten your belts, roll up your sleeves and get to work fixing the problem. I know which option I prefer.

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  11. With regards to GDP it appears that on a superficial exammination of the figures on Wikipedia (yes I know its not that reliable!) that GDP per capita was higher at the end of WW2 than it was at the beginning. Which rather supports CE's idea that GDP is not a good measure of a Nation's wealth. If our GDP could grow, while large areas of our cities were laid flat by bombing, and massive amounts of material was used for the manufacture of guns, planes, tanks and ships, which were promptly destroyed in action, and the population had to endure rationing of food and goods, then its obviously flawed as an economic measure.

    If every single car in the land were scrapped, and everyone had to buy a new one, but of inferior quality to their old one, it would show up in the GDP figures as a massive rise. All that manufacturing, garage sales, work for the scrap dealers recycling the old ones etc etc. But at the end we'd all have a lesser quality car than before, and be poorer.

    GDP has no way of measuring destruction of wealth, just its creation. Visit any town 'recycling' centre on a weekend, and see the mountains of perfectly reasonable stuff thrown away each week, just because the owners don't want it anymore, or its broken (but probably easily repairable).

    If something breaks in my house, and I fix it, that results in little extra GDP(the cost of whatever materials I use). If I throw the old one away and buy a new one, thats a big boost to GDP. Surely the GDP increase should be the net wealth created - the value of the item purchased minus the value of the item destroyed?

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  12. Reply to Steve Tierney

    WHY are Western economies in this hole?.

    You exaggerate ridiculously.
    Many Western economies are fine. Germany - the largest economy in the EU - has a huge trade surplus and massive manufacturing base.
    It - along with N. Europe - gives the whole EU a trade surplus.
    The north European countries are doing fine and mostly have trade surpluses. Canada is in fine shape: it never even had a financial crisis because of good financial regulation.

    Australia tends to run current account deficits (tough it does sometimes have surpluses), but it has so many natural resources badly needed throughout the world, that it is unlikely to have a problem running a capital account surpluses, and moreover has always been a capital importing country: this is just a fact of life.

    The US is still the largest economy in the world and the largest manufacturing nation.
    It’s a military superpower that’s till has high tech industries and highly skilled labour and the best universities in the world.
    It's main problem is that it allows it multinational corporations to ship its jobs to East Asia.
    This can be fixed quite easily through industrial and trade policy or by taxing corporations according to the value added in the US. Yes, that means higher prices for manufactured goods. But it also means employment, investment, stronger industries and a healthy economy.

    Now we come to the endless hysteria about Greece: a piddling little country that is 3% of total EU GDP.

    The PIGS maybe represented 15% of total EU GDP

    So you think the whole West is falling because of this??

    And we've convinced ourselves of "entitlements" and "rights" which only exist in our minds - thus perpetuating the situation.

    “Entitlements” have little to do with the current economic problems.

    Your ranting about “entitlements” suggests the usual nonsensical Tory hatred of welfare.

    It is financial deregulation and free market economics that are explanations for the economic problems you complain about. How will complete deregulation of all financial markets or adopting completely free trade possibly help the UK? It would just mean the collapse of more manufacturing industries and more economic problems.


    Take a look at Greece. All these strikes and all this fury from the people who live there just represents a denial of the state of things.

    Nope, it represents a repudiation of the insane EU system with no federal fiscal policy and a ECB run by neoliberal idiots.

    I imagine people in Greece want to be free of the EU, a perfectly reasonable desire.

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  13. Reply to Anonymous

    You think it's preventable at this stage Lord Keynes? All that can be done is push the eventual debt deflation scenario a bit further into the future and making it worse in the process

    No, you don’t. You re-regulate banks and financial markets, prick asset bubbles, but then stimulate the economy by deficit spending, channel credit into productive lines of investment, and, if necessary, industrial and trade policies, import substitution industrial etc.

    The asset bubbles can fall without causing debt deflation.

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  14. I'm not entirely convinced by this idea that GDP is boosted by wars and destruction. There may be a short term boost when the effects of a disaster are repaired, but in the long term the wealth really is lost and this must show up as reduced activity in the GDP figures. Unless, of course, the spending takes hold as 'investment'. This would fly in the face of one of CE's central tenets, however: that if spending could create a profitable return, the free market would already have done it.

    Similarly, I think that borrowing only boosts GDP temporarily (but the 'investment' idea is also relevant here). Eventually the money must be paid back with interest. However, while the level of borrowing is increasing (as it is now in the UK), GDP is boosted, which is the main argument against believing that an instantaneous measurement of debt-to-GDP ratio is meaningful.

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  15. Lord Keynes

    You are a voice of reason here. Too much regulation did not cause this collapse - lack of it did. I worked in the industry for ten years before the crisis and lack of oversight and regulation was breathtaking and astonishing. And what has been perpetrated is not just shoddy practices but in many cases fraud.

    As for what you said to Steve - you are right. The Tories and the right wing press hate welfare and so talk about 'living within our means' - of course that means poor people - not them. They don't want to have to live within their means - that's just for the proles. Or they talk of the Wests 'sense of entitlement' etc, etc.

    The welfare state in Europe and the US (and yes the US does have one just as it already has the 'socialised' medicine the raging Republicans are so scared) is why our industries have managed to do so well. Without the stable society that having a welfare state ensures, you could not have had the sixty odd years of mostly growth and benign political conditions.

    Now those on the right are dancing to the tune of their masters and instead of blaming neo liberal globalisation for this crisis, due to losing production and jobs to developing economies - the right blame 'living beyond our means' and revert to ridiculous Thatherite ideas of comparing household economics to national economies.

    But the fact is a government can only govern with the consent of the people - and history shows that (thank God) people in Europe do not take attempts to roll back their standards of living too happily. A Tory government can come in and apply all the austerity measures it wants, cut public sector jobs all it wants - it won't do it much good when two years in rioting breaks out that makes the poll tax riots look like a kids tea party!

    And there is the rub - the hard nosed line of the righties 'live within your means you poor people' comes up - tme and time again, with political and social reality.

    If we keep down this path then the West will - once again - inexorably march down the path to severe strife, geopolitical consequences and eventual war.

    Under both Thatcher and before her Heath the country faced severe unrest. Under Heath - the miners stopped the country nearly - three day week, rolling black outs etc.

    To the right these are militant lunatics who should just take their nasty medicine like good little boys but they were defending their livelihoods and standards of living. This time it is the public sector that the neo liberals are coming for. But they are a different kettle of fish altogether - less militant yes - but hugely more powerful if they really do decide to fight.

    And what next when you have hollowed out the public sector as you hollowed out traditional manufacturing? We will be left to rely on the six million or so private sector workers to keep the country going? Or will the private sector rush in in an orgy of investment and R&D to replace the millions of manufacturing and now public sector jobs? Of course it wont.

    Countries once again will fall into social breakdown and unrest - or far left or far right extremism - all over again!

    All because of the lunatic idea of economic liberalism. A practice that has led to disaster every time it has been followed. Periods of liberalism - neo or old fashioned always result in unrest, a return to protectionism and ultimately war.

    As to how this mess IS caused by financial services and not by ''socialism'' read Simon Johnsons - The Quiet Coup. Ex IMF banker explains it all.

    Suzy Smitt

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  16. Manufacturing Wage Stagnation in China

    Here’s an interesting report from back in 2005:

    Worker unrest is particularly rife in Guangdong, one of China's main industrial centers, where exports surged 24% to $190 billion--one-third of the national total--last year alone [2004]. Yet base assembly-line wages in the Pearl River Delta, the province's manufacturing belt, have been virtually frozen at about $80 per month for the past decade [1995-2005], according to a recent survey by the Ministry of Labor and Social Security. Factor in inflation over roughly the same period, and average pay in real terms has declined by as much as 30%..

    Gough, Neil. "Trouble on the Line," Time International (Asia Edition). 165. 4 (Jan 31, 2005): 38

    Also:

    Many argue that China’s wage competitiveness originates in its fixed exchange-rate regime, which undervalues its currency considerably …. [But even] if the yuan appreciated by 20–30 per cent relative to the dollar—as many American critics of China’s currency manipulation advocate—Chinese wages would still be significantly lower. Second, an unlimited supply of labour is not a natural phenomenon given by China’s population structure, as is so often assumed. Rather, it is a consequence of the government’s rural-agricultural policies which, intentionally or unintentionally, bankrupt the countryside and generate a continuous rural exodus …. Over the last twenty years, the Chinese government has largely concentrated investment in the urban-industrial sector, particularly in coastal areas, with rural and agricultural investment lagging behind. State-owned banks have also focused their efforts on financing urban-industrial development, while rural and agricultural financing were neglected. In the last two decades, rural per capita income has never exceeded 40 per cent of the urban level .... The result of this urban bias has been relative economic stagnation in the countryside and a concomitant fiscal stringency on the part of rural local governments. From the 1990s onwards, the deterioration of agricultural incomes and the demise of collective rural industries—the township and village enterprises which used to be vibrant generators of employment in the early stages of market reform—forced most young labourers in the countryside to leave for the city, creating a vicious cycle which has precipitated a rural social crisis. China’s agrarian sector was not only neglected, however, it was also exploited in support of urban growth. A recent study has found that there was a sustained and increasing net transfer of resources from the rural-agricultural to the urban-industrial sector between 1978 and 2000, both through fiscal policy (via taxation and government spending) and the financial system (via savings deposits and loans).

    Hung Ho-Fung, “America’s head servant? The PRC’s Dilemma in the Global Crisis”, November-December 2009.

    The punitive fiscal policies imposed on the Chinese rural population is examined in Huang Jikun, Scott Rozelle and Wang Honglin, ‘Fostering or Stripping Rural China: Modernizing Agriculture and Rural to Urban Capital Flows’, The Developing Economies, vol. 44, no. 1, 2006, pp. 1–26.

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  17. Well said Suzy Smit and Lord Keynes. Hopefully, there are enough sensible people in the UK that see the truth and vote Labour or Libdem. A Tory cutting spree is the last thing the UK needs.

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  18. It always makes me laugh when a lefty comes on railing about how the Conservatives: "hate the poor". Yet most of the Conservative activists I know come from solid working class backgrounds and are far from rich. We don't hate the poor - we hate poverty. We want to give people the opportunities and ability to live their lives as they see fit - and improve them if they want to.

    It's a very easy line for a lefty to run - and to rant about - but the truth is that it is the left that hold people back. It suits them to keep the poor on the breadline - begging at the door of their socialist masters for scraps and being thankful for it. It suits them because it keeps them and their corrupt kind in power so that they can leech away at the economy and spirit of a nation. It suits them to keep people dependent rather than independent - because then (god forbid) they might start to question the Powers That Be. They might demand the right to aspiration and freedom. And for the dark-hearted socialist that Just. Wouldn't. Do.

    Hey! I can do an emotive partisan rant too! Who would have thought! ;)

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  19. Hilarious.

    The childishness of the lefties and rights debate shows the idiotic, useless and boring level of debate and analysis that the mainstream media provides (as referred to in CE's post).

    Lefties and righties! Children, please!

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  20. Can the ranting leftie, Suzy Smitt please explain what we do about sorting out this deficit problem?

    The numbers are, approximately:-

    Tax revenue = £500bn per year
    Government expenditure £660bn per year

    So to get the two to balance we either raise taxes by about 30% or cut government expenditure by about 25% or some combination of the two.

    This doesn't even begin to address the issue of paying down the Government debt, standing at about £900bn I believe.

    I know Lord Keynes will be on in a minute saying we shouldn't cut the Government debt, but humour me as I don't want to be paying interest to anyone out of my taxes thank you very much.

    Personally, I believe the Government should live within its means as a matter of principle.

    Why should I and future generations be lumbered with paying off debts as the price for allowing politicians to indulge their idealogic fantasies, which in the long run can't be afforded?

    Even if we get continuous on trend growth it will take in excess of 10 years before tax revenues catch up to Government expenditure even if that stands still at the current level. Meanwhile Government debt continues to escalate meaning ever more interest to be paid.

    Now, I actually think our politicians won't dare to truly tackle the issue and therefore we will bumble on for a fair few more years before the day of reckoning comes and we get to the position that Greece now finds itself in.

    One thing I do agree with the ranting leftie about though, is that there will probably be rioting in the streets by the lefties in the future as the poor do in deed get poorer. What they will never admit though is that it is all courtesy of their beloved Labour party and their insane spending policies.

    ReplyDelete
  21. Reply to Mr Welldodgy 1

    Can the ranting leftie … please explain what we do about sorting out this deficit problem?

    Let me do the honours. The deficit “problem” is largely a figment of the fevered conservative imagination.

    The numbers are, approximately:-
    Tax revenue = £500bn per year
    Government expenditure £660bn per year


    You can’t understand these numbers without looking at debt to GDP ratios.

    For example, if the government has a total debt of 1 trillion dollars, this seems like a disaster. But if GDP is $15 trillion, it’s only 6% of GDP: a comparatively tiny debt.

    Personally, I believe the Government should live within its means as a matter of principle.

    It’s an absurd principle – and was abandoned by governments all over the world in the 1930s because of its poisonous consequences.

    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’s central bank has the power to control interest rates and bond yields if necessary.

    (4) 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.

    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

    The 2010 debt is on the higher end of the spectrum, but is not really historically high.

    According to the “government-debt-will-bankrupt-the-nation” idea, 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 such thing happened, for the 4 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.

    Do you as a member of a “future generation” feel burdened by WWII debt?

    ReplyDelete
  22. Reply to Mr Welldodgy 2

    I know Lord Keynes will be on in a minute saying we shouldn't cut the Government debt, but humour me as I don't want to be paying interest to anyone out of my taxes thank you very much.

    Then you can live in a UK mired in depression and economic collapse. That is what would have happened in the absence of government intervention.

    Effectively you are saying “I don’t want some tiny part of my taxes going to interest payments on government debt, because in my view a better solution would be letting the whole economy collapse into a depression.”

    Moreover, you are certainly free to leave your country and live in another country with no debt if it bothers you that much: you’re not living in Soviet Russia.

    Assuming you accept democracy as a political system and not monarchy or plutocracy, then you will always find policies you don’t agree with.

    However, the truth is that the burden on you as an individual is likely to rather small given we have progressive taxes and most debt in rolled over. Other debt is bought back by the central bank – which isn’t a burden to anyone.

    Why should I and future generations be lumbered with paying off debts as the price for allowing politicians to indulge their idealogic fantasies, which in the long run can't be afforded?

    The future generations are not burdened if you have the right macroeconomic policies: they benefit in the future from deficit spending now.

    In fact, the truth is that vicious deflationary policies and budget balancing is what will really rob future generations: it will rob them of the wealth we could create now and the larger economy they would have had in the future.

    Above all, it prevents parents now from having children because of poor job prospects, low income, reduced growth and economic stagnation: it prevents future generations from even being born.

    I have to laugh every time I hear this “robbing future generations” balderdash.

    The extreme proponents of free market economics would rob future generations of their very existence.

    What they will never admit though is that it is all courtesy of their beloved Labour party and their insane spending policies.

    Given that a lot of the budget deficit is just automatic stabilizers that prevent further economic contraction, your claim about “insane spending policies” is laughable.

    You prefer massive recession instead?

    I wonder whether you realise that John Major (1990-1997) presided over a huge surge in public debt from 26% to 41% of GDP??

    In other words, the debt to GDP ratio increased by a shocking 57%!!

    Care to comment on that? Was our Tory friend John Major engaged in “insane spending policies”?

    The debt ratio fell rapidly under New Labour from 1997 to 2002. Did you forget that too?

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  23. Reply to Steve Tierney

    Yeah, an amusing rant. But I notice you don’t respond to any of the arguments. Like the ridiculous notion that the whole West is collapsing – care to respond to that?

    It always makes me laugh when a lefty comes on railing about how the Conservatives: "hate the poor". Yet most of the Conservative activists I know come from solid working class backgrounds and are far from rich. We don't hate the poor - we hate poverty

    Read the comments again. No one accused you of “hating the poor”. The expression was “hating welfare” – which seems an entirely reasonable statement.

    Let’s see you declare that welfare is important and humane part of any society.

    It suits them to keep the poor on the breadline - begging at the door of their socialist masters for scraps and being thankful for it.

    Given that when leftist Keynesian politics were actually implemented in most Western countries (1945-1970s), we had nearly full employment, astonishing increases in living standards, real wages and very high social mobility, your argument is what you apparently said it was: an emotive partisan rant :)

    Curiously, the conservative notion of the "natural rate of unemployment" or the "Non-Accelerating Inflation Rate of Unemployment" (NAIRU) really is a method for keeping people poor:

    http://bilbo.economicoutlook.net/blog/?p=1502

    ReplyDelete
  24. Josiah Stamp's GhostMay 4, 2010 at 2:56 AM

    "I gave food to the poor and they called me a saint; I asked why the poor have no food and they called me a communist." ~ Dom Helder Camara

    ------------------------

    Sadly some people on here can't seem to see that after successive of Conservative and New Labour governments the gap between rich and poor has increased. This says all you need to know about their ideological beliefs. Additionally, given the elite rich are now richer than ever (despite having gone through a worldwide recession), then you'll excuse me for my cynicism when a certain poster claims that 'Conservatives hate poverty'.

    That's why the Tories are going to slash benefits and public spending (whilst cutting inheritance tax for the rich) and then send in their paid goons in the police force when people revolt and riot because their living standards are being lost. Of course 'Etonian Tories' and 'Champagne Socialists ', won't be suffering, oh no...but they will turn on the TV to watch the sordid spectacle whilst toasting the next economic voodoo recipe the are going to try out on the population.

    -------------------------

    "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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  25. @Lord Sidcup

    I come here to discuss economics, not politics. Although it is inevitable that one often leads somewhat to the other.

    However, Suzi rattled my cage and I felt obliged to respond in kind. You might have noticed my wink ; ) to reflect I was just playing with her really. This sort of partisan rant achieves little.

    Nevertheless, its not "childish" as you say. Its fundamental. Different styles of economics are at home with different styles of politics. You may choose to divorce yourself from that, but it doesn't make it go away.

    ReplyDelete
  26. Mr Welldodgy,
    who said those two figures need to balance? The 'markets'? They do not need to balance end of. Britain has its own currency and is monopoly issuer thereof. GBGov needs to keep spending to support aggregate demand.retrenchment now would hurt an already poorly economy, hurt the people at the bottom for no reason other than dogma (of the neo liberal variety). GB is not Greeece or any of the PIGS. The PIGS really are up shit creek since they have no currency of their own. Anb by the way your taxes finance nothing really. That is not how it works. The 'markets' actually know this that is why they are not after the UK (yet).

    ReplyDelete
  27. SteveTierney - I do actually agree that leftie and rightie etc are in many ways redundant - look at the differences within the Tory party or the Labour party. There are many in the Labour party who would be more at home in the Conservatives and some in the Conservatives who would be more at home in the Liberals or New Labour.

    However the fact remains that this mess HAS been created by finance and by rolling back of trade barriers to allow financiers to move money through London 'so fast it didn't touch the sides' (Robert Peston) and New York of course. It allowed voodoo economics to really come into its own. It allowed de facto fraud to be carried out as if it were legitimate business.

    And when all this fell apart what happened? Governments rushed to save the banks - they put the tax payer allegedly in hock to the finance masters for generations. And to those who follow neo liberal economic dogma that was okay. But it is not okay to allegedly put future generations in hock to feed a child or house a destitute person. To me that means that those who follow neo liberal principals are not particularly humane. Their politics cannot be divorced from their economic beliefs.

    The full employment policies of the late forties, fifties and sixties worked very well. The high tax policies worked very well. The US had the most stable period of economic growth in its history during this time. When Friedman et al began to take a hold of economic dogma this all went horribly wrong. As soon as governments switched their priorities to monetarist policy and inflation the real economy began to suffer.

    The consequences of which are being disastrously played out in front of our eyes now. Well the plain fact is that eventually economic theories come slap bang against real politik and that is what is happening in Greece. This is going to get very interesting. People will not just roll over and allow the banks to enrich themselves at the cost of ordinary peoples lives and whole nation states.

    Suzy S

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  28. Lord Keynes

    You are going on about debt-to-GDP ratios again, and ignoring CE's central point about the elasticity of the GDP measure.

    But even putting that aside, constantly referring to statistics to 'prove' your point, and making optimistic assumptions of future global growth can't avoid an obvious truth: the British population lives in lavish luxury and idleness compared to the Chinese and many other nations, but we must all now compete for dwindling supplies of energy and raw materials. Who will win that competition? And how can we continue to live the way we do without our lifestyles eventually converging (or crossing on the way down) with that of, say, the Chinese?

    No statistics, please!

    ReplyDelete
  29. >>However the fact remains that this mess HAS been created by finance and by rolling back of trade barriers to allow financiers to move money through London 'so fast it didn't touch the sides' (Robert Peston) and New York of course.<<

    Except, Suzy, that this "fact" is only actually your opinion. Well, yours and Lord Keynes, apparently. I don't accept that description at all. Nor do many others.

    You can call your opinion "fact" if you like. That's entirely up to you. I find that a little presumptious.

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  30. @Lord Keynes
    >>Yeah, an amusing rant. But I notice you don’t respond to any of the arguments. Like the ridiculous notion that the whole West is collapsing – care to respond to that?<<

    The "whole" west is a big place. But yes, I would say that on its present course it is in serious decline. I have hope that can be reversed.

    I generally don't bother to argue with committed left-wing spokesmen like yourself online - though I'll do so in real-world debate. I'll do a bit of to-and-fro online but I simply have better things to do than to trade tractor stats with you. Like trying to make sure other people don't get taken in by your voodoo.

    ReplyDelete
  31. You can't reform this system, its not agile enough. The economy is an intangible, used to measure human activity, whioh in turn is driven by a myriad of biological inputs, the tangible.

    If you want to reform a system, you need to provide alternatives to the methods that contributed to the problem. Without open, informed debate among people in general, pragmatic decisions will not come to pass.

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  32. Evgueni in HorleyMay 5, 2010 at 9:39 AM

    Lord Keynes,
    your argument sounds more plausible than most on here, especially the simplistic tory and socialist perspectives. However I am baffled by your insistence that this place we find ourselves in, is a Democracy. Yes, GB and most of the developed world is a democracy by the most narrow of definitions which insists only that elections take place to legitimise "representative" government. But this is absurd, it is like saying that we have free speech because anyone can speak their mind at Hyde Park Corner. To say we have free speech would disregard the practical reality that actual or legal persons with deep pockets can (and do) buy air time, or media outlets, outright. Our news media are run for profit and not as a public service, with all the implications that this has for the scope and quality of public discourse.

    Does it matter? It should if you wish to define democracy in a meaningful way. Thomas Jefferson made the point that he "would rather live without elections than without newspapers" - a recognition of the fact that we cannot speak of a meanigful democracy without information on which to base decisions, and by implication that elected government is not the only source of power. It is a truism then to say that information is crucial, but how important is the quality of it? This line of enquiry is not overlooked, though you will struggle to find references to it in the mainstream. Numerous studies, notably by Herman/Chomsky in Manufacturing Consent show that the historically prevalent media structure is successful in imposing very severe constraints on the public imagination. Hence most of us remain so politically naive as not to be able to get past the superficially adversarial but in practice severely constrained by elite interests, public spectacle of one party versus another versus (if we are lucky) another. It does not occur to question whether representative government is a sufficient condition of democracy, or even whether we have anything remotely resembling a representative government in practice. As another regular here puts it in his blog, we live in a "shamocracy". You are right we do have the democratic freedom to emigrate, but only by foregoing our freedom to stay close to our family, friends and favourite brewery! Some freedom indeed..

    And since this is a discussion about economics - it stands to reason that in this system of ours only those economic theories are entertained seriously that are least contradictory to elite interests and the status quo. Thus when the banks are in a sufficiently vulnerable position, Keynesian economics is conceded. Private credit creation is allowed to be replaced by government spending. Conversely when the private banks are once again in a strong position, the more greedy economic theories are promoted. And so it goes. The battle of people versus banks is still to take place. The people will win, but first they must see. What are your views on monetary reform, e.g. re-nationalising the money supply?

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  33. Reply to Steve Tierney

    Like trying to make sure other people don't get taken in by your voodoo.

    A statement that shows your ignorance. "Voodoo economics" was used by George Bush (senior) to refer to the ridiculous snake oil of monetarism - conservative economics.

    [on financial deregulation]: Well, yours and Lord Keynes, apparently. I don't accept that description at all. Nor do many others.

    What ridiculous claptrap. The belief that financial degulation caused this crisis is confined to me and another commentator on this blog?! :o

    Maybe in your conservative fantasies...

    How about Joseph Stiglitz, James Galbraith, Paul Krugman, or the former Tory, Robert Skidelsky etc

    Take a look here:

    http://www.youtube.com/watch?v=SJf-s-fivLQ

    I find it amusing that you - who have offered no justification for your economic views from any school at all - now cite ... yourself as some great expert?

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  34. I am baffled by your insistence that this place we find ourselves in, is a Democracy.

    We live in a dysfunctional democracy that needs reform.


    Numerous studies, notably by Herman/Chomsky in Manufacturing Consent show that the historically prevalent media structure is successful in imposing very severe constraints on the public imagination

    Yet the internet has opened up a rich world of dissent for people who want more than the 6 pm news.

    I, by the way, have a great deal of respect for Chomsky's views on most issues.


    What are your views on monetary reform, e.g. re-nationalising the money supply?

    My views on monetary policy are in line with the post Keynesian neo-chartalists / modern monetary theory. However, you do need a trade surplus before you can really implement the kind of monetary and fiscal policy advocated by the neo-chartalists.

    Governments do not need private bond market money to deficit spend in times of depression or severe recession, but bonds are a useful and reasonably safe financial asset for people saving for retirement. Governments should, however, control the yield curve and not be intimidated by bond market speculators.

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  35. By the way, Steve Tieney, my challange still stands: Let’s see you declare that welfare is an important and humane part of any society.

    Otherwise the statement that you (apparently)hate welfare seems entirely reasonable.

    ReplyDelete
  36. MMT feels kinky. Not sure we should be caught practicing it.

    ReplyDelete
  37. Josiah Stamp's GhostMay 6, 2010 at 5:12 AM

    The Tories don't hate the poor? Pull the other one.

    http://www.independent.co.uk/opinion/commentators/johann-hari/johann-hari-welcome-to-cameron-land-1962318.html

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  38. Hey all,

    Wow - fiery topic!

    I have to confess that trying to follow all the comments has left me feeling rather dizzy - physically and politically!

    The only thing I think to add is that, to my way of thinking, if you and your friend have been kidnapped and put in the boot of a car it makes little sense to try and negotiate routes with the driver, and even less to argue with one another about the direction he is taking.

    Hope all are well,

    T.

    ReplyDelete
  39. Just a very quick note on what has become a very heated debate. I have considerable respect for the standards of the comments on the blog, and have always thought that they 'make' the blog. As such, I am a little concerned that, in the heat of the argument, the comments are moving away from the economic arguments and onto the person. As such, can I suggest a little more focus on the economics and less on the commentator.

    Many thanks.

    ReplyDelete
  40. The first human who hurled an insult instead of a stone was the founder of civilization.

    ReplyDelete

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