Tuesday, June 8, 2010

The Fiscal Beauty Contest Starts

The realisation that endless government borrowing could not be sustained really started with the (still unfinished) Greek crisis. As the risks of sovereign debt became apparent, risk aversion, and sometimes panic, have gripped the markets for government debt.

In the title of this post, I mention a beauty contest. However, in some respects, what we are looking at is not a fiscal beauty contest - but a fiscal 'least ugly' contest. I proposed that the world was about to enter a beauty contest some time ago as, whatever happens, many of the major debtor nations are going to have to keep borrowing for a while yet, and that means ongoing access to credit. I highlight this, as it looks like the UK is about to embark on a path of radical change in fiscal policy, with a firm and decisive attempt to seek to deal with the UK's fiscal problems:

George Osborne braced the country for cuts in government spending of up to 20 per cent as he laid the ground for an austerity programme to last the whole parliament.

The Chancellor announced an unprecedented four-year spending review in which every Cabinet minister will have to justify in front of a panel of colleagues every pound they spend.

Mr Osborne said the task ahead represented “the great national challenge of our generation” and that after years of waste, debt and irresponsibility it was time to rethink how government spent its money.

There is, of course, a huge gap between rhetoric and achieving action on the ground, and this means that such announcements need to be treated with caution. The inspiration for the fiscal retrenchment is Canada in the 1990s, and the process will involve a careful review of each element of government expenditure, including asking the vital questions of whether any activity might be necessary or contribute to the economy overall. Whilst a similar process worked for Canada, this was undertaken in less stressed times, so that it may be more difficult to emulate the Canadian example than might be believed.

The interesting point about the case of the UK is that they are increasingly faced with little choice but to cut back savagely. Whilst not personally having any respect for the ratings agencies, I nevertheless accept that they impact markets. As such, the latest from Fitch highlights the necessity of action in the UK:

Britain's debt problems returned to the spotlight Tuesday after Fitch Ratings warned of the need for bigger austerity measures in a report that rattled investors but could help new Prime Minister David Cameron justify severe spending cuts to a worried public.

In its first major statement since Britain's Conservative and Liberal Democrat parties formed a coalition government last month, Fitch warned the U.K. "faces a formidable fiscal challenge" and needs to be more ambitious in cutting its debts. The warning comes as new U.K. Treasury chief George Osborne prepares on June 22 to unveil emergency measures to cut Britain's budget deficit, which at more than 11% of gross domestic product ranks among the largest among advanced countries.

The point of the Fitch report is that, in the least ugly contest, the UK still has a long way to go. However, as each country seeks to beautify their balance sheet, the pressure on other countries to follow suit will increase. In other words, even if the UK seeks to be fiscally sound, other countries will be forced to outdo the UK, as they too seek further funding. This is from the same article quoted earlier:

"As more European countries respond to market pressure by tightening fiscal policy more aggressively than originally planned … there is a risk that the U.K.'s existing deficit-cutting targets begin to look distinctly weak," Fitch analysts said.
This coordinated shrinkage in debt growth follows the coordinated growth in debt, or going from feast to famine. Whilst the view of this blog has always been to recognise the dangers in the growth of debt, and the absolute necessity to reform to fiscal responsibility, the coordination of the fiscal consolidation over so many economies presents significant dangers. In particular, the consolidations will force a drop of activity over many economies simultaneously, and with that drop in activity, each country that consolidates will see a major drop in imports, further ratcheting each economy down.

This potential systemic shock over many economies risks a collapse in confidence, and therefore a hard economic 'undershoot'. By this, I mean that the drop in activity will in turn undermine confidence more broadly than the real consequences of austerity might reasonably point to. This might further ratchet down economic activity. Just as the debt fuelled activity created massive over-confidence, the collapse in debt driven 'growth' might create under-confidence. And to add to the potential nose-dive, there is the talk of fiscal retrenchment in Japan:

Despite the prime minister's hair-raising words [that Japan will face a sovereign debt crisis if it continues on the current path], markets did not bat an eyelid, with the Japanese yen, the Nikkei stock market index and Japanese government bonds unmoved.

"Fiscal austerity measures are long overdue," said Chris Scicluna, deputy head of economics at Daiwa Capital Markets in London.

He forecasts that the government's budget deficit will be 8% of GDP this year, a number that Mr Kan has promised to reduce to zero by the end of the decade.

Having said all of this, the current move to fiscal austerity is not as severe as is popularly believed. It might be noted that Japan is not planning to pay down debt, but just slow the accumulation of debt. The same might be said for most of the so called austerity measures, as can be seen in the following chart:



The problem is this. The beauty contest is now enacted, and the only possible result is an ever fiercer spiral of fiscal consolidation, with the effects of this spiralling economies ever deeper into recession/depression. The chart just shows that there is still a long way to go to achieve a realistic and long term fiscal correction. The beauty contest will ensure further measures will change the shape of the chart.

The trouble is that, having splurged in the wake of the financial crisis, having simultaneously strained fiscal positions towards breaking point, there is nowhere left to go. Had it been the case that only a few small economies had built up so much debt, the world economic system might have been able to absorb the retrenchment, albeit with some pain. However, this is not what happened, and the collective market awakening to the risks of sovereign default can not be turned back. Even Japan, with its willing army of domestic savers, is twitching.

Then there is the US. With the 'safe haven' and reserve currency status, the US has chosen to remain on the path of ongoing growth in debt and spending. There is further talk of more more fiscal stimuli. The US is getting into ever deeper trouble, all the time relying on the safe haven and reserve status to last to eternity. In my last post, I discussed the risks in being perceived as a safe haven, and this is the latest news on the US trade situation:

WASHINGTON — The U.S. trade deficit rose to the highest level in 16 months as exports fell for the second time in three months, a potentially worrisome sign that Europe's debt troubles are beginning to crimp American manufacturers.

The Commerce Department said Thursday the trade deficit widened to $40.3 billion in April, up by 0.6 percent from March. U.S. exports dropped 0.6 percent, while imports declined by 0.4 percent.

U.S. manufacturing has been a standout performer as the U.S. recovers from the worst recession in decades. But the concern is that Europe's debt crisis will slow growth in that part of the world and dampen demand in a key U.S. export market.

For April, exports slipped to $148.8 billion, with demand for U.S. farm products falling by $647 million and weakness spread across a number of manufactured goods from electric generators to industrial machinery and aircraft engines.

This latest news serves to highlight the dangers described in my last post, that the safe haven status is a danger to the US economy. The US is in very deep trouble, and the safe haven and reserve currency status are encouraging them deeper into a quagmire. As long as the world keeps buying US treasuries, they seem willing to keep deepening the fiscal hole, all the while importing and consuming based upon debt growth. At some stage, the markets must realise that the beauty of the US has faded, and that in reality it is looking both tired and haggardly. The trouble is, the US is still deeply entrenched in the (neo-) Keynesian dream.

In the world of the (neo-) Keynesians, the answer is not to consolidate, but to continue government borrowing, to prevent a choking of 'recovery'. No doubt, in the future, as the inevitable consequences of the consolidation take place, they will blame the problem on the fiscal consolidation, rather than on the fiscal splurge and consumer debt splurge that preceded it. This despite the fact that this borrowing and spending was supporting an economic structure that could not be sustained...and that the choices of borrowing of the scale needed to support a continuation was becoming impossible. And that is the problem with their solutions, that they can never be proved wrong, as whatever is done, it always necessitates more to be done. If the fiscal stimulus runs out of steam, have another one, and another one, and another one. If it is not working, a larger one will do the trick. If the larger one does not do the trick, then there is an even larger one that might be do the trick. In nobody will lend, print money. If that does not work, just print more.

Their solutions have just been tried, and the result is what we see before us. Massive fiscal stimuli have been tried. Quantitative easing (printing money) to fund government debt has been tried. Despite this, the economic crisis just keeps coming back. The difference now is that we can see where these policies have left the world economy - on the edge of a cliff. They can not claim that the problem is a market failure, as any reasonable economic theory must account for the actuality of markets. That actuality is quite reasonable - the markets think that, if they continue to lend to the major debtor governments, they will not have their money repaid in real terms, or will not be paid due to default. The markets have recognised that there is no clear plan for how the ongoing debt accumulation, and repayment of debt, might be achieved/sustained.

Despite all of the money flooding into the US, the 'safe haven', the doubts about the sustainability of the (neo-) Keynesian approach are mounting. It is only a matter of time before the markets confront the US. With the commencement of fiscal retrenchment elsewhere, and the drive for deeper austerity measures, eventually the markets will turn more cynical eyes upon the US economy. By that time, the US will be even deeper in the quagmire of debt.

I might summarise the position as follows; just as the consumer debt spiralled and unwound, sovereign debt has replaced that debt and must eventually unwind. The nature and the speed of that unwinding is still uncertain. The politicians and policymakers have still yet to fully play their hands, and they will be confronted with resistance from their populations as they seek to win the beauty contest. Set against the governments will be the bond markets, the judges in the beauty (least ugly) competition. Furthermore, in the tangled world of mutual dependency of one economy upon other economies, it is still uncertain where the really weak players in the world economy might be. As the debt accumulation goes into reverse, the dependencies will start to become apparent, and may present some surprising outcomes. However, one thing is certain; whatever the eventual outcome, no country is going to come out of the progressive fiscal consolidation untouched.

Note: I have been planning to discuss the neo-Keynesian approach for a while, but have lacked the time to do the subject justice. I may devote a post to this subject in the future, in particular a response to the volumes of material posted in the comments section by a regular commentator who posts under the name of 'Lord Keynes'. In the meantime, I will leave the discussion as the brief comment above.

59 comments:

  1. Well, those with a mathematical bent will see a geometric series under construction here, with successive people getting successive smaller fractions of the original 10K , paying their tax, and spending the remainder , in a process reminiscent of fractional reserve banking.

    And the astute will see that we don't have to go too far down this road for the govt to get back pretty well EVERY PENNY of it's original outlay of 10K , in .... taxes on repeated uses of this slowly diminishing 10K.

    AND YET ..... we have also ( without even trying ) managed to get a decent ( ish !) income not only to #1 ( the obvious beneficiary ) but also to #2, #3 #4#5 #6 #7 #8...... #23.... etc etc... AND get ALL our money back.

    In short we appear to have performed an economic miracle.

    All these various people in Economically Deprived Area X are now busily making each other sandwiches / doing each other's hair / cutting each other's grass / shampooing each other's dogs etc etc ..& paying each other with the SAME 10000 quid ( or remnants thereof ).

    The whole area is now blatantly economically vibrant.

    The people are employed, busy & ( I hope ) happy.

    The prisons are relatively empty.

    And all this for NO net cost to the govt / taxpayer. (recall they get it all back in taxes - how counter -intuitive is that ?)

    OK that's the Keynesian thang.

    Now let's try the Austere 'You Have Been Naughty & Now You Must Pay' approach. :

    Person #1 is sacked.

    She now has no income. And neither do Dave. Bert . Sid , Ivy nor anyone else oop thar.

    They all turn to social security, drug dealing & wife murder as the local economy spirals down the proverbial.

    GDP plummets.

    Tax revenues plummet.

    Crime / unemployment / misery skyrocket.

    National Debt/ GDP ratios remained unchanged or even rise, since GDP plummets so much.

    (hello Greece!)
    (part 2 ... 2 many characters apparently for one post)....

    Well..... this is where I am.

    I seem to be a Keynesian .

    Persuade me otherwise .

    regards,
    and thanks again for a though provoking blog

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  2. cynicus -

    First I should say that I am one of the doubtless many many bamboozled ignoramuses who knew ( nor cared) nothing whatever about economics until about september 2008 when I guess we pretty much all couldn't fail to notice that something extraordinary was happening bank-wise.

    Since those 'interesting' days ( like many people I am sure ) I have not been able to stop myself poring over FT articles & blogs of all descriptions trying to work out what the &^%$ went wrong, and in particular, how will it affect me & is there any way to make large amounts of money out of it etc etc.

    The net result of 18 months of self imposed education is the discovery that ( after all these years ) 'economists ' still seem to be divided into 2 broad camps, to whit, the 'take the pain' school ( austrians / you / faber / mish / denninger .... ) & the keynesians ( krugman / martin wolf / michael hudson / roubini .. )

    The immediate question is ( obviously ) 'who is right' ?

    Should governments be 'borrowing & spending' like crazy , regardless of their face value debt ( to make up for the obvious & troublesome lack of private demand ) or should they be rapidly & virtuously paying off their bloated debt , as per your good ( presumably ) self, for fear of imminent hyperinflation / bankruptcy / weimar part 2 syndrome ?

    Now, I have been trying to just learn all i can & let an opinion form itself somehow automatically , and after a few months of veering towards your camp .. ( ok let's take the damn pain ... 'austerity is your friend' ...etc etc ) I seem to be ( sorry ) coming round to the MMT / Krugman 'why take pain you don't have to take' view.

    This crystallised this evening in a little mathematical exercise i forced my self to work through which seems to me to illustrate how wonderfully non-intuitive sovereign expenditure actually is.

    So, finally , to get to the point :

    Imagine a single govt job, let's say up in area X ( oop north bah gum ) in some area where there is very little in the way of 'real' employment.

    Now , that nice mR cameron is about to axe said govt job, because he wishes to attempt to 'balance the books '

    Sounds good huh ?

    OK let's go.

    Let's say ( sake of arg ) it pays £10000 p /a ( make the sums obvious).

    So there;'s a 10K govt expenditure to kick off with. And what could be better than to axe it & axe it NOW by st george ? Why, we will immediately save 10 grand of taxpayers money ( just what the doctor - faber ?- ordered !)

    Now let's follow that through , in a neccessarily simplified environment where the lucky 10 job holder ( call her #1 ) has 10K , get's taxed say 10% ( makes the sums easier ) and is left with 9K.

    So, the govt has already got 1K back , net outlay now 9 K , and person #1 now has 9K to spend.

    OK, so let's say ( to keep it comprehensible by the human mind) that she just goes out & spends the lot at Joe the Butchers. Call him person #2.

    Now he has an income of 9K, & gets taxed 10% ( that's 900 quid more back to the govt) and is left with 8100 to spend.

    HE goes off to Dave the Plumber's and spends the lot on a new boiler for 8100. ( It's a really good boiler).

    Call Dave person #3.

    So HE now has an income of 8100, which is taxed at 10%, giving the govt another 810 quid, and off he jolly well goes to Edna the Electricians to buy a new flat screen TV with the remaining £7290 ( again, it's a state of the art TV).

    Edna ( you are begining to get the picture )has now an income ( 7290 ) on which SHE is taxed @ 10 % ( 729 more to the govt) and she is left with £6461 to spend, which she promptly does down at George the Gardeners ....

    ReplyDelete
  3. Cynicus -

    This is an explanatory for the 2 part post I just sent in, ( it was apparently too long to be done in one shot).

    The point, to be perfectly clear ( to quote Mr Obama ) is not the perfect accuracy of the scenario suggested but the PRINCIPLE that govt expenditure simply does not seem to behave in the simple / intuitively obvious way that everyday household expenditure does.

    The 'common sense ' economics we all love to write to the Daily Telegraph expounding , learned at our mother's knee, is apparently , then , NOT an accurate model of national spending, and treating it as such ( as we all tend to do , having little hands on experience of running national budgets) leads to naive ( Thatcherian) errors of the 'balance the budget' & 'must stop spending before we go bankrupt' kind.

    The example I worked through shows at least the theoretical possibility of providing incomes totaling 10 X 10000 £ ( do the maths) to such and such an area for a net outlay of ZERO ( yes i said zero) pounds sterling, the initial outlay ALL being retrived via taxation.

    Obviously on a household basis i cannot generate 10 X 10000 worth of income at NO net cost to members of my family by handing over 10000 to my son .... which again goes to the point that govt expenditure cannot be treated analogously to household expenditure no matter how tempting ( easy ?) it may be to try to do so.

    ReplyDelete
  4. To CGC,

    Here's something to read, and then maybe you can rethink your arguments.

    http://fee.org/library/books/economics-in-one-lesson/

    ReplyDelete
  5. Stimulation has been tried but *only* via financial markets, not via the real economy. Governements are in thrall to the financial markets and need to reassert their independence to get out of the trap laid by capital.

    Sovereign governments do not need to borrow. They can stop issuing bonds and let the currency exchange rates take the strain.

    Then you realise that there is no 'debt' to repay and no 'deficit' - only an effect of the exchange rate and an adjustment in import and export costs (primarily oil I would say).

    That is not to say that government can spray money around at will. Inevitably that is inflationary eventually - but only once we reach the full current productive capacity of the country.

    The problem is that the deficit money is being wasted in the public sector and is not obtaining the counter-cyclical value it should be at this point

    My proposal would be to restructure the public sector as much as possible around temporary, casual minimum wage jobs. The opportunity to profit from slave labour should be removed and public sector functions should work at that level of the economy where possible. That way when the private sector recovers people will readily leave the public sector and projects can be mothballed. No more fluffy pillows.

    Then the public sector becomes a buffer for employment downturns. Projects short of people will fill up in the bad times and get done.

    Taxation is then used to calm things down. I would suggest a land value tax, replacing council tax and business rates, and charged to the freeholder. The rate of tax is then set by the Bank of England much as the base rate is. In this way we can control property bubbles without putting up the cost of borrowing for businesses.

    QE failed because it was a financial transaction, not a real one. Government needs to get money to real people that need to buy real resources directly, not via the broken banking system.

    So I see this as a several stage process

    - government needs to stop running scared of 'the markets' and reassert its authority.
    - the public sector should be concerned primarily with providing buffer stock employment at minimum wages - not fluffy pillows.
    - let the exchange rate take the strain - slowly. Everybody else is stuffed as well so flights from currency will always be short lived.
    - governments should stop borrowing money and just 'create' money as required - always remembering that they have to 'delete' it via taxation to control inflation.
    - taxation needs to be equitable and simple. Get rid of the complexity. Tax profits. Levy charges on monopolies (such as land ownership) and other bad stuff.
    - if foreigners want to sell their sterling bonds, then offer to buy them at a set discount to market, using printed cash. Then foreigners daft enough to support Labour's bubble take the hit.

    ReplyDelete
  6. chaingangcharlie,
    Another way of viewing the past 10 years is that it was all one big period of 'borrowing and spending'. The government created all of these 'government jobs' and got the economy going. It did the job of giving one person a job and they spent the money to give another business trade and so on, just as you described. All the time the government was spending more than it raised. This is where it differs to your analysis.
    The last 10 years were the stimulus that many are advocating. It worked, but has just delayed the problem. The fact that we still don't do anything to earn our living is clear. The stimulus just left us living off the stimulus money and now we have to pay it back.

    This did not sneak up on us. Everything is imported and owned by foreign companies. Even the British companies farm out the work and pay taxes abroad. We need an income. All has been left on the shoulders of law and accounting/banking to bring money into the UK.
    I agree that sacking people leads to a downturn and knock-on effect to others that seemed to have viable businesses. But it cannot go on indefinitely. The market has seen it taking us nowhere for 10 years.

    They want their money back.

    ReplyDelete
  7. chaingangcharlie
    I find your analysis fascinating. What bothers me is your bit here:
    'All these various people in Economically Deprived Area X are now busily making each other sandwiches / doing each other's hair / cutting each other's grass / shampooing each other's dogs etc etc ..& paying each other with the SAME 10000 quid ( or remnants thereof ).
    The whole area is now blatantly economically vibrant.'
    Sounds lovely but I feel it's unlikely to be the cosy autopoetic, self-sustaining, community affair you depict. People will still be buying food from Tesco and Asda, drugs from pharmaceutical companies, cheap products from China. That intitial £10,000 would be great if it were really utilised for small sustainable community enterprises.

    ReplyDelete
  8. Anonymous pointed me here :

    http://fee.org/library/books/economics-in-one-lesson/

    ..presumably to give me an elementary lesson in economics. I quote from that piece :

    "for every public job created by the bridge project a private job has been destroyed somewhere else. We can see the men employed on the bridge. We can watch them at work. The employment argument of the government spenders becomes vivid, and probably for most people convincing. But there are other things that we do not see, because, alas, they have never been permitted to come into existence. They are the jobs destroyed by the $1,000,000 taken from the taxpayers. "

    Now, the rather lengthy -though simplified - explanation I gave showed quite clearly why this is just not the case. The govt recoups ( via taxation) pretty well all the 1M 'taken from taxpayers', and the net cost ( in GBP ) is ( or at least ideally can be) actually zero.

    So the 'household budget' outlook on state financing is plainly just not true, no matter how much hard nosed 'realistic' folks might jump up & down & claim it's obvious.

    Now , again from the citation , it says :

    "All that has happened, at best, is that there has been a diversion of jobs because of the project. More bridge builders; fewer automobile workers, radio technicians, clothing workers, farmers."

    Now, this would be true, of course, IF & ONLY IF all those auto workers / radio techs / clothing workers etc etc *were all in full employment before the nasty govt came along & put them to bridge building*. But ( by hypothesis ) they weren't, they were unemployed , and the fact that they weren't employed is of course the very reason for the govt to get them bridge building in the first place !

    The govt has simply taken *otherwise idle* people & out them to some productive use. ( ie rather than have them sitting around watching jeremy kyle all day ), & it does this at essentially NO COST, in so far as ALL the outlay is (by hypothesis , as in my example )eventually recouped via taxation.

    My point is ( again) that it is now i hope obvious ( tho extremely counter-intuitive ) that govt spending *in a time of less than full employment * does NOT take away resources from other ( more worthwhile ?) private projects and does not ( at least does not *neccessarily *, as I have shown ) 'cost the taxpayer* a single penny.

    ReplyDelete
  9. Following on from the 'govt creating pointless jobs' meme ( building bridges
    to nowhere etc etc )...

    It strikes me that a large proportion of the supposedly 'pointful' jobs
    created during the late lamented "boom-by-private-borrowing" years were as
    guily of utter pointlessness as the most ridiculous govt scheme imaginable.

    We all recall those little brochures that used to drop through the post
    about once a week called 'Innovations' or something similar, full of
    supposedly indispensible 'useful gadgets' like nose hair removal tweezers
    for cats, chromium plated executive desk mobiles , magic pyramids with which
    to sharpen our razor blades.... page after page of pretty well entirely
    useless rubbish that someone was hoping to convince the jaded consumer to
    feel she absolutely HAD to buy.

    Think of all the people involved in this mighty private useless job creation
    project .. the advertising whizz kids ... the printers .. the manufacturers
    .. thousands of people spending millions of man hours desperately trying to
    sell rubbish to each other.

    But apparently this kind of thing is a perfectly 'good' waste of human life
    , in that
    it's a *privately organised waste of time & money * rather than the 'bad'
    kind ( building bridges, cleaning up hedgerows, removing graffiti, cleaning
    out drainage ditches etc etc ) that the govt might organise.

    In what way is govt sponsored creation of stupid pointless jobs worse than
    private sector creation of stupid pointless jobs ?

    And as to those who issue dire warnings about 'printing money' & the country
    'going bankrupt' ... well, you only have to look at Japan ( still fighting
    DEflation , still paying zilch on govt bonds ! ) to see that once again the
    'household budget' analogy gets the whole story wrong.

    After all if anyone should be suffering hyperinflation & paying 30% interest
    rates it's the Japanese, assuming the 'household budget / live within your
    means' meme is true.

    Plainly it just isn't.

    ReplyDelete
  10. The Success of Keynesianism 1

    First, a quick point about the different types of Keynesians.

    There are 3 types:

    (1) The post-WWII neoclassical synthesis Keynesians
    A largely American group, who (partly in the environment of McCarthyism) diluted Keynes’ work by joining it with the flawed theory of neoclassical economics. The term “neo-Keynesian” properly refers to them. But there are not many of these Keynesians left. They no longer have any role in government policy. Owing to their flawed neoclassical theory, they could not deal with stagflation, and were discredited in the 1970s.

    (2) New Keynesians
    The New Keynesians are even further from Keynes’ theory than the neoclassical synthesis Keynesians. They are one of the two main schools of mainstream macroeconomics today, but their “Keynesianism” is so watered down that it hardly even deserves that name. They are essentially neoclassicals who believe that fiscal policy might be useful in some circumstances. Some of them are actually skeptical about fiscal policy. Krugman was a New Keynesian, but has become a bit more radical since the 1990s. Obama has some New Keynesians in his administration.

    (3) Post Keynesians, the true heirs to Keynes, who are closest to his work and who have built upon it.
    Post WWII, they were influential in the UK, Canada, continental Europe, and Australia and New Zealand, but went into decline post 1980, as neoclassical economics once again became mainstream economic theory. Post Keynesians generally are NOT guiding government policy today, and in contrast to the New Keynesians they want strict financial regulation, an end to asset price bubbles, and rebuilding of industry. The neo-chartalists or modern monetary theorists (MMT) are a sub-branch of post Keynesian economics.

    ReplyDelete
  11. Some other comments:

    The interesting point about the case of the UK is that they are increasingly faced with little choice but to cut back savagely.

    The present government has chosen austerity because of its flawed macroeconomics. A different government could implement alternative polices and refuse to be bullied by financial markets.

    In particular, the consolidations will force a drop of activity over many economies simultaneously, and with that drop in activity, each country that consolidates will see a major drop in imports, further ratcheting each economy down. This potential systemic shock over many economies risks a collapse in confidence, and therefore a hard economic 'undershoot'.

    Precisely. So why let irrational and self-destructive financial markets determine government policy??

    The chart just shows that there is still a long way to go to achieve a realistic and long term fiscal correction

    How on earth will the severe fiscal austerity you advocate restore growth?

    Having correctly identified that the limited austerity now will lead to global contraction, it follows that even more severe austerity would be much worse.

    Then there is the US …. There is further talk of more fiscal stimuli. The US is getting into ever deeper trouble, all the time relying on the safe haven and reserve status to last to eternity.

    This talk of further US stimulus seems to be mostly hot air. On the contrary the Obama administration may well have joined the global austerity drive.

    The US is in very deep trouble, and the safe haven and reserve currency status are encouraging them deeper into a quagmire.

    Austerity in Europe leading to a drop in US exports has nothing to do with the “safe haven” status of the US dollar.
    Greater QE in the EU could provide freedom for more simulative budget deficits.

    In the world of the (neo-) Keynesians, the answer is not to consolidate, but to continue government borrowing, to prevent a choking of 'recovery'. No doubt, in the future, as the inevitable consequences of the consolidation take place, they will blame the problem on the fiscal consolidation, rather than on the fiscal splurge and consumer debt splurge that preceded it. This despite the fact that this borrowing and spending was supporting an economic structure that could not be sustained

    The neo-Keynesians you refer to are essentially mainstream neoclassical economists who suddenly “discovered” Keynesian stimulus in the worst months of the global downturn.

    These economists in the Obama administration initially experimented with Keynesian stimulus but then utterly failed to address the 2 underlying problems in the US as below:

    1. bubbles due to an poorly regulated financial system and
    2. loss of manufacturing due to poor trade policies.

    You ignore the Post Keynesians, the real school of macroeconomics closest to Keynes’ vision, who have advocated regulating the financial system to stop bubbles and rebuilding manufacturing.

    Your objections have no force against Post Keynesians.

    No doubt, in the future, as the inevitable consequences of the consolidation take place, they will blame the problem on the fiscal consolidation

    And they will be entirely correct.

    If the fiscal stimulus runs out of steam, have another one, and another one, and another one. If it is not working, a larger one will do the trick. If the larger one does not do the trick, then there is an even larger one that might be do the trick. In nobody will lend, print money. If that does not work, just print more.

    I assume this is mainly meant to be rhetoric?
    If not, which countries have tried 6 stimulus packages that failed? Answer: none.
    Have any countries tried 5, 4, or 3 stimulus packages that failed? Answer: none.
    In fact, have any countries even tried 2 stimulus packages yet??

    ReplyDelete
  12. Comments 2

    In the world of the (neo-) Keynesians, the answer is not to consolidate, but to continue government borrowing, to prevent a choking of 'recovery' …. Their solutions have just been tried, and the result is what we see before us. Massive fiscal stimuli have been tried. Quantitative easing (printing money) to fund government debt has been tried. Despite this, the economic crisis just keeps coming back.

    What do we see before us?

    First: the tremendous success of Keynesian stimulus in China and Australia.
    To repeat a previous post:

    In the face of a massive collapse in their export-led growth economy, what did China do?

    They implemented a massive $586 billion dollar Keynesian stimulus – and then got a very impressive recovery, so impressive in fact that with growth in the first quarter of 2010 at 11.9%, there is talk that they may need to cool down the economy.

    Does that sound like a “failure”?

    Australia also implemented a large Keynesian fiscal stimulus, which worked very well, and it benefited from China's stimulus as well.

    Conclusion? Countries that are close trade partners benefit tremendously from Keynesian stimulus in both countries.

    Your failure to even address this point severely undermines your whole argument.

    Secondly, the Western countries have returned to mild growth and are not contracting: this is proof of the success of fiscal policy (you are mistaken to say that Keynesian stimulus can never be proved “wrong”: if we got a major depression and negative growth in the face of large fiscal stimulus, then this WOULD demonstrate that something is wrong with the Keynesian theory).

    Thirdly, in 2008 and 2009 there was serious concern the world was sliding into a depression on the scale of the 1930s, and the data compiled by Barry Eichengreen and Kevin H. O’Rourke at the Tale of two Depressions website strongly support this view. And their data strongly support the view that fiscal stimulus PREVENTED another great depression. In no sense can the fiscal stimulus be judged a failure in this respect either.

    Fourthly, the “economic crisis” in the sense of severe recession has not yet returned. It will return in the face of austerity. But that just reinforces the success of fiscal policy.

    What has occurred is financial market instability and some sovereign debt crisis in Europe, which is the result of the irrational and dangerous financial markets, and the ridiculous monetary and fiscal conservatism of the EU.

    ReplyDelete
  13. Addendum:

    It's far better to refer to the "New Keynesians" rather than "neo-Keynesians" if you are referring to the economists now influencing US policy under Obama.
    And also note that the Post Keynesians have quite different views from the neoclassical "New Keynesians" (who hardly even deserve that name).

    ReplyDelete
  14. Chain Gang Charlie: All looks very neat doesn't it - What you are describing is like a perpetual motion machine. But who is paying for the materials and energy consumed to create transaction? I think that you will find your model falls over when you consider this.....

    Sorry for such a short reply...

    ReplyDelete
  15. Jonpaul said...

    "" chaingangcharlie,
    Another way of viewing the past 10 years is that it was all one big period of 'borrowing and spending'. The government created all of these 'government jobs' and got the economy going. It did the job of giving one person a job and they spent the money to give another business trade and so on, just as you described. All the time the government was spending more than it raised. This is where it differs to your analysis. ""

    Well, sure I agree that in actual fact the govt won't get all it's 10 K back ( in my hypothetical ), because some people won't be taxed at all ( income too low, etc etc ). But the point was just that I have finally convinced myself that govt money ( ok taxpayer's money ) spent creating jobs is much more productive than appears at first 'household budget' sight, because at least most of it will eventually be recouped via taxation & the money does ';do the rounds' & gets spent multiple times over. Another point annemari raised above was that if this money is spent at Tesco's ( or whatever multinational uber-conglomerate ) a proportion then 'leaves ' the local economy... I can't argue with that either.

    Nevertheless my example ( somewhere above) does I think show that govt spending undeniably CAN very positively affect local ( national ) economies , despite the tendency to call these jobs 'make work' & treat them as somehow crap, 'phoney' jobs.

    In yet another post above I pointed out that an awful lot of 'real' jobs created over the past N years have also been pretty 'crap '... recall my allusion to the highly amusing 'Innovations' advertising brochure with it's vast collection of useless junk carefully packaged to tempt the ( ahem) discerning shopper. !

    So the govt doesn't have a monopoly on the creation of dumb jobs.

    Examples given above by various people about the apparent success of the vast Chinese Stimulus go further to the point.

    Conclusion : Govt spending obviously has it's uses, and the questions would then have to be about HOW MUCH , WHEN and ON EXACTLY WHAT , rather than pointlessly debate about what I think I now regard as the settled question of principle.

    There seems to be pretty universal agreement that our old friend Gordon Brown went somewhat hog wild with public spending *during the good times* ( in the apparent belief that bad times had been permanently abolished by [ahem] enormously intelligent markets ), leaving the country's debt situation looking a bit mountainous when the time finally came when we really did need it.

    The histories I read of countries going whole hog the 'austerity' route ( cf Argentina ) are very much not encouraging.
    The IMF seems welded to the idea that a bit of belt tightening works wonders when in fact it seems to me to have generally pushed the victim ... sorry , ' beneficiary' ... country in the direction of real social collapse.

    For eg yet MORE austerity for Spain ( already in the middle of a massive downturn) looks positively lunatic.

    ReplyDelete
  16. CynicusEconomicus said...

    " Chain Gang Charlie: All looks very neat doesn't it - What you are describing is like a perpetual motion machine. But who is paying for the materials and energy consumed to create transaction? I think that you will find your model falls over when you consider this....."

    Cynicus : (Bearing in mind that I am posting these things more to help clarify my own thoughts than to persuade anyone else of anything ) ...

    OK, you ask where do the materials / energy used in the transactions I describe come from ?
    Let us ignore my somewhat nebulous initial 'govt worker' ( as I never specified what s/he was actually working at ) and follow the progress of her 9K spending as it works through the economy, bearing in mind your question.

    In fact, the answer is pretty obvious - the materials / energy used in every transaction AFTER she has spent her surplus 9K at the lucky butcher's shop is that these inputs come in exactly the same way they do were her 9K the product of any ( doubtless entirely praiseworthy ) private sector job.

    In fact no-one 'post' the #1 (ie govt ) worker in my example works for the govt. So wherever those inputs come from they come in the same magical way they do for any private sector enterprise.

    AFTER individual #1 spends his / her govt cheque, the economic process is identical to any private sector process.

    So your question only makes sense in the context of where does the energy / materials used BY OUR NOBLE GOVT WORKER HERSELF come from ?

    WEll, without imagining a specific govt warranted task for her to be busy at, we can at least say that she will require to be kept warm & be provided with heat & light while working.

    But then, if she were sitting at home on the dole she would need these things anyway. ( Unless we propose putting her to death ;-? ).

    So no additional energy inputs there.

    Otherwise we can suppose she is at least involved in some task that has SOME benefit to society ( remember that word ? :-) say picking up litter, which involves expenditure on a sharp stick & a bag in which to put said debris.

    Nothing neccessarily too outrageously expensive then.

    ( We are not proposing she be given a particle accelerator to play with for eg)

    In fact I can think of any number of definitely USEFUL tasks the public sector could be involved in ( graffiti removal, bag carrying at train stations , helping old ladies across the road, planting vegetables on idle land...) all of which seem to me more socially worthy than ( for eg ) creating & advertising & selling & disposing of chromium plated executive toys ( for the man who literally already has everything and for whom we now need to invent 'wants' because ... well he's kinda jaded already ) .

    I do agree with a poster above who suggested that these govt jobs we are busy imagining should be not fantastically well paid, but should provide a 'marginally better than social security' level of economic well being. I realise that with child benefits / tax credits etc etc we get ourselves stuck in poverty traps...

    Anyway , to your original question re energy inputs , either I missed something or I don't see the problem . Can you explain what you meant in a bit more detail ?

    ReplyDelete
  17. cynicus says :

    "The US is in very deep trouble, and the safe haven and reserve currency status are encouraging them deeper into a quagmire."

    You mean that the proud owners of the world's largest ever record shattering debt mountain are in trouble BECAUSE PEOPLE ARE TOO KEEN TO LEND THEM THEIR OWN MONEY BACK ???

    Wickedly & foolishly encouraging them to *carry on borrowing even more* when they should be slashing public expenditure , wearing hair shirts and generally flagellating themselves ?

    But the 'debtor's will revolt' theory says that THIS SHOULD NOT BE HAPPENING !! Treasury interest rates ( by this theory ) should be through the roof! And yet the ( foolish ? misguided? ) bond buyers just keep on buying !! Are they mad ?? Don't they read this blog ??? !! :-)

    The fact that the US still finds it easy to sell it's debt shows that the 'US will go bankrupt!" theme ( hello Peter Schiff ...) is simply wrong.

    The US *cannot* go bankrupt - at least not on debt denominated in dollars.

    No more can the UK, at least in debt denominated in GBP.

    Spain / Greece Latvia etc have problems because their debt is effectively denominated in a currency ( the euro) which they cannot unilaterally create.

    As someone who used to think "well, the euro looks like a good idea I suppose" I am thankful no-one listened to me when joining the damn thing was on the table :-)

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  18. Further Point about Budget Deficits

    Just because a country runs a budget deficit, it does not necessarily mean that the deficit is actually stimulating further growth in the economy.

    Here is a great post on the breakdown of the US budget deficits:

    Despite all the conservative uproar against Obama’s stimulus plan, the largest portion of the increase in the deficit has come from automatic stabilizers and not from discretionary spending …. Decreasing taxes coupled with increased transfer payments have automatically pushed the budget into a larger deficit, notwithstanding the flat consumption expenditures… These automatic stabilizers and not the bailouts or much-belated and smaller-than-needed stimulus are the reason why the economy hasn’t been in a freefall รก la the Great Depression. As the economy slowed down, the budget automatically went into a deficit putting a floor on aggregate demand.

    http://neweconomicperspectives.blogspot.com/2010/02/what-caused-budget-deficit-not-what-you.html.

    So with falling tax revenue, and rising unemployment, the government deficit automatically rises because of transfer payments (“automatic stabilizers”).

    These automatic stabilizers do not necessarily stimulate the economy back into strong growth at all, but prevent further collapses in demand and hence GDP. In other words, automatic stabilizers place a floor below which GDP cannot fall – and this is a very good thing indeed.

    To genuinely stimulate the economy back to stronger growth you need much larger discretionary spending and bigger fiscal stimulus.

    But even this needs to take account of the highly contractionary effects of local and state government budget cuts – therefore to calculate the genuine stimulative effects of a budget deficit you need to look at these factors:

    (1) how much is just automatic stabilizers,
    (2) how much is discretionary spending and
    (3) to what extent is the additional discretionary spending (2) offset by local/state austerity.

    To judge the success of Keynesian stimulus, you have to take these factors into account.

    And it is also obvious that - without discretionary spending - some budget deficits are not really stimulating higher growth, but just preventing further collapses in GDP.

    ReplyDelete
  19. South Korea: Another Keynesian Success Story

    In 2008, South Korea was quick to pass a 14 trillion won stimulus package in November 2008:

    Bettina Wassener, South Korea announces 14 trillion won stimulus Monday, November 3, 2008

    It then returned to economic growth after a brief contraction in 2009:

    http://www.tradingeconomics.com/Economics/GDP-Growth.aspx?Symbol=KRW

    And its economic recovery has been impressive:

    South Korea's economic stimulus expenditure is expected to drop by the widest margin among the Group of 20 (G20) countries thanks to the rapid pace of economic recovery …. In 2009, Seoul spent 3.6 percent of its GDP on economic stimulus measures, including the 28.4 trillion won (US$23 billion) supplementary budget approved in April. South Korea's economy grew 2.1 percent on-quarter in the first three months of this year, while surging 8.1 percent on-year. The Organization for Economic Cooperation and Development predicted last month that the country's economy may expand 5.8 percent this year from a gain of 0.2 percent in 2009. The 3.6 percentage point drop is the largest among the G20 large industrialized and emerging economies, and is lower than the average 1.9 percent of the GDP that the IMF predicted will be used by all member countries to sustain growth in 2010.

    http://english.yonhapnews.co.kr/business/2010/06/07/8/0502000000AEN20100607001600320F.HTML

    Yet another blow to the "Keynesianism" doesn't work school of economics.

    ReplyDelete
  20. Canada: Yet More Proof of Keynesian Success

    Canada unveiled a 40 billion Canadian dollar ($32bn, £23bn) stimulus in January 2009:

    http://news.bbc.co.uk/2/hi/americas/7855311.stm

    Growth returned in late 2009 and continues:

    http://www.tradingeconomics.com/Economics/GDP-Growth.aspx?Symbol=CAD

    Because of their effective financial regulation, there were also largely untouched by the financial crisis.

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  21. Lord Keynes,

    What you don't seem to understand is that Keynesian policies of spending money that is borrowed and printed is always a success till it suddenly collapses in failure when the money runs out and is devalued via hyperinflation when those left holding some will immediately exchange it for something of greater value.

    Spending money is easy, any fool can do it, but creating wealth to save and repay debt is what Keynesian policy goes against and is the challenge.

    ReplyDelete
  22. The thing is Cynicus and other cuts hawks - that your argument of public sector jobs taking money out of the private economy make absolutely no sense to me at all. It just doesn't work that way.

    And also - today Will Hutton wrote a piece in the Gruaniad that claimed that only three percent of bank lending over the last ten years was to manufacturing. Three quarters of it was to real estate - commercial and private. Shocking figures that show that it was the private sector that failed to provide jobs and it did so because of a lack of investment by the finance industry - which is also a part of the private sector. The private sector is not creating the jobs we need so the public sector took up the slack - it didn't occur the other way around. And if we are going to cut the public sector why does anyone think the private sector will suddenly grow - when it hasn't done for a long time - or not anywhere near enough?

    A week ago I had a long chat with a very clever economist chap (who writes degree level text books etc) he told me he believes that this austerity drive may see the collapse of the Euro and if that happens 'all bets are off' - the thirties will look like a walk in the park.

    This chat coupled with the underlying data coming out of the US - the money supply situation, employment etc and the situation in Europe leads me to believe we are about to make a huge mistake - just as we did in the thirties. We are speeding towards a second dip but to call it a recession is a joke it is going to be a full blown depression.

    SuzySmith

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  23. Reply to George

    Keynesian policies of spending money that is borrowed and printed is always a success till it suddenly collapses in failure when the money runs out

    There is a strange contradiction in your argument. If a country was monetizing its budegt deficit in whole or in part, then it has the central bank create the money from nothing.
    How can it run out of money?
    The US used Keynesian stimulus in 1930s and then monetized massive budget deficits in the 1940s to fight WWII. Has it ever had hyperinflation? Just this one counterexample shows you are wrong.

    .... and is devalued via hyperinflation when those left holding some will immediately exchange it for something of greater value.

    You seriously believe that EVERY country that has ever tried Keynesian stimulus just ends up causing hyperinflation? This is utterly false – it is rather difficult even to take this argument seriously.

    Australia, New Zealand, Sweden, France, and a ton of other countries have been using Keynesianism since the 1930s. Have any of them ever had hyperinflation or economic collapse? Nope.

    In your opinion, what percentage of countries using Keynesianism in normal circumstances (and not after cripping wars/reparations or output shocks, where even Keynesian economists would reject stimulus as a bad idea) have ended in hyperinflation? 20%? 10%? 5%? 1%?
    Care to give me any actual example and back your statement up with empirical evidence?

    ReplyDelete
  24. Sweden: Keynesianism Works Again

    Sweden implemented a large Keynesian stimulus in 2008 and 2009:

    Sweden ... outlined a 8.3 billion Swedish kronor ($1 billion) fiscal stimulus package for 2009, to complement earlier spending plans, in a measure aimed at further propping up the country's teetering economy in the face of a sharp global economic slowdown .... Friday's package will complement the SEK32 billion already laid out in September in the government's 2009 budget proposal .... That means Sweden's plan, including the stabilizers, comes close to 3% of GDP, which will be the biggest in Europe as percentage of total GDP

    http://news.alibaba.com/article/detail/europe/100028044-1-update%253A-sweden-adds-%25241-billion.html

    The result?
    Sweden returned to good growth in 2009:

    http://www.tradingeconomics.com/Economics/GDP-Growth.aspx?Symbol=SEK.

    Not a sign of bond market crisis there either.
    The only danger is ridiculous austerity through Europe to derail their recovery.

    ReplyDelete
  25. New Zealand: Keynesian Works Yet Again - for some reason...

    The New Zealand government [February 2009] announced Wednesday a 500-million-New-Zealand-dollar (about 260 million US dollars) stimulus package for the economy, which has been in recession for a year.

    http://www.monstersandcritics.com/news/business/news/article_1458746.php/New_Zealand_government_announces_stimulus_package

    The result? Return to growth in 2009:

    http://www.tradingeconomics.com/Economics/GDP-Growth.aspx?Symbol=NZD

    I am getting the feeling there will be many more examples too...

    ReplyDelete
  26. Well I am damned if I know the answer to the questions being asked, not that I really understand the questions either, however, its all so thought provoking.

    Having followed and ridden the roller-coaster ride we are all on I find the arguments/solutions proposed so intertwined and yet I cannot help but think the solutions do not need to be so complicated.

    The depth of analysis by some whom have posted comments does nothing but murky the waters further. Its a lesson on how to make a fairly simple process as complicated as possible.

    In simple terms, we elect a government to act on our behalf (that is after all democracy, isn't it?), they (the government) choose the course and the plan of action with the mandate of the people. The outcome (historical data indicates) they/we spend far more than our income, net result, debt, of increasing amounts. In a boom/bust cycle (seem to recall that was something consigned to the dustbin)

    The solution is easy, pay down the debt, however, a fly in the ointment, we in the West are like drug addicts. We need our consumerism, we need to spend, we can no longer live within our means, we are on a feeding frenzy. We associate success with an accumulation of possessions an ability to do what we want when we want. But like a drug addict we must be weaned off our drug. With each and every solution there will be some sort of collapse in social cohesion (that is assuming in our current state we have much left), but only at that point can social cohesion be re-established.

    But what do I know, I am just a bloke on the street.....who has a very limited understanding and perspective, perhaps not to dissimilar to the bull in a china shop idiom.

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  27. @SuzySmith

    We are not "speeding towards a double dip" or a "depression" because we never actually left the recession in the first place. The sleight of hand that suggests we did is smoke and mirrors - and not particularly clever smoke and mirrors at that. The mess we are in is the mess we are in. Delivered by crazy Keynesian policies by a lunatic left-wing government. The repair will be long and hard - but absolutely necessary.

    @chaingangcharlie
    You are confusing "money" and "wealth". If a village has only enough food for one person then you can pay all the public sector workers in the village a million pounds each if you like and they are still mostly going to starve. Meanwhile, the value of that single meal skyrockets with each new coin introduced into the market.

    @Lord Keynes
    -sigh- Meanwhile, in the real world, if you borrow more than you can afford you go bankrupt. Simplistic? Yes. True, nonetheless.

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  28. Lord Keynes, I like this blog.

    It is one thing to make your point, it is another to troll. Can you take your foot off the pedal a bit?

    ReplyDelete
  29. One CE's arguments is that GDP is not a good measure of a country's sustainable production. The economic 'activity' generated by the stimulus and debt is merely a transient effect caused by an injection of cash.

    ReplyDelete
  30. Lord Keynes,

    You accept that hyper-inflation is a phenomenon which can occur, but you also deny that it can happen here, therefore please define at what level of money creation or other measured reason you believe hyper-inflation can occur. Also, what do you think was the difference between the US in the 30's and Zimbabwe or Weimar Germany?

    Our monetary system since the full abolition of the gold standard in 1971 is a pyramid scheme dependent on ever more growing debt (money creation), but the difference now versus hystory is that we are maxed out and cannot afford to borrow any more, yet alone pay it back, that we have started printing it. ie. government QE printing bailouts to capitalise the banks, so that via fractional reserve banking the banks can lend back to the government multiples more via treasury bond/gilts purchases.

    My point is that spending money that you don't have is always a success till you cannot borrow any more (or it won't be lent to you cheaply), and printing it has its limits before a sudden collapse in its value and confidence (ie hyper-inflation).

    ReplyDelete
  31. Steve Tierney said...
    "You are confusing "money" and "wealth". If a village has only enough food for one person then you can pay all the public sector workers in the village a million pounds each if you like and they are still mostly going to starve. Meanwhile, the value of that single meal skyrockets with each new coin introduced into the market."

    OK let's see what we can do with your village that has only enough food for one person.

    Can we assume that they can borrow some money from the next village to buy some seeds & agricultural tools so that they can be assured of having food for all say, come autumn ?

    Or would you suggest that because they would have to pay interest on the borrowings this amounts to them having to pay back more than they borrowed & that this will put them further into debt, & that this is bad & that therefore they should all dutifully starve in the name of financial rectitude ?

    Or I might ask, why are they all starving ?
    Perhaps because they were convinced that they could live on the asset price appreciation of their mud huts, and that nasty dirty farming work was thus unneccessary ?

    Then in that case shouldn't we be really daring and bribe them by any means neccessary to get out in the rain to start planting & hoeing & ... digging & such ?
    Isn't that their only hope of not starving next year too ?

    But how are we going to bribe them ?
    ( Pause for thought ...)
    O I know !
    How about we print up a pile of counterfeit money & pay them with that ?
    "NO NO!" says the vicar.
    "That will devalue the coin of realm! Better we all starve !"

    ( to be continued...)








    ...

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  32. [continued ...]

    [Some time passes. Within 9 months the fields are ripe with golden corn and everyone except the vicar is happy]

    Hey we just saved 243 lives by creating some monopoly money .

    Not only that, but the injection of that 1 million of 'fake' 'monopoly' money created a *real* economic boom in the village!

    Those not planting are running pubs, cooking in restaurants, doing up each other's hovels... ( rumour has it that some of the more enterprising - & good looking - young ladies even set up 'one of those places' & became very wealthy ... in mere monopoly money , of course ) but...but one of their number ... & it was of course the vicar ... decided to put a stop to this counterfiet money madness & founded the first bank in the village , to bring in a regime of SOUND MONEY & FISCAL RECTITUDE, where no money could be created by any tom dick or harry , it had to be created by HIM , & then merely borrowed , from him , at a very very reasonable rate of a mere 25%.

    Luckily I see in my mind's eye that the fat & happy villagers had the good sense to string him up from the classically inspired ionic portico of his very own bank before he caused any more trouble.

    Sadly in the next village something similar happened, but there, sad to relate, the vicar was successful & because he wouldn't lend to any of his parishioners , preferring the value at risk profile of US treasuries, he leant all his newly made money to the US govt at 4.5% and that is why there is no longer a village there, just a few cheap tombstones.

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  33. Reply to George 2

    You accept that hyper-inflation is a phenomenon which can occur, but you also deny that it can happen here

    I don’t deny that hyperinflation could in principle happen to a Western country. I argue that it is extremely unlikely in absence of severe output/supply shocks or abnormal circumstances like wars or trade embargoes or sanctions.

    therefore please define at what level of money creation or other measured reason you believe hyper-inflation can occur.

    Such a “definition” would be a pointless, because different economies have different resources, output levels, capacity utilization, and external balances.

    The level of money creation for one country will depend entirely on its particular available resources, capacity utilization, unemployment and external balance.

    Also, what do you think was the difference between the US in the 30's and Zimbabwe or Weimar Germany?

    A very big difference: unlike Zimbabwe the US in the 1930s was not suffering a suffering from a severe output shock and contraction caused by expropriating productive resources from their previous owners and handing them over to new owners who weren’t competent to manage them. Also, the Zimbabwe suffered severe droughts in 2002-2003 and again in 2007, and then a catastrophic flood in 2008 that devastated agricultural production. Output collapsed in response to these shocks. It also had its economy crippled by Western sanctions. In the face of all this, monetizing budget deficits was catastrophic and should not have been done and was undoubtedly the cause of the hyperinflation. See here:

    Zimbabwe for hyperventilators 101

    As for Weimar Germany, it had come out of WWI with severe output shocks, loss of productive capacity and then the crippling post-war reparations.
    I assume you can see the difference?

    Our monetary system since the full abolition of the gold standard in 1971 is a pyramid scheme dependent on ever more growing debt (money creation)

    The Bretton woods system (1945-1971) allowed the conversion of US dollars held by surplus countries into gold at the Fed – if they chose to do so. It didn’t significantly reduce the capacity of every country on earth to expand their money supply.

    It wasn’t remotely like the Classical gold standard or even the gold exchange standard of the 1920s.

    After 1971, we got the deregulation of financial markets, capital account liberalization and neoliberalism/neoclassical economics. This was the cause of explosion of private debt.

    My point is that spending money that you don't have is always a success till you cannot borrow any more (or it won't be lent to you cheaply), and printing it has its limits before a sudden collapse in its value and confidence

    You forget that fixing your basic macroeconomic problems will allow Keynesian stimulus to restore growth. Once that happens you no longer need stimulus and the public debt falls.

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  34. Reply to Ian

    The economic 'activity' generated by the stimulus and debt is merely a transient effect caused by an injection of cash.

    You seriously believe that stimulus does not produce real public goods like roads, schools, infrastucture or R&D?

    For example, you think that a badly needed new road or transport system does not enhanceeconomic activity and increase business and trade?

    That the effect of a stimulus is “transient” is an utterly trivial point. Of course it is.
    The whole point is to temporarily stimulate the economy back into growth, so that demand for private goods will be restored and private business confidence and output will rise - which creates a self-sustaining economic expansion.

    Unfortunately, many countries have broken financial systems and need to introduce financial regulation, and use trade and industrial policy to restore good growth.

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  35. Reply to Steve Tierney

    We are not "speeding towards a double dip" or a "depression" because we never actually left the recession in the first place.

    Plenty of countries got out of recession, mate. Take a look at my posts above: New Zealand, Canada, China, France.
    Australia never even had a recession in the techinical sense because of an early and large stimulus.

    The mess we are in is the mess we are in. Delivered by crazy Keynesian policies by a lunatic left-wing government.

    This is fairly amusing. You think the financial crisis of 2008 was caused by Keynesianism?

    Lord Keynes
    -sigh- Meanwhile, in the real world, if you borrow more than you can afford you go bankrupt.


    In the real world, the government controls monetary policy. Its debt isn’t even remotely like private debt. An entity that has the power to create money cannot go bankrupt.
    It can certainly use too many real resources, cause inflation in boom times, increase the external deficit unsustainably, or stupidly borrow money from private markets when it has no need to.

    But these are separate issues.

    ReplyDelete
  36. Sometimes when I feel low
    and things look blue
    I wish a boy I had... say one like you.
    Someone within my heart to build a throne
    Someone who'd never part, to call my own

    If you were the only girl in the world
    and I were the only boy
    Nothing else would matter in the world today
    We could go on loving in the same old way

    A garden of Eden just made for two
    With nothing to mar our joy
    I would say such wonderful things to you
    There would be such wonderful things to do

    If you were the only girl in the world
    and I were the only boy.

    Written in 1916 by Clifford Grey (music) and Nat D. Ayer (lyrics), it was the perfect antidote to the mayhem and horrors prevalent of the time

    Keynes detractors could easily argue it was the inspiration for Keynes thinking.

    It wasn’t of course and I don’t mean it to be critical nor to undermine the intention of policy that was appropriate for the time.

    I’ve merely reproduced it to highlight the fact that the UK and the £ are not the only couple in the world and despite the many examples and torturous references to other equally complex argument, the whole world will not dance to the one song.

    Reasoned arguments have brought us to this moment in time, eloquently articulated in the comments section of this blog. The sad reality is that reasoned argument is only appropriate if the parties involved are reasonable, something that reasonable people fail to see time after time.

    Daily examples of head burying in sand moments are clear to see, with the regular cry ‘if the Bankers were able to be bailed out surely I’m a special case’ ringing out, leading to the obvious conclusion that surely we must all be special and thereby planting the seeds of its ultimate failure as the policy is not equipped to deal with so many special people.

    Intellectuals and indeed intellectualising has been offered as the cause of many a problem by many a populist leader during many a popular revolt and who’s to say they’re not wrong. Certainly nobody after the revolution, that’s for sure.

    Bite the bullet, figuratively speaking and let the pain run through the veins of the man in the street so he can learn his proper place in the world’s pecking order, at least then he and she of course, as poverty isn’t a respecter of gender, will be able to begin to rebuild their lives, just like they do after every catastrophic event.

    The $1 a day worker is your competition not your enemy, let’s try not to have a war over it this time.


    Dave O’Carroll Romford

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  37. A great Post from Steve Keen

    Many countries still need massive deleveraging of private debt (or massive debt cancellation) but this can only happen with large fiscal stimulus without causing catastrophe:

    http://www.debtdeflation.com/blogs/

    ReplyDelete
  38. Well color me confused.

    What goes on in my Joe Six Pack economic mind:

    -Can’t have too much austerity as the tax base will be eroded & social disorder will ensue.
    - Can’t just borrow & print as taxis will increase/value of the monies will decrease.
    - Can’t just consume thinking consumption creates value.
    -Can’t just expect a job for x monies when somebody else will do same job for 10% x monies.
    -Can’t expect the Guvment to take care of me.
    -Can’t steal the value component of somebody else’s labor & not expect resentment.
    -Can’t expect others to not aspire to my standard of living.
    - Can’t expect my globalization cake & expect to eat it too.
    - Can’t have monies that are not backed by energy (oil).
    - Can’t have the oil unless backed by force.

    JSP.

    ReplyDelete
  39. Lord Keynes,

    At last we have some vague definitions from you as to what you believe can cause hyper-inflation, but you avoid to quantify them at least in percentage terms to cover different economies. This is not good enough, just as you previously have failed to answer just how much money printing or monetisation of deficits as a percentage of some economic measure, you believe is the limit before money becomes worthless (hyper-inflation). Please don't be vague, but put some measure to your argument.

    You state New Zealand, Canada, Sweden, South Korea, France as having Keynesian success, but I bet their national debt increased in order to do this, just as any bankrupt lives the high life in relative to their income status, till he very suddenly becomes bankrupt.

    ReplyDelete
  40. According to Wikipedia, economics is the social science that studies the production, distribution, and consumption of goods and services. Most of what is happening now can be shown to be a replay of similar events in the past, as clearly demonstrated by Lord Keynes’s copious references. However, there is an unprecedented social change brewing across the US which could have an enormous impact on the course of the banking crisis.

    I am referring to homeowners in serious negative equity that 'Strategically Default’ on their mortgages. Even well-healed professionals who can afford their mortgage payments are opting to cease payments.

    Prior to the 1950’s, there was a strong social stigma about being in any kind of debt, and even personal mortgages were rare. Personal loans were unheard of. And an even greater stigma was not paying a debt if you had one.

    The first stigma of being in any kind of debt has now been erased from the public psyche and this has worked to the advantage of the Banks who have offered almost unfettered easy credit to anyone with a pulse. The greater stigma of not paying a debt if you had one is now evaporating, as shown by strategic defaulting in the US. This is a social change which has not been considered by bankers and economists. This change will work against the Banks. More property is being foreclosed and the liabilities of the banks increasing.

    Does Keynesian Economic theory embrace this new social phenomenon?

    ReplyDelete
  41. Lord Keynes

    Over the last few years, ordinary people in the UK have appeared to make more money from owning houses than doing their actual jobs. And they've spent against it too. Road sweepers have holidayed in the Bahamas and hairdressers have bought speedboats and sports cars. They invariably have granite countertops in their kitchens and huge TVs in most rooms in the house, all paid for with borrowed money. At the same time, our industry and technology has been 'off-shored', and a generation or two of children educated to work in 'services'. And all the while, the government has been borrowing and spending like mad, too.

    What I want to know is whether you think there is a price to be paid for all that. You seem to be suggesting that although the country has huge public and private debts, it can just carry on stimulating with borrowed or printed money until growth resumes, and then it's business as usual. Your Keynsianism cannot allow for *any* reduction in spending as far as I can tell, until self-sustaining growth has taken hold, so therefore you do not envisage the average Briton paying any price whatsoever for the last decade or two; growth will swallow his debts. Do I understand you correctly?

    Isn't this just a version of the old gambler's notion of betting with higher and higher stakes until you eventually 'must' win and cover your previous losses?

    ReplyDelete
  42. OK folks, here's a case study in the real world effects of fiscal deficit reduction, featuring the darling boy of fiscally proper behaviour, Ireland :

    "In 2009 in Ireland, the year that steep cuts began, the deficit was about 12 percent of GDP. In 2010, with previous cuts now implemented and new ones added, the deficit was, er, about 12 percent of GDP. In 2011, with 2 years of cuts to build on and more to come, the deficit is projected to be, drum roll please, 10 percent of GDP.

    So what’s going on? First, some of the fiscal effort has gone in preventing even worse outcomes if no cuts had been made. That’s how bad the cratering of the Irish public finances is. But another conclusion is inescapable: the cuts themselves have been contractionary and have made deficit reduction harder to achieve, both in terms of higher unemployment benefits and lower tax revenues. "

    http://fistfulofeuros.net/afoe/economics-country-briefings/fiscal-austerity-the-cases-of-ireland-and-spain/

    To repeat :
    " the cuts themselves have been contractionary and **have made deficit reduction harder to achieve** "

    Whatever the superficial appeal of the cut cut & cut again school of thought, isn't this yet further evidence that thinking of your national economy as some kind of analog of your household budget simply doesn't work ?

    ReplyDelete
  43. Reply to George 3

    At last we have some vague definitions from you as to what you believe can cause hyper-inflation

    They are hardly vague definitions – they are quite specific. When severe output/supply shocks happen, then you don’t stimulate the economy. Simpel as that.
    Instead, some kind of demand contraction is required (e.g., a budget surplus, tax increase, or in very extreme cases such as when the US or UK were fighting WWII, rationing and wage and price controls).

    you avoid to quantify them at least in percentage terms to cover different economies. This is not good enough, just as you previously have failed to answer just how much money printing or monetisation of deficits as a percentage of some economic measure, you believe is the limit before money becomes worthless (hyper-inflation).

    Giving percentage figures is utterly pointless, as I said, because different economies in different times have different resources, output levels, capacity utilization, and external balances.
    I can’t calculate these figures for the UK in 2 or 3 years time. No one can with certainty.

    You state New Zealand, Canada, Sweden, South Korea, France as having Keynesian success, but I bet their national debt increased in order to do this

    Of course their national debt increased! Who denied that it would not?
    However, the government debt is utterly different from private debt, so your “bankrupt living the high life” analogy completely fails.

    ReplyDelete
  44. Reply to Anonymous

    Does Keynesian Economic theory embrace this new social phenomenon?

    Post Keynesian economists would argue that the private sector needs massive deleveraging. This can be helped by writing off much bad debt or restucturing it (bailing out depositers in comemrcial banks, however).
    Then effective financial regulation and tighter credit standards, as well as fixing the trade imbalances in the world and using some kind of industrial policy to rebuild manufacturing. This will have to be done with large budget deficits to prevent deleveraging causing a depression.

    ReplyDelete
  45. Reply to Lemming

    See my response to Anonymous above.

    ReplyDelete
  46. Reply To George 4

    For excellent analysis of hyperinflation, see here:

    http://www.newdeal20.org/wp-content/uploads/2010/03/rch_0609.pdf

    (p. 3 following)


    http://neweconomicperspectives.blogspot.com/2010/03/hyperinflation-hyperventalists.html

    ReplyDelete
  47. A great new post from Steve Keen on private and the Great Depression and in the current crisis:

    http://www.debtdeflation.com/blogs/.

    ReplyDelete
  48. Lord Keynes,

    There is nothing specific in just mentioning words such as output and supply, whilst giving figures in percentage terms instead of absolute values is all about allowing for different economies. Avoiding to give figures is bad enough, but you cannot even specify the measurement ratios that one should be monitoring for limit danger levels in Keynesian spend/borrow/print policies.

    I am glad that you have specified that your definition of success is actually getting into bigger debt, and your argument that countries are different because they can print more money is so blatantly wrong because it just makes it worthless as history has proven with failed fiat currencies. Remember, the definition of money is meant to be a store of value as well as a means of exchange.

    Your lack of specific measured definitions, plus your belief that endless growing debt is a success, highlights that Keynesian policies are nothing but hot air, just as our current monetary system creates money out of thin air via the issuence of debt.

    I was hoping your policies were correct, but now I can see that they actually created this mess we are in.

    ReplyDelete
  49. Reply to Lord Keynes

    LK says "Post Keynesian economists would argue that the private sector needs massive deleveraging. This can be helped by writing off much bad debt or restucturing it".

    Great in theory but disastrous in practice. What is the effect of the private sector defaulting on mortgages and other personal loans such as credit card loans, car loans and student loans?

    These loans have been packaged up by the Banks into high-income Bonds and sold to Pension funds needing “secure income” for the baby boomers retiring in ever-greater numbers. If the private sector default on their debts then the pension funds will see a loss of income as well as capital falls. They will have to start selling assets to make up the shortfall in income needed to pay pension benefits to their retirees. This will precipitate a global deleveraging of all asset classes, wealth destruction on a massive scale. The snake starts to eat its own tail. This is the road to hell.

    ReplyDelete
  50. I wonder what the balance of payments are for the countries which "Lord Keynes" quotes above as successful?

    I am suggesting affordability is the key to whether Keynesian Economic theory is sustainable for a particular country....

    ReplyDelete
  51. Here is a single page article from a quarter of a century ago, which seems appropriate given the will we-wont we debate raging through the developed and not so developed world.

    Obviously the sums involved are demonstrably smaller, but the basic premise remains the same and made more interesting by the countries mentioned in the article, as the outcome can be looked at both in today's terms and in a period that we should be able to easily identify with.

    http://www.heritage.org/Research/Reports/1985/09/The-US-as-a-Debtor-Nation-What-It-Really-Means

    I was struck by how small the sums involved were, leaving me to wonder if in 25 years time we'll all be looking back and thinking along similar lines for todays trillion $ throwaway lines. More importantly, for me anyway is that it shows the importance of borrowing and by default, spending for the right reasons.

    It does endorse both Chaingangcharlie's & Lord Keynes views somewhat, but simultaneously exposes the dangers of such policy, which tends to be where my minds-eye is focused.

    Dave O'Carroll Romford

    ReplyDelete
  52. SteveTierney you say: ''Delivered by crazy Keynesian policies by a lunatic left-wing government. The repair will be long and hard - but absolutely necessary.''

    This is hilarious. Lunatic left wing? Well they were certainly pretty mad I will give you that but they were NOT left wing. The hint is in the name NEW labour my friend. They dropped Clause 4 and with it any attempt to socialism.

    Some basic facts for you. NEW Labour reduced taxes - much less tax was paid than under Maggie - Income tax was reduced, CGT massively reduced and IHT bands put up.

    NEW Labour were harsher on the unemployed than either Maggie or Major. They cut benefits - now a newly unemployed man only gets sixty quid a week to live on. They introduced workfare and they brough in very draconian and right wing sweeping welfare reforms.

    NEW Labour allowed a huge amount of PFI to take place - Major introduced this and New lab ran with it.

    All these policies are neo liberal policies. It is hilarious that you think new labour were left wing just because labour was in the name. They were neo liberal through and through and just in case you didn't notice the Tories voted for and backed every single one of their spending commitments before the crash. As Paxman excellently pointed out to Cameron.

    There is little difference between new labour and the Tories - if New Labour were in now they would be cutting just the same. They lied in the run up to the election and said they wouldn't but they would. Cuts were already beginning on the ground.

    The issue is not the fag papers difference between the political parties in the Uk the issue is the dominant economic model worldwide. It is the neo liberal economic model that has failed yet we are still being guided by arch monetarists as to how to get out of this mess. That worries me.

    Great posts chaingangcharlie and lordkeynes.

    SuzySmith

    ReplyDelete
  53. Wow, so much complexity, which is the problem. We can argue about the macro dynamical keynsian philosophy and its intended implications within a cosmic transdimensional quantum function, until......june 22nd, and if the country holds together after the cuts and tax increases, we may just release that we have exhausted every scam in the book. the world has called time on us and we need to go back to the farm, and stay there until we understand how to produce things of tangible value again.

    ReplyDelete
  54. Reply to Anonymous 2

    Great in theory but disastrous in practice. What is the effect of the private sector defaulting on mortgages and other personal loans such as credit card loans, car loans and student loans?

    I already addressed this problem: you bail out depositors. Deleveraging can certainly cause debt deflation – which you need to avoid.

    These loans have been packaged up by the Banks into high-income Bonds and sold to Pension funds needing “secure income” for the baby boomers retiring in ever-greater numbers .... This will precipitate a global deleveraging of all asset classes, wealth destruction on a massive scale.

    Hedge funds should not be bailed out. Pension funds are different. There is a case for nationalizing the pension funds. The central bank can take the bad assets off their books, and then the state writes off or restructures bad mortgages, personal loans such as credit card loans, car loans and student loans etc.

    ReplyDelete
  55. Reply to Prometheus

    I wonder what the balance of payments are for the countries which "Lord Keynes" quotes above as successful?

    Many of them have persistent current account deficits: e.g., Australia, France.
    If they attact the capital account surplus to pay for their current account deficits, then it is perfectly sustainable.
    Moreover, if some countries are in current account surplus, then other countries must be in deficit. It is impossible for every nation to run a current account surplus at the same time.

    ReplyDelete
  56. Reply to George 5

    There is nothing specific in just mentioning words such as output and supply

    Either you didn’t read my comments or didn’t read them properly: I listed examples of output/supply shocks: e.g., destruction of productive capacity, catastrophic floods, droughts (e.g., Zimbabwe), wars, crippling sanctions, or reparations that allow foreigners to take a substantial part of your output so it is not available for domestic consumption (e.g., Weimar Germany). Quite specific.
    Other specific instances of supply shocks include massive rises in the prices of basic commodities (e.g., oil) essential for production – this will tend to cause prices to rise. That might require a demand contraction as well.

    I am glad that you have specified that your definition of success is actually getting into bigger debt

    Nowhere did I say that getting into debt is my “definition of success”. You are using a feeble straw man argument.
    That fact that you are doing this suggests to me that you are desperate and have no response to my arguments.

    and your argument that countries are different because they can print more money is so blatantly wrong because it just makes it worthless as history has proven with failed fiat currencies

    I assume you mean that QE or monetizing government debt will cause inflation or hyperinflation?
    QE is actually a poor method stimulating demand. QE-created excess reserves can only be put into people’s hands by debt - which the banks are reluctant to do at the moment, not only because they are dysfunctional, but also because business confidence is low.

    In a severe recession or depression when capacity utilization is low, increasing demand through monetizing government debt will just increase capacity utilization or lead to a surge in imports. You seem to forget that most Western economies are very open to trade and cheap imports - which can actually decrease inflation.
    When the economy recovers and inflationary pressures build, you run a budget surplus, raise taxes to contract demand, and raise interest rates.

    If you run a budget surplus and don’t spend the money back into the economy, then the money is effectively destroyed, which will thus permanently decrease demand.
    You forget that government has the power both to create and destroy money.


    plus your belief that endless growing debt is a success
    Again, straw man argument.

    just as our current monetary system creates money out of thin air via the issuence of debt

    You forget that before fiat currencies private banks could create fiduciary media (= money substitutes) out of thin air too, particularly in free banking systems. Private banknotes or bills of exchange functioned as money in the 19th century and banks could create them even though they were not all backed by gold.
    Strangely, you also ignore that monetising a budget deficit does not create debt: it creates debt-free fiat money.

    ReplyDelete
  57. More on Creating money out of Nothing in the 19th century:

    At the beginning of the 19th century, bills of exchange constituted roughly 70 % of the money in circulation. Only 30 % consisted of banknotes and precious metals

    http://books.google.co.nz/books?id=mJ4TfKL4wcAC&pg=PA74&dq=bills+of+exchange+19th+century+gold&hl=en&ei=i2IZTJXJKs6HkAW124ivBw&sa=X&oi=book_result&ct=result&resnum=1&ved=0CDAQ6AEwAA#v=onepage&q=bills%20of%20exchange%2019th%20century%20gold&f=false.

    Once banks started to issue banknotes against gold deposits that were already also used to back bills of exchange, the banks were creating new money.

    ReplyDelete
  58. Top Manufacuring Nations 2007

    (1) United States (manufacturing output worth $1.831 trillion US Dollars
    (2) China ($1,106 billion USD)
    (3) Japan ($926 billion USD)
    (4) Germany ($670 billion USD)
    (5) Russian Federation ($362 billion USD)
    (6) Italy ($345 billion USD)
    (7) United Kingdom ($342 billion USD)
    (8) France ($296 billion USD)
    (9) South Korea ($241 billion USD)
    (10) Canada ($218 billion USD)
    (11) Spain ($208 billion USD)
    (12) Brazil ($206 billion USD)

    http://www.wisegeek.com/what-are-the-top-manufacturing-countries.htm

    Note that the UK comes in at number 7 above France, but below Italy.
    The term PIIGS really is contemptibly insulting given that both Italy and Spain are quite strong manufacturing nations.
    Italy is ranked above the UK.

    ReplyDelete

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