Tuesday, October 2, 2012

The Perpetual Economic Growth Machine

When first starting this blog, I had a thesis; that debt growth was the underlying cause of 'economic growth'. As the blog progressed, along with the breadth and depth of my analysis, I came up with the idea that the economic crisis had an underlying cause; a labour supply shock in conjunction with a lack of commensurate increase in commodity supply. It was an idea that I then used to develop the idea of hyper-competition. In light of this theory, I thought that the outcome would be clear. The Western economies were uncompetitive, and they would lose out in the face of the competition from the emerging economies. It seemed so screamingly obvious that I wrote a post in 2009, predicting that it was the year of the fall of the West (Japan was counted in the West, which I know is a little odd). It was a post in which I made a poor assumption; I thought that, one way or another, the underlying and obvious problems of the Western economies MUST be recognised.

The crash I predicted failed to take place, and I took a hit to my credibility.

When the predicted crash failed to materialise, I was heavily criticised by commentators on Reddit. I responded by saying that at least I was willing to put a date on the turning point, whilst others lack confidence in their theories and refuse to predict outcomes. I should have added that a theory needs to be tested by evidence; can it predict? If it cannot predict, then it fails. Most of what you read does not offer the confidence to predict outcomes, or leaves the timings of outcomes open. The authors shroud their thesis in ambiguity, and nothing they say can be held accountable.

My mistake at the time I wrote of the Downfall of the West was that I failed to see that there was plenty of extremes to which policy makers were willing to resort. In addition, I failed to see how entrenched views of the world were; the West was the heartbeat of the world economy, and NOTHING would ever change that. It a question of government action acting to support and shore up a world view that is resilient the the underlying facts. We would return to the status quo of the West living high on the hog, whilst those poor countries tried to catch up. The world economy would return to the natural order, once we just sorted out the fallout from the 'financial crisis'. It was just a problem in the financial system, and some policy action here and there would return all back to 'normal'.

If you have contrary evidence to your theory, you need to ask why you got it wrong. Perhaps, in the explanation I have given above, I am making excuses. I am highly self-critical, and do not believe these are excuses. In fact, as time has progressed, I have come to the view that I was right all along. Not right that there would be a terrific crash, but right in my underlying thesis. I expected drama, not the steady and relentless decline that has taken place. I argued that the West is 'poorer than we think' and we are steadily recognising this in the decline of the standard of living in many Western countries. We are slowly but surely seeing the middle classes being hollowed out, declining real incomes, growing unemployment (or underemployment). This is taking place against the backdrop of crazy levels of sovereign borrowing, money printing, and the related issue of extraordinarily low interest rates. None of this extreme policy seems able to lift the economies of the West.

Instead, whilst governments rack up debts, and money is pouring forth from central banks, we are just getting poorer. I have to emphasise the point that governments are creating mountains of debt, and we are still in day-to-day terms, getting poorer. We are already poorer, but how much poorer will we be when (assuming we actually pay it) we start to bear the load of the debt being accumulated now. Tax must rise at some stage to pay for it. The opposite view is that economies will return to major growth, and this will cover the debts. It is a promise that has been made for a long time. However, even as governments borrow, as money is printed, there is no real growth. There is only the anaemic growth that is following profligate borrow and spend policy.

It has never been complicated. If I borrow money, and use that money to pay for consumption, it generates activity in the economy. The borrowed money circulating through the economy creates activity, and that reflects in the GDP figures. Take away the borrowing, and GDP falls. We see this in Greece and Spain, and start to see what takes place when an economy reliant on borrowing stops borrowing. The evidence is there in plain sight. Nevertheless, there are many who argue that the problems of overly in-debt countries is to borrow more, and they convince many people. Borrow 1 billion, and it will produce 3 billion of activity in the economy, and the tax income from that activity will allow the economic growth to pay back the debt through increased tax revenue.

Just think about this. A country borrows money to produce revenue to pay back the borrowing. The problem is simple; resources are being consumed along the way. The view that borrowing more is going to solve problems is based upon the idea of a perpetual motion machine. There is no loss of energy, or in this case no loss through the consumption of resource. Borrow and spend is a perpetual motion machine. Borrowed money comes in, generates revenue to pay back the borrowing, and revenue then pays the borrowing. Nothing is lost. No resource is consumed. It is the perfect system. Except that it is impossible.

The perpetual borrow and spend, create revenue, repay borrowing machine is a truly unique idea. It is unique in that so many people have persuaded themselves of its possibility. We laugh at the perpetual motion machine, but many view this perpetual economic growth machine as possible. No loss. Just gain. Here is how it can work. Every year, we can increase our borrowing, and increase the activity in the economy. As the activity increases, we can increase our revenue, and that increases our ability to service our debts. In fact, we are not borrowing enough. If we accelerate our borrowing, we will increase our revenue, and we will be in an even better position to repay our borrowing. The more you borrow, the better you are able to pay back the borrowing. No loss, just growth in revenue, as nothing is apparently being consumed in the process.

If only the perpetual economic machine were true. We could forget having to compete and just borrow our way to prosperity.

I now return to my failed prediction of the 'downfall of the West'. We are growing poorer. And we are consuming based upon growing debt. Real resource is being consumed through debt accumulation. All would be good if there were a perpetual economic growth machine, but it is a fantasy. Nevertheless, that fantasy has real currency in the real world. It has prevented a crash, but we are nevertheless getting poorer. My error of thought was to believe that illogic would be uncovered. Instead, debate and discussion takes place, and the perpetual economic machine is the winning argument that drives belief.  Policy will make the economies of the West return to their natural and rightful position. If in doubt, just keep borrowing towards wealth.

The exceptions, the Spain and Portugal examples, just need to abandon austerity, and they will return to growth. The perpetual economic growth machine will deliver. It WILL deliver, because it MUST deliver. It is a costless machine. Nothing is consumed.

Update just after publication: Just a little note as I left my  thread of thought behind as I wrote (yet again). I missed making a key point. How could anyone predict that people might believe in a perpetual economic growth machine? But people do..... this was a crucial fault in my prediction. Sorry, but I was distracted from the point I was trying to make. I could not accept that the perpetual economic growth machine could be a foundation of belief, and the belief therefore might avoid the crash which I predicted. What we are looking at in the world economy is the contradiction between the perpetual economic growth machine as a belief, and the reality that it cannot and does not work (barring the exceptions such as Spain where we can see the idea collapsing). Reality and belief are bumping together, and reality is slowly winning out.

2nd Update just after publication: Long term readers will have seen my prediction, but still come back. I have always left it in place as I think my record of what I have got wrong is as important as what I have been right about (notwithstanding that I argue here that I was not so wrong). I do not believe that bloggers should 'airbrush' their record, and have left all of my posts as live.  I encourage new readers to dig into the archives. See where I have been right and wrong. Make a judgement on  whether I have something interesting to say based upon my record. I am obviously biased, but I think my record overall puts me in a strong position.....despite my admission/s that I have got things wrong (there is one case where I presented a detailed analysis of an economic forum, only to have an astute reader point out that I was a year out of date; I was analysing the meeting and output of the previsous year, but the post and apology is still online).


14 comments:

  1. 'The perpetual borrow and spend, create revenue, repay borrowing machine is a truly unique idea. It is unique in that so many people have persuaded themselves of its possibility. We laugh at the perpetual motion machine, but many view this perpetual economic growth machine as possible. No loss. Just gain.'

    The perpetual growth delusion is founded upon hopes for endless gains from capitalized geo-rent.

    Foldvary explains how the 18 years land cycle drives the business cycle, leading to inevitable boom/bust:

    Fred Foldvay: The Progress Report: Real Estate Forecasts 2012–2026
    http://www.progress.org/2012/fold787.htm

    Fred Foldvary: The Business Cycle: A Geo-Austrian Synthesis
    http://www.foldvary.net/works/geoaus.html

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  2. Not related to this post but just a message to say thanks for taking the time and effort to continue this blog.

    As a complete novice to economic and financial matters your posts have helped me understand things clearly.

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  3. > If I borrow money, and use that money to pay for
    > consumption, it generates activity in the economy. The
    > borrowed money circulating through the economy creates
    > activity, and that reflects in the GDP figures. Take away
    > the borrowing, and GDP falls.

    First, if this is supposed to be a description of government spending, the latter includes a large public investment component, which turn strongly supports the private sector (e.g., better transport for business, applied R&D leading to technology gains, health care for workers, increasing their productivity).

    And secondly, the consumption spending will also generate private investment activity, for demand and sales drive the level of private investment.

    Whether the debt is public or private, this is the way capitalism has always worked throughout modern history.

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  4. Wrong?
    As a regular reader since 2008 I thought you had be amazingly accurate.
    You have dared to stick your neck out and enlightened us on what was approaching way before the media "got it".

    When you where questioning why Iceland was offering high interest, our local councils were investing our money there. I actually stopped a friend putting £30,000 there a couple of weeks before it went.

    Another that comes to mind was the mention of us losing some famous car makers.
    Well Saab and Rover went and the Chinese bought Volvo.

    Our local council has to save millions next year, lets hope "forget care for the elderly" doesn't come too soon.

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  5. Your perpetual growth machine is the same mythical beast that our politicians use when they try to convince (con) us that cuts in investment or numbers will produce more productivity in either the private or public sectors.
    Unfortunately the fools believe both to be the truth.

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  6. I've followed your blog for some time, and I thought that your original commentary putting a date on the 'coming crash' was unnecessary at the time. It was as if you were forced to make a prediction to establish credibility. I would suggest that your analysis has been good enough all along without trying to enhance it in this way.

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  7. Overly harsh on yourself CE, the defence above is unnecessary and seems almost whiny.
    You got the direction right before just about everyone else. Timing is for traders and damn the rest.

    I am indebted to you* as this blog first awoke me and allowed me to prepare for whatever-it-is-that'scoming.
    I found you in the Guardian comments section which indicates how far off the track I was.

    Here is someone who is very specific on the mechanics of Western downfall.
    http://fofoa.blogspot.dk/2011/04/deflation-or-hyperinflation.html
    An Austrian tinged hyper-inflationist – very verbose, but by far the best Goldbug blogger I know of.

    For me the big question is whether we are facing collapse by inflation and/or deflation.
    I am working through FOFOA's back catalogue and there is a lot there that rings true to me.
    Interested to hear yr thoughts.


    *This debt is like all the other debt in the world; it will never be repaid :)

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  8. Overly harsh on yourself CE, the defence above is unnecessary and seems almost whiny.
    You got the direction right before just about everyone else. Timing is for traders and damn the rest.

    I am indebted to you* as this blog first awoke me and allowed me to prepare for whatever-it-is-that'scoming.
    I found you in the Guardian comments section which indicates how far off the track I was.

    Here is someone who is very specific on the mechanics of Western downfall.
    http://fofoa.blogspot.dk/2011/04/deflation-or-hyperinflation.html
    An Austrian tinged hyper-inflationist – very verbose, but by far the best Goldbug blogger I know of.

    For me the big question is whether we are facing collapse by inflation and/or deflation.
    I am working through FOFOA's back catalogue and there is a lot there that rings true to me.
    Interested to hear yr thoughts.


    *This debt is like all the other debt in the world; it will never be repaid :)

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  9. There is no model/theory of human behavior (psychological, sociological or economical) that could male predictions with accurate timing, that doesn't mean that they are wrong or poor models. A theory should explain, not predict: leave this to physics and natural sciences and don't be so self-critical...

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  10. I wondered if anyone saw Evan Davis's new programme 'Made in Britain' on the BBC last night.

    http://www.bbc.co.uk/programmes/b0125v5k

    In it, he puts the case quite strongly for borrowing to build 'infrastructure' in times of recession, to "give the economy options". Without a new Heathrow runway, or improved roads and railways, Britain will not be ready to create the future growth that everyone agrees we need. In the UK, the population is expected to grow by 10 million over the next 20 years. Do we want everyone to move to the South East (London) or must the economy be balanced away from service industries and back into manufacturing in other areas of the country. Apparently we must expect to make mistakes and build infrastructure that no one will use in the end, but by spending a little more cash we can make it environmentally friendly anyway.

    Any views? On the face of it, it all sounds very logical, and indeed it is hard to see how private industry on its own can steer the economy in a particular direction without the infrastructure being there in the first place (chicken and egg) so some pre-planning is necessary (goes the argument).

    However, my immediate thought is that the argument starts by assuming that the current state of the economy is 'real'. If, as you have pointed out on many occasions, CE, the true economy is much smaller than it appears, then we simply won't need so much infrastructure to support it, nor will we be able to afford to build and maintain it. On the other hand, I sense some desperation in the programme: no one can see any alternative other than throwing the dice and hoping for the best. He doesn't say it as such, but I think there's a suggestion that if we borrow lots of money to build infrastructure and then default, at least we'll have the infrastructure; if we don't do that, we'll still default because we won't be able to grow, and we won't have the infrastructure for the future either.

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  11. Lemming

    I haven't seen documentary you mnetion, but the excellent Richard Duncan (previously discussed on this blog) suggests an even more extreme version of this solution. He says that as trillions of dollars are going to be borrowed anyway, the US government should use these trillions to create new industries (rather than infrastructure) in energy, medicine, food etc. that will ensure American leadership and economic dominance for years to come.

    http://www.cbsnews.com/8301-504367_162-57501925-504367/the-new-depression-the-breakdown-of-the-paper-money-economy-by-richard-duncan

    http://www.youtube.com/watch?v=HwsG-SfHtRg

    I find CE's 'real' -VS- 'unreal' dichotomy not useful. Maybe it once applied to a world where capitalists were men with 'capital', but we now live in a world of mirrors that Duncan calls 'creditism'.

    For example - the price of gold has been rising very steadily 12 years ago - is this value 'real'? Of course not. It is purely in the minds of humans -- as we become more fearful, the price increases.

    Britain, though, is toast. Really tragic.


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  12. @Lord Sidcup

    Yes, people still like to pretend that the economy is the same as a business or household's books ("Greek loan repayments are due on the xx/yy/zz") which seems to make it all above board and sustainable; and at the same time they believe that growth will magically repay all previous debts without any sacrifice needed on the part of the borrowers.

    I have noticed (I think) that when CE refers to the multiplier effect, he means it as purely illusory growth and that people should factor this into their predictions. However, commenters in the Guardian, for example, always seem to think of it as real growth, and can't understand why it shouldn't be harnessed ad infinitum. This morning on Radio 4, Stephanie Flanders, Evan Davis et al were referring to the multiplier in the negative sense i.e. the more you cut government spending, the lower GDP becomes. (Apparently it was once thought to be a 50% ratio, but is now looking more like 100%.) They left it to the listener to fill in the blanks and conclude that the only true way is higher spending.

    Where do materials and energy factor into this? CE's central thesis is that we now have many more workers globally, but not greatly increased resources. It seems that a 'digging holes then filling them in again' pseudo-Keynsian strategy may once have been fairly harmless if the workers really were idle and likely to be for some time, but nowadays every useless activity has a real cost in scarce energy and materials for which real money has to be borrowed - and which fairly obviously encourages mal-investment in the manufacture of vans, shovels and copies of The Sun. What's the alternative? Without government intervention doesn't the whole thing collapse anyway? The harder people work, the more resources are consumed until industry grinds to a halt - unless we really do believe that the Invisible Hand will always find a way around resource constraints. Perhaps a way out would be some sort of fanciful international agreement to limit working hours and let everyone take it easy but with a low standard of living - or maybe to release a bird flu virus or similar...

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    Replies
    1. Or as history shown us war, and I don´t think the next one will be very pretty!

      Delete
  13. Levels of consumer debt will be limited by the ability of the individual to repay. Levels of government debt can be sustained for much longer(in the US at least) by reducing borrowing costs and shifting the debt onto the Federal Reserve. The US debt will never be paid down. It is no longer possible. But I'm no longer certain that the US will have it's day of reckoning anytime soon.

    ReplyDelete

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