tag:blogger.com,1999:blog-78204851300174596192024-03-14T03:01:29.900-07:00CynicusEconomicusCharting the world economy, with a particular focus on the UK and US, as well as the rise of China. A cynical view of bailouts, stimuli and quantitative easing (printing money).Unknownnoreply@blogger.comBlogger293125tag:blogger.com,1999:blog-7820485130017459619.post-49189282719447033532013-03-22T15:55:00.002-07:002013-03-22T15:55:28.609-07:00What the Cyprus case tells usIn order to understand the current problems in Cyprus, it is first necessary to know how the mess arose in the first place. Reuters have a very good background article <a href="http://www.reuters.com/article/2013/03/22/us-cyprus-banks-idUSBRE92L0CQ20130322" target="_blank">here</a>, and I will use it extensively. The 'series of events' that led up to the crisis commences with Cyprus joining the Euro zone:<br />
<br />
<blockquote class="tr_bq">
<span id="articleText"></span><br />
Before joining the euro, the Central Bank of
Cyprus only allowed banks to use up to 30 percent of their foreign
deposits to support local lending, a measure designed to prevent
sizeable deposits from Greeks and Russians fuelling a bubble.<br />
<br />
<span id="midArticle_4"></span>When
Cyprus joined the single European currency, Greek and other euro area
deposits were reclassified as domestic, leading to billions more local
lending, Pambos Papageorgiou, a member of Cyprus's parliament and a
former central bank board member said.<br />
</blockquote>
Following the 2008 crisis, this conservative reputation was to lead to money flowing into the banks in Cyprus as a 'safe haven'. The problem was that the money arriving has nowhere productive to go, so mirroring what had taken place in other economies (e.g. the US), the money ended up in real estate, fuelling a bubble in real estate prices. However, this flow of money could not all be absorbed in real estate, with the Cyprus banks growing at a rate totally divorced from the wider economy. Due to historical ties, the destination of choice for the inward flow of money was an outwards flow towards Greece:<br />
<br />
<blockquote class="tr_bq">
<span id="articleText">The EBA figures showed 30 percent (11 billion
euros) of Bank of Cyprus' total loan book was wrapped up in Greece by
December 2010, as was 43 percent (or 19 billion euros) of Laiki's, which
was then known as Marfin Popular.<br />
<br />
<span id="midArticle_11"></span>More striking was the bank's exposure to Greek debt.<br />
<br />
<span id="midArticle_12"></span>At
the time, Bank of Cyprus's 2.4 billion euros of Greek debt was enough
to wipe out 75 percent of the bank's total capital, while Laiki's 3.4
billion euros exposure outstripped its 3.2 billion euros of total
capital.</span></blockquote>
There is considerable more detail that could be added, such as the high returns offered by Cypriot banks, but also underlying the high risk speculation is a finger pointing at lax regulation by the central bank:<br />
<br />
<blockquote class="tr_bq">
<span id="articleText"></span><br />
Whatever the motive, the Greek exposure defied
country risk standards typically applied by central banks; a clause in
Cyprus' EU/IMF December memorandum of understanding explicitly requires
the banks to have more diversified portfolios of higher credit quality.<br />
<br />
<span id="midArticle_4"></span>"That
(the way the exposures were allowed to build) was a problem of
supervision," said Papageorgiou, who was a member of the six-man board
of directors of the central bank at the time.<br />
<span id="midArticle_5"></span>The
board, which met less than once a month, never knew how much Greek debt
the banks were holding, both Papageorgiou and another person with
direct knowledge of the situation told Reuters.<br />
</blockquote>
It seems that, when reflecting on the lead up to the current mess, the factors that drove the crisis forwards are oddly familiar. If looking at the US crisis, floods of money were pouring into the US in the lead up to the crisis, with that money over-spilling into the real estate market, and thus causing a bubble. Just as in the US, the central bank was happy as long as everyone <i>seemed</i> to be getting richer. In both cases, it was a flood of overseas money entering the economy that underpinned the problems (e.g. see <a href="http://cynicuseconomicus.blogspot.co.nz/2008/09/banking-crisis-what-is-really-going-on.html" target="_blank">here</a>). <br />
<br />
There is an important point in this story, and it a point that does not receive enough attention. There is a widespread misconception that the politicians and policy makers are in control of their own economies. However, this is a myth. They may have influence on their own economy, but they do not control it. The problems in Cyprus are derived from excessive capital flows, and just as happened in the US, when faced with a wall of money, the Cypriot banks were not going to turn it away, but find a home for it. Thus there is a real estate boom, and this will then drive the Cyprus economy into apparent growth, as ever more money chases a limited supply of real estate, and paper gains in value of real estate create economic growth, without any real underlying increase in the output of the economy. Instead, the increase in output is simply the result of excess credit appearing in the economy. <br />
<br />
The difference in the Cypriot and US examples is that the small size of the economy serves to exagerate the same effect. When the Fed acts, it is acting on an economy which is relatively large in relation to the flows of capital throughout the world, so is more influential. In the case of a small economy like Cyprus, the actions of policy makers are swamped by the influence of that same capital. Similarly, the US real estate market was so large, that it was able to absorb a large amount of capital. In other words, it is a similar process that took place, but with differences in degree of effect. We can see a similar process taking effect in other economies. For example, in New Zealand (population about 6 million), the central bank labours under the illusion that it has some control over the New Zealand economy through <a href="http://www.3news.co.nz/NZ-dollar-tumbles-after-rate-review/tabid/421/articleID/290243/Default.aspx" target="_blank">interest rates targets</a>.<br />
<blockquote class="tr_bq">
<div class="count_el">
The New Zealand dollar tumbled almost a cent against
the US dollar after the Reserve Bank said interest rates will remain at
a record low through this year. </div>
<div class="count_el">
<br /></div>
<div class="count_el">
The bank also hinted at a cut to the official cash rate if the currency was higher than justified by economic fundamentals.</div>
<div class="count_el">
<br /></div>
<div class="count_el">
The kiwi fell to 81.66 US cents from 82.60 cents immediately before the statement.</div>
</blockquote>
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This is the <a href="http://www.nbr.co.nz/article/rbnzs-wheeler-says-ocr-stay-unchanged-year-amid-uneven-recovery-bd-137187" target="_blank">interesting point</a>:</div>
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<blockquote class="tr_bq">
Local property prices rose 7.6 percent last month on increasing sales
numbers, according to Real Estate Institute figures. New Zealand's
property market gains have been driven by a lack of supply in its
biggest city, Auckland, and as the Canterbury rebuild gets underway.<br />
<br />
"House price inflation is increasing and the bank does not want to see
financial stability or inflation risks accentuated by housing demand
getting too far ahead of supply," Mr Wheeler says.<br />
The Reserve Bank estimates house prices increased in real terms at an
annual pace of 6 percent last year, and will rise 6.2 percent and 3.6
percent this year and the next.</blockquote>
Although following an earthquake there is a genuine supply problem, this is not the real driver of the real estate market. You will notice that the interest rates are relatively high in comparison with other Western economies. The chart and quote below come from the <a href="http://www.rbnz.govt.nz/keygraphs/Fig8.html" target="_blank">New Zealand Reserve Bank</a>:<br />
<blockquote class="tr_bq">
The US Dollar cross rate should be interpreted as one New Zealand dollar
buying <i>x</i> US dollars. The TWI (Trade-weighted index) is the nominal
NZ dollar exchange rate weighted 50/50 by New Zealand's trade with its
major trading partners and the nominal GDPs (in US dollars) of those countries.
The graph shows monthly averages.
</blockquote>
<blockquote class="tr_bq">
In October 2000 the New Zealand dollar reached record lows, dropping below 40 cents per NZD.
However, after 2002, the currency strengthened considerably, reflecting a strong domestic economy,
rising export commodity prices and associated increases in interest rates.
The TWI behaved very similarly to the US dollar cross rate over most of the decade .
<br />
<br />
In 2008, continuing financial market uncertainties and a deteriorating global economic outlook
saw many investors move into perceived 'safe-haven' currencies such as the USD.
As a result the NZD fell sharply against the USD and other currencies in the TWI (the Japanese Yen and Euro in particular),
but these falls proved to be quite shortlived.
In part that reflected the way in which New Zealand was hit less hard in the
recession than many of the countries whose currencies make up the TWI.
</blockquote>
<div style="text-align: center;">
<img alt="" height="200" src="http://www.rbnz.govt.nz/keygraphs/Fig8_large.jpg" width="400" /></div>
<br />
In a small economy like New Zealand, here is the problem. They currently have what looks like a <a href="http://www.nzherald.co.nz/nz/news/article.cfm?c_id=1&objectid=10873038" target="_blank">real estate bubble</a>. <br />
<blockquote class="tr_bq">
The country's average salary of $45,000 was more than double that of
many lower-income families who struggled to pay rent, Mr Evans said.<br />
<br />
"Once you've paid rent and power bills and put petrol in the car so you can get to work, there's not much left over for food."</blockquote>
And then we have <a href="http://auckland.scoop.co.nz/2013/03/asking-prices-remain-high-as-new-listings-surge-in-february/" target="_blank">this</a>:<br />
<blockquote class="tr_bq">
The New Zealand property market rebounded from the seasonal lull in
listings over the summer break with 13,145 new listings coming to the
market in February. Auckland saw its average asking price exceed
$600,000 for the third time, while Canterbury’s figure surpassed
$400,000, for the fourth time. </blockquote>
It is very clear that the underlying driver of house prices is not wages, as there is a mismatch between income and house prices. Although there may be some supply issues within the house prices (in particular in Christchurch), this would not explain this disconnect between salary and house price. The real driver is that there is an oversupply of credit into the market. To put this simply, if there is 100 units of credit chasing 100 units, and then we increase the supply of credit to 130 units without changing the supply of units, then we will see the cost of each unit increase. Note, nothing has changed in the quality of the units; just by increasing supply of credit is sufficient to increase prices. </div>
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This is why the central bank is not in control. For those unfamiliar with the idea of the carry trade, it works like this. I borrow extremely cheaply in the US with effective 0% interest rates, and then lend that same money into another economy with higher interest rates. I take a risk on the currency in so doing, but the rewards are potentially very high. Even better, if lots of people are doing the same thing as me, the demand for $NZ is increasing and this leads to currency appreciation. Even better, the new money entering the economy creates a positive uptick in the New Zealand economy, and this further strengthens the currency. This is exactly what is taking place in <a href="http://www.nbr.co.nz/article/rbnzs-wheeler-says-ocr-stay-unchanged-year-amid-uneven-recovery-bd-137187" target="_blank">New Zealand now</a>:</div>
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<blockquote class="tr_bq">
<div style="background-color: white; border: medium none; color: black; overflow: hidden; text-align: left; text-decoration: none;">
The economy grew faster than expected through the tail end of last
year, underpinned by the Canterbury rebuild, and that stronger domestic
demand is seen as creating medium-term inflationary pressures, even as
consumer prices remain subdued in the foreseeable future, the bank says
in the monetary policy statement.<br />
<br />
"Monetary policy settings must balance this low near-term inflation
outlook and concerns about the exchange rate and weak labour market,
against increasing signs that output will accelerate and inflationary
pressures will pick up."<br />
<br />
New Zealand food prices fell 0.3 percent last month, led by seasonally
cheaper fruit and vegetables and discounted meat, according to
government figures published yesterday.<br />
<br />
Food prices account for about 19 percent of the consumer price index,
which was tracking below the central bank's target 1 percent to 3
percent band in the December quarter at 0.9 percent.<br />
<br />
The bank sees the annual pace of inflation staying at 0.9 percent until
the September quarter this year, rising the mid-point of its band in
latter half of 2015. Medium-term pressures are expected to come in the
housing and construction sectors, with the risks skewed to the upside,
it said.</div>
</blockquote>
Again, the Christchurch rebuild is undoubtedly a factor, but so is the entry of new credit into the economy. Note that inflation is subdued. If you have currency appreciation, imports become cheaper, and this will help keep inflation in check.<br />
<br />
Into this interesting bubble scenario, we have the role of the central bank. The brief fall in the $NZ was probably due to previous speculation that the interest rate would be raised to tame the house price bubble. However, had the central bank increased interest rates, the impact would have been to make New Zealand even more attractive to the carry trade, and thus have the opposite effect to the one intended. The problem is that, in keeping a low interest rate target, there is nothing to pop the bubble in house prices. In other words, until such time as the carry trade winds down, there is nothing that the central bank can do which will tame the house price bubble, with the associated problems that will develop from the bubble.<br />
<br />
In other words, the New Zealand economy is in the hands of others. For example, if a large economy such as the US targets 0% interest, this will lead to carry trade activity, and this will impact on other economies such as New Zealand. Whether New Zealand is a carry trade destination is determined by New Zealand interest rates, but they are determined by factors such as the currency, and the current levels of credit entering the economy. Most importantly, there is the speculation of the capital markets, based upon exchange rate risk, and the exchange rate risk is determined in part by the speculation, and this is divorced from the underlying economy of New Zealand, as their own collective actions are determining the value of the currency. For the carry trade, it is all about timing. Getting in early, and getting out before it unwinds is the key. The more new entrants into the carry trade, the higher the currency appreciation, the more profit to be made. However, the credit creates an artificial boom in the economy, which can rapidly turn to bust as credit based growth starts to reach saturation, and the situation unwinds, including currency depreciation. The carry trader needs to get out before this takes place.<br />
<br />
Returning to Cyprus, the key difference is that Cyprus is a Euro economy which meant that, in consideration of the size of Cyprus, the state of the economy had no influence whatsoever on the value of the currency. This disassociation between the underlying economy and the currency, and the wall of money being thrown at the economy, means that there was no currency derived time 'to get out' excepting where the Euro area was perceived to be at risk. This and the reputation for being conservative but providing outsize returns, made Cyprus an attractive destination. The key to the outsized returns was, in turn, the result of lax bank regulation. Regulation gave an illusion of stability, but it was no more than this; an illusion. Cyprus had only one means to control the situation, which was central bank regulation. However, just as with the many cases in recent history, when a flood of money enters into an economy, the economy booms, the regulators always seem to look the other way. Whilst things are 'good', they suddenly freeze, and fail to act. We have now seen this so many times that it is becoming sadly comedic. However, the illusion that all is okay due to regulation always remains, and ultimately contributes significantly to the growth of the problem.<br />
<br />
However, one element of the Cyprus problem was not derived from central bank regulation, which was the property bubble. It has yet to unwind fully. However, we can see it time and time again; when a flood of money arrives in an economy, with nowhere productive to go, real estate is the destination of choice. This in turn creates a boom, and a boom that, in the end is unsustainable, being derived not from underlying economic growth, but in increased consumption. As <a href="http://krugman.blogs.nytimes.com/2013/03/21/cyprus-the-sum-of-all-fubar/" target="_blank">Krugman</a> (goodness, am I referencing Krugman?) points out, this led to a 15% of GDP current account <a href="http://www.tradingeconomics.com/cyprus/current-account-to-gdp" target="_blank">deficit in 2008</a>:<br />
<br />
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<img alt="Cyprus Current Account to GDP" height="169" id="ctl00_ContentPlaceHolder1_ctl00_ChartUC1_ImageChart" src="http://www.tradingeconomics.com/charts/cyprus-current-account-to-gdp.png?s=cyppruscurgdp" style="border-width: 0px; color: white;" width="400" /> </div>
Is this all sounding all too familiar? It should be, because what we are seeing is an exaggerated picture of the reality of many economies. I will pick out the key points:<br />
<br />
<ol>
<li>Banking regulators; they fail, fail, fail and fail time and time again when it matters</li>
<li>Policy makers only have limited influence on an economy, and the degree of that influence is often far less than is perceived. The size of the economy in relation to capital markets determines the influence. </li>
<li>Carry trade bubbles are self-reinforcing, and even more so when removed from currency risk </li>
<li>Real estate bubbles are economic weapons of mass destruction, and appear to be primarily derived from carry trade activity</li>
<li>Developing an oversize financial services industry is fatal. </li>
</ol>
With regards to point (2), even though the US economy is huge, we can see the carry trade undermining the policy of the central bank. As fast as new money is pumped into the economy, it leaks out through carry trade activity and creates mayhem in other economies. A long time ago (January, 2010) I discussed 'the <a href="http://cynicuseconomicus.blogspot.co.nz/2010/01/masters-of-universe.html" target="_blank">Masters of the Universe</a>' who suffered the illusion of control over their economies:<br />
<br />
<blockquote class="tr_bq">
What we are seeing is a grand experiment, in which economists and
policymakers are attempting to structure wealth in economies by fiat. As
each lever is pulled, as each policy is enacted, there are ripples
through the world economy. Flooding $US into the markets whilst holding
interest rates low sees the export of $US popping up and creating
bubbles elsewhere. Backstopping the mortgage market sees foreclosures
reduced, but at the risk of calling into question (contributing to
doubts about) the financial viability of the state. Holding the value of
the <span class="blsp-spelling-error" id="SPELLING_ERROR_17">RMB</span>
down leads to greater trade imbalances. Each policy has a consequence,
and each policy interacts with the policy pursued by every other
government.<br /><br />In other words, as each lever is pulled, the
consequences defeat the intention of the lever puller. For example, if
the trade imbalances destroy the economic stability of the destination
of Chinese exports, where will this leave the Chinese economy? The more
each state pulls on the levers, the greater the turbulence between each
of the economies. The world economy is a dynamic system, such that
policy in one country impacts on the economy of another country, which
then reacts with its own policy provisions, which then impact upon other
countries. It is an endless cycle of reactivity, with each reaction
driving further reaction, and developing an increasingly unstable system
as each country enacts ever more dramatic policy to counter or
ameliorate the effects of the policies of other countries.</blockquote>
One of the points that I made all that time ago was that the US crisis that emerged in 2008 was, in part, derived from the Japanese Yen carry trade, which was driven by the Japanese bank printing money. When we look at small economies, such as New Zealand and Cyprus, we can see the policy spill-over from other countries more clearly. Whilst there are some very clear differenced between the two economies, they share a single common characteristic; the policy makers are not in control. Furthermore, it is apparent that, as I long ago suggested, policy makers are resorting to ever more dramatic policies (e.g. QE Infinity in the US), and we will no doubt see this generate even greater instabilities in the global economy, and also in the lever pulling countries. It leaves us with the troubling question of how the global economy might look as these ever more extreme policies generate yet more extreme policy in response? It is a worrying question, but those 'in control' of policy have yet to even recognise their own position in the world economy, let alone think through the answer to this question. <br />
<br />
Note: Thank you Lemming for the comment that prompted this post. Please accept my apologies for not posting, but I have been working 7 days a week again, and could not face more time in front of the computer. I will try to post more regularly, but my work is consuming me at present.<br />
<br />
Note 2: I did think about commenting on the 'haircut' policy, but thought that the question of lack of control was more interesting. I hope you agree. Unknownnoreply@blogger.com12tag:blogger.com,1999:blog-7820485130017459619.post-47218130939983107282013-02-15T19:02:00.004-08:002013-02-15T19:02:56.144-08:00The Minimum WageApologies for not posting for so long. Also, this is going to be one of the shortest posts I think I have written. I occasionally browse the Mises institute, although I am not an Austrian economist (they have some good points, but others are more questionable). This time round, I stumbled on an <a href="http://mises.org/daily/6367/Outlawing-Jobs-The-Minimum-Wage" target="_blank">article</a> on the minimum wage. This key passage was of particular interest:<br />
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<blockquote class="tr_bq">
The advocates of the minimum wage and its periodic boosting reply that
all this is scare talk and that minimum wage rates do not and never have
caused any unemployment. The proper riposte is to raise them one
better; all right, if the minimum wage is such a wonderful anti-poverty
measure, and can have no unemployment-raising effects, why are you such
pikers? Why you are helping the working poor by such piddling amounts?
Why stop at $4.55 an hour? Why not $10 an hour? $100? $1,000?</blockquote>
The logic appears to be simple and very clear. The 'piddling' amounts is because higher amounts would cause unemployment, and the advocates know it! I do not favour the minimum wage as I have always considered it a misguided tool (I will not go into all my reasons now). However, this single passage seems so simple and logical, it is difficult to argue with. Rarely in economics is there such a simple, concise and clearly expressed argument. Does anyone have a counter-argument to this simple logic, as I would be fascinated to hear it? Maybe this is too simple?Unknownnoreply@blogger.com20tag:blogger.com,1999:blog-7820485130017459619.post-1210096169380184222013-01-20T13:55:00.000-08:002013-01-20T14:03:13.474-08:00Another 'automation is bad' argument....I have just stumbled on a new article which is arguing that automation is not a good thing (see ref below and discussion of the article <a href="http://www.boston.com/ideas/2013/01/06/will-robot-take-your-kid-job/343faBBTpGnZJr9MpelRpJ/story.html" target="_blank">here</a>) and this follows my <a href="http://cynicuseconomicus.blogspot.co.nz/2012/12/krugman-new-luddite.html" target="_blank">discussion</a> of Krugman's Luddite point of view some time ago. They discuss robots, but also quite reasonably discuss other forms of substitution for human labour, such as the ability for computers to calculate taxes, and automated toll collection etc. This new article argues that the rise of automation is going to cause an inter-generational wealth gap:<br />
<br />
<blockquote class="tr_bq">
As shown below, in an admittedly highly stylized life-cycle model, the general equilibrium effects of this generational redistribution can transform enhancements in machines into very bad news not just for contemporaneous young generations, but for all future generations. The model treats all young workers as unskilled agents who invest their savings in the acquisition of both skills and machines. When today’s machines get smarter, today’s young workers get poorer and save less. This, in turn, limits their own investment in themselves and in machines. The knock-on effect here is that the economy ends up in all future periods with less human and physical capital, which further depresses the first-period wages of subsequent young generations. Although the skilled wage premium and the return to capital rises, the net impact of smartening up today’s machines is a reduction in the lifetime wellbeing of today’s and tomorrow’s new generations. In short, better machines can spell universal and permanent misery for our progeny unless the government uses generational policy to transform win-lose into win-win.</blockquote>
As a positive in the article, they recognise that the massive increase in labour in places like China and India has been a force that has driven down global wage rates. They also recognise that China is likely to also go down the road of automation, a point I made in my earlier post on the subject. <br />
I can also at least give them credit for the novelty of their approach to the machines are bad argument.<br />
<br />
However, the problem with their argument is very simple. It would apply equally to the <a href="http://en.wikipedia.org/wiki/Luddite" target="_blank">Luddites</a>, if not more. Indeed, today, capital is probably less concentrated than in 19th century England. So why is it that the industrial revolution created the many benefits that we still enjoy today? <br />
<br />
After all, it was not just weaving in the industrial revolution that was impacted by automation, but many industries. In each case of automation, previously skilled work was automated, and also unskilled work, but the result was a revolution that saw long term improvements in standards of living. Modernity is the product of this revolution. The whole point of automation is to drive down costs of production, and this leads to cheaper goods, and cheaper goods means greater affordability, and more goods being available and so forth. Now if we jump back in time to the time of the Luddites, automation was undoubtedly a bad thing for skilled weavers, but also gave cheaper cloth for everyone else. This cloth was made in factories which themselves created a whole raft of new jobs, for example generating employment for skilled and/or semi-skilled engineers, as well as unskilled work in the manufacturers of the machines. As labour was freed as a result of industrialisation, new products could be made and the general stock of products available increased, and the cost of those products fell. In other words, automation destroyed jobs, but also created new jobs, and provided a wider range of products (and services) as lower costs.<br />
<br />
There is no real difference here, except that some of the jobs that are being replaced are white collar. However, the idea that a computer can do complex tax calculations is directly equivalent to a skilled weaver doing complex weaving. The nature of the technology makes no difference, and nor does the status of who is being replaced. Indeed, if we read their introduction, we find this:<br />
<br />
<blockquote class="tr_bq">
But what if the Luddites are now getting it right -- not for labor as a whole, but for unskilled labor whose wages are no longer keeping up with the average? Indeed, what if machines are getting so smart, thanks to their microprocessor brains, that they no longer need unskilled labor to operate?<br />
<br />
Evidence of this is everywhere. Smart machines now collect our highway tolls, check us out at stores, take our blood pressure, <b>massage our backs</b>, give us directions, answer our phones, print our documents, transmit our messages, rock our babies, <b>read our books</b>, turn on our lights, shine our shoes, guard our homes, fly our planes, write our wills, teach our children, kill our enemies, and the list goes on.<br />
<br />
Yes, technology has always been changing. But today’s change is substituting for, not complementing unskilled labor. Yesterday’s horse-drawn coaches were replaced by motorized taxis. But both required a human being with relatively little human-capital investment – a cabbie -- to drive them.<br />
<br />
Tomorrow’s cars will drive themselves, picking us up, dropping us off, and returning home all based on a few keystrokes. This will make cabbies yet another profession of the past. </blockquote>
I have put emphasis on a couple of points. Take the example of the frivolous machine that massages our backs. This is a product which replaces a human masseur. That must be a bad thing, right? However, there is now employment in the manufacture of a new machine, and one which makes having an affordable massage available to more people. Automation has allowed this to be achieved, and for those (unlike me) who value a good cheap massage, their life is improved by this becoming affordable. Or take the idea of machines reading our books. For the blind, this constitutes (I guess) a huge potential improvement in their lives, and again, the development of software and manufacture of computers to do this is a source of employment. Sure, braille producers will eventually go out of business, but would we begrudge the availability of the books for the blind due to this loss of employment. In a recent example, Excel software undoubtedly would have led to less employment for the less skilled account clerks, but also would have created greater demand for those who could interpret accounts. Now, some of that interpretation is automated, and this in turn will reduce the need for skilled interpreters of accounts. In neither case did the employment world fall in as a result. <br />
<br />
The important point is that in the introduction to the paper there is a whole list of new consumer goods and devices that were previously unimagined and that directly <i>or indirectly</i> result from the technology of automation. Who could have imagined a mobile phone 50 years ago (notwithstanding science fiction), but here they are. As technology improves further, other unimagined devices, services and consumer products of all kind will become available, whilst existing products will become cheaper and more widely available. New skills will be in demand. For example, as result of relative affluence in some countries, more people can afford to eat out, and this generates new demand for labour that is skilled, semi-skilled or unskilled. It allows for new leisure pursuits to be developed such as bungi-jumping. All of this is contingent upon the expansion of productive capacity, and automation does exactly this. <br />
<br />
Just as the stock of types of goods increased and cost of goods fell in the industrial revolution, so the same will happen today, as exemplified in the examples the authors give. It really is no different. Where once there were skilled hand loom weavers, there were then other skilled and unskilled jobs that were created in their stead. This net increase in the availability of types of goods and reduction in the cost of producing goods can only be a good thing. However, automation of any kind sees a short term cost to those who are replaced. <br />
<br />
The real difference today is nothing to do with automation, but is to do with something the authors themselves highlighted. There is indeed the question of the supply of labour in the world, and competition is particularly intense between unskilled labour. However, there is also intensifying competition in the middle as countries such as China seek to expand their higher education and increase the supply of graduates. This is nothing to do with automation, and everything to do with the supply of labour. As such, they are correct when they suggest that new Western workers face a challenging future, but are wrong about the reasons. I am genuinely puzzled at the revival of Luddism, and the rather odd justification for it. Is it simply fear of change? Comments welcomed. <br />
<br />
Note: I realised I forgot a key point in the post just after hitting
publish. What the authors are mistaken on is that they see automation as
creating income inequality. What is actually taking place is greater
income equality in which income is being redistributed to places like
India and China, whilst income inequality within countries increases due
to the oversupply of labour overall. Capital wins in a situation of an
oversupply of labour as labour is unable to bargain for a greater share
of profits. It really is very simple. Their claims of greater income inequality only stands up if looking within a country, not if looking between countries. <br />
<br />
<br />
Sachs, J. D. and L. J. Kotlikoff (2012). Smart Machines and Long-Term Misery, National Bureau of Economic Research.<br />
<br />
<br />Unknownnoreply@blogger.com12tag:blogger.com,1999:blog-7820485130017459619.post-25735257055906176962013-01-18T12:49:00.000-08:002013-01-18T12:49:01.682-08:00Reforming Law and Order: Drugs ReformIt seems that it has been a very, very long time since I have posted on the subject of solutions to the UK's current fiscal crisis. My posts on the subject of reform have been mostly well received by readers, but I am not sure that this proposal will please many. However, it is perhaps the most simple reform that I have proposed, and would play a very significant role in cutting the costs of law and order, and would make the UK a significantly safer place as well.<br />
<br />
My proposed reform may have you spluttering in your coffee. It is very simple. It is to legalise all drugs. And I mean all. I was hoping to be able to show you a video called 'Breaking the Taboo' to convince you of many of my arguments, but it has puzzlingly <a href="http://www.huffingtonpost.com/2012/12/07/breaking-the-taboo-video_n_2258632.html" target="_blank">stopped being made freely available</a>, and attempts to watch it describe is as a 'Private Video'. Although the film is focused on the US, the arguments made in the film are far more widely applicable. The film presents a persuasive argument in favour of drugs legalisation, and features some somewhat surprising supporters; Bill Clinton, Jimmy Carter as well as many other senior politicians. The argument is simple, and that is that the 'war on drugs' has long been lost, and the cost of the war is greater than the benefits. It is both a financial and moral cost that is discussed. Wired offers <a href="http://www.wired.co.uk/news/archive/2012-12/07/breaking-the-taboo" target="_blank">a good summary</a> of the film:<br />
<blockquote class="tr_bq">
<i>Breaking the Taboo</i> is straightforwardly honest about
its message from the start -- the war on drugs is futile and
misguided, and it makes people's lives miserable. It makes its
points clearly: the drug war has devastated South American
countries; it has devastated poor communities in the US; it's given
rise to a huge prison-industrial complex in the US; countries that
have approached drugs as a health problem and not a criminal one,
like Portugal, the Czech Republic or the Netherlands, have fewer
problems with organised crime and addiction. It's even narrated by
Morgan Freeman, giving it that warm tone of reliability (Gael
García Bernal narrates the Spanish-language version).<br />
<br />
They're not new points, but then the whole point of <i>Breaking
the Taboo</i> is that it's for people who may not have heard
these counterarguments made so succinctly and matter-of-factly --
that's what the title of the film is referring to, the proposition
that speaking about drugs as anything other than a problem that
needs to be wiped out with force is a taboo topic among much of
mainstream society. It heavily features the 2011 <a href="http://en.wikipedia.org/wiki/Global_Commission_on_Drug_Policy#Reactions_to_report">
Global Commission on Drug Policy</a>, the organisation which
released a report declaring that the war on drugs had "failed",
something made more notable by the number of former high-ranking
public officials it included in its ranks -- including three former
presidents and one former prime minister.</blockquote>
The views expressed in the film mirror many of the views I have held for a long time. For example, the US prohibition of alcohol provides a case study of the impacts of drug prohibition; it launched an organised crime crime wave. <a href="http://en.wikipedia.org/wiki/Al_Capone" target="_blank">Al Capone</a> was not fiction, but fact. This is from <a href="http://en.wikipedia.org/wiki/Prohibition_in_the_United_States" target="_blank">Wikipedia</a> and, although requiring additional citations, the account conforms with more reliable sources I have seen:<br />
<br />
<blockquote class="tr_bq">
Organized crime received a major boost from Prohibition. <a href="http://en.wikipedia.org/wiki/American_Mafia" title="American Mafia">Mafia</a> groups limited their activities to prostitution, gambling, and theft until 1920, when organized <a href="http://en.wikipedia.org/wiki/Rum-running" title="Rum-running">bootlegging</a> manifested in response to the effect of Prohibition.<sup class="reference" id="cite_ref-67"><a href="http://en.wikipedia.org/wiki/Prohibition_in_the_United_States#cite_note-67">[67]</a></sup>
A profitable, often violent, black market for alcohol flourished.
Powerful criminal gangs corrupted law enforcement agencies, leading to <a href="http://en.wikipedia.org/wiki/Racket_%28crime%29" title="Racket (crime)">racketeering</a>. In essence, prohibition provided a financial basis for organized crime to flourish.<sup class="reference" id="cite_ref-68"><a href="http://en.wikipedia.org/wiki/Prohibition_in_the_United_States#cite_note-68">[68]</a></sup><br />
<br />
Rather than reducing crime, Prohibition had transformed the cities
into battlegrounds between opposing bootlegging gangs. In a study of
over 30 major U.S cities during the prohibition years of 1920 and 1921,
the number of crimes increased by 24%. Additionally, theft and
burglaries increased by 9%, homicide by 12.7%, assaults and battery rose
by 13%, drug addiction by 44.6% and police department costs rose by
11.4%. This was largely the result of “black-market violence” as well as
the diverting of law enforcement resources elsewhere. Despite the hope
of the prohibitionist movement that the outlawing of alcohol would
reduce crime, the reality was that the Volstead Act led to higher crime
rates than were experienced prior to prohibition and the establishment
of a black market dominated by criminal organizations.<sup class="reference" id="cite_ref-69"><a href="http://en.wikipedia.org/wiki/Prohibition_in_the_United_States#cite_note-69">[69]</a></sup><br />
<br />
Furthermore, stronger liquor surged in popularity because its potency
made it more profitable to smuggle. To prevent bootleggers from using
industrial ethyl alcohol to produce illegal beverages, the government
ordered the <a href="http://en.wikipedia.org/wiki/Denatured_alcohol" title="Denatured alcohol">poisoning of industrial alcohols</a>.
In response, bootleggers hired chemists who successfully renatured the
alcohol to make it drinkable. As a response, the Treasury Department
required manufacturers to add more deadly poisons, including the
particularly deadly <a class="mw-redirect" href="http://en.wikipedia.org/wiki/Methyl_alcohol" title="Methyl alcohol">methyl alcohol</a>.
New York City medical examiners prominently opposed these policies
because of the danger to human life. As many as 10,000 people died from
drinking denatured alcohol before Prohibition ended.<sup class="reference" id="cite_ref-70"><a href="http://en.wikipedia.org/wiki/Prohibition_in_the_United_States#cite_note-70">[70]</a></sup></blockquote>
The current state of the 'drug war' mirrors the prohibition era, and this is one of the points made in the film 'breaking the taboo'. The cure is doing more harm than the problem. Support for legalisation is appearing from the most unlikely sources; for example, just recently, I found an article in the <a href="http://www.spectator.co.uk/features/8813601/stop-the-drugs-war/" target="_blank">Spectator</a> which argued that the only way to end the horrendous violence engulfing Mexico is to legalise drugs, even making the comparison with the prohibition era. Putting it very simply, prohibition of drugs creates crime, and criminalises large numbers of people who would otherwise likely remain law abiding. As well as the social costs, drug prohibition is very, very expensive. This is a point made in a recent <a href="http://www.tdpf.org.uk/TransformCBApaper.pdf" target="_blank">report</a> by the Transform Drug Policy Foundation (TDPF). <br />
<br />
The TDPF report commences by pointing out that no cost benefit analysis has ever previously been undertaken for legalisation of drugs, and yet assertions have been made as if this were not the case. The upshot of this policy is summarised here:<br />
<br />
<blockquote class="tr_bq">
Despite the billions spent each year on proactive and reactive drug law enforcement, the punitive prohibitionist approach has consistently delivered the opposite of its stated goals. The Government’s own data clearly demonstrates drug supply and availability increasing; use of drugs that cause the most harm increasing; health harms increasing; massive levels of crime created at all scales leading to a crisis in the criminal justice system; and illicit drug profits enriching criminals, fuelling conflict and destabilising producer and transit countries from Mexico to Afghanistan. This is an expensive policy that, in the words of the UN Office on Drugs and Crime, has also created a raft of negative ‘unintended consequences’.</blockquote>
My intention is not to reproduce every point in the report, but there are some examples that I would like to highlight (note, they are conservative on the costs of prohibition, and conservative on the benefits of a legal and regulated market), such as their calculation of savings under four scenarios (p.7):<br />
<br />
<blockquote class="tr_bq">
Scenario A: 50% fall in use, net benefit = £13.943 billion<br />
Scenario B: No change in use, net benefit = £10.834 billion<br />
Scenario C: 50% increase in use, net benefit = £7.724 billion<br />
Scenario D: 100% increase in use, net benefit = £4.616 billion</blockquote>
<br />
These are just for heroine and cocaine legalisation and regulation, and their estimates are indeed very, very conservative (e.g. they exclude costs of the large contribution of the UK government to global enforcement of prohibition). Further, although there are often attempts to suggest that legalisation will increase usage, this is argued without evidence. Indeed, since the Misuse of Drugs Act of 1971, intended to stop the use of drugs, this is the outcome (p.11):<br />
<br />
<div class="separator" style="clear: both; text-align: center;">
<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhdVeiz2nSj4S2hc3vWBWw_gGQrA2m6GMbjWEcQLzIoGXAkQB-t-VRCTyJ7AhKtMITNPyPLY813v7kZPK2rIj7rJEXZvNwTmjoIfDc1ijf_MiwzieoVPVL2KFImKo1Wbo0W4rH5BLQ87GAQ/s1600/Heroine+and+Cocaine+Use.gif" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="242" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhdVeiz2nSj4S2hc3vWBWw_gGQrA2m6GMbjWEcQLzIoGXAkQB-t-VRCTyJ7AhKtMITNPyPLY813v7kZPK2rIj7rJEXZvNwTmjoIfDc1ijf_MiwzieoVPVL2KFImKo1Wbo0W4rH5BLQ87GAQ/s320/Heroine+and+Cocaine+Use.gif" width="320" /></a></div>
<br />
The report makes the point about increased usage very strongly, with this section quoted below just one example:<br />
<br />
<blockquote class="tr_bq">
The proposed deterrent effect is poorly supported by empirical research. The Science and Technology Select Committee report in 2006 on the drug classification system ‘Drug Classification: Making a Hash of it?’60 stated that:<br />
<br />
<i>“We have found no solid evidence to support the existence of a deterrent effect, despite the fact that it appears to underpin the Government’s policy on classification. In view of the importance of drugs policy and the amount spent in enforcing the penalties associated with the classification system, it is highly unsatisfactory that there is so little knowledge about the system’s effectiveness”.</i><br />
The Government rejected this finding and responded with:<br />
<br />
<i>“The Government fundamentally believes that illegality is an important factor when people are considering engaging in risk-taking behaviour. The exposure to criminal sanction, in particular through sentencing, influences perceptions and behaviours. It believes that the illegality of certain drugs, and by association their classification, will impact on drug use choices, by informing the decisions of dealers and users. Imposing penalties on the offence of possession is intended to deter use, particularly experimentation by young people. Whilst the Government accepts that there is an absence of conclusive evidence in relation to the deterrent effect of the existing classification structure, there is some evidence from the Offending, Crime and Justice Survey that the deterrent effect of harsher sentencing was greater among those admitting to the supply of a Class A drug, compared with other offences. The Government will consider ways in which the evidence base in the context of the deterrent effect can be strengthened.”</i>61<br />
<br />
However, in the field of evidence-based policy making what the Government ‘believes’ is neither here nor there, and there is notably no evidence provided to support the ‘belief’ of the system’s effectiveness as a deterrent (it was not made clear which evidence from the Offending, Crime and Justice Survey was being referred to). In the absence of this or any other credible evidence, this ‘belief’ can only remain an untested assumption.</blockquote>
The report accepts that estimating future use under a legalised and regulated scenario is difficult to calculate, for example with different effects and impacts according to the type of drug, and different impacts upon sub-types of population etc. However, although they give the scenarios, they consider the increased usage scenario for heroine as unlikely, and their discussions certainly point in this direction. I will not make my argument here, and will leave their conservative assumptions in place, but I think the most likely outcome would be a significant reduction in use of drugs like heroine, and an increase in the use of drugs like cannabis (used as an alternative to alcohol). Much would depend though on the nature of the regulation for each drug, and I broadly agree with the regulation scenarios they give in the report for each drug type.<br />
<br />
I have to emphasise that the TDPF report is filled with caveats, is restricted to the impacts of just two drugs, but I also have to emphasise that it is <i><b>very</b></i>, <b><i>very</i></b> conservative. I very strongly urge you to read the <a href="http://www.tdpf.org.uk/TransformCBApaper.pdf" target="_blank">report</a> if you have any doubts. Excepting the moral panic and emotive arguments, legalisation of drugs is <i>the single easiest reform that could be made to save significant amounts of government expenditure</i>. However, as the film 'Breaking the Taboo' identifies, drugs policy is hard to separate from rhetoric and moralising. This is the problem of the idea of being 'soft' on drugs. However, the problems of drugs is largely a problem of illegality, rather than a problem of drugs <i>per se</i>. I am sure that many readers will have doubts, and concerns. For these readers, I cannot do justice to all of the arguments in a post, and I would urge you to read the report, and also try to see 'Breaking the Taboo'. It has never been the case that the arguments for legalisation and regulation were not compelling; it is just that, until recently, they were never given wide airing. It has taken 40 years of failure in the 'war on drugs' to finally allow the arguments some traction. <br />
<br />
<br />
Note: If you want to understand the arguments for drugs legalisation in a less weighty format, I strongly recommend Ben Elton's humorous book 'High Society'. Although a comedy novel, he also very clearly presents the arguments in favour of legalisation, which he weaves in amongst the narrative. It may not be a 'serious' book, but the argument made is nevertheless serious.<br />
<br />
Note 2: I changed my mind on discussing my own views on the impact of legalisation and regulation on usage and will give one example of my reasoning, with the case for regulation of heroine by making it available as a prescription. For current addicts, this would see the addicts switching from buying from illegal dealers to obtaining the drug on prescription, which would be cheaper and safer. As a result, the heroine dealers would be put out of business. As such, the availability of heroine to potential new users would be restricted to people who were willing to actively seek a prescription. It seems that someone one day saying to themself that they would like to take heroine is quite unlikely. Even if a person did, for some odd reason, decide to start taking heroine, they would be advised of the risks and addictive nature of the drug before starting.<br />
<br />
By contrast, for anyone who has encountered the world of illegal drugs, the ease of access and the 'culture' of the 'drugs world' is a world apart. It is easy to see how people are exposed to, and eventually try drugs like heroine. For an addict, selling drugs, and actively encouraging new users can help support their own habit through dealing the drug. Under the prescription scenario, I suspect there might be some exceptional and rare cases of existing addicts introducing new users, but this would result in far less new addicts than having people actively encouraging new use, for example by existing addicts who can use new users to pay for their own habit. I suspect that, as addicts recover (and without illegality they would be in the 'system' and availability of help would improve), heroine use would very rapidly decline to a small number of long term addicts.<br />
<br />
Note 3: I welcome comments, but would ask that you try to make yourself familiar with the details of the pro-legalisation arguments before doing so. Unknownnoreply@blogger.com2tag:blogger.com,1999:blog-7820485130017459619.post-90105553162311824062013-01-09T21:30:00.000-08:002013-01-09T21:30:24.531-08:00Bash the Bankers or the State?I don't much go in for the sport of 'banker bashing', as I see the responsibility for the failures in the banking system sitting at the feet of politicians and other policy makers. Notwithstanding this, I have noted two articles, both of which could be said to be of the bashing variety, but which nevertheless capture some of the problems and the ongoing ludicrous situation of the banks being immune from their own failures. The first comes from Matt <a href="http://www.rollingstone.com/politics/news/secret-and-lies-of-the-bailout-20130104" target="_blank">Taibbi </a>in the 'improbable' Rolling Stone magazine. Matt has been railing against the excesses of the banks for a long time. His writing is polemical, includes <i>ad hominems</i>, and a list of other 'sins', but he nevertheless makes some very good points. Somebody needs to. This is in his introduction:<br />
<br />
<blockquote class="tr_bq">
It was all a lie – one of the biggest and most elaborate falsehoods ever
sold to the American people. We were told that the taxpayer was
stepping in – only temporarily, mind you – to prop up the economy and
save the world from financial catastrophe. What we actually ended up
doing was the exact opposite: committing American taxpayers to
permanent, blind support of an ungovernable, unregulatable,
hyperconcentrated new financial system that exacerbates the greed and
inequality that caused the crash, and forces Wall Street banks like
Goldman Sachs and Citigroup to increase risk rather than reduce it. The
result is one of those deals where one wrong decision early on blossoms
into a lush nightmare of unintended consequences. We thought we were
just letting a friend crash at the house for a few days; we ended up
with a family of hillbillies who moved in forever, sleeping nine to a
bed and building a meth lab on the front lawn.</blockquote>
I will not quote endlessly from the article but his introduction sums up the situation, in his unique style, rather well. Regular readers will know that I was firmly opposed to any bailouts at the time of the financial crisis blowing up, and have been firmly against ever since. Of course, the massive scale of the bailouts in the US only became apparent a long time later, thanks to <a href="http://www.bloomberg.com/news/2011-11-28/secret-fed-loans-undisclosed-to-congress-gave-banks-13-billion-in-income.html" target="_blank">Bloomberg's persistence</a> in pursuing the detail of the Federal Reserve's support for the banks, at a grand total of over $7 trillion in guarantees and lending limits. The interesting thing about the Taibbi article is that it puts some of the details of the kind of shenanigans that were taking place, such as how bank executives benefited from the support. Again, I will not detail the article here, but my interest is that Matt seeks to foment outrage, and he is right to do so. The reason I mention Matt's article is that I had it in mind when I read <a href="http://www.businessweek.com/articles/2013-01-08/forget-gratitude-aig-considers-suing-u-dot-s-dot-over-bailout" target="_blank">this</a>:<br />
<br />
<blockquote class="tr_bq">
At the behest of its former chief executive, Maurice Greenberg, <span class="ticker_wrap">AIG (<a class="ticker" data-symbol="AIG" href="http://investing.businessweek.com/research/stocks/snapshot/snapshot.asp?ticker=AIG">AIG</a>)</span> is <a href="http://dealbook.nytimes.com/2013/01/07/rescued-by-a-bailout-a-i-g-may-sue-its-savior/">considering joining a lawsuit</a> filed by its shareholders against the government. On Wednesday, according to the <em>New York Times</em>,
Greenberg, 87, will try to persuade the AIG board that the terms of the
company’s $182 billion government bailout were too onerous, the
interest rates were too high, and ultimately, that AIG shareholders got a
raw deal. What’s that about biting the hand that feeds you?</blockquote>
Since this article, AIG have rapidly <a href="http://www.reuters.com/article/2013/01/09/us-aig-lawsuit-government-idUSBRE9080S720130109" target="_blank">retreated</a> from the lawsuit in the face of general public outrage. The first reason I write this post is that the initial action of AIG is beyond belief, and indicates that they are entirely incompetent.The second reason is a more fundamental concern; they actually must have thought that they could use the law to achieve their ends. This suggests that financial institutions really believe that the law in the US is putty to be toyed with. No sense of a functioning judicial system would give even the slightest inkling that AIG could win, but AIG nevertheless believed they might do so. Such an impression can only come from experience, and this returns to the many points made in Matt's article. The situation is one in which the US government and the federal reserve, and the judicial system seem completely under the influence of the major banks and financial institutions.<br />
<br />
Matt is seeking to foment outrage and I am guessing that, when surveying the world around him, he must be baffled that there is so little outrage. <i>And there is so little</i>. The nearest thing to popular outrage were the sit-in protests whose name I cannot even remember (I did visit one of the sit-in sites, and found that the protesters had nothing coherent to say). Other than this, there seems to be little popular outrage, and I find this odd. It seems that key institutions of state have been, and continue to be, corrupted by these major financial institutions. My belief is that part of the problem has been the focus on the ills on the banks, or 'banker bashing', when the ills are actually to be found in the state institutions that are supporting them. I will even go as far as to say the banks are not to blame. Why, when they have every reason to play the game as they can do, would they do otherwise?<br />
<br />
Yes, there might be some personal ethics that might prevent the banks acting to use the system as they do but that is not the point. Banks, by their nature, are institutions aimed at making money and they will therefore seek to further this interest. There should never have been a state system that allowed their rampant corruption in the first place, and that system is and can only be the responsibility of the state. In summary, just as Matt must look around him with bafflement, I find myself doing the same. <i>Where is the outrage, and demand for reform? </i><br />
<br />
<br />Unknownnoreply@blogger.com1tag:blogger.com,1999:blog-7820485130017459619.post-72198058162554881962012-12-30T14:09:00.000-08:002012-12-30T14:09:02.279-08:00Middle Earth EconomicsAfter so much gloom, I had to pass on this link as follows:<br />
<br />
http://worthwhile.typepad.com/worthwhile_canadian_initi/2012/12/the-macroeco.html<br />
<br />
<br />
Enjoy!Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-7820485130017459619.post-87835509786516071832012-12-29T13:19:00.000-08:002012-12-29T13:38:07.265-08:00The Fiscal CliffIt is hard to ignore the big news of the moment, which is the US fiscal cliff. For those who are not from the US, this is a summary from the <a href="http://www.cbo.gov/publication/43539" target="_blank">Congressional Budget Office (CBO)</a>:<br />
<br />
<blockquote class="tr_bq">
<ul>
<li>A host of significant provisions of the Tax Relief, Unemployment
Insurance Reauthorization, and Job Creation Act of 2010 (Public Law
111-312) are set to expire, including provisions that extended
reductions in tax rates and expansions of tax credits and deductions
originally enacted in 2001, 2003, or 2009. (Provisions designed to limit
the reach of the alternative minimum tax, or AMT, expired on December
31, 2011.)</li>
<li>Sharp reductions in Medicare’s payment rates for physicians’ services are scheduled to take effect.</li>
<li>Automatic
enforcement procedures established by the Budget Control Act of 2011
(P.L. 112-25) to restrain discretionary and mandatory spending are set
to go into effect.</li>
<li>Extensions of emergency unemployment benefits
and a reduction of 2 percentage points in the payroll tax for Social
Security are scheduled to expire. </li>
</ul>
</blockquote>
From the same article, this is the projection of the CBO:<br />
<br />
<blockquote class="tr_bq">
<i>CBO’s Baseline: </i>Taking into account the policy changes listed above and others contained in current law, under CBO’s baseline projections:<br />
<ul>
<li>The
deficit will shrink to an estimated $641 billion in fiscal year 2013
(or 4.0 percent of GDP), almost $500 billion less than the shortfall in
2012.</li>
<li>Such fiscal tightening will lead to economic conditions in
2013 that will probably be considered a recession, with real GDP
declining by 0.5 percent between the fourth quarter of 2012 and the
fourth quarter of 2013 and the unemployment rate rising to about 9
percent in the second half of calendar year 2013.</li>
<li>Because of the
large amount of unused resources in the economy and other factors, the
rate of inflation (as measured by the personal consumption expenditures,
or PCE, price index) will remain low in 2013. In addition, interest
rates on Treasury securities are expected to be very low next year.
</li>
</ul>
</blockquote>
The current situation is summarised <a href="http://www.theaustralian.com.au/news/breaking-news/us-in-frantic-rush-to-avoid-fiscal-cliff/story-fn3dxix6-1226545205803" target="_blank">here</a> (sorry, it's long):<br />
<br />
<blockquote class="tr_bq">
<b>WITH the clock ticking toward a New
Year's time bomb of huge tax increases and spending cuts, US politicians
are working to keep America from tumbling off the so-called fiscal
cliff. </b><br />
<b> </b>
<br />
The stakes in the game of holiday-interrupting brinkmanship are
huge. Economists agree the $US500 billion ($A484 billion) in fiscal pain
due to kick in as soon as the new year starts will stifle the gathering
US economic recovery and send the United States back into recession,
spelling bad news for the global economy as well.<br />
<br />
Aides to leaders
of the Democrat-controlled Senate worked behind closed doors on
Saturday morning to fashion a deal palatable to both Republicans, who
control the House of Representatives, and the Democrats.<br />
<br />
A senior
Republican aide said "discussions are under way". He added that details
of any deal will not come out until leaders brief their caucuses on
Sunday.<br />
<br />
Both chambers would need to pass a deal by New Year's Eve. They thus
have three days to get done what has eluded the White House and Congress
for weeks, and will interrupt their year's end vacation in the process.<br />
<br />
As
negotiations proceeded, President Barack Obama urged Congress to
protect the middle class from higher taxes and lay the groundwork for
economic growth.<br />
<br />
"We've got to do what it takes to protect the
middle class, grow this economy, and move our country forward," Obama
said in his weekly radio and internet address.<br />
<br />
"Leaders in
Congress are working on a way to prevent this tax hike on the middle
class, and I believe we may be able to reach an agreement that can pass
both houses in time," he added.<br />
<br />
Obama met with top congressional
leaders on Friday and said Senate Democrats and Republicans would work
overtime this weekend to try to head off the fiscal cliff.<br />
<br />
The
president, sensing a mandate from his re-election last month, wants to
raise taxes on the rich but exempt the middle class. Republicans want
only to close tax loopholes to raise revenue and demand significant
spending cuts in return.<br />
<br />
But if nothing is done by the deadline, all taxpayers will see an increase.</blockquote>
The first point to note is the 'cliff' metaphor. It frames the spending cuts and tax increases in terms of something scary; falling off a cliff leads to harm. The use of this metaphor is of itself an argument, and and argument that says the tax increases and budget cuts are a bad thing. Framing the changes in this way also becomes an urgent call to action, and that is exactly what is taking place (albeit with no success so far). Another problem with the metaphor is that it is not actually a <a href="http://theweek.com/article/index/237182/would-going-over-the-fiscal-cliff-help-the-us-in-the-long-run" target="_blank">cliff</a>:<br />
<br />
<blockquote class="tr_bq">
For one thing, it isn't really a "cliff." The impact of the tax hikes
and spending cuts will be felt gradually, over several months, so there
will "be plenty of time beyond January 1, 2013 for things to get worked
out."</blockquote>
In short, the term 'cliff' is a distortion of the actuality of the situation. The most worrying aspect of this distortion is that it is driving action, and driving hurried action. Although I am completely in favour of action to reduce the deficit, this is absolutely not the way to take action. Instead, what should be taking place is a more measured look at spending and taxation, and how the activity of government is prioritised and how it might be reformed. This is a question of what constitutes the core functions of government, and elimination of non-core functions. I do not give my view here on what those core functions are, as this is a political question, but it is a question that needs to be answered. Having answered the question of core functions, the functions thus identified have to be given priority, and hard decisions made on the allocation of finite resource to each core function, and how the underlying purpose of the function can be retained, whilst reducing the costs of the function (regular readers will have seen examples I have given for the UK where I have taken this approach, e.g. <a href="http://cynicuseconomicus.blogspot.co.nz/2008/07/reforming-education-market-based.html" target="_blank">here</a>). It is also about what share of the wealth of a country will be given over to the use of the government, and accepting that the government must operate from tax receipts and not use borrowing to dishonestly bribe the electorate with tax breaks <i>now</i> at future cost and provision of services funded with borrowed money at future cost. <br />
<br />
The other point that needs measured examination is the US tax system, which is notoriously complex and unwieldy. Again, the US needs to go back to the core, and ask what taxation is really supposed to achieve. I have <a href="http://cynicuseconomicus.blogspot.co.nz/2008/12/taxes-taxes-and-more-taxes.html" target="_blank">written</a> on the UK tax system, but much of what I have written would certainly apply to the US. In particular, just as in the UK, the US tax system has become a political policy tool, rather than a system for collecting <i>x</i> amount of revenue. All taxation systems are in some respects political, but the politics should be limited to the distribution of the burden of taxation, rather than a political tool used for wider political goals. Although the arguments over the 'cliff' are focused on questions of distribution, the real problems of the current system's complexity and distortions are ignored.<br />
<br />
Indeed, the entire debate over the 'cliff' is one of political grandstanding, rather than any serious attempt to address the real question that needs resolution; how can finite resource be best collected and used in order for government to achieve its core functions? The word 'cliff' is a problem, as it drives urgency that was never there, and plays to the desire for political grandstanding. I want to be clear here, that I believe that there is an absolute necessity to cut the deficit, but this is not the way to do it. It is urgent, but it is not 'fiscal cliff' urgent. All the term fiscal cliff has achieved is to drive out the mature debate that is necessary to enact real reform. This suits the politicians. Rather than take hard decisions, they can bury issues in messy compromises within the current system instead of facing the more fundamental and difficult questions.<br />
<br />
Update: I nearly forgot. Thanks for the paypal donations from several readers, which I am guessing were inspired by Christmas. I would also like to wish all the readers a happy New Year!Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-7820485130017459619.post-10409039338480598362012-12-23T17:24:00.000-08:002012-12-23T17:34:35.773-08:00False Assumption, Ponzi, and the Developed WorldWe are now heading towards 2013, and it very, very striking that the world is still mired in an economic crisis. It is very easy for people to be caught up in the 'events' that comprise the daily news stories in the media; the events appear as more real than the abstractions that are the explanations that sit under the events. The explanations of 'events' is 'events'. Thus we have an event such as a government announcement A, leading to event B. It is wonderfully tempting and seductive to take this view, as the correlations between events can be easily determined, easily seen, and easily explained. However, the event A does not take place in a vacuum, and the event B that follows likewise does not take place in a vacuum. Instead, what is really happening is the events sit in a messy context of broader drivers, the beliefs and perceptions of innumerable actors, contesting interests, and sometimes just plain irrationality.<br />
<br />
For example, take the belief that seems to be common in the developed world that relatively high levels of wealth are a given, a natural state of affairs. Would anyone contest that this belief is firmly entrenched? Whilst some might argue about the distribution of the wealth, for example arguing that true wealth should see more even distribution, they would still proceed from an assumption that there is and will be a relatively high level of wealth for distribution. I have now been blogging for several years, and have been thinking about economics for longer, and have not found any examples which do not proceed from an assumption that the developed world should just somehow be more wealthy. Even when articles bemoan the rise of China, they do so on the basis that, somehow, it is a natural place/position/state of affairs that the developed country should, well...... just be more wealthy.<br />
<br />
The articles that worry about the sliding position of the developed world are the most interesting. They have a sense that 'something must be done', and often they will offer their policy prescriptions to fix the problem. It does not matter whether the author is left or right leaning, the aim is to maintain the relatively high levels of wealth in the country under discussion. With the right tweak of policy here, tweak there, all will be fixed. They assume that the natural position of relative wealth might be maintained, if only we could just do x, y or z.<br />
<br />
Most of the readers of this blog seem to be well informed about economics. As such, I ask you to think about the many articles you read, and the assumptions that underpin them. You will find an assumption that the developed world not only is naturally more wealthy than the rest of the world, but also <b><i>should</i></b> be more wealthy than the rest of the world. There are some exceptions, in particular on the left, that the developed world is somehow sinful for being wealthier, and that the developed world should <i>actively</i> redistribute its wealth to the poorer parts of the world. Even here, we see an assumption of natural wealth.<br />
<br />
The problems with the assumption of natural wealth, and that the developed world should be more wealthy is that it is just that; an assumption. It is treated like a natural force, and a right that is dictated by some kind of natural law. The problems is that there is no natural law, and no right that can be supported or defended in any way whatsoever. When a less well developed country pulls itself up by its metaphorical boot straps, sees rapid economic development, and contests for a position in the top tier of wealthy countries, there is no natural force that might stop them, or reverse the ascent. Instead, there are the complexities of the trillions of individual purchase decisions, the choices of individuals in economic entities such as firms, regulators, and policy makers.These are the real forces at work in economics, rather than some unseen and non-existent forces and rights.<br />
<br />
I too have been guilty of the assumption that the developed world should be more wealthy. Like many others, I have argued that the developed world should act to defend its position as 'wealthy', including offering my own solutions. In some respects it is wrong-headed. There is no real reason why any particular country should be more wealthy than its neighbours, if the people of each country are equally as hard working and innovative. It seems that, in this situation, there can be no justification for one country being wealthier than another. There are, of course, situations where a particular country is just blessed, as in the examples of the oil resources available to countries in the Middle East. Putting it crudely, they just do not have to work as hard as others. Resenting such good fortune is, of course, pointless and sometimes such blessings also turn out to be a curse.<br />
<br />
However, the world is not so simple as I paint it here. It assumes a world of competition between economic entities, based upon hard work and innovation. However, there is another competition at work, and that is the competition of systems; systems of how society is ordered. At one extreme we have what might be described as a something like a fascist state; China. All ideas that are imported into the country are subject to 'sinification', so China's system is uniquely Chinese. I use the word fascist therefore in a very loose way as the nearest equivalent. It would then be tempting to say that, on the other side, we have liberal, democratic and free market countries of the developed world. It would be a neat narrative of black versus white, but it does not hold. <br />
<br />
However, the latter categorization is nevertheless partially true. With differing degrees of dysfunction, the developed world is democratic, and to different degrees 'liberal'. I say dysfunctional, because democracy is not working well. The system is failing. There are certain types of dysfunction that I will put to one side here, such as the shocking amount of money that is necessary to compete for the US presidency (albeit that such problems also relate to my area of concern). My concern is rather with the dysfunction of the electorate.<br />
<br />
A significant economic challenge has developed, and that challenge is very real. We have seen a significant shift in the economic structure of the world. It has been assumed that what we are witnessing is a game of 'catch-up', in which countries such as China are seeking to chase after the on-going growth of wealth in the developed world. The idea that 'surpass' might take place is only in aggregate, not at the level of individual wealth. However, the developed world is not growing in wealth, but seeing a diminishment of wealth. The developed world is on a down escalator, even whilst the developing world is on the up escalator. As I have pointed out recently, those on the up escalator now face their own problems, but to assume that they will not continue upwards and the developed world downwards would be complacent.<br />
<br />
It is here that I return to the dysfunction of the electorate and the question of liberal democratic and free market. In the developed world, the electorate have been seduced by the idea of the natural right to wealth in their own country. They know that there are now challengers to their position of wealth. They cannot avoid seeing this reality. Even those with the most passing interest in economics will be aware that the world has changed. Faced with the challenges of a new economic structure, instead of facing the new competition, electorates have <i>demanded</i> that the world remains unchanged. However, demanding that the world remains unchanged does not make the world unchanged. All that has happened in response to this demand, is that the politicians have responded to the demand by developing a pretense that the world is unchanged. Happy days are just around the corner. But the corner continues to be elusive. So what is the pretense?<br />
<br />
The pretense is that we still operate in a world of free markets and that the world has not changed. Of course, it has never been the case that markets have ever been truly free, so we are talking about degrees of freedom. The point is that, since the economic crisis came into view, the marketplace has come to be dominated not by market signals, but monetary and fiscal policy of governments. Governments have always had a role in the marketplace, but underlying market signals could still (mostly) be discerned from the noise created by government. This is no longer true. More pertinently, it is now being recognised, even in conservative organisations like the Boston Consulting Group, that current policy is <a href="https://www.bcgperspectives.com/content/articles/management_two_speed_economy_ending_the_era_of_ponzi_finance/#chapter1" target="_blank">simply impossible to sustain</a>. They are blunt; they call current policy in the developed world a 'ponzi scheme'. This is just one extract from the report, and the content will be no surprise to regular readers of this blog:<br />
<br />
<blockquote class="tr_bq">
<b>Intensifying International Competition and Rising Inequality.</b>
Globalization has brought the promise of economic prosperity to
billions of people around the world. But it has also contributed to
tougher international competition and the creation of new inequalities
of wealth and income in the developed world. The growth in the global
labor force continues to put pressure on labor costs in developed
economies. At the same time, globalization is leading to increasing
inequalities in income and wealth within countries, as some groups (such
as investors) benefit more from increased globalization than others
(such as manufacturing workers).<br />
<br />
Income statistics highlight this
development: between 1979 and 2007, the income of the average U.S.
household grew by 62 percent. Over the same period, the income of the
top 1 percent of households grew by an extraordinary 275 percent and the
income of the rest of the top 20 percent grew by a slightly
above-average 65 percent, while the income of the remaining U.S.
households grew by less than 40 percent. The incomes of the lowest
quintile <a class="Overlay" href="http://www.blogger.com/blogger.g?blogID=7820485130017459619" rel="hoverId-2032854014" style="font-size: 1em; line-height: 18px;" title="">grew by only 18 percent</a>.<br />
<br />
Inequality
increases the risk of social unrest and declining support for
capitalism and a free society. As University of Chicago economist and
former IMF chief economist <a class="Overlay" href="http://www.blogger.com/blogger.g?blogID=7820485130017459619" rel="hoverId779192554" style="font-size: 1em; line-height: 18px;" title="">Raghuram Rajan points out</a>,
“Ultimately, a capitalist system that does not enjoy popular support
loses any vestige of either democracy or free enterprise.”</blockquote>
In the last passage, they capture the problem of democracy, and why it is that the response of governments is to pander to demands. All of the new workers who have entered the global workforce are not going to go away. The advantage of capital over labour will not disappear for a long time. This is the reality and no amount of propping up of demand, printing of money or borrow and spend will make this reality disappear. <i>Demanding</i> a standard of living will not make it so. <br />
<br />
When starting this blog, I was largely a lone voice. The economic crisis was called a financial crisis, with a suggestion that, with bailouts, and some largess from central banks, the problems would disappear. They have not. They have simply been magnified. I argued for the idea that the world had entered a world of 'hyper-competition' and that is still where we stand. I am no longer a lone voice in this, and the BCG report is just one of the more 'conventional' sources that has finally recognised the changes that have taken place. The problem was not, as I have always argued, some isolated financial crisis, but a shocking change to the world economy - to the very structure of the world economy. Globalization was more than a word, but was a description of an accelerating revolution. On my bookshelf, I have a long unopened book on globalization; even when I read it several years ago, it appeared fanciful and arrogant. It now seems positively quaint. So here we are now in a world of hyper-competition. I will highlight a quote from the BCG report:<br />
<br />
<blockquote class="tr_bq">
Fortunately, there is still time to act. But leaders from all social
sectors—government, business, organized labor, environmental and other
stakeholder groups—need to act decisively and quickly in order to secure
future economic prosperity, social cohesion, and political stability.
It is in the nature of Ponzi schemes to collapse suddenly, without
warning. No one knows what event may send the developed world and the
global economy as a whole back into crisis.</blockquote>
They get what I did not get when I first started writing this blog. The absurdity of a ponzi scheme continues till it doesn't. The magic of a ponzi scheme is that they can sustain themselves for so long, before the weight of the fraud finally topples them. I thought that people would see through it much earlier because, in reality, it has always been in plain sight. People just had to choose to see it. And that is the problem. When confronted with reality, we (the electorates, the policy makers, the economists, the politicians) choose to look away. A while ago, I saw a film about the Madoff ponzi scheme (sorry, I forget the name), and the most striking point in the film was the stubborn refusal to see what was in plain sight. It is the same situation in the developed world economies. After all, it can run a little longer, and we will be ok, won't we? <br />
<br />
Note: I did think about posting this after Christmas. It is not full of festive spirit, after all. However, when is the best time for bad news? I am not sure. So, I end here by wishing that you all enjoy Christmas, and only give thought to economics after enjoying Christmas with your families. On Christmas day, I will raise a glass of appreciation to all the regular readers of the blog, as it your interest that keeps me posting. Thank you, and have a great Christmas. <br />
<b><b><b><br /></b></b></b>
<b><b></b> </b><br />
<br />
<br />
<br />
<br />Unknownnoreply@blogger.com19tag:blogger.com,1999:blog-7820485130017459619.post-30557563808974328432012-12-15T12:59:00.000-08:002012-12-15T12:59:17.550-08:00The RMB as a Reserve Currency: Breaking Habits of ThoughtThe economic power and influence of China continues to grow. In September, 2009, I <a href="http://cynicuseconomicus.blogspot.co.nz/2009/09/china-and-treasuries-puzzle.html" target="_blank">wrote</a> the following:<br />
<br />
<blockquote class="tr_bq">
The last line of reasoning I considered appears to be the most probable.
It is simply that China's wealth is indeed denominated in the $US, and
they are just doing enough to hold the $US from <span class="blsp-spelling-corrected" id="SPELLING_ERROR_5">free fall</span>.
The reason is that this allows them time to use the $US, which they are
still accumulating in large quantities, to prepare themselves for the
post-$US world. Returning to the <a href="http://cynicuseconomicus.blogspot.com/2009/03/china-gold-and-us.html">speculative post</a>
in which I imagined what I might do if I were China, I suggested that
they would also diversify their holdings into commodities (in particular
gold), other currencies, and would continue and accelerate their
purchase and control of commodity/resource companies.</blockquote>
Some quotes from a recent article from <a href="http://www.afp.com/en/news/topstories/chinas-accelerating-overseas-buys-raise-fears" target="_blank">AFP</a>:<br />
<br />
<blockquote class="tr_bq">
Chinese firms have become more active in mergers and acquisitions since
the global financial crisis that began in 2008, as economic distress has
thrown up bargains around the world.<br />
<br />
[and]<br />
<br />
Between 2005 and 2011, the number of China's overseas acquisitions
tripled to 177 and jumped five-fold by value to $63 billion, according
to law firm Squire Sanders and intelligence service Mergermarket.<br />
<br />
[and]<br />
<br />
But academics said more was at work than commerce, as China seeks
growing stature and competes with other countries for resources. </blockquote>
If you can cast your mind back to 2007, how did you think of China? The AFP reports on the unease being felt by China's growing influence. If jumping back in time to 2007, if somebody had suggested that China would be this influential, would you have taken them seriously? Whilst China was seen as important, the idea that China would be causing this kind of unease would have been dismissed as fanciful. Another point that I long ago made, at about the same time as discussing China's potential shopping spree, was that China would seek to displace the $US as a reserve currency, and develop the RMB as a potential replacement. This from April 2009:<br />
<blockquote class="tr_bq">
I have a very curious sense at the moment of the world moving in slow
motion. I had thought that the economic crisis would create dramatic
moments, but in some respects it appears to be moving through a gradual
shift.<br /><br />One of the predictions that I have made, on two occasions,
is the collapse of the $US and the end of the reserve status of the
$US. However, it appears that the end of reserve status is being
achieved with little drama, as it is apparent that the <span class="blsp-spelling-error" id="SPELLING_ERROR_0">RMB</span> is slowly but surely being positioned as a replacement of the $US as the reserve currency. We have this latest news from the <a href="http://www.chinadaily.com.cn/china/2009-04/09/content_7660017.htm">China Daily</a>:<br />
<blockquote>
Five
major trading cities have got the nod from the central government to
use the yuan in overseas trade settlement - seen as one more step in
China's recent moves to expand the use of its currency globally.</blockquote>
</blockquote>
From these modest beginnings, the process of moving the RMB to reserve status has continued, and I have occasionally given examples in my posts. This is <a href="http://www.marketoracle.co.uk/Article37892.html" target="_blank">recent development</a>:<br />
<br />
<blockquote class="tr_bq">
Cracks are beginning to appear; the latest sign is that China and South
Korea have come to an agreement in which banks from either country are
able to borrow funds from a swap line that makes loans available to
companies for deals in local currencies. (Source: “China, South Korea to
Boost use of Local Currencies in Trade,” Bloomberg, December 4, 2012.) </blockquote>
<br />
This is analysis from <a href="http://www.reuters.com/article/2012/10/03/us-economy-global-currencies-idUSBRE8920Q820121003" target="_blank">Reuters</a>:<br />
<br />
<blockquote class="tr_bq">
<span id="articleText"></span><br />
Fed up with what it sees as Washington's
malign neglect of the dollar, China is busily promoting the cross-border
use of its own currency, the yuan, also known as the renminbi, in trade
and investment.<br />
<span id="midArticle_3"></span>The aim is both
narrowly commercial - to reduce transaction costs for Chinese exporters
and importers - and sweepingly strategic.<br />
<br />
<span id="midArticle_4"></span>Displacing
the dollar, Beijing says, will reduce volatility in oil and commodity
prices and belatedly erode the ‘exorbitant privilege' the United States
enjoys as the issuer of the reserve currency at the heart of a post-war
international financial architecture it now sees as hopelessly outmoded.<br />
<br />
<span id="midArticle_5"></span>Zha
Xiaogang, a researcher at the Shanghai Institutes for International
Studies, said Beijing wants to see a better-balanced international
monetary system consisting of at least the dollar, euro and yuan and
perhaps other <a href="http://www.reuters.com/finance/currency" title="Full coverage of currencies">currencies</a> such as the yen and the Indian rupee.<br />
</blockquote>
However, I would not want to give a false impression that everyone thinks that the RMB as a reserve currency is likely. For example, this rather curious <a href="http://www.forbes.com/sites/greatspeculations/2012/04/18/chinese-renminbi-no-reserve-currency-yet/" target="_blank">article</a> from Forbes gives a consideration of the many ways in which the RMB's status is accelerating before then oddly concluding:<br />
<blockquote class="tr_bq">
Does all this mean China is about to overtake the dollar as the world’s
reserve currency? Not anytime soon. A reserve currency, in our view,
requires deep and credible government bond markets, an open capital
account and critical mass in global financial systems. China’s central
bank has laid out a 10-year plan for “internationalization” of its
currency. China’s FX bands are widening, but in an incredibly cautious
way. Dollar holders need not panic. </blockquote>
Indeed, most articles, including the Reuters one quoted earlier, give caveats, express doubts etc. It is all rather odd, as the expansion of the international role of the RMB is an actuality. Indeed, as long as I have been tracking this steady expansion, the same things are said with each new step, and always that reserve status is something for the distant future. There is a growing conflict between what is taking place, and the analysis of what is taking place. This is a habit of thought and I made the point in an <a href="http://www.tfreview.com/feature/regions/last-word-shanghai-surprise" target="_blank">article</a> for Trade and Forfaiting Review in November 2009:<br />
<br />
<blockquote class="tr_bq">
Imagine a world in which there was no international reserve currency,
but that an organisation was proposing that the US dollar ought to be
the future reserve currency. Would you take such a proposal seriously?<br />
<br />
Your response might be that the US dollar sits atop mountains of
debt, a shrinking economy and you would point out that the US monetary
authorities are printing money to fund record government borrowing. You
might actually laugh at such a prospect.<br />
<br />
On the other hand, how would you view the Chinese renminbi? You might
point out that China holds large reserves of other currencies, the
renminbi rests on top of a massive current-account surplus, China’s
economy is growing and that the prospects for future growth are all
positive. Furthermore, China is a country of savers, with a small fiscal
deficit and is an export machine selling goods around the world,
ensuring an ongoing utility for the currency in trade. </blockquote>
I do not have a copy of the full article to hand, but recall that I argued something along the lines of the $US as a reserve currency was a habit of thought, rather than a rational assessment. Time has moved along since I wrote the TFR article, and time has supported my case, and still there is a sense that it just isn't possible, even though the step-by-step expansion of the RMB into a reserve currency progresses forwards.<br />
<br />
However, at this stage, I am <i>not so certain</i> that the RMB will be the major reserve currency, but not for the reasons that are generally given (e.g. deep bond markets). As regular readers will be aware, I am increasingly cautious about the overall position of the Chinese economy. I am not entirely convinced that China can sustain its economic miracle and, as ever, see political risk in any major slowdown in the growth of the Chinese economy.<br />
<br />
Nevertheless, if China does manage to continue its growth, then the indications are that it will continue to chip away at the reserve status of the $US. Returning to the start of the post, the influence of China continues to expand, as the Chinese state
encourages firms to seek out and purchase access to resources, and also
expand internationally. It is but one example of the astonishing growth in China's economic heft. That influence is being felt throughout the world, and the influence just further enhances China's credibility as a 'major player', and that, in turn, enhances the credibility of the RMB as a reserve currency. Set against this, the economic policy of the US can only continue to erode the influence of the $US. The <a href="http://www.marketoracle.co.uk/Article37892.html" target="_blank">following</a> is a commentary on the $US and the challenge of the RMB:<br />
<br />
<blockquote class="tr_bq">
Rome in its day held the reserve currency of the world, and how the
mighty have fallen. Unless real changes are made, we might be witnessing
the beginning of such a shift here. The rising U.S. debt levels are
raising questions by many countries around the world as to the
legitimacy and viability of the U.S. dollar as the reserve currency.</blockquote>
<blockquote class="tr_bq">
Politicians in Washington must wake up to the realization that the
U.S. dollar’s status as a reserve currency is not written in stone. The
financial markets are currently more dynamic and fluid than ever before.
It takes only the click of a mouse to move money around the world.</blockquote>
<blockquote class="tr_bq">
Unless America gets its fiscal house in order, I believe we will see
more agreements, such as this one with China and South Korea, which will
avoid the U.S. dollar and increase the continuing questions about the
viability of its reserve currency status.</blockquote>
The author has a point. After all, if the $US was not already the reserve currency, would you pick it out as a new reserve currency? I think that this unlikely, but perhaps you would disagree? <br />
Unknownnoreply@blogger.com3tag:blogger.com,1999:blog-7820485130017459619.post-30345732627524587352012-12-10T01:15:00.002-08:002012-12-10T01:15:41.419-08:00Krugman: The New LudditeI know, I post too often on Krugman's musings in the New York Times. However, I could not resist the later <a href="http://krugman.blogs.nytimes.com/2012/12/08/rise-of-the-robots/" target="_blank">missive</a> from Krugman regarding automation (robots, and I presume he also means software that automates tasks currently performed by humans, but that is a guess): <br />
<blockquote class="tr_bq">
If this is the wave of the future, it makes nonsense of just about
all the conventional wisdom on reducing inequality. Better education
won’t do much to reduce inequality if the big rewards simply go to those
with the most assets. Creating an “opportunity society”, or whatever it
is the likes of Paul Ryan etc. are selling this week, won’t do much if
the most important asset you can have in life is, well, lots of assets
inherited from your parents. And so on.<br />
<br />
I think our eyes have been
averted from the capital/labor dimension of inequality, for several
reasons. It didn’t seem crucial back in the 1990s, and not enough people
(me included!) have looked up to notice that things have changed. It
has echoes of old-fashioned Marxism — which shouldn’t be a reason to
ignore facts, but too often is. And it has really uncomfortable
implications.<br />
<br />
But I think we’d better start paying attention to those implications.</blockquote>
Welcome to the new Luddite approach to the improvement of the human condition. The robots will move wealth to the holders of capital from the workers.....and that is bad for us all. And what, might I ask, does he think happened in the industrial revolution? The hand loom weavers were put out of business due to automation. It was one of the heralds of the greatest changes in the history of mankind, and one from which we all now benefit. The industrial revolution was, in some respects, a painful process, but also served to create the potential for the huge benefits that we now enjoy.<br />
<br />
In the modern and developed world, the adjustment to this new source of productivity should be less painful, albeit that the transition will not be easy either. However, unlike the industrial revolution, we are not transitioning from a system that was for many people barely above subsistence. Today, we are not barely above subsistence, but that is not to say that the transition will not be hard for some people. If you have spent years learning to do something like a search for legal precedents, the automation of this process will be a hard blow. However, for all of this pain, automation will have positive benefits alongside of these costs. In the case of legal services, access to the support of the law will be more affordable to those who would otherwise struggle to have access to the services, and that may matter a lot to many people. It is no different to the access to relatively cheap cloth that will have made new clothes more affordable to poorer people; at a cost to the hand loom weavers in the short term. <br />Just as the spinning jenny benefited the capitalists, the providers of automated legal searches will benefit the owners of law firms who adopt the technologies that are now available. <br />
<br />
The examples of automation creating wider economic benefits are so many that it is difficult to know where to start. The end of canals in the face of the competition from more efficient trains (which created a boom and bust that left the UK with a railway system paid in full by the loss of the capital owners), the redundancy of the typing pool with the advent of the PC and so forth. In all these cases, automation has the result of getting more from less labour, and that means more 'stuff' per unit of employed labour, even in the case of the indirect effect of removing the typing pool. As fast as labour is being removed, more output is being created per worker, meaning that more 'stuff' is available per worker. With greater output of stuff per unit of labour, labour is freed to do new things. It is, just as happened in the industrial revolution, a situation in which new jobs arise to replace the old jobs, as people find new stuff to produce, as the emerging surplus of labour is absorbed in producing 'stuff' that was previously only afforded by the few. It is the process which generates greater wealth. <br />
<br />
One wonders, when Krugman says that there are 'uncomfortable implications' and suggest that those implications 'need attention', what exactly he might mean? Does he mean that we should halt the current process of automation, perhaps smash the robots? I mean really, what does he mean? He leaves his article vague and open, hinting at ominous consequences. However, those consequences have precedents that (for once in economics) are clear. We see the result of the precedents all around us in the developed world; more than enough food, better health, heated and comfortable homes, our many forms of entertainments, our freedom to access information, and so the list goes on. <br />
<br />
Think of the example of the impact of the PC on the typing pool. It saw what was a hard earned skill eventually made redundant (however, I taught myself touch typing, so not entirely redundant, but I do not need the level of skill of the typing pool where there is no 'backspace'). Should we have looked at the 'uncomfortable implications' of this shift? For a typist, it was undoubtedly not a good situation. However, would we turn back the clock, and stop this change if we could? We could certainly reverse the change, by making word processing software illegal, and blocking any web services that might offer a similar facility. In a few year time, with the magic of backspace button gone, we would have huge numbers employed in typing pools. Those same individuals will be drawn from the labour force, and will be an opportunity cost; the opportunity to do something else which is genuinely in more demand.<br />
<br />
What we are discussing here is nothing more than a variant of the broken window fallacy; that breaking a window is a good thing as it creates employment. In breaking the window as a deliberate act, it creates employment, but employment with no real point. Better that the people employed in repairing the window are engaged in productive labour with a genuine demand, rather than an artificial 'created' demand. In the same way, better people are employed in new avenues than artificially supporting, or creating, employment through the rejection of more efficient means of engaging the same labour. It is a make-work scheme where there is no need for the work. Better that the labour is employed in creating real value.<br />
<br />
If ever there were evidence that Krugman has nothing to offer, this rather odd article is the evidence. It is no wonder that he leaves the 'implications' and solutions unsaid. If he were to say clearly what his article implies, he would be ripped to pieces. It is, as the title of this post implies, nothing more than a disingenous revival of Luddism. Krugman hides in ambiguity, but the 'implications' are clear; break the machine to save the interest of labour. He cannot see that, painful as the adjustment might be, labour is also the recipient of the benefits of automation.<br />
<br />
Further, Krugman writes from a US perspective, and the potential benefits to the US worker are obvious; the cost of labour differential is diminished through automation. Maybe the labour will no longer be the crude repetitive labour of yesteryear, but all those 'on-shored' factories that benefit from automation will nevertheless create new employment opportunities. There may, in other words, be losers from automation, but there will be many more winners; and the win will keep on delivering, just as the industrial revolution today reverberates to the benefit of all in our day-to-day lives. <br />
<br />Unknownnoreply@blogger.com14tag:blogger.com,1999:blog-7820485130017459619.post-53852496766143726332012-12-06T18:56:00.000-08:002012-12-06T18:56:15.513-08:00The UK Mid Year Budget StatementThe mid-year budget statement has prompted concerns about the UK economy. It is a classic case of 'incrementalism' and fiddling. For example, see here for <a href="http://www.telegraph.co.uk/finance/budget/9728298/Autumn-Statement-Osborne-attacked-over-Mummy-Tax.html" target="_blank">benefits</a> reform and the silliness of framing the limited reform with the discussion of 'Mummy Tax'.<br />
<br />
This is gloomy pre-statement commentary from <a href="http://www.telegraph.co.uk/finance/comment/9722044/Autumn-statement-Why-George-Osbornes-Budget-wont-be-a-game-changer.html" target="_blank">Alexander Heath</a> in the Telegraph:<br />
<br />
<div class="secondPar">
<blockquote class="tr_bq">
Psychologists call this cognitive dissonance; unkind folk would see it as
plain cowardice. What is clear is that such self-deception has reached
epidemic proportions when it comes to the economy, and has contaminated all
major political parties as well as many professional forecasters.<br />
</blockquote>
<blockquote class="tr_bq">
In the absence of shock and awe supply-side and tax reforms, which are not on
the cards, our long-term growth prospects are bleak. George Osborne’s
greatest problem, as he prepares to deliver the <a href="http://www.telegraph.co.uk/finance/budget/?source=refresh">Autumn
Statement</a>, is that the British economy is stuck in a rut.
</blockquote>
</div>
He has grasped something of the reality. In the UK, we are now starting to see something of the negative spiral that follows in the wake of attempts to incrementally cut government borrowing growth in the face of an economy that is structured around servicing the growth in borrowing (sorry, for the convoluted sentence). However, this from the <a href="http://online.wsj.com/article/SB10001424127887324640104578160911203700522.html" target="_blank">WSJ</a>:<br />
<br />
<blockquote class="tr_bq">
The U.K Treasury painted a grim economic picture, acknowledging that
growth was weaker than the government expected and that a tough
austerity plan would drag on longer than planned.<br />
<br />
Treasury chief George Osborne, who presented his closely watched
twice-yearly economic update Wednesday, delivered a triple whammy of bad
news. He conceded the economic recovery was taking longer than
expected; that he would likely fail to meet a key self-imposed debt
goal; and that government cost cutting would continue until 2018, three
years longer than initially planned. At that point, the U.K. will have
experienced eight straight years of austerity.<br />
<br />
Mr. Osborne and the Conservative-led coalition government is halfway
through its five-year term. Having come to office promising to fix
Britain's weak economy, Mr. Osborne is under immense pressure to
demonstrate that his strategy is working ahead of the next general
election, due 2015. </blockquote>
Except for the misuse of austerity, it is a reasonable summary. The pressure is no doubt building to get the money <a href="http://uk.reuters.com/article/2012/12/05/markets-sterling-close-idUKL5E8N57VF20121205" target="_blank">printing presses running again</a>:<br />
<blockquote class="tr_bq">
Sterling edged up from one-month
lows against the euro on Wednesday after a gloomy UK budget
statement which traders said was in line with expectations.<br />
<br />
<span id="midArticle_5"></span>But forecasts from finance minister George Osborne that
Britain would miss its debt-reduction and growth targets left
the currency looking vulnerable.<br />
<br />
<span id="midArticle_6"></span>Analysts said the poor UK economic outlook might revive
prospects of more monetary easing by the Bank of England and
increase the risk of a credit agency cutting the UK's top-notch
rating, both of which would be negative for sterling.</blockquote>
The OBR is taking a negative view, saying that:<br />
<blockquote class="tr_bq">
<br />
The independent Office for Budget Responsibility predicted the UK
economy would shrink slightly this year and grow less over the next four
years than it had forecast in March. Robert Chote, chair of the
watchdog, said: "What's striking is the weakness of the recovery over an
extended period of time."</blockquote>
I hope that, for regular readers of this blog, that the 'weakness of the recovery' is in fact unsurprising, and that they already realised that the UK economy has only now just <i>started</i> an unavoidable process of shrinkage i.e. any economy which is structured around servicing debt growth cannot shrink the debt growth without negative consequence. Worryingly, the current state of affairs is leading to threats to the <a href="http://edition.cnn.com/2012/12/06/business/uk-rating-threat/" target="_blank">UK credit rating</a>:<br />
<br />
<blockquote class="tr_bq">
The chancellor's statement did nothing to dispel fears that the UK could
be stripped of its triple A credit rating. Both Moody's and Fitch, two
of the three major rating agencies, put negative outlooks on the UK's
rating this year.</blockquote>
Whilst the ratings agencies are generally hopeless, they are still important. They make a major difference due to their role in banking regulation and their pronouncements have real impacts. I seem to recall that George Osborne placed the credit rating of the UK as one of the drivers for his policy, so any significant downgrade would certainly add to the pressure now being placed upon the government. This is <a href="http://www.businessweek.com/articles/2012-12-06/bloomberg-view-why-austerity-in-britain-has-run-its-course" target="_blank">Bloomberg's view</a> on the mid-year budget statement:<br />
<br />
<blockquote class="tr_bq">
In lieu of real change, he proposed a set of well-intentioned but
ultimately insignificant policies, restricted by the need to make the
package as a whole fiscally neutral. Osborne did not need to be this
cautious.<br />
<br />
The chancellor did act to redirect government money in a
few ways likely to produce growth. He said he’d reduce the nominal rate
of corporation taxes to 21 percent from 24 percent in 2014 (compared
with 35 percent in the U.S.). He also increased by a factor of 10 the
amount of capital investment that U.K. companies can make exempt from
taxes each year, to £250,000 ($402,300) from £25,000.<br />
<br />
Osborne
scraped together £5 billion to spend on schools, transportation, and
flood defenses. He also set up a body to eliminate the regulatory
gridlock that’s blocking development of shale gas in the U.K. and
promised tax breaks for exploration, ahead of a new policy aimed at
increasing Britain’s production and use of natural gas. These are all
intelligent ideas that may boost construction and employment in the near
term, and growth in the longer term.</blockquote>
I am inclined to agree that there was no real change, but suspect that, <b><i>if</i></b> shale gas lives up to its promise, then this will have <i>very significant impacts</i> through the potential to lower energy costs; a factor in living standards but most importantly in the cost of manufacturing. However, this will not really have any major impact for several years, and before it will be a positive contributor to a more competitive economy and better living standards. In the short term, there may be a small impact through increased investment, with the activity that follows from this, but it will not be enough to significantly lift the economy. As such, although a positive, it does little to address the problems in the short term.<br />
<br />
Nor will the rest of the measures. The problem that will now face the government will be the political pressure to reverse course. For example, I disagree with Bloomberg's view, which is inevitably echoing around the media, that the government should give a 'modest boost' to the economy by relaxing budget constraints. The one thing that the government should not do is relax on this issue. <br />
Regular readers will know my answer is to take more aggressive measures on government spending, at a cost of short term pain, in order to avoid a worse situation in the future. However, I accept that the real pressures mounting for the government to loosen will make this nearly impossible at this moment in time.<br />
<br />
As a pragmatic compromise, instead, the government should follow what is (in some respects) <i>sometimes</i> good advice, but which is given as advice for the use of additional borrowing (i.e. the projects will increase borrowing). Rather than funding through additional borrowing, those projects which address genuine problems in infrastructure should be given as a priority but as a priority that <i>displaces</i> current levels of spending on consumption based services provided by the government. <br />
In other words, the government should cut spending to fund investment (and I mean investment in the sense before the distorted use of the word as a synonym for government spending). Where there is genuine need for certain types of infrastructure (and I
here accept the current reality that government will fund this), it is a better way to use borrowed money than borrowing for consumption.This will require cuts in services, and the answers I give on how to cut remain the same.The answer is to ask which services are a priority, and then to make choices according to the priorities.<br />
<br />
In my mind, this is best achieved by asking the question of whether service <i>x</i> or <i>y</i> is really the role of the government, and cutting anything which is not a core government function. It is a question of 'luxury' over 'necessity'. The economic question is 'what can the UK afford?' but the answers as to what is necessity and luxury are political questions. The other answer is the one that I have discussed previously in my sections on reform. Having established the priorities, how can they be delivered in a way that is cost effective, but also hold to the principles on which they were established? As an example, I have <a href="http://cynicuseconomicus.blogspot.co.nz/2008/08/reforming-benefits-system.html" target="_blank">proposed</a> reforming benefits, such that there is still a (generous) <i>safety net</i> for those who are confronted by bad luck / unexpected difficulties, but where the costs of the system are minimised.<br />
<br />
As the situation stands, the UK is continuing down a road which does not
address the fundamental problems of the UK, with reductions in
borrowing growth that will not address the underlying economic problems, and without the
kind of <i>substantive reform</i> necessary to lay a real foundation for economic recovery. I believe that I long ago expressed the concern that the UK government
would try to resolve the UK's economic problems with incremental cuts and policy measures, and this is
exactly the path being followed. The trouble with this approach is not just that overall debt continues to grow whilst the economy shrinks, but also the problem is that the inevitable contraction in the economy leaves the government open to pressure to reverse course mid-term. It is, in summary, self-defeating even when taking a political perspective. <br />
<br />
I can never make up my mind what prevents the solutions that are possible to help resolve the problems of the UK economy; is it lack of courage, political consensus or lack of imagination, or the economists whispering 'easy' solutions in the ears of politicians. Perhaps it is all of them. I started the post with Alexander Heath's article, and who proposes cowardice; in light of the self-defeating nature of incrementalism, perhaps he is wrong? Perhaps it is just lack of imagination? <br />
<br />
<br />
<br />
<br />Unknownnoreply@blogger.com7tag:blogger.com,1999:blog-7820485130017459619.post-5271848116854699612012-11-29T00:24:00.000-08:002012-11-29T00:24:05.685-08:00The Rating AgenciesThere is a fascinating piece of news that I have just stumbled upon <a href="http://www.bloomberg.com/news/2012-11-27/credit-rating-companies-to-face-sovereign-debt-curbs-in-eu-plan.html" target="_blank">in Bloomberg</a>, regarding the EU and the ratings agencies:<br />
<br />
<blockquote class="tr_bq">
Credit rating companies face curbs
on when they can assess government debt and restrictions on
their ownership under draft plans agreed upon by the European
Union to limit the industry’s influence and tackle conflicts of
interest.<br />
<br />
Investors will also get the right to sue ratings companies
if they lose money because of malpractice or gross negligence in
the plans agreed upon yesterday by lawmakers from the <a href="http://www.europarl.europa.eu/" rel="external" title="Open Web Site">European
Parliament</a> and Cyprus, which holds the rotating presidency of
the EU. </blockquote>
The interesting point here is that the Basel banking regulations entrenched the ratings agencies within the financial system. Essentially, the ratings agencies became the key to the level of capitalisation of the banking system. The small detail that the ratings agencies were paid by said same banks to undertake the ratings did not cause concern in the bizarre world of banking regulation. No doubt there will be many who will applaud the EU for taking action against the agencies; they really are, in some respects, the guys with the black hats. However, we must also remember that their power in the market was underpinned by a regulatory framework; the Frankenstein that created this monster was the regulators.<br />
<br />
The problems with this latest move from the EU is that it does not seem to be founded in a genuine motivation for reform, but rather to de-fang the major ratings agencies, which are coincidentally downgrading sovereign debt. One suspects that the motives here are not entirely about the aim stated in the article, which is about 'financial stability'. The reason I am doubtful about the intentions is that the stated aim is to address conflicts of interest. This is the most simple problem to fix, and does not require this rather odd approach. It is so absurdly simple to fix the conflict of interest that the solution given absolutely must have different motivations; the absurdly simple answer to resolve conflicts of interest would be to ban any rating of any financial product that is paid for by the issuer of the product. It does not matter whether the product is a personal pension, or a complex derivative product.<br />
<br />
Also, with regards to sovereign ratings, this is one of the few areas
where (relatively) there is little conflict of interest. How curious is it that this is
the focus of the attention of the EU? The following passage from
Bloomberg tells the story: <br />
<blockquote class="tr_bq">
<br />
On sovereign debt ratings, lawmakers and officials agreed
that each credit rating firm must pick three days a year when
they would be allowed to give so-called unsolicited assessments
of governments’ creditworthiness, according to Jean-Paul Gauzes,
a lawmaker involved in the talks. Ratings firms may get a chance
to issue unsolicited ratings -- those that haven’t been
requested and paid for by a client -- outside those dates if
they can justify it to regulators.<br />
<br />
“Credit rating agencies will have to be more transparent
when rating sovereign states, respect timing rules on sovereign
ratings and justify the timing of publication of unsolicited
ratings,” Barnier said. “They will have to follow stricter
rules which will make them more accountable for mistakes.” </blockquote>
Here we have the distinctly curious situation of the lawmakers seeking to restrict the access to the ratings when the ratings are paid for by entities that need an independent rating; it is the very opposite of the absurdly simple solution to conflict of interest. Just as the rating of a derivative should be paid for by the potential purchaser, the same with bonds. In this case, this is exactly what the ratings agencies are doing. They may be useless at their job, which is not the point of this post, but they are in this case presumably acting in the interest of the purchasers, not the issuer. This is how the system <i>should work</i>, but that is what is being attacked. In summary, this is simply an attempt for the EU to try to bury the crisis that is threatening the EU and the Euro project.<br />
<br />
The news should be greeted with outrage, but the visceral ant-ratings agency feeling will probably see applause from many quarters. Whilst I would like to see the agencies de-throned, this is not the solution, and it tells us more about the terror being felt in the upper echelons of the EU than it does anything substantive to fix the agencies. <br />
Unknownnoreply@blogger.com4tag:blogger.com,1999:blog-7820485130017459619.post-63992845745468530032012-11-20T11:58:00.000-08:002012-11-20T11:58:07.375-08:00France DowngradedFor regular readers, they will know that I do not have much (any?) respect for the ratings agencies, but will also recognise that their pronouncements have impact. When they pronounce, the world listens, and in the case of the banks, they must listen due to capital adequacy regulations. This is from <a href="http://in.reuters.com/article/2012/11/20/moodys-france-downgrade-idINDEE8AJ05J20121120" target="_blank">Reuters</a>:<br />
<br />
<blockquote class="tr_bq">
<span id="articleText">France lost its prized triple-A badge from the
Standard & Poor's in January and so Monday's move by Moody's was not
surprising but it underlined doubts about Socialist President Francois
Hollande's ability to fix France's public finances.</span></blockquote>
This is a commentary from the same article:<br />
<blockquote class="tr_bq">
"I don't expect it (the downgrade) to have an
immediate knock-on impact today on access to and cost of funding," said
Espirito Santo analyst Andrew Lim of the possible impact on the banking
sector. "But it's symptomatic of
the wider concerns of a plain-vanilla negative impact on the economy
being suffered in the next few months and quarters. Spain, Italy and
peripheral Europe are weakening and France's exposure to them is
something to be aware of."</blockquote>
<div style="background-color: white; border: medium none; color: black; height: 0.1px; left: -1001px; overflow: hidden; position: absolute; text-align: left; text-decoration: none; top: -1000px; width: 0.1px;">
The stronger news is that the EFSF and ESM ratings may
suffer with the French downgrade. Also, French corporates and banks
may be subject to downgrades following the sovereign action as
well.
<br />
<br />
"We do note that downgrades are warranted as our own sovereign
ratings model shows France's implied ratings at AA/Aa2/AA, which
remain below actual ratings of AA+/Aa1/AAA", wrote the BBH team of
analysts, seeing scope for more downgrades given what we see as
major misalignments in its ratings, especially with Fitch now.<span><br /><br />Read more: <a href="http://community.nasdaq.com/News/2012-11/france-rating-downgrade-threatens-efsf-and-esm-bbh.aspx?storyid=191416#ixzz2Cn4QcAbM" style="color: #003399;">http://community.nasdaq.com/News/2012-11/france-rating-downgrade-threatens-efsf-and-esm-bbh.aspx?storyid=191416#ixzz2Cn4QcAbM</a></span></div>
Whilst the Euro <a href="http://www.sfgate.com/business/bloomberg/article/Asian-Stocks-Rise-for-Third-Day-Euro-Falls-on-4053235.php" target="_blank">sank a little</a>, it is not seen as a harbinger of crisis, or at least not yet. Another <a href="http://community.nasdaq.com/News/2012-11/france-rating-downgrade-threatens-efsf-and-esm-bbh.aspx?storyid=191416#.UKvRMYbOJqE" target="_blank">article</a> notes some of the upcoming risks:<br />
<br />
<blockquote class="tr_bq">
The stronger news is that the EFSF and ESM ratings may suffer with the French downgrade. Also, French corporates and banks may be subject to downgrades following the sovereign action as well.<br /><br />"We do note that downgrades are warranted as our own sovereign ratings model shows France's implied ratings at AA/Aa2/AA, which remain below actual ratings of AA+/Aa1/AAA", wrote the BBH team of analysts, seeing scope for more downgrades given what we see as major misalignments in its ratings, especially with Fitch now.</blockquote>
It is a very good point. When those doing the bailouts look less creditworthy, there are the makings of a future crisis. This from the <a href="http://online.wsj.com/article/BT-CO-20121120-710703.html" target="_blank">Wall Street Journal</a>:<br />
<br />
<blockquote class="tr_bq">
The European Financial Stability Facility is widely expected to
receive a credit rating downgrade within the week, allowing it to
resurrect plans to issue bonds after the rescue fund's second-biggest
backer--France--saw its rating trimmed.<br />
<br />
A downgrade could marginally curb demand for EFSF debt. It would
normally make it harder for borrowers to raise funds. But for the EFSF,
it would help resume plans to finish its 2012 funding program after it
was forced to shelve a three-year bond sale Tuesday due to the rating
discrepancy between the EFSF and France.<br />
<br />
The EFSF--Europe's short-term bailout fund that has helped raise cash
for Greece, Ireland and Portugal--said Monday that it planned to sell
three-year bonds denominated in euros.But the decision later in the day from Moody's Investors Service Inc.
to strip France of its triple-A rating complicated the proposed EFSF
deal, as it left the rescue fund's rating standing above that of one of
its key backers. The EFSF described the decision to shelve the deal as
"technical." Under its so-called Deeds of Guarantee rules, it was forced
to pull it despite having attracted more than 3 billion euros ($3.8
billion) in investor demand. </blockquote>
A piece in the Australian is highly critical of the (relatively) new French President, Francois Hollande (in some respects, a rather silly piece describing how he is enjoying the perks of power, but also with some more serious material): <br />
<blockquote class="tr_bq">
<br />
Unfortunately, economic indicators suggest otherwise: unless it acts
fast, "la belle France", for all its fine talk could become the latest
and most significant victim of the eurozone debt crisis.<br />
<br />
Economist Nicolas Baverez was one of the first to predict France's
downfall a decade ago. He argued last week that the President, whose
popularity has plummeted faster than that of any of his predecessors
since his election in May, is in denial of the financial tsunami that
could batter his palace walls by next year.<br />
<br />
"He has missed at
least three opportunities to begin a recovery," said Mr Baverez, warning
that unless Mr Hollande quickly implemented reforms, the country would
face the humiliation of being forced to go cap in hand to the eurozone
and the International Monetary Fund for a bailout.<br />
<br />
"In 2013 our
country will be the world's biggest borrower of euros, bringing
recession, soaring unemployment and an inevitable financial crisis,"
said Mr Baverez. "Germany will make France pay dearly for its backing."<br />
<br />
[and later]<br />
<br />
As thousands of people marched through the streets of Paris last week
as part of a pan-European protest against austerity, student Laurent
Botti, 21, handed out leaflets accusing Mr Hollande of being a "clone"
of the conservative Mr Sarkozy.<br />
<br />
"He has betrayed us," Mr Botti
said, complaining that Mr Hollande had presented himself in the election
as Europe's anti-austerity champion but had ended up siding with "big
business".<br />
<br />
Whatever the case, something has to be done, quickly:
public spending accounts for more than half of French GDP, the highest
share in the eurozone. No government has balanced the budget since 1981,
thus public debt has risen from 22 per cent in those days to more than
90 per cent. The economy is stagnant and will hardly grow next year.
More than 10 per cent of the workforce - and close to a quarter of the
young - are without work.</blockquote>
This story has a particularly interesting aspect. Hollande campaigned on an anti-austerity ticket, and is now confronted with the power of the bond markets to discipline perceived high risk states. I found this an interesting story in light of a very thoughtful piece in <a href="http://www.spiegel.de/international/business/playing-poker-with-trillions-a-prison-of-debt-on-both-sides-of-the-atlantic-a-867404.html" target="_blank">Spiegel</a> recently (I have growing respect for this publication, as one of the few outlets that offers real depth of analysis). This particular point came to mind when seeing the French downgrade:<br />
<br />
<blockquote class="tr_bq">
The attempt by countries to bolster the faltering financial system has in fact increased their dependency on the financial markets to such an extent that their policies are now shaped by two sovereigns: the people and creditors. Creditors and investors demand debt reduction and the prospect of growth, while the people, who want work and prosperity, are noticing that their politicians are now paying more attention to creditors. The power of the street is no match for the power of interest. As a result, the financial crisis has turned into a crisis of democracy, one that can become much more existential than any financial crisis.</blockquote>
I have long railed against government debt, and continue to wonder why governments in mature economies need to borrow at all. The Spiegel analysis is quite correct. Democracy, and the belief in democracy is now on the chopping block. We can see this most clearly in the countries that are already going through the most severe crises, such as Greece.<br />
<br />
The problem that we, meaning all of the electorates of the Western democracies (to varying degrees) face, is our own immaturity. Whilst some of the democracies are very mature in terms of age, the behaviour of the electorate remains immature. When we see protesters on the streets of Europe, protesting against austerity, we have a picture that is analogous to the teenager having a tantrum and demanding a new iPad. The fact that his parents are already in debt, and cannot afford the iPad is entirely absent from his thoughts.<br />
<br />
In the case of Francois Hollande, he promised the goods and the French electorate duly elected him. However, when coming to power and facing the reality of France's economic situation, he is now being forced to backtrack. The result is that his popularity is plummeting (sorry, cannot find the link for this). The problem faced by Francois Hollande is the problem faced in so many countries. The electorate <b><i>demand</i></b> a standard of living that is higher than can be funded from the output of the economy. To return to the article in the <a href="http://www.theaustralian.com.au/news/world/francois-hollande-dithers-as-europe-looks-for-action/story-fnb64oi6-1226519100347" target="_blank">Australian</a>:<br />
<br />
<blockquote class="tr_bq">
The figures tell only part of the story. A report commissioned by Mr
Hollande from Louis Gallois, a respected business leader, blamed the
eurozone's heaviest social charges on payrolls, over-regulation and
exceptionally high taxes for undermining France's competitiveness.<br />
<br />
Genevieve
Forestier, who abandoned her dream to set up a fashion label last year
to take a job in a lawyer's office instead, could not agree more. "All
the social charges and taxes are enough to put off even the most
enthusiastic of entrepreneurs," she said. "The worst thing, though,
about running your own business in France is that once you've hired
someone it is virtually impossible to fire them. I've heard of a case
where an employer had to continue paying a worker's salary even though
he was in prison."<br />
<br />
Not surprisingly, new firms seldom get off the
ground and France has fewer small and medium-sized companies than
Germany, Italy or Britain. At the same time the government continues
living beyond its means. Mr Hollande agrees that the state should spend
less, but some of the cuts thus far seem cosmetic.<br />
<br />
The prospect of
France losing market confidence terrifies European Union officials. It
might need a bailout on such a scale that the mechanism to preserve the
euro would be overwhelmed.</blockquote>
It is a crude piece of commentary, but nevertheless captures some of the problems being faced by France. As France has lost competitiveness, the debt has been increasing. This is the story that sits underneath the economic crisis. The immaturity of demanding <i>'x'</i> standard of living in economies that can only really afford '<i>x-</i>' standard of living. Even as the emerging economies were rising in competition with the mature economies, the demands for ever higher standards of living increased. It was the role of governments, whatever it might take, to deliver these ever higher standards. This from the <a href="http://www.spiegel.de/international/business/playing-poker-with-trillions-a-prison-of-debt-on-both-sides-of-the-atlantic-a-867404.html" target="_blank">Spiegel</a> article:<br />
<br />
<blockquote class="tr_bq">
When the debts of companies and private households are added to the
public debt, the sum of all debt has grown at twice the rate of economic
output since 1985, and it is now three times the size of the gross
world product. Economies in the developed world would appear to require
credit-financed demand in order to continue growing -- they need
consumers, companies and governments to go into debt and to put off
paying for their demand until some unspecified point in the future. Of
its own accord, this economic system produces the compulsion to drive up
the debt of public and private households.<br />
<br />
Governments delegate power and creative force to the markets, in the
hope of reaping growth and employment, thereby expanding the financial
latitude of policymakers. Government budgets that were built on debt
continued to create the illusion of power, until the markets exerted
their power through interest.<br />
<br />
Interest spending is now the third-largest item in Germany's federal
budget, and one in three German municipalities is no longer able to
amortize its debt on its own. In the United States, the national debt
has grown in the last four years from $10 trillion to more than $16
trillion, as more and more municipalities file for bankruptcy. In
Greece, Spain and Italy, the bond markets now indirectly affect
pensions, positions provided for in budgets and wages.</blockquote>
<div style="background-color: white; border: medium none; color: black; height: 0.1px; left: -1001px; overflow: hidden; position: absolute; text-align: left; text-decoration: none; top: -1000px; width: 0.1px;">
The stronger news is that the EFSF and ESM ratings may
suffer with the French downgrade. Also, French corporates and banks
may be subject to downgrades following the sovereign action as
well.
<br />
<br />
"We do note that downgrades are warranted as our own sovereign
ratings model shows France's implied ratings at AA/Aa2/AA, which
remain below actual ratings of AA+/Aa1/AAA", wrote the BBH team of
analysts, seeing scope for more downgrades given what we see as
major misalignments in its ratings, especially with Fitch now.<span><br /><br />Read more: <a href="http://community.nasdaq.com/News/2012-11/france-rating-downgrade-threatens-efsf-and-esm-bbh.aspx?storyid=191416#ixzz2Cn4QcAbM" style="color: #003399;">http://community.nasdaq.com/News/2012-11/france-rating-downgrade-threatens-efsf-and-esm-bbh.aspx?storyid=191416#ixzz2Cn4QcAbM</a></span></div>
<div style="background-color: white; border: medium none; color: black; height: 0.1px; left: -1001px; overflow: hidden; position: absolute; text-align: left; text-decoration: none; top: -1000px; width: 0.1px;">
The stronger news is that the EFSF and ESM ratings may
suffer with the French downgrade. Also, French corporates and banks
may be subject to downgrades following the sovereign action as
well.
<br />
<br />
"We do note that downgrades are warranted as our own sovereign
ratings model shows France's implied ratings at AA/Aa2/AA, which
remain below actual ratings of AA+/Aa1/AAA", wrote the BBH team of
analysts, seeing scope for more downgrades given what we see as
major misalignments in its ratings, especially with Fitch now.<span><br /><br />Read more: <a href="http://community.nasdaq.com/News/2012-11/france-rating-downgrade-threatens-efsf-and-esm-bbh.aspx?storyid=191416#ixzz2Cn4QcAbM" style="color: #003399;">http://community.nasdaq.com/News/2012-11/france-rating-downgrade-threatens-efsf-and-esm-bbh.aspx?storyid=191416#ixzz2Cn4QcAbM</a></span></div>
<div style="background-color: white; border: medium none; color: black; height: 0.1px; left: -1001px; overflow: hidden; position: absolute; text-align: left; text-decoration: none; top: -1000px; width: 0.1px;">
The stronger news is that the EFSF and ESM ratings may
suffer with the French downgrade. Also, French corporates and banks
may be subject to downgrades following the sovereign action as
well.
<br />
<br />
"We do note that downgrades are warranted as our own sovereign
ratings model shows France's implied ratings at AA/Aa2/AA, which
remain below actual ratings of AA+/Aa1/AAA", wrote the BBH team of
analysts, seeing scope for more downgrades given what we see as
major misalignments in its ratings, especially with Fitch now.<span><br /><br />Read more: <a href="http://community.nasdaq.com/News/2012-11/france-rating-downgrade-threatens-efsf-and-esm-bbh.aspx?storyid=191416#ixzz2Cn4QcAbM" style="color: #003399;">http://community.nasdaq.com/News/2012-11/france-rating-downgrade-threatens-efsf-and-esm-bbh.aspx?storyid=191416#ixzz2Cn4QcAbM</a></span></div>
<div style="background-color: white; border: medium none; color: black; height: 0.1px; left: -1001px; overflow: hidden; position: absolute; text-align: left; text-decoration: none; top: -1000px; width: 0.1px;">
The stronger news is that the EFSF and ESM ratings may
suffer with the French downgrade. Also, French corporates and banks
may be subject to downgrades following the sovereign action as
well.
<br />
<br />
"We do note that downgrades are warranted as our own sovereign
ratings model shows France's implied ratings at AA/Aa2/AA, which
remain below actual ratings of AA+/Aa1/AAA", wrote the BBH team of
analysts, seeing scope for more downgrades given what we see as
major misalignments in its ratings, especially with Fitch now.<span><br /><br />Read more: <a href="http://community.nasdaq.com/News/2012-11/france-rating-downgrade-threatens-efsf-and-esm-bbh.aspx?storyid=191416#ixzz2Cn4QcAbM" style="color: #003399;">http://community.nasdaq.com/News/2012-11/france-rating-downgrade-threatens-efsf-and-esm-bbh.aspx?storyid=191416#ixzz2Cn4QcAbM</a></span></div>
<div style="background-color: white; border: medium none; color: black; height: 0.1px; left: -1001px; overflow: hidden; position: absolute; text-align: left; text-decoration: none; top: -1000px; width: 0.1px;">
The stronger news is that the EFSF and ESM ratings may
suffer with the French downgrade. Also, French corporates and banks
may be subject to downgrades following the sovereign action as
well.
<br />
<br />
"We do note that downgrades are warranted as our own sovereign
ratings model shows France's implied ratings at AA/Aa2/AA, which
remain below actual ratings of AA+/Aa1/AAA", wrote the BBH team of
analysts, seeing scope for more downgrades given what we see as
major misalignments in its ratings, especially with Fitch now.<span><br /><br />Read more: <a href="http://community.nasdaq.com/News/2012-11/france-rating-downgrade-threatens-efsf-and-esm-bbh.aspx?storyid=191416#ixzz2Cn4QcAbM" style="color: #003399;">http://community.nasdaq.com/News/2012-11/france-rating-downgrade-threatens-efsf-and-esm-bbh.aspx?storyid=191416#ixzz2Cn4QcAbM</a></span><br /><div style="background-color: white; border: medium none; color: black; height: 0.1px; left: -1001px; overflow: hidden; position: absolute; text-align: left; text-decoration: none; top: -1000px; width: 0.1px;">
The stronger news is that the EFSF and ESM ratings may
suffer with the French downgrade. Also, French corporates and banks
may be subject to downgrades following the sovereign action as
well.
<br />
<br />
"We do note that downgrades are warranted as our own sovereign
ratings model shows France's implied ratings at AA/Aa2/AA, which
remain below actual ratings of AA+/Aa1/AAA", wrote the BBH team of
analysts, seeing scope for more downgrades given what we see as
major misalignments in its ratings, especially with Fitch now.<span><br /><br />Read more: <a href="http://community.nasdaq.com/News/2012-11/france-rating-downgrade-threatens-efsf-and-esm-bbh.aspx?storyid=191416#ixzz2Cn4QcAbM" style="color: #003399;">http://community.nasdaq.com/News/2012-11/france-rating-downgrade-threatens-efsf-and-esm-bbh.aspx?storyid=191416#ixzz2Cn4QcAbM</a></span></div>
</div>
One of the notable points is about household debt. We can see the mentality that is driving the electorate, which is in turn driving the politicians, by visiting an electrical store. Why pay now when you can pay later? We know that the people who enter the store, with a tight household budget already, deep down know that the purchase of the latest shiny good is going to put their overall budget at risk. However, they still buy. They just <i>want</i> that shiny new good. This is the mentality of the electorate, and it is no surprise that we get politicians who pander to this immaturity. There is a fundamental lack of maturity, and self-justification is given for poor budget choices. <br />
<br />
As such, when the politicians, economists, and policy makers seek to justify yet further increases in debt, they are pushing at open doors of an immature electorate. We, the electorate grasp at their justifications willingly, as they are telling us that they can 'magic' into existence the shiny goods that we desire. And, as if by magic, they seem to keep on making them appear. However, it is just another variant of the electrical store offering 'buy now, pay later'. The Spiegel article understands the point. It subtitles the article 'betting with trillions'. The principle is this; increase the borrowing to solve the problem of previous borrowing. It is perhaps the greatest wager ever made. It is a wager that might collapse the global economy. We, the electorate, are collectively urging them to raise the stakes. <br />
<blockquote class="tr_bq">
<span id="articleText"></span></blockquote>
Unknownnoreply@blogger.com4tag:blogger.com,1999:blog-7820485130017459619.post-50307623349687004772012-11-02T16:17:00.000-07:002012-11-02T16:17:46.383-07:00GDP And 'Economic Growth'It seems a long while since I discussed the Economist article in which Hurricane Katrina was given a positive slant due to its potential to add to GDP growth (so long ago the I do not have a link). I was therefore fascinated to see <a href="http://www.telegraph.co.uk/news/worldnews/northamerica/9643569/Superstorm-Sandy-Clean-up-could-offset-hit-to-US-growth.html" target="_blank">this account</a>: <br />
<blockquote class="tr_bq">
<div class="firstPar">
Paul Ashworth, chief US economist at Capital Economics, said in a note that
while the <strong><a href="http://www.telegraph.co.uk/news/worldnews/northamerica/usa/9642169/Hurricane-Sandy-live.html">initial
impact of the storm</a></strong> on the economy could be quite large" when the
clean-up is taken into consideration the "overall impact on GDP growth could
even be positive."<br />
</div>
<div class="secondPar">
He said, assuming all output was lost in the two regions for two days, it
could mean a 0.7pc loss for the quarter as a whole.The economy expanded 2pc
in the last quarter.<br />
</div>
<div class="thirdPar">
However, he cautioned that this was an extreme assumption: "These back of
the envelope calculations undoubtedly overstate the loss of output. Not all
output has been lost, particularly not across the whole East Coast region.
Some people will be working as normal, others will be working from home."
</div>
</blockquote>
Regular readers know that I have long railed against the use of GDP, which I see a being close to useless, if not positively dangerous. This analysis just highlights the point. It was therefore extremely encouraging to find an <a href="http://www.forbes.com/sites/bobmcteer/2012/10/31/sandy-and-gdp/" target="_blank">article</a> by Bob McTeer, a former Dallas Fed President, who recognises the danger in the use of GDP: <br />
<blockquote class="tr_bq">
Generally and loosely speaking, a higher GDP, reflecting both higher
spending and higher incomes, is a good thing. However, if the higher GDP
is boosted by hurricane clean-up and repair, that’s not so good. The
problem is we don’t get a subtraction for the destruction of existing
assets; just an addition for replacing them. At least one might think of
the clean-up as “shovel ready” projects. Wars are similar in that they
generate GDP without bringing with them a higher standard of living.<br />
<br />
My favorite example in school of the short-comings of GDP (GNP then)
was provided by the question what happens if a man marries his maid. If
she keeps doing the household chores as a wife, they are taken out of
the market place and GDP shrinks. Getting hair cuts at home or eating at
home more and eating out less would have a similar impact on GDP
without necessarily reducing standards of living. Just remember that GDP
was designed to measure output in the marketplace, not to measure
economic well-being.</blockquote>
The article seems to imply that the faults of GDP are well recognised, but this is not apparent when considering the almost fetishistic focus that is made on the GDP measure. One of my biggest bugbears is the government debt to GDP ratio. It is now a commonplace, and frequently replaces the hard number of the actual cumulative total of debt and GDP growth is used as a signal that an economy is capable of servicing debt. In the case of our earlier commentator, we can see quite how dangerous GDP actually is.<br />
<br />
In the case of Hurricane Sandy, hurrcane damage will apparently be able to improve the governments capability to service debt. Never mind that the government will be borrowing a bucket load of money to pay for the clean up of the devastation and destruction of assets; this will better allow the government to pay back its debt because, you see, GDP will grow from the fallout of a hurricane. I can see no better illustration of the fallacious thinking of those who worry about GDP slipping when governments cut back on borrow and spend. Borrowing to create activity in an economy, as I have argued <a href="http://cynicuseconomicus.blogspot.co.nz/2012/10/the-perpetual-economic-growth-machine.html" target="_blank">previously</a> is seen as a perpetual growth machine which is 'lossless'. In this case, the loss and replacement of perfectly good assets apparently creates economic growth. <br />
<br />
No doubt some commentators will claim that government 'investment' is different; it creates long term growth. For example, many such people will propose project 'x' or 'y' as an investment. What they do not discuss is that these projects will come on top of borrowing for consumption. Also, as I discussed in a recent post, in one case I found a proposal to 'invest' in new rail infrastructure for the UK, even though rail is heavily subsidised such that this is not an investment with a positive return, but an investment to increase expenditure into the future (not withstanding that it might have quality of life benefits). 'Yes', there are some genuine investments that might be made, but these should not be made on top of borrowing for consumption. However, the term 'investment', as used by government, is often highly malleable, and is often nothing to do with investment but is rather concerned with expenditure for consumption.<br />
<br />
The case of the US is interesting, as I have seen arguments made that the US has under-invested in infrastructure, and then present the idea that investment now is the solution. Again, why was the US government borrowing during the 'good times' and not investing in these apparently neglected projects? Why were they borrowing for consumption rather than for investment? Why is it that these economists were not railing against the government borrowing and consuming in the good times, when they could have been borrowing to invest in these projects? The answer is simple; they do not want to make the hard choices. Every element of government spending can be found to have a justification, but that justification does not include confronting the hard choices of either raising taxes or choosing between priorities within the constraints of the actual tax revenue available. <br />
<br />
It is much easier to just borrow the money and leave the problem of paying until later. As I have long argued, at least in developed economies, there is no real reason why governments should be borrowing at all, barring major natural disaster or events like World War II. They have a strong base of income to draw upon, and can pay for both expenditure and investment from that income. Even if taking a Keynesian position, governments are not supposed to be borrowing and spending for consumption during the good times, but are supposed to only do this during the bad times. <br />
<br />
I reiterate the point; those who support government borrowing and spending have never wanted to make the hard choices - either persuade the taxpayers that they really need to pay more taxes, or confront the difficult problem of priorities for expenditure. Instead, they propose borrowing and spending, during both the good and bad times. As they do so, they hide behind fig leaves such as GDP, which hides the long term damage that they are inflicting upon the economy; they persuade people that the economy is 'growing', even whilst the debts mount, and the activities which are developed through borrow and spend boost GDP. The real problem is cowardice; they cannot persuade people to pay for the expenditure of the government, so they pass on the problem of paying to the future. They believe that all of those government expenditures are 'good', but do not have the guts to make their case honestly and openly and subject the real cost to the scrutiny of voters. It is a tragedy, and I can only wish that voters would start to punish this cowardice. <br />
<br />
<br />
Unknownnoreply@blogger.com19tag:blogger.com,1999:blog-7820485130017459619.post-44496377311592165032012-10-23T01:29:00.003-07:002012-10-23T01:29:47.510-07:00Krugman and Money BubblesIn a recent <a href="http://krugman.blogs.nytimes.com/2012/10/22/things-that-arent-bubbles/" target="_blank">NYT piece</a>, Krugman suggests that 'money is only a “social contrivance”. It’s a convention, which works as long as the future is like the past.' He then goes on to say later:<br />
<br />
<blockquote class="tr_bq">
A final thought: the notion that there must be a “fundamental” source
for money’s value, although it’s a right-wing trope, bears a strong
family resemblance to the Marxist labor theory of value. In each case
what people are missing is that value is an emergent property, not an
essence: money, and actually everything, has a market value based on the
role it plays in our economy — full stop.</blockquote>
Before reading the rest of the post, you should really <a href="http://krugman.blogs.nytimes.com/2012/10/22/things-that-arent-bubbles/" target="_blank">read his full discussion</a>, as this post will not make sense without you doing so. For me, the problem is his idea that there is no fundamental source for the value of money. It is wholly fantasy.<br />
<br />
Here, for the sake of simplicity, I will treat the following as 'money'; base money (e.g. bits of green paper, and money created by the central bank through open market operations, and debt money (e.g. bonds, bank credit etc.). I know that we could debate the question of differences between these money types, what should be included in money etc. However, my purpose here is specific, and you will (I hope)understand why I characterise money in this way. <br />
<br />
For me, the most important thing about money is not about the nature of the money, but about the demands that money might make on the economy. For example, each unit of money is a future demand for <i>x</i> value of product and services in a particular economic unit, typically but not always a country. The interesting thing about money is that it can very broadly be divided into 'now' money, and money in <i>y </i>period of time, or money in <i>y</i> period of time and <i>z</i> now etc. In other words, money units have a temporal dimension. This gives us something of an idea of how money can be seen to be founded in something. This is that the value of money is determined by the demands that might be made on the total value of output in the economic unit.<br />
<br />
The important point about this is that, at given moments in time, there is a combination of credit money and base money in any economy. However, at any given moment, there is a total level of output of value in the economy. I use the word value here because what value might be is subjectively derived; for person A, they may value a new television over a Wedgewood tea set, even where the tea set has a higher price. However, regardless of what individuals value, there is a total output, however difficult that might be to measure accurately, but with relative prices making the best proxy that we have for perceptions of value. The point is that, with a given labour force, given technologies, given skill sets, and so forth, there is finite amount of value that can be created in an economy at any given moment.<br />
<br />
You will notice here that I am treating an economy as if it is an economic island, which is false. Economies are not islands, and an economy's output is also contingent on the value creation in other economies. For example, if country B makes a product better/more cost effectively (I leave this loose here) than country A, then the country A output of value is questionable unless they do something to match the country B output of value. As such it possible to have potential for output of value that will not be realised, as there is a real world of competition. Therefore, the potential output of value of an economic unit is not its potential, but its potential in relation to other economic units. That potential is continually shifting, dictated by policy, individual and corporate endeavour etc.<br />
<br />
The value of money is therefore contingent upon several factors; temporal, quantity, and the potential value of output of the economy which the money represents. For example, the bond market is driven by second guessing the relative influence of these factors, albeit that the second guessing is often crude and misdirected. The key point here is that each monetary unit, given these contingencies, at any given moment in time, represents one <i>x</i> percent of the total value of output in the economy. In other words, money is rooted in the total output of value in the economy, at a given moment in time. There can only be, as an economy is currently structured now, <i>x</i> amount of value of goods/services that can be purchased. I am being simplistic here, as some people simply hold the 'now' money, so that it ceases to be a demand on the economic unit, even though the money exists. In this circumstance, it makes no call on the output of value at that moment. It is another contingency on how money is valued, but by not making a call on the value in the economy now, it allows for a call on value tomorrow. For example, for a bond that has matured, might not be used as money now, but to buy more bonds with a view that this will allow an even greater capture of value in the future.<br />
<br />
There are several things that are important when viewing money and value of output in the future. It is quite possible to issue more money now in the expectation that output of value will increase in the future to match the increase in money. Creating a greater supply of money, with the contingency that output of value will match the increase in supply is a risk. If output of value does not increase commensurate to the increase in money, then there is a problem. The value of output per unit of money has diminished. Most damaging of all, is when the demand for the value of output sits outside of the economic unit; if the demand is within the economic, it might represent a transfer, for example the liquidation of a mortgage debt.<br />
<br />
However, even then, it is possible that the issuance of too much mortgage 'money' might be inflationary, and problematic. If the mount of money created for mortgages increases faster than the value of the value of the housing stock, this means that there is a specific and narrow price inflation, but also with a wider price inflation in the economy as a whole, as that mortgage money transfers into the economy. It just takes time. The housing bubble was this process in action. The rate of mortgage money creation increased faster than the value of housing stock, and also prompted bubble activity, such as building McMansions as a process of trying to soak up some of this new money creation. This brings me back to the problem of external credit, which is far worse, as it never represents an internal transfer.<br />
<br />
The external funding of new money in the economy, such as mortgage debt, is a future external demand on the output of value in the economy. In all cases, it quite literally means that in the future, a demand will be made on the value of output in the economy such that some of that value output will no longer be available within the economic unit. The greater the value of the money created through external debt, the greater the demand on future output of value. This kind of demand can accumulate to the point where the external demands on the total output of value are so large, that an economy has no reasonable chance of servicing the value without having so many goods and services flow out of the economic unit that the actors in the unit will be reduced to penury. This is Greece now.<br />
<br />
The curious part of the Greece story is that it is divorced from base money, and the problems are entirely created by creditors realising that the output of the Greek economy is not able to provide the value that they expected, or rather that Greece is unwilling to deliver that value as the loss of that value of output from within the economic unit of Greece is too hard to bear. The external debt of Greece is simply a massive demand on the value of the total output of value of the economic unit called Greece. <br />
<br />
The idea that monetary units have no foundation, except in a social construction is simply not true. It is founded in the output of value in the economy for which a particular currency pertains. It may be complex, due to the contingencies that I describe. This is why all debt markets are so complex. However, there is one thing that is certain. If the aggregrate money supply increases faster than the value of output, the value of each unit of money will be diminished. We must also remember that the value of each economic unit is contingent upon the ability of each unit in each area of business, and that the aggregate of the ability will inherently effect the value of money, as this will impact upon the ability to realise potential output of value in an economy. Finally, externally created money is the highest risk, as it will absolutely make a demand on output of value in the future, and that value, if repaid will mean less output of value in the economic unit. Even if the economy does grow in an economic unit, a portion of that growth will no longer be available in the economic unit. The economic unit will have less output of value at the time that the demand is made for the output of value. <br />
<br />
The final point is this; expanding money supply without an ability for increases in the output of value destroys the value of money. Borrow and spend is exactly this, and external borrowing is horrendously risky. <br />
<br />
Note: This started as a short and quick and 'dirty' post, but did not turn out that way. I hope it all hangs together, and I have avoided some complexity that might have been added due to time constraints, and to keep the ideas as simple as possible. The nature of internally generated debt money is a case in point. Comments, as ever, welcomed. Feel free to be critical and pick holes. I published despite this despite being loose ideas with critiques in mind; I would like to refine these ideas, and critiques (constructive ones) and suggestions will help. In short, I have thrown the ideas 'into the ring' to see how they stand up to critical eyes. Regular readers will know that I have considered money before (sorry, no time to find the link, but it would help in supporting this post), and this is just some further thoughts/evolution/adaptation of the earlier longer and more detailed consideration. <br />
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<br />Unknownnoreply@blogger.com3tag:blogger.com,1999:blog-7820485130017459619.post-2864593441099411652012-10-20T20:49:00.001-07:002012-10-20T22:02:13.681-07:00The UK: Statistics and EconomySome time ago, I was complaining about the increasing opacity/difficulty in obtaining information about the UK economy, for example with the previously wonderful National Statistics now completely hopeless. As such, I have to offer a big word of thanks to Dr. Tim Morgan of Tullett Prebon, who has made an excellent <a href="http://www.tullettprebon.com/strategyinsights/UK_Economic_and_Fiscal_Database.aspx" target="_blank">database</a> of statistics available here, and would also recommend the database to those who are likewise frustrated with finding basic data from the official sites. In practical terms, it means less time looking for information, and more time looking at what the data might mean. This is what Dr. Morgan has to say:<br />
<br />
<blockquote class="tr_bq">
Finding key data on UK issues such as inflation, the economy, spending,
taxation and debt can all too often prove time-consuming and baffling.
The Tullett Prebon UK Economic & Fiscal Database is designed to
contribute to the quality of the public debate by providing all
participants with ready access to objective and consistent data.</blockquote>
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As a celebration of so much easily accessible information, I will today overload on statistics, and use the statistics as a foundation for a review of the UK economy. First of all the government finances, commencing with a breakdown of revenues (billions):<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEixIajS9s6UetM1tEUeDNVeKNn0shBfyTLIZe-zRdzPgVbfjN_yXEmTZoP3qNWGEKAuoh7giKHqC5-zzRJkLtrPuo06QRip1MPTsOCF-mT4aWEEvDw8chywwRjLh14UoTZhuF-_RhiHbwIa/s1600/Revenue+Breakdown.gif" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="256" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEixIajS9s6UetM1tEUeDNVeKNn0shBfyTLIZe-zRdzPgVbfjN_yXEmTZoP3qNWGEKAuoh7giKHqC5-zzRJkLtrPuo06QRip1MPTsOCF-mT4aWEEvDw8chywwRjLh14UoTZhuF-_RhiHbwIa/s400/Revenue+Breakdown.gif" width="400" /></a></div>
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There are a couple of points of note here; the first is that after the drop that took place when the economic crisis became visible, revenue has been steadily increasing with VAT revenue growth particularly pronounced. A commentator recently suggested that the deficit growth was due to a collapse in revenue, but we can see that this only explains a small element of the deficit. With regards to collecting revenues, I <a href="http://cynicuseconomicus.blogspot.co.nz/2008/12/taxes-taxes-and-more-taxes.html" target="_blank">propose</a> a more open, efficient and transparent system, and a system that will also reduce costs and distortions in behaviour. For example, I propose the abolition of all corporation tax, and a flat income tax. Since writing the post on reform, I have identified some problems with the proposal, but still hold with the principles (I may update the post if I have some time). <br />
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Below, we have spending (£billions):<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjxS7GuhuFk8wDraRsO_Yb3HVbfUWqEJDVQpR3mBhN0aapR7_KsQle6CWpvnJ7dnq9WsiBEaB8HQMa1jX2bJVGgId0_2P1EfqSxKzJ3NCeL02z5EOysSqqtzuL9ipEzDzZthHXvc3MEjX0c/s1600/Spending+Breakdown.gif" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="255" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjxS7GuhuFk8wDraRsO_Yb3HVbfUWqEJDVQpR3mBhN0aapR7_KsQle6CWpvnJ7dnq9WsiBEaB8HQMa1jX2bJVGgId0_2P1EfqSxKzJ3NCeL02z5EOysSqqtzuL9ipEzDzZthHXvc3MEjX0c/s400/Spending+Breakdown.gif" width="400" /></a></div>
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEipn6sNRyAgbWY2vRD1pceT0zbM6_as38a2qYMFGkg9hcoTFuMcTj_bcFWXxwV45BiLV5KP-xc3KbooOXuDycIveYrkECDz-z9ra-7XvCs4KBBV6mGmsKPzY0LnAJXtaauk_G6VFJHkiBUW/s1600/Spending+Breakdown.gif" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><br /></a></div>
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I don't think any reader of this blog will be unaware of the growing problems of financing pensions and health with an ageing population. I have often spoken about the necessity of priority; that the government needs to make some hard choices between where an ultimately limited amount of resource might go. I have also argued that there are ways of cutting the expenditure of government whilst also maintaining provision of services and safety nets. For example, as one of the more controversial suggestions, I <a href="http://cynicuseconomicus.blogspot.co.nz/2008/08/reforming-benefits-system.html" target="_blank">propose</a> that welfare becomes an interest free loan with a finite duration and amount. It is a system that would see the welfare share of spending fall, albeit that it would increase government borrowing in the short term. It is a return to the principle of welfare; that it is a safety net. If you look at the links at the top right of the page, you will find solutions to some other areas of spending. I chose the area chart format as they give a good picture of direction of spending and income, but the overview is better represented through a bar chart (billions, at current values):</div>
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjOlk3R6rbAXe-YW6eOahBOQrhmKmJbHpe1qd_xgQduTReq6p7WRHImauDyL7FJ7-qD1zqvxNXH_isIG3p4Uj-bFYDh9PyAYeVpb6vGxmymP1XzzjditGV-zzs_gE8gxVzklJt_64z-2WU5/s1600/Revenue+and+Spending.gif" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><br /></a></div>
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiMg0k7J_7izFk1c5u8JJYNKVQEVLtmuVu5eX5OwFFH1gjyRNl_LVDq_76bz9oKmsONvrcIHNQ7GhA9kKDJwUHGk2mnovfIlw175Z5ZYtIfbyadPrMgRfq8-nkXNrQl-20lUQkoLr1FzSDG/s1600/Revenue+and+Spending.gif" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="211" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiMg0k7J_7izFk1c5u8JJYNKVQEVLtmuVu5eX5OwFFH1gjyRNl_LVDq_76bz9oKmsONvrcIHNQ7GhA9kKDJwUHGk2mnovfIlw175Z5ZYtIfbyadPrMgRfq8-nkXNrQl-20lUQkoLr1FzSDG/s400/Revenue+and+Spending.gif" width="400" /></a></div>
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It does not look very pretty overall. In fact, it look downright ugly. We then have to ask what this is achieving. How is the UK economy really doing? This is unemployment during massive credit expansion:</div>
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjh0Tz_cVYq0FwL2W-Q-pr7QWhvtgZqNjBs24YH6aj1S1Q_rVKmVL8g7y2FTIeRR-zS6bFZBv0BOizD2URX1xeALvBgu_l0e_VPEHLfZaFIwt0MBUXeuaQPvsoZhpZWtyqUpCA9rVSzGhYu/s1600/Unemployment.gif" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="255" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjh0Tz_cVYq0FwL2W-Q-pr7QWhvtgZqNjBs24YH6aj1S1Q_rVKmVL8g7y2FTIeRR-zS6bFZBv0BOizD2URX1xeALvBgu_l0e_VPEHLfZaFIwt0MBUXeuaQPvsoZhpZWtyqUpCA9rVSzGhYu/s400/Unemployment.gif" width="400" /></a></div>
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In this figure, we can see the impact of the boom, and the appearance of the economic crisis is vivid. When looking at the chart, when looking at the fall in unemployment, it needs to be considered in relation to debt, both government (see above) and private:</div>
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgsHr4_Lqo3r-hhroFxwROn1sgGcs_blvrOJAFc_BB0AmehhafrXlsHpT3QhyphenhyphenUNsAWOefGenctadNVCbPQj1WHd9okc2YM9_xAGLVPIrOFjMLUz9FBmbn5P0evrnCsmVaw34QBIsPMrIsoZ/s1600/Private+Debt.gif" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="255" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgsHr4_Lqo3r-hhroFxwROn1sgGcs_blvrOJAFc_BB0AmehhafrXlsHpT3QhyphenhyphenUNsAWOefGenctadNVCbPQj1WHd9okc2YM9_xAGLVPIrOFjMLUz9FBmbn5P0evrnCsmVaw34QBIsPMrIsoZ/s400/Private+Debt.gif" width="400" /></a></div>
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjq5bXuPU3I6dyjxe8oTNQSGcJ878YTBi2XjakHZwKsf-vcYzK6yIcQHK5WA7bnaWrnG_Cnps5A8IUZkUG1kMQWSnabt14HLN0Wal67lUg6z5FhaWpAFkek9pyK0Cju6UDHD-Z_e2JWb2yl/s1600/Debt+versus+Unemployment.gif" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="211" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjq5bXuPU3I6dyjxe8oTNQSGcJ878YTBi2XjakHZwKsf-vcYzK6yIcQHK5WA7bnaWrnG_Cnps5A8IUZkUG1kMQWSnabt14HLN0Wal67lUg6z5FhaWpAFkek9pyK0Cju6UDHD-Z_e2JWb2yl/s400/Debt+versus+Unemployment.gif" width="400" /></a></div>
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It is very apparent that debt growth was masking underlying problems in the UK economy. The second chart perhaps is more scary than it should be. We need to remember that the massive increase in aggregate debt took place during a period of high immigration; the massive expansion of borrowing and the activity that it generated had less impact upon unemployment as it also coincided with high immigration levels. This is from the <a href="http://www.ons.gov.uk/ons/dcp171778_264614.pdf" target="_blank">ONS</a>: </div>
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjReeNrUcy3S9z9LBiNK25M_GGgXoM-ZjSrR52zzlw_8yKHOkeTEFcB8QoO5u_7-gsuEDGWLVxHpA9xXUszwT0Ai4E4iFG9g48Ovpnzvt7i68QBFEVpbqZO1Ohq1HMaxXFtlgMEfmEX2H9e/s1600/migration.gif" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="218" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjReeNrUcy3S9z9LBiNK25M_GGgXoM-ZjSrR52zzlw_8yKHOkeTEFcB8QoO5u_7-gsuEDGWLVxHpA9xXUszwT0Ai4E4iFG9g48Ovpnzvt7i68QBFEVpbqZO1Ohq1HMaxXFtlgMEfmEX2H9e/s400/migration.gif" width="400" /></a></div>
And this reflects in the number in employment:<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhnV8KjDn9h_9iHp6G4j45n940MPDK5j_rAZ6lpHOmLj_OxQaBKrQR7fw6G_g31f-yY-xRekc3qH4aJZmcyKHAn48Mk2KxmRfhvxC6R9Oh3RKos8xygcHIJNHo9OwBRjbe0YAmVvW_7i0qm/s1600/Numbers+in+Employment.gif" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="255" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhnV8KjDn9h_9iHp6G4j45n940MPDK5j_rAZ6lpHOmLj_OxQaBKrQR7fw6G_g31f-yY-xRekc3qH4aJZmcyKHAn48Mk2KxmRfhvxC6R9Oh3RKos8xygcHIJNHo9OwBRjbe0YAmVvW_7i0qm/s400/Numbers+in+Employment.gif" width="400" /></a></div>
In these charts, we can see that the rapid credit expansion did dent the unemployment statistics as much as would be expected, as the size of the workforce was also increasing, with significant immigration accompanying the credit boom. The really interesting part is to see what all of these people were actually doing:<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjvuO_a1R0_hrrcaHu9tPXl5VLu5efygsi_rKj6x3AnJJTgh237T5JY9ilPT0L9VZW01RHMfAwySPv1Z1fSf_GjkuBCxMFjIxaIbD_ymx6A8xZOVbmcUihmexUCrCGxVTXUArqWzjmf9syv/s1600/GVA+by+Secor.gif" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="262" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjvuO_a1R0_hrrcaHu9tPXl5VLu5efygsi_rKj6x3AnJJTgh237T5JY9ilPT0L9VZW01RHMfAwySPv1Z1fSf_GjkuBCxMFjIxaIbD_ymx6A8xZOVbmcUihmexUCrCGxVTXUArqWzjmf9syv/s400/GVA+by+Secor.gif" width="400" /></a></div>
Perhaps the most notable point in this, is the increasing size of financial intermediation. Although the figures only go to to 2010, we can see the expansion and subsequent contraction of areas that would be associated with a credit boom; wholesale and retail, real estate. Somewhat surprising is that hotel and restaurants did not see greater expansion. Financial intermediation by contrast, has grown and grown, and (at least as far as these figures go) has not yet started to contract, but I believe that this is now taking place from various news stories (and see below). I took a look at the <a href="http://www.ons.gov.uk/ons/guide-method/classifications/current-standard-classifications/standard-industrial-classification/index.html" target="_blank">2007 SIC code</a>s, to get some sense of what the high expansion in 'all other' means, and examples include legal and accounting, management consultancy, scientific research, R&D, Market Research, rental and leasing of machinery, recruitment consultancy, security services, administrative support services etc. In other words, some of these activities might be associated closely with credit expansion, and other not. Manufacturing is notably flat, as are the primary commodity sectors. Although the chart given above is helpful, it does not give an indication of actual employment, and I dug out some figures from ONS, and created the following (key is given underneath):<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg16Z_wYqJ0kTJT3JE_0Srz48wYxzoM9Lzp9WigeT3NNVHPvRgYPqjs4avNqN6M0yZ-Xg0Rz9BjH62TBZj6xiJtdSN6gHYGiyro6pnVdnLNocZI0hQrkaPavBqdqTxl2lDTn5AjmXU0HF6M/s1600/Employment+by+Sector.gif" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="336" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg16Z_wYqJ0kTJT3JE_0Srz48wYxzoM9Lzp9WigeT3NNVHPvRgYPqjs4avNqN6M0yZ-Xg0Rz9BjH62TBZj6xiJtdSN6gHYGiyro6pnVdnLNocZI0hQrkaPavBqdqTxl2lDTn5AjmXU0HF6M/s640/Employment+by+Sector.gif" width="640" /></a></div>
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A = Agriculture, forestry & fishing, B = Mining and Quarrying, C = Manufacturing, D = Electricity, gas, steam & air conditioning supply, E = Water supply, sewerage etc., F = Construction, G = Wholesale, retail, motor trades, H = Transport and Storage, I = Accommodation and food, J = Information and Communication, K = Financial and Insurance, L = Real Estate, M = Professional and Technical Services, N = Admin and Support Services, O = Public admin, defence and compulsory social security, P = Education, Q = Human Health and social work, R = Arts, entertainment and rec, S = All other services.<br />
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The stand outs are the decline in manufacturing employment, Construction, Real Estate, and Retail, albeit that there is something of an uptick in the latter. Also notable is that the numbers working for the state appears to be in decline, but we need to consider this against the increase in 'All other' in the earlier chart of GVA and the increase in Professional Services in this chart; it may be that there is displacement going on here..... Another stand out is the increase in Q, Human Health and Social Work, which now seems to be reversing. A real curiosity is the growth in in D & E, which covers utilities; for E this can be explained by the rejuvenation of infrastructure being undertaken by the water companies (as a guess), but the increase in numbers for electricity is more of a puzzle. As discussed earlier, finance and insurance sees the numbers reducing, which is not apparent in the GVA chart. However, whilst this paints a picture of the post economic crisis, more interesting is to look at what has taken place whilst the world economy restructured in response to the entry of the emerging economies into the system, so I have added December 2000 to the chart, with the label of 'Series 6'. I have placed it next to the 2011 figures to make the changes more apparent.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjweq1Q4UZj6ZdOt9UOJ309lAlnxSdVk4wGGz24eeiI-D4PHDEoa7unrOZutuo9525t6jTTP5-4GKTu7R7QOPcXfhlhbKP3e1mzj6ahMiZl6PzPSitAxcrCcD7IuocV3DIapO8PF1cW6b55/s1600/Employment+by+Sector-Long.gif" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="336" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjweq1Q4UZj6ZdOt9UOJ309lAlnxSdVk4wGGz24eeiI-D4PHDEoa7unrOZutuo9525t6jTTP5-4GKTu7R7QOPcXfhlhbKP3e1mzj6ahMiZl6PzPSitAxcrCcD7IuocV3DIapO8PF1cW6b55/s640/Employment+by+Sector-Long.gif" width="640" /></a></div>
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Manufacturing is startling, even though we have long known this to be the case. For construction, there is still have a way to go before reaching pre-boom numbers, and any reversal of credit growth will mean this sector will shrink even further than pre-boom numbers. If we look at retail now in comparison with unsecured debt now and in 2000 (see earlier chart), the picture is mixed. In contrast to the more recent picture, accommodation and food, however, appears to be an area that may have some contraction if credit growth slows, but there is a question of whether people will forgo retail to continue to enjoy these services, which is a different question, and might mean contraction in retail. In other words, how will disposable income be split between these two sectors if credit expansion stops. Real estate activities still seems to over-large in numbers employed, and still has a way to go down. An offset here is that there are reports of inwards investment into UK real estate, with buyers considering the UK a safe haven. In other words, the sector may yet have 'legs', but my guess is that it is unlikely to last too long.<br />
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I have already discussed professional services, and the picture here may be seen as supporting the point about displacement (also see N, Admin support, which may be the same question). However, when looking at export figures, these services appear to have grown, so it is hard to make sense of the figures when aggregated. Education (P) is a real standout for growth in employment. It would be interesting to see how much of this growth is in the tertiary sector, which would reflect the government goals of expanding tertiary education, and also the increase in numbers of overseas students. Whether overseas students will continue to want a UK education is a question that is debatable, as questions are being raised about educational quality (beyond the scope of this post). Finally, we come to another huge standout; health (Q). This stands as an exemplar of the hard choices being confronted by government. In simple terms, each additional person employed in the health system is one less person with potential to be employed in underlying wealth generating activity in the wider economy. And the numbers are going to keep on growing as the population ages. Much more could be said on this subject, but I will leave this open for the moment (at risk of comments that point out that it is not as simple point as I make it). <br />
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We now come to wages. Below are some key figures for wages and inflation:<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgatsu8Pqs2nkRX_E_sp1tqtaTkmNkv7ob7ZVTUIUKCpvns2VYnTKL5OCDFbnJoG49iQLQCPr6_AYGeL9Akzjritp86KVi6OBNAPafTeZvqA2X1bSitWmKAhoBpRXu3tqfiBCXlsz0Zk9VS/s1600/Getting+Poorer.gif" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="210" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgatsu8Pqs2nkRX_E_sp1tqtaTkmNkv7ob7ZVTUIUKCpvns2VYnTKL5OCDFbnJoG49iQLQCPr6_AYGeL9Akzjritp86KVi6OBNAPafTeZvqA2X1bSitWmKAhoBpRXu3tqfiBCXlsz0Zk9VS/s400/Getting+Poorer.gif" width="400" /></a></div>
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I have titled the chart 'getting poorer', as this is the picture it paints. You need to consider this in light of the ongoing massive borrow and spend of government, and the dubious activity of printing money. Also, you need to consider that the indices for inflation are questionable, and that even if accepting the indices in principle, the impact upon individual households is variable. If we really want to understand something about the underlying nature of the economy, the devil is in the detail (sorry for the messy chart, but it is readable). I have gone a bit further back than the chart above, and this is because of the fascinating story of consumer durables.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiEloCGXCyLSXd-q04RY3Xo2YrTnqF07eDtps4ELZUFsWRisbVuKMgVjH3SQMpe_2glo4BWiYa_DGxm5H3FIx26NU06-c76r64LV8BLJFm9aH0Dthtq3ghCPxQfA4ktftYbEYN7o4B7olLG/s1600/CPI+detail.gif" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="464" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiEloCGXCyLSXd-q04RY3Xo2YrTnqF07eDtps4ELZUFsWRisbVuKMgVjH3SQMpe_2glo4BWiYa_DGxm5H3FIx26NU06-c76r64LV8BLJFm9aH0Dthtq3ghCPxQfA4ktftYbEYN7o4B7olLG/s640/CPI+detail.gif" width="640" /></a></div>
You will note how there was significant deflation in the price of consumer durables, which we can safely say reflects the entry of countries like China into the world economy. We can see the peaks in energy prices, and the fall in the same prices as the economic crisis bit home. And now, we see inflation in energy once again; however, this time, the inflation may yet be offset as the global economy teeters (in part driven by higher energy prices), in part by the adoption of fracking. On the other sideof the coin, so called 'green energy' are a potential driver in the UK towards higher electricity prices. The chart below gives annual electricity bills, and it is apparent that they are growing rapidly. It deserves a post in its own right, but there are considerable problems looming for UK electricity supply, and the real cost of 'green' energy is now becoming apparent in Germany (e.g. see <a href="http://www.spiegel.de/international/germany/energy-turnaround-in-germany-plagued-by-worrying-lack-of-progress-a-860481.html" target="_blank">here</a> and <a href="http://www.spiegel.de/international/germany/instability-in-power-grid-comes-at-high-cost-for-german-industry-a-850419.html" target="_blank">here</a>)<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhSnG3BuWBcuZnPMqHqdqMVIHCkw7oj6B-Mcobl-V2ureUNGl1tVxuoko28B9LZKsNOIb9tu9LKInwY-_JbWR_JJCv9jKx2EAKxvPwHGi57H4VRnHDcUx6_j9TFBk-TIdjKzdYwyrUgjw0D/s1600/Electricity.gif" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="255" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhSnG3BuWBcuZnPMqHqdqMVIHCkw7oj6B-Mcobl-V2ureUNGl1tVxuoko28B9LZKsNOIb9tu9LKInwY-_JbWR_JJCv9jKx2EAKxvPwHGi57H4VRnHDcUx6_j9TFBk-TIdjKzdYwyrUgjw0D/s400/Electricity.gif" width="400" /></a></div>
<br />
<br />
Higher energy prices, it should be remembered, impact more upon those with lower incomes, and the same can be said of food prices. Income spent on energy is not spent elsewhere. The final point of note is that consumer durables have now started to climb in price. If we look at the $US exchange rate, which is the currency of trade, we can see something of the reason (£GB - $US).<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi9LCTDtfzNezb6FKCc_HSp6wcSIzlZV3P876ndzPnswkXdAIl8m8Uc6i6e6vICQHFHy8K-vIY-Wea4Ocne3PI_Vy8Bu9HYQIHbPOHw7A-pHqywePRr-OsocnWDE0w5_dOUmdvdCeEVxmvA/s1600/Dollar.gif" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="255" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi9LCTDtfzNezb6FKCc_HSp6wcSIzlZV3P876ndzPnswkXdAIl8m8Uc6i6e6vICQHFHy8K-vIY-Wea4Ocne3PI_Vy8Bu9HYQIHbPOHw7A-pHqywePRr-OsocnWDE0w5_dOUmdvdCeEVxmvA/s400/Dollar.gif" width="400" /></a></div>
<br />
Other factors that may also having an impact are rising wages in places like China, and rising energy prices. However, if China does slow significantly, it is quite possible that there will again be deflation in consumer durables; as orders in Chinese factories decline, there may be a period of significant discounting as businesses seek to at least contribute something to their fixed costs. However, the trajectory of the £GB may offset this, and there is ongoing money printing policies in the major economies to muddle any idea of future exchange rates. Competitive devaluation through printing money means that UK money printing effects may be neutralised by other countries printing money. In summary, inflation is very likely to continue, but the degree of future inflation is a very open question. There are simply too many variables that might impact upon inflation in the UK, with UK government and central bank policy simply additional influences. <br />
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With regards to house prices, they continue to fall in price in inflation adjusted terms, even if headline prices are relatively stable:<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgb_G2AnHB-Qph3CxWR-hoFO56AtVMJpTuEPyUbuOqV1MoXz3lu4g1oxBxUoQOLeXOkahyj-AUw79DkFr26ABUkx3lvQEhkS6o9_nP3ctlujy-GKI2P8-C4wFJAh_MswfLR4QYPCUVDNJi_/s1600/House+Prices.gif" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="255" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgb_G2AnHB-Qph3CxWR-hoFO56AtVMJpTuEPyUbuOqV1MoXz3lu4g1oxBxUoQOLeXOkahyj-AUw79DkFr26ABUkx3lvQEhkS6o9_nP3ctlujy-GKI2P8-C4wFJAh_MswfLR4QYPCUVDNJi_/s400/House+Prices.gif" width="400" /></a></div>
More interesting is the house price to earnings ratio, given below:<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj_H_ATSLXRfmC-SFnIDC1sih1gZjZ1-RoRhpdxoPK7Y0vNWbvOyUSFht6FQnjb7e6jKY_VG-YJ0HLxwOjCcbvBOFW6USvoDYvmVWKg4erYK7zDlnp3iZ5uNlGbtQBDPQCajU3H25YOcJ5h/s1600/Housing+Earnings.gif" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="255" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj_H_ATSLXRfmC-SFnIDC1sih1gZjZ1-RoRhpdxoPK7Y0vNWbvOyUSFht6FQnjb7e6jKY_VG-YJ0HLxwOjCcbvBOFW6USvoDYvmVWKg4erYK7zDlnp3iZ5uNlGbtQBDPQCajU3H25YOcJ5h/s400/Housing+Earnings.gif" width="400" /></a></div>
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By historical standards, they are still high. I must however mention that house prices are, in part, being supported by the inwards investment, as discussed earlier, in particular in London. Nevertheless, the current ratio suggests current prices are not as stable as they may appear. The <a href="http://www.economist.com/node/21551486" target="_blank">Economist</a> also proposes that UK real estate is overvalued compared with rental value (26%) and income (17%), suggesting that real declines will continue at some stage.</div>
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My final chart of the day is one I will copy from a previous post, covers the balance of trade, and comes from the (from <a href="http://www.ons.gov.uk/ons/rel/uktrade/uk-trade/july-2012/stb-uk-trade--july-2012.html#tab-Key-figures" target="_blank">ONS</a>):</div>
<br />
<img alt="£billion, seasonally adjusted" src="http://www.ons.gov.uk/ons/resources/01fig1balanceofuktrade_tcm77-278517.png" title="£billion, seasonally adjusted" /><br />
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As I stated in a recent post, it is a good indicator of the long term sustainability of the standard of living within an economy and, again, it is not a very positive picture. </div>
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So how can we add up all of these piles of charts? The first point I would like to make is that we can, in part, see that the economic crisis did NOT start in 2008, but started much earlier. It has been so easy for commentators to blame the 'financial crisis', as it evades the fact that there were changes taking place earlier, and that these were simply hidden under the cloak of massive extension of credit. The UK entered the 'financial crisis' already in a state of economic crisis. When looking at relatively benign inflation in the face of credit expansion, the impact of ongoing deflation driven by cheap labour and cost structures in emerging economies was not accounted for. The very real inflation in house prices was ignored; apparently that was un-worrisome inflation. When <a href="http://cynicuseconomicus.blogspot.co.nz/2008/06/funny-view-of-wealth.html" target="_blank">I first looked at the UK</a> economy in any depth, it quickly became apparent that the boom years were built upon foundations of credit expansion, and I worried for the future and proposed that people were poorer than they thought. We can now see people becoming poorer in the decline in real standards of living, and the now steady decline in the value of most people's primary asset. </div>
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People are becoming poorer in spite of government borrow and spend, which is at astoundingly high levels. When consumers were unable to 'grow' the economy through more debt accumulation, the government tried to 'grow' the economy through debt. Spending tomorrow's income now is not a way to grow an economy, as it will see a shrinkage of disposable income in the future. As it is, private debt is now in a very slight decline. However, this slight decline is more than offset by the massive increase in government borrowing; but incomes still continue to fall. This only serves to illustrate the depth of the economic crisis that confronts the UK. Even whilst borrowing and spending more in aggregate, people were becoming poorer, and unemployment was rising. The UK has not even started to address the crisis that sits metaphorically in front of its nose. It does not take much imagination to see what might happen if the UK was to seriously try to balance its budget. Those £billions of debt generate a large amount of employment. What it does not do is generate underlying wealth; that wealth is generated in the primary commodity industries, manufacturing and the export of services. </div>
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These sectors are the ones that are either sitting on plateaus or in decline. Sure, a flood of money into UK real estate might help tide the UK over for a little longer, but that is surely just another repeat of a bubble. There are still such temporary sticking plasters to cover the gaping wound in the UK economy. What these do not do is increase the ability of the UK to export goods and services, which allow the UK to trade in the goods and services necessary to sustain current standards of living. Quite simply, the UK is unable to compete well enough in world markets to sustain the current standard of living. In this post, I looked at government expenditure, and it is apparent that some expenditure is subject to upwards pressure; health care and pensions. These two expenditures look set to rise, even as the UK faces ongoing competitive pressures. In real terms, it means labour being taken from potentially wealth creating industries, and either being redirected into health care, or labour becoming inactive in increasing numbers. The ability to compete with such shifts in the labour force is a challenge the UK must face, in addition to facing the fiercer competition in the world. The UK is not, of course, alone in such challenges, but faces them whilst already struggling to compete. </div>
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I keep on discussing this, but it does not do harm to say it again. The so-called 'austerity' of the current government is not austerity, but a luxury; a luxury that cannot be afforded. It is spending borrowed money to avoid confronting the real underlying standard of living in the UK. It is storing up trouble in the face of the challenges of shifts in the labour force, and a less forgiving world economy. So what is to be done?</div>
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The answer is to start to question what can, and cannot be afforded. My benefits reform is an example of how a principle might survive intact, whilst seeing reduction in cost. The aim is simple; to allow what was intended as a safety net to return to its original purpose. Real reform, the kind of reform that is increasingly necessary, requires that the shackles of historic legacies be thrown off. The benefits system did not start out as it is now; it evolved over time into what it has become. The same can be said of swathes of policy that comprises the foundation of government expenditure. If you look at the UK's tax code, it is possible to see that the (sometimes) good intentions of government after government has evolved into a sinkhole to drain away productive activity. Instead, the UK has a massive and fundamentally unproductive industry with the sole purpose of managing tax. Can the UK really afford to have so much productive capacity dedicated to what, in the end, is a process of collecting <i>x</i> amount of government revenue? </div>
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It is these really fundamental questions that must be asked, and asked of every area of government; what must the government do, how can it do what it must do differently and better, and where are the priorities for what government should do? These are the questions that are still not being addressed. In the meantime, the UK is becoming poorer. I see no change to this in current policy; but rather see the opposite outcome, which is an acceleration of the decline in the standard of living. After all, where is the policy to <i>really</i> address the poor and declining performance of the UK economy? </div>
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Note: I hope this is not too 'clunky'; comments welcomed on this and all points of the post. I have covered a lot of ground in this, so please point out any errors you may see. </div>
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Note 2: Shortly after publication - I am not sure I have made the best use of the data given - a bit like a kid in a sweetshop gorging without pause. Thoughts / comments welcomed. <br />
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<br />Unknownnoreply@blogger.com6tag:blogger.com,1999:blog-7820485130017459619.post-59207483650398289182012-10-15T22:30:00.000-07:002012-10-15T22:32:51.302-07:00Oh dear, Prof. KrugmanThis is a very short post. This from the <a href="http://www.guardian.co.uk/politics/2012/oct/15/osborne-austerity-policy-opponent-krugman-portes" target="_blank">Guardian</a> on the ever more odd discussions of Prof. Krugman:<br />
<br />
<blockquote class="tr_bq">
On the day the Nobel prize for economics was announced in Stockholm, a
former winner was in London urging the government to ditch the "mad"
austerity policy that was keeping the British economy depressed. Paul
Krugman joined Jonathan Portes for a debate on whether the government
had gone too far, too fast.</blockquote>
In what world is the current level of government spending 'austerity'? It is the oddest idea that can be imagined. The deficit is huge (from the <a href="http://www.guardian.co.uk/news/datablog/2010/oct/18/deficit-debt-government-borrowing-data#" target="_blank">Guardian</a>):<br />
<br />
<img height="235" id="il_fi" src="http://static.guim.co.uk/sys-images/Guardian/Pix/pictures/2012/3/21/1332345654504/UK-deficit-graphic-008.jpg" style="padding-bottom: 8px; padding-right: 8px; padding-top: 8px;" width="400" /><br />
Apparently this is 'austerity'. Or at least according to the ever more unreal Prof. Krugman this is 'austerity'. Nevertheless, his words will be taken seriously by many. He may have won a nobel prize, but that does not make his pronouncements any more sensible than any other of the many economists that failed to recognise the problems in the world economy until they were already in plain sight. Unknownnoreply@blogger.com4tag:blogger.com,1999:blog-7820485130017459619.post-14252390623135062242012-10-13T15:54:00.001-07:002012-10-13T18:35:19.978-07:00The Multilplier Effect of Borrowing and Economic StructureThis was originally part of a larger post, but I decided to edit it down to a single point, and will probably chop the remainder of the post up later. As such, it is not up to date on the latest news, but the news on which it is based I think is not the stuff of 'events', but rather reveals something which is driving current problems in Europe and many other countries are facing.This is from the <a href="http://www.tradingfloor.com/posts/tradingfloorcom-highlights-france-goes-berserk-onausterity-1363434914" target="_blank">article</a> that started the post:<br />
<blockquote class="tr_bq">
“This week the socialist government in France went berserk with
austerity and tightening measures. This could put the country’s recovery
at serious risk and perhaps President François Hollande may need to
re-read the economic page on ‘fiscal multipliers’ – if no book is
available the <a href="http://static.ow.ly/docs/The%20Eurozone%27s%20New%20Recession--Confirmed_Ojw.pdf" target="_blank">S&P Rating Services</a>
offers a sanguine view on page 5. The study proves how the fiscal
multiplier in Spain has been closer to 6 to 1, rather than 1 to 0.5%
rule which IMF applies. In the case of France we have an economy with
low rates, an expensive labour market and now a new marginal tax of 75% -
everything being equal will that lead to lower or higher growth? I
think you know the answer, even without 5 years wasted at a university
becoming an economist.” Steen Jakobsen, Chief Economist at Saxo</blockquote>
There
is a link in the quote to an a report from S&P, which gives a
breakdown of fiscal multipliers; 'For instance, in the UK, a fiscal
contraction equivalent to about 4% of GDP between 2009 and 2011 had a
negative effect on GDP growth about twice as high as the typical fiscal
multiplier implies.' (p.5) The reason given in the S&P report
for the higher multiplier is that there has been a simultaneous fiscal
tightening over the developed world, and that the effects of
reflationary policies in countries like China are fading. <br />
<br />
There
are two interesting points that emerge from the S&P report. The
first point is that they are actually identifying how critical
government borrow and spend is in supporting many developed world
economies. The ever well-informed but ever more dubious analysis of <a href="http://blogs.telegraph.co.uk/finance/ambroseevans-pritchard/100020504/multiplying-europes-fiscal-suicide-technical/" target="_blank">Ambrose Evans-Pritchard</a> leads to this conclusion being drawn from the report:<br />
<br />
<blockquote class="tr_bq">
Europe's manic determination to tighten further into recession to meet its bureaucratic targets is nothing less than suicidal.</blockquote>
However,
the real point that can be understood from the report is that it
reveals something of the depth of the economic structure that is being
supported by government borrow and spend policy. Regular readers will know that I have often expressed concern about the way in which many countries have structures that have developed to service debt driven consumption. The interesting thing about this report is that it starts to hint at the degree to which economies are now reliant on ongoing government borrowing to maintain current standards of living. In my first ever post, I argued that, for example, the UK is poorer than it thinks, and this is the case in all of the countries that are following the borrow and spend path through the economic crisis.<br />
<br />
It is not at all complicated. Current standards of living are to a very large degree contingent on borrowing and consuming. Economies that do so are simply entrenching the structure to service consumption based upon growing debt. As soon, as a government cuts back on debt growth, the structure that is supported by debt growth starts to collapse, and the real wealth generating economy underneath the unsustainable structure becomes exposed. Quite simply, there is no way out of the pain of restructuring, unless there is major economic upturn around the world. The problem is that, as the situation stands, this is not going to happen.<br />
<br />
The Keynesians argue that the answer is more fiscal stimulus, and that this will regenerate demand, and all boats will rise with the fiscal stimuli. If only everyone borrowed and spent, all would be well. However, there is a fundamental problem with this idea. The more countries borrow, the more they restructure their economies around the borrowing. If, as they Keynesians had their way, all the countries of Europe were to raise their borrow and spend, this would (assuming that creditors would go along with it; a big assumption) lift Europe out of its current funk. The problem is that the restructuring of all economies to servicing debt based consumption would simply be greater. As country A borrows more, it would not only lift country A, but also countries B and C, which would help service the new demands in country A. The new activity in country B would also lift demand in country A amd B, and so forth.<br />
<br />
The problem with this solution is that it is simply spreading the underlying structure of debt based consumption more broadly. Instead of just being reliant on your own borrowing to support your current standard of living, you become reliant upon country A, C, D, E etc. also continuing to borrow and consume. It merely extends the reliance of borrow and spend into an ever more entrenched network. As soon as any country in the network stops borrowing and spending, it impacts upon other countries within the network. Just as the upwards multiplier in the above paragraph lifted all boat, the same can be said of the downwards multiplier. It is this downwards multiplier that the Keynesians fear, and they are right to fear it.<br />
<br />
The Keynesian's problem is that they simply do not accept that the more governments borrow and spend, the more entrenched the underlying problem becomes. The greater the coordination in borrow and spend, the greater the network effect of the multiplier, and the greater the negative impact when any single borrower cuts back. In the case of Europe, the fate of each economy is closely entwined with the European economy as a whole due to dense trade links. Any increase in borrowing of any country will improve the economy of its neighbours, and thus make those neighbours more reliant upon continued borrowing. The problem is that borrowing must have a limit. And as each borrow and spend domino falls, the others start to wobble as the effects of the falling domino moves through the network, multiplying the effects beyond the original domino. Coordinated borrow and spend is metaphorically moving the dominoes ever closer together.<br />
<br />
The other problem is also distantly related to game theory. If country A tightens whilst all other countries increase borrow and spend, country A will start to restructure its own economy to be less reliant on borrowing. The stimuli from other countries will help it through the adjustment, and it will be left in a position of relatively less debt. It will still be reliant upon the network effect of the debt accumulation of the other countries in the network, which still means further pain at some point in the future, but the pain will be less than those who borrowed most profligately. By contrast, the country that borrows the most will undergo the greatest restructuring to service debt, and will contribute most to the network, at a cost of being in a weaker position in the future. Whilst this debt accumulation will maintain (or even enhance) their own standard of living in the near term, they are also disproportionately contributing to the network at a cost of increasing their debt and greater cost in the medium to long term. In other words, the smart policy now is to restructure whilst encouraging others to borrow and spend; as long as you are not the lender to those borrowing and spending, as these countries are going to have the greatest problems in repaying the debt later.<br />
<br />
When looking at the fiscal multipliers, it is possible to see <i>something of</i>
quite how large the debt consumption structure actually is for each
country, but what is does not show is how those multipliers might effect
a dense network. The problem is that we know that individual country
multipliers will certainly have network multipliers, but nobody can
calculate the network multipliers, which would require understanding of a
dense network of interlinking relationships and layer upon layer of
feedback between actors in the network. The real complexity in the European network is the different starting
points of different countries, and that apparently less debt structured
countries have already been lending heavily to those that have been net
contributors to the system, not realising how dependent they themselves
were becoming upon debt based consumption. Without this, we would see a
very different response to the crisis. <br />
<br />
What this finally comes to is that government borrowing to support consumption cannot be sustained. Borrowing must have a limit. Although cut backs in borrowing will result in a downward spiral, and the downward spiral will be large if there is simultaneous cuts in borrowing, this does not alter the fact that, at some point, economies must restructure. Coordinated borrow and spend can only make the problems even larger in the future. Acting as a net contributor in the network is foolhardy. Lending to a net contributor is foolhardy. Notwithstanding the complexity engendered by past lending, it leaves Europe in a position where the only real solution is to accept
that the restructuring will lead to a downwards spiral. Better now than
later.<br />
<br />
<i>Notes on Comments on the Last Post:</i><br />
<br />
Lord Sidcup: I agree that, in some respects, the dichotomy between real and unreal becomes ever harder to see. I am very sympathetic to the creditism argument, and the original version of this post was going to address what is 'real' to some degree. For the moment, I will just say that what we are seeing is not that there is not a real underlying economic reality, it is just getting harder and harder to see. In some respects, it is a flight of fancy to use the world 'real', but what I mean by this is the idea that economies, in the long run, are comprised of individual actors who buy and consume 'stuff' and create 'stuff'. The global economy still comprises this fundamental structure. The relationships between these actors are the fundamental drivers of economics in the long run. <br />
<br />
These actors operate in a global system comprised of the other actors, and there are subsystems in which these actors participate, which is individual country economies, and these operate more or less efficiently. These in turn have economic entities which operate more or less efficiently. Beneath this is the layer of individual actors, who also are more or less efficient. Obscuring this is money and debt (I will not argue about the distinction between these here), which is a layer over the top of a system in which each individual actor is a consumer of resources and/or adding value to resources (not all actors are both consumers and 'value adders') within a system.<br />
<br />
The fundamental of 'real' wealth creation is the efficiency with which value is added to any given resource, relative to other actors. If you can take an input and add more value to it than another actor, then in the long run you will be more wealthy. The obscuring layers hide where the real value is being created. I know this is an incomplete answer, but I hope it helps to clarify a little about what I mean by real. However, in some respects I accept what you say about a false dichotomy, as the unreal and the real are ever less separable.<br />
<br />
Lemming: An interesting point about throwing the dice on infrastructure:<br />
<br />
<blockquote class="tr_bq">
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.</blockquote>
I did not see Evan Davies, but note your mention of 'investment' in infrastructure for new rail lines. These were no doubt called an investment, but rail requires subsidy. As such, it is an investment almost guaranteed to create a negative return in financial terms. However, it <i>might </i>have a positive return in improving 'quality of life', but that is achieved at a cost that needs to be considered against other priorities for government spending.<br />
<br />
However, the problem runs deeper than this example. If it is accepted that government should provide and invest in infratructure such as roads (which is another topic), then it is quite right that investing in infrastructure might be viewed as a positive, provided that there is a real need (and in the case of roads I would think that this is probably the case). However, the problem of the UK is not one caused by investment in infrastructure, but rather that there is overall consumption that exceeds the wealth generating capacity of the country. The question then becomes one in which it is necessary to ask what can be afforded. Provided that there is a real need for x infrastructure project, it absolutely should be at the top of the priorities. The problem is that nobody is willing to really accept that there must be much tougher priorities or the resources available to goverment must be used more efficiently.<br />
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In other words, asking for greater investment in infrastructure may be reasonable, but still leaves the problem that the current undertakings of the government cannot be afforded in their current form. The assumption is that the spending on infrastructure must be undertaken on top of the current undertakings. Where does the assumption come from? It is quite possible to cut undertaking x and y, and at the same time put resource into infrastructure. They are not mutually exclusive. And if, and it is a big if, the infrastructure improves the economy, this will allow for greater resource for the government in the future. My real worry in all of this was that, in particular during the build up to the crisis, was that the words spend and investment became interchangeable. However, that again is another topic. The main point here is to point out the problematic assumption. There is no reason that spending on infrastructure should mean incresing borrowing. It is just a question of priorities. <br />
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General Comments: Thanks for the positive feedback. Also, some challenges and interesting contributions. I would love to answer all the comments, but as you can see, this is already a long post with some long answers to a couple of the comments already. Quite simply, I have run out of time.<br />
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Final Note: For some reason, the Blogger service keeps changing 'S&P' to gobbledygook - apologies if this takes place when I hit the publish button, but I am unsure how to fix it (and it may happen in this note as well).<br />
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A reply to a comment on this post (same day as post, the reply was too many characters for the comments so added here):<br />
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Nice to see you commenting again Chaingangcharlie. I agree that the lead up to the crisis was not a very positive picture for the invisible hand but..... but the sudden dropping of massive surplus of labour into the world economy was not the work of the invisible hand, but very visible hands. China and India kept their workforce out of the global supply, and then 'dropped' their workforce into the supply. The invisible hand was not the cause here. As a regular reader, I am sure that you will know my argument that this labour shock was the underlying cause of the financial crisis (aided by regulation), the boom in credit etc. I cannot detail this here. However, the point is that it is not the visible hand. <br /><br />As for bankrupt, you are right that printing money is not going bankrupt in the strictest terms. However, if you hold a devalued GBP that has taken a 'haircut' as a result of devaluation, how is this different from taking a haircut more directly from a failure to pay and renegotiation? <br /><br />In both cases, the value of your bond holding has fallen, and the issuer has failed to pay what they implicitly promised; returning to you x% of greater value that you lent. A country cannot be legally bankrupt, but being unable to pay your debts is, from a pragmatic point of view the same thing. <br /><br />As for the market knows best, as I have detailed in other posts, the global economy is no longer about market signals, but about government and central bank actions. Again, there are very visible hands at work, and how is that working out for us? You say we will head into a long period of pain, and suggest this is not the answer. However, we can see what has happened when the other answer has been pursued to a conclusion; Greece and Spain. When it comes to other borrow and spend countries, they may have a while yet, but......what must finally happen unless they eventually accept that they cannot consume more than they produce....?<br /><br />You have confidence, it seems in the policy makers who failed to see the crisis coming, who have not resolved the crisis since it became apparent in 2008, and who have in the meantime printed and borrowed to no effect. And despite this policy action, as I have discussed before, people are still getting poorer, and doing so whilst racking up future commitments that will make people even poorer. <br /><br />In the meantime they have obliterated any functioning of the market, created monetary time-bombs, and borrowed to the point where any prospect of repaying the debt grows ever more dim. In so doing, what have they created; an economic system that is now policy driven. But driving where? Do you see this policy action working on any level at all, except for building and ever less sustainable and distorted structure? <br /><br />You have faith in policy makers to make things right. I have no faith in them whatsoever, as their record is dismal. They have failed on every level, and even the most casual reading of the news shows that this is the case. Even when the news is positive, the situation always reverses. The overused phrase of 'green shoots' appears, only to see that there were no <i>real</i> green shoots, or that the shoots whither as soon as they emerge. How much failed policy would it take to convince you? What would it take to dissuade you of the necessity to change course? <br /><br />Unlike those who proposed exansionary austerity, I never bought this idea. I always recognised that you cannot restructure away from debt fuelled and unsustainable consumption without a painful adjustment. And this is why I emphasise that the problems are that economies are structured around debt based consumption. If that is accepted, then more debt just deepens the problem. More countries simultaneously increasing debt just raises the problem to a new level and deepens the structural problems. I understand your concern, but surely leaving the current system in place can only eventually make things worse. <br /><br />And then what will the final mess look like? I do not like the choice I propose but it is the same point I have made for a long time; pain now or more pain later. I go for pain now. It is not good, it should never have got to this situation etc. etc. but the situation as it stands is still the situation. Unknownnoreply@blogger.com6tag:blogger.com,1999:blog-7820485130017459619.post-70318129335251067572012-10-02T02:48:00.000-07:002012-10-02T03:30:03.683-07:00The Perpetual Economic Growth MachineWhen 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.<br />
<br />
The crash I predicted failed to take place, and I took a hit to my credibility.<br />
<br />
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.<br />
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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'. <br />
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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.<br />
<br />
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. <br />
<br />
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.<br />
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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.<br />
<br />
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.<br />
<br />
If only the perpetual economic machine were true. We could forget having to compete and just borrow our way to prosperity.<br />
<br />
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.<br />
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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.<br />
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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.<br />
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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). <br />
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<br />Unknownnoreply@blogger.com14tag:blogger.com,1999:blog-7820485130017459619.post-17090099005685681062012-09-28T12:41:00.000-07:002012-09-28T13:07:25.338-07:00The Hollow Men of the EU<br />
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<a href="http://www4.ncsu.edu/%7Edsbeckma/The%20Hollow%20Men%205.jpg" imageanchor="1" style="clear: left; float: left; margin-bottom: 1em; margin-right: 1em;"><img border="0" height="200" id="il_fi" src="http://www4.ncsu.edu/%7Edsbeckma/The%20Hollow%20Men%205.jpg" style="padding-bottom: 8px; padding-right: 8px; padding-top: 8px;" width="128" /></a><i>Here we go round the prickly pear<br />Prickly pear prickly pear<br />Here we go round the prickly pear<br />At five o'clock in the morning.<br /><br />Between the idea<br />And the reality<br />Between the motion<br />And the act<br />Falls the Shadow</i><br />
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This section of T.S. Eliot's poem '<a href="http://www.lorenwebster.net/In_a_Dark_Time/2003/06/04/ts-eliots-the-hollow-men/" target="_blank">The Hollow Men</a>' just popped into my head whilst thinking about the latest chapter in the Euro crisis, but other parts of the poem also seem oddly appropriate. The prompt for thinking about the poem was the ongoing woes of Spain and the reporting about the Spanish budget, and the wider concerns about the Euro. Reuters gives <a href="http://in.reuters.com/article/2012/09/28/spain-budget-reforms-idINDEE88Q0DJ20120928" target="_blank">a good overview</a> of the budget:</div>
<br />
<blockquote class="tr_bq">
Ministry budgets were slashed by 8.9 percent for next year and public sector wages frozen for a third year as Prime Minister Mariano Rajoy battles to trim one of the euro zone's biggest deficits.<br />
<br />
"This is a crisis budget aimed at emerging from the crisis ... In this budget there is a larger adjustment of spending than revenue," Deputy Prime Minister Soraya Saenz de Santamaria told a news conference after a marathon six-hour cabinet meeting.<br />
<br />
Beset by anti-austerity protests and threats of secession by the wealthy northwestern region of Catalonia, Rajoy is resisting market and diplomatic pressure to apply for a rescue, partly out of concern for national sovereignty but also because European Union paymaster Germany insists Spain doesn't need help.<br />
<br />
The central government sees budget savings of 13 billion euros in 2013, with spending down 7.3 percent -- not including social security and interest payments -- and income rising 4 percent thanks to a 15 percent leap in value-added tax take.<br />
<br />
The budget goes to parliament on Saturday and debates could last weeks. The country's 17 autonomous regions still must present budgets and find an additional 5 billion euros in adjustments to meet overall public deficit reduction goals.</blockquote>
Apparently, the budget was well received with the Euro <a href="http://uk.reuters.com/article/2012/09/28/markets-forex-idUKL1E8KS4RU20120928" target="_blank">gaining</a> against the $US, and stock markets <a href="http://v/" target="_blank">rising</a> in response. As I have mentioned in an earlier post, there was also an audit of the Spanish banks, with the following <a href="http://online.wsj.com/article/SB10000872396390443389604578024433572756940.html?mod=googlenews_wsj" target="_blank">finding</a>:<br />
<br />
<blockquote class="tr_bq">
Spain's banks need €53.75 billion ($69.23 billion) in new capital, an
independent audit showed, a figure below initial estimates that
provides a benchmark for the cleanup cost of the ailing sector, the
government and the Bank of Spain said Friday.<br />
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The number was lower than an €62 billion estimate
Spain gave in June, providing some welcome news to the government of
Primer Minister Mariano Rajoy which this week announced a series of
spending cuts and tax increases in an effort to stabilize the economy
amid protests and political challenges from the country's richest
autonomous region. </blockquote>
In my last <a href="http://cynicuseconomicus.blogspot.co.nz/2012/09/spain-banks-and-real-estate-again.html" target="_blank">post</a> on the Spanish crisis, I questioned whether the audit would genuinely reveal the true extent of the losses, and that more toxic debt would be revealed at a later date. I am still of that view and, as I stated before, I suspect that we will see further requests for bailouts in the future. In short, I suspect that the requests for bailout money will be given in 'bite-sized' chunks. The <a href="http://www.telegraph.co.uk/finance/financialcrisis/9574667/Spanish-banks-need-60bn-the-full-report.html" target="_blank">disclaimer of liability</a> at the start of the report and the explanation that the report 'methodology and process' was agreed with the Spanish Government and Banco de Espana might be seen as indicative of the reliability of the report.<br />
<br />
The devil is in the detail, of course, and a quick look through the <a href="http://www.telegraph.co.uk/finance/financialcrisis/9574667/Spanish-banks-need-60bn-the-full-report.html" target="_blank">report </a>and raised concerns in my mind, such as the limited sample size used for the assesment due to time constraints (p.13), and crucially, the audit assumes that 2014 is the date of sale of real estate assets, but I found no <i>real</i> clarity on how the values were projected, and it makes heroic assumptions that the assets will sell at all. However, I have only briefly glanced through the report and may have missed details or misunderstood sections, and I am not an expert. In other words, I just looked at the report to get a 'flavour' of the approach.<br />
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The point is this; it is not the initial positive market reaction that matters, but the reaction once experts have dissected the detail and methodology. It is then that the quieter shifts in markets will take place, and at which time the real judgement on the report will be felt. In many cases, those assessments will not be make public, but will remain proprietary. An article in the <a href="http://www.ft.com/cms/s/0/603ab4a6-0800-11e2-a2d8-00144feabdc0.html#axzz27nF8ya9P" target="_blank">FT</a>, before the audit publication, captures the pressures for positive results from the audit:<br />
<br />
<blockquote class="tr_bq">
This time, it has to work. This is the view of senior bankers in Madrid as Spain prepares to unveil on Friday the results of an <a href="http://www.ft.com/intl/cms/s/0/762f42d6-bbca-11e1-9436-00144feabdc0.html" title="Madrid moves to ease bailout fears - FT.com">audit of its financial sector</a>. Many now consider it the Spanish government’s last chance to convince the world that it has the banking crisis under control.<br />
<br />
[and]<br />
<br />
The
investors and analysts that Madrid is anxious to convince, however, are
already questioning the integrity of the latest review, with some
arguing it is likely to resemble a stage-managed announcement with few
surprises.<br />
<br />
Mr Guindos has said that the final amount of total capital required
is likely to come in at about €60bn, which is close to a provisional
estimate of between €51bn and €62bn made by Oliver Wyman and fellow
consultant Roland Berger in June.<br />
<br />
In what he labels “the Don Quixote approach to valuation”, Santiago
López, an analyst at Exane BNP Paribas, has said it is not credible that
the Ministry of Finance has already indicated no listed bank, aside
from Bankia, will need new capital under the tests, even though they use
aggressive economic assumptions.<br />
<br />
[and]<br />
<br />
“Spanish banks are not giants but windmills,” Mr López says. “The
assumptions of the tests seem reasonable but the conclusion is not
credible.”</blockquote>
We have seen plenty of similar bank reviews in the past, and the pursuit of confidence over clarity seems to be the real purpose in many cases, such at the EU bank 'stress tests' that found <a href="http://www.guardian.co.uk/business/blog/2011/oct/05/europe-bank-stress-tests-dexia" target="_blank">Dexia</a> to need no additional capital just a few months before it ran into trouble. In summary, perhaps I am wrong about the audit but I do not believe that this is the end of this story. My own view is that it is now just a question of 'when' the next bad news will arrive as the hollow men continue to seek that the crisis resolves, <i><a href="http://www.lorenwebster.net/In_a_Dark_Time/2003/06/04/ts-eliots-the-hollow-men/" target="_blank">Not with a bang but a whimper</a>.</i><br />
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<i>Added Just after Publication:</i><br />
<br />
<b>German Wages </b><br />
<br />
I just thought I would add a quick note. I stumbled on an article in <a href="http://www.slate.com/blogs/moneybox/2012/09/25/german_wage_stagnation_is_it_the_real_secret_to_their_employment_success_.html" target="_blank">Slate</a> which grumbles that the low unemployment of Germany is based upon wage stagnation, and could not resist mentioning it. <br />
<blockquote class="tr_bq">
The real secret to Germany's job market success, though perhaps in some
ways related to the labor market regulations, seems to be simpler—<a href="http://blogs.lclark.edu/hart-landsberg/2012/02/15/germany-a-false-model/" target="_blank">don't give the workers any raises</a>:</blockquote>
<blockquote class="tr_bq">
Now you look at this and you can see why Germans aren't chomping at the
bit to offer bailouts to their southern cousins. But by the same token,
you can see why the rest of Europe isn't rushing to embrace this model.
The pitch for more flexible labor markets is supposed to be that you'll
earn higher wages if employers have more freedom to organize work
relationships to maximize productivity. Less job security <i>and lower pay</i>
is not a great slogan. It is, however, a huge exporting success story.
Germany has completely reoriented its political economy around the needs
of its export industries which is nice except that just like in all
other rich countries the majority of Germans work in non-tradable
services.</blockquote>
My central thesis proposes that the shock of oversupply of labour sits underneath the economic crisis. That Germany has followed the logic of this position to its conclusion might be seen as explaining why German workers are still employed. I suspect that, given a choice, many unemployed workers would be pleased to turn back the clock and follow a similar path if it was to keep them in employment. However, before we get carried away with the German success story, it should be remembered that the fallout from the wider crisis may yet pull Germany down. Nevertheless, it is interesting that the German model was the correct response; with the labour supply shock, German workers allowed their compensation to drift down such that their value remained aligned with changing circumstance. And that value still remains high, perhaps reflecting the quality of the German workforce overall.<br />
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<i>Another addition Just After Publication:</i><br />
<br />
I nearly forgot, but there have been several people who have used the Paypal donate button, including some fairly large sums. I just thought I would express my appreciation. In particular, although traffic has remained relatively high (it dropped off during the period when I stopped posting but is climbing again), there is less commentary than before. As such, it is good to know that the blog is appreciated. Thanks!<br />
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Unknownnoreply@blogger.com1tag:blogger.com,1999:blog-7820485130017459619.post-47738946844829339032012-09-26T04:29:00.000-07:002012-09-26T04:29:08.974-07:00China: What Next?There is something that we need to remember about China; it is a powder keg. Like a powder keg, it is perfectly safe provided that there is no spark. The communist government of China undoubtedly realise the nature of the society over which they govern. When China opened with the reforms of Deng Xiao Ping, the government firmly turned its back on the world that was built by Mao Zedong, removing the imperial system that gave communism the legitimacy of the mandate of heaven. Mao was an emperor in new clothes, but rejection of the new imperial system represented by Maoist 'communism' left a gaping hole in Chinese society. It was a hole filled with the pursuit of economic growth. Never mind ideology, just enjoy a growing economy, and all the benefits that it will bring.<br />
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It is both a shallow and deep form of legitimacy. It is deep, because who would want to return to the poverty of the empire of Mao. It is shallow because it rests the stability and legitimacy of the ruling party only on growth in the economy. It gets worse; the Chinese government has raised expectations of endless growth to the point where it is a minimum expectation. This is combined with nationalism and resentment. Read a Chinese school history textbook in the original Chinese, and you can see how a metaphorical chip on the shoulder has developed. China is growing to become a major superpower, and with a desire to overturn the shame of recent history. What happens if China stops growing?<br />
<br />
We may now be at that turning point. I emphasise may. There are worrying signs that are developing, and the prospect of a hard landing needs to be considered. A review of current news about China tells the story. Yukon Huang, writing in the <a href="http://blogs.ft.com/the-a-list/2012/09/24/the-economics-behind-the-china-japan-dispute/" target="_blank">FT</a> 'gets it'. The dispute over the Senkaku/Diaoyu islands are tinged with economics, and the economics are tinged with politics. However, the politics versus the economics may become ascendent; if the economy nose-dives, the risk is that nationalism will be seen as a route to re-establish the legitimacy of the government. There is a lot at stake when considering the Chinese economy, including the stability of Asia Pacific, and the intertwined question of the stability of China itself. In short, the stakes are high if China should have a serious hard landing. Perhaps not as high as this discussion might suggest, but certainly high.<br />
<br />
From this context, I will review the questions surrounding the Chinese economy. We could look at the <a href="http://www.bloomberg.com/news/2012-09-26/china-s-stocks-fall-poised-for-biggest-quarterly-loss-in-year.html" target="_blank">lows</a> being plumbed by the Chinese stock market, but this particular casino is not to be trusted as an indicator of the real state of the Chinese economy. If the stock markets of the West have ceased to reflect economic fundamentals, the Chinese stock market has never really been anything but a stereotype of the Chinese love for high stakes gambling. Official outlets, such as the China Daily trumpet <a href="http://www.chinadaily.com.cn/business/2012-09/26/content_15784221.htm" target="_blank">positive news</a>, but are not trustworthy, being driven by political considerations. However, even official sources are reporting some worries about the Chinese economy.<br />
<blockquote class="tr_bq">
<a href="http://www.chinadaily.com.cn/business/local_beijing.html">BEIJING</a>
- Since the latest data reignited concerns about excessive production
capacity in some raw materials industries in China, experts have urged
those industries to step up restructuring and add more value to their
products.<br />
<br />
Data released this week by the <a href="http://www.chinadaily.com.cn/business/2006-11/16/content_734828.htm">National Development and Reform Commission</a>,
the country's top economic planner, showed that many raw materials
industries have seen slowing growth and falling profits from a year
earlier.<br />
<br />
Total cement production in the first eight months grew by 5.9
percent, 12.5 percentage points slower than the same period last year,
while the growth rate of crude steel output slowed 8.3 percentage points
to 2.3 percent during the same period, according to the NDRC.<br />
<br />
Profits of the country's building materials industry dropped 9.6
percent in the first seven months this year, with cement producers'
profits plunging 53.1 percent.<br />
<br />
The <a href="http://www.chinadaily.com.cn/business/iron_steel_industry.htm">steel industry</a> saw profits tumble 48.3 percent <a href="http://www.chinadaily.com.cn/bizchina/2006-09/27/content_697902.htm">year-on-year</a>, the NDRC said.<br />
Zhu Hongren, chief engineer of the Ministry of Industry and
Information Technology, said Tuesday in an exclusive interview with
Xinhua that many materials industries in China are currently confronting
serious problems, including overcapacity, dropping sales and sliding
profits.</blockquote>
The problem is simple. China has state owned enterprises that have favoured status, and the Chinese government has been pouring capital at cheap rates into these industries. When the process started, the only direction could be positive; industry had been flattened by the destructive policies of Mao. As time moved forwards, the state juggernaut could hardly put a foot wrong, but in recent years - they have overtaken themselves; they are overinvesting in capacity for which there is no real market. A bust is on the way, albeit a bust that is backstopped by the government, and/or state banks that are likewise backstopped by the government. I have been discussing the malinvestment in real estate since 2008 (see post <a href="http://cynicuseconomicus.blogspot.co.nz/2012/09/the-world-economy-state-of-play.html" target="_blank">here</a>) so will not continue on that theme in this post, except to say that some of the excess capacity will become even more 'excess' if there is a significant real estate bust. After all, miles of apartment blocks, office blocks, and shopping malls need a lot of industrial capacity to be built.<br />
<br />
The possibility of an internal bust in China is intimately entwined with the wider global economy. The chinese economy was built upon a mercantilist export model. It has served China well in that it has seen what might be regarded as an economic miracle take place. It has seen the largest reduction in poverty in history, and a backward economy developed into a modern and sophisticated economy in the space of a heartbeat. I have said it before, and will say it again; the Chinese government played a blinder of a game. Stunning is the correct expression. They have almost managed to pull off an economic coup. However, as with so much in the Chinese economy, what started as an easy win game, as they have progressed, the game has become more complex. As the world economy faces increasing headwinds, this impacts upon the potential of Chinese exports. Furthermore, it is not clear that China is as competitive in some industries as during the period of huge growth.<br />
<br />
Just one example of the increasing complexity is that there are <a href="http://www.nst.com.my/latest/made-in-america-more-attractive-to-manufacturers-1.147363#" target="_blank">reports</a> of manufacturers wanting to return to the US due to diminishing cost advantages of manufacturing in China. In isolation, these reports offer a convincing case in some exemplar industries, but some perspective is needed. Whilst direct costs of manufacture need to be considered, location choices also bump up against other advantages of manufacture in China; the 'ecosystem' of manufacturers that present advantages above flat cost advantage i.e. large numbers of specialists, who develop particular areas of expertise (my own experience in China saw the development of an area that specialised in lighting, though this is not one of the areas that might perhaps attract foreign manufacturers). Although flat cost comparisons may favour onshoring, the ecosystems present another factor that will undoubtedly be considered in the decisions to return 'home'.There will be<b><i> some</i></b> impact from onshoring for cost, but this is only one factor that might influence the China policy of companies. <br />
<br />
Perhaps a more compelling driver for manufacture in China is concern about the nature of China and stability. For several years now, there has been a policy in many manufacturing companies of China +1. The principle is to have an alternative manufacturing base in addition to China as an insurance policy. That principle may be extended and become more widespread. The recent reaction of Japanese companies to the tensions with China will only serve to create concerns: <br />
<blockquote class="tr_bq">
<span id="articleText">Nissan, Japan's top automaker in China, said
it would halt production at a joint venture in China starting on
Thursday, three days earlier than planned, and extending through next
week's national holiday period.<br />
<br />
<span id="midArticle_2"></span>A
Toyota executive in Beijing, who spoke on condition of anonymity, said
it was "likely" the automaker would cut output in China in the coming
weeks. A Toyota spokeswoman said the company had no immediate comment.<br />
<br />
<span id="midArticle_3"></span>Suzuki, meanwhile, said it had stopped one of two shifts that it normally runs in China.<br />
<span id="midArticle_4"></span>Production
slowdowns are a normal feature of the auto industry in mature markets
like the United States, where they are used to keep inventories from
ballooning and avoid pressure for automakers to offer deep discounts
that erode profitability.<br />
<br />
<span id="midArticle_5"></span>But the
steps by the Japanese automakers to cut output in China are an anomaly
in a market that has driven the industry's global growth over the past
decade and where most automakers had been adding capacity until China's
economic slowdown in recent months caused production to outpace sales.</span></blockquote>
<br />
The anti-Japanese sentiment in China at present is undoubtedly causing reconsideration of investment into the Chinese market. For the wiser Western companies, ccurrent tensions with Japan may be seen as a signal for caution; 'there but for the grace of God go I'. China is starting to look a little dangerous, and many companies will undoubtedly be considering the potential benefits of China in relation to the very real risks that result from a nationalist environment that might see sentiment and profits determined by political considerations. Combine this with worries about intellectual property theft, and all of the other vagaries of doing business in China, the shifing cost advantages, and China may start to look positively unattractive. <br />
<br />
In summary, the hard times are now starting to impinge on China. Their confidence is perhaps their greatest enemy. In the early days of opening the Chinese market, they could hardly do any wrong. A willing and compliant labour market, open for business attitudes, and there was a state that could only win when it picked 'winners'. These advantages are diminishing in the overall picture. In addition, there was some wonderful playing of the 'great game' by China, which saw countries clawing at the doors of China, competing with each other for a piece of the 'action' and giving China the position the belle of the ball (to mix mataphors). It was a great recipe. However, it is no longer the belle of the bal. Doubts about the politics are surely starting to impact on the economics, and the economics are in any case no longer so attractive. <br />
<br />
Up to this point, the economics has driven the growing Chinese confidence, and the confidence of the politics may now be negatively influencing the economics - and at a time when both global and national factors are working against the economics. There can be no better expression of the problems of Chinese over-confidence than recent reports of propsals for a 'bond attack' on Japan:<br />
<br />
<blockquote class="tr_bq">
It’s not often that the words “bond” and “attack” are part of the
same headline, but that’s exactly what appeared in the Sept. 19 edition
of the <em>Daily Telegraph</em>.<br />
<br />
The story, titled <a href="http://www.telegraph.co.uk/finance/china-business/9551727/Beijing-hints-at-bond-attack-on-Japan.html" target="_blank">“Beijing hints at bond attack on Japan,”</a> is a telling look at China’s economic policy — and it’s one that carries some important implications for the United States.</blockquote>
The gist of the story is that China has indirectly, with official deniability built in (a common Chinese tactic), threatened to attack the Japanese economy through the bond market by using quasi-official sources. It is an exemplar of the growing over-confidence of China, and an over-confidence that is self-defeating for their own economic position. Quite frankly, it is scary. China is throwing its weight around, and it is being noticed. They are overplaying what is a a powerful hand, but not as powerful as some in China might imagine. Whilst there are many politicians still courting China, there are going to be many who seek the opposite path. China's overplaying of its hand is going to strengthen the latter, and that could be very bad news for the Chinese economy. <br />
<br />
There is plenty more that could be said about the situation in China, and China's economy in relation to the world economy, such at their proclivity for industrial (state sponsored?) espionage. There is much more that could be said about the state of Chinese investment (or malinvestment). There is much more that could be said to emphasise the questions of the sustainability of the Chinese economic miracle. However, this is an overview, and I have limited the review to a very broad overview.<br />
<br />
Although I have lived and conducted business in China, and read extensively on Chinese history, both recent and modern, and speak (and used to be able to read) Chinese, I do not profess to be all-knowing about the Chinese situation. Having lived in China, I view China with affection and fear. I would like to see a bright future for China, but the politics in China threatens the miracle of the last few decades. The politics cause the fear, and the endeavour and determination of the Chinese people to create a better life creates the affection and also an admiration. Regardless of my personal views, warning signals are starting to flash, and I would not, if it were my money, risk my money by investing in China. I am somewhat conservative, but not risk averse.<br />
<br />
Chinese workers are restive. Whilst a few <a href="http://www.theaustralian.com.au/business/wall-street-journal/foxconn-riot-illustrates-larger-issue-of-restive-workers-slower-economy/story-fnay3ubk-1226481164961" target="_blank">reports</a>
do not make a trend, it is necessary to remember that Chinese workers
have been raising their expectations, and that the expectations may be
dashed in the even of a downturn.The growing wealth and expectations
might not match up in the event of a serious downturn. We should also remember that nearly <a href="http://news.bbc.co.uk/today/hi/today/newsid_9754000/9754506.stm" target="_blank">50% of Chinese</a> exports originate with foreign multinationals. China still needs those companies, and they may be thinking of alternatives to China. <br />
<br />
On balance, I think that China may be entering a period when there is a real risk that the powder keg may be lit. It is both a worrying and scary conclusion. As China goes through another opaque process of power transfer, I can only hope that the new regime recognises that the current paths of policy are taking China towards a world of high risk. <br />
<br />
<br />
<br /> <br />
<br />
<a href="http://news.bbc.co.uk/today/hi/today/newsid_9754000/9754506.stm" target="_blank"></a>. Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-7820485130017459619.post-17905749250992912852012-09-22T18:17:00.001-07:002012-09-22T18:17:38.457-07:00Spain , Banks and Real Estate - Again....After two quick posts in succession, this will be a very quick post. Just before my long pause in posting, in June I <a href="http://cynicuseconomicus.blogspot.co.nz/2012/06/spain-it-is-worse-than-is-imagined.html" target="_blank">posted</a> on the subject that Spain would be in a worse state than was being claimed. This is what I said:<br />
<br />
<blockquote class="tr_bq">
My own belief is that the prospects of such a bailout are remote, and
that the scale of the problems in Spain have not yet been fully
acknowledged. In particular, there are <a href="http://www.euromoney.com/Article/3048834/Category/1/ChannelPage/0/Spain-sovereign-bailout-fears-grow.html" target="_blank">concerns</a> about the true scale of losses for Spain's banks. As the <a href="http://www.economist.com/node/21556954" target="_blank">Economist</a>
reports, construction and real estate loans grew from 10% of GDP in
1992 to 43% in 2009. The same report highlights the degree and severity
of the real estate bust in Spain, and the various (self-defeating)
methods the Spanish banks are using to hide or delay the losses.<br />
<br />
It perhaps comes as no surprise that there are <a href="http://www.bloomberg.com/news/2012-06-19/spain-said-to-delay-detailed-bank-audit-results-to-september.html" target="_blank">rumours of delays</a>
of an audit of the Spanish banks, although the government denies any
delays and is still promising to publish results at the end of July.
Even when published, it is not clear how real estate assets might be
valued in the context of the broadening problems and downwards spiral of
the Spanish economy; the spiral will continue to impact upon real
estate prices, and any assessment will only reflect, at best, a guess at
the non-performing and underwater loans going forward. In other words,
the losses in the Spanish banks are likely to be far greater than is
currently accepted, and the Spanish economy likely has a long way to
fall yet. When so much of an economy is dedicated to real estate, and
real estate goes bust, the damage is going to be huge. As such, even if a
large rescue fund were put together, however improbable that prospect
remains, the scale of the rescue needed may be larger than is currently
imagined. </blockquote>
Well, this is what has appeared in the <a href="http://www.telegraph.co.uk/finance/financialcrisis/9559991/Debt-crisis-Spain-will-need-extra-bail-out.html" target="_blank">news</a>:<br />
<blockquote class="tr_bq">
A bank-by-bank test of financial stability due on Friday is expected to
conclude that Spain's lenders are dangerously over-burdened with toxic debts
and need to be recapitalised, restructured or shut down. </blockquote>
<blockquote class="tr_bq">
<div class="firstPar">
The stress test is expected to show a dramatic deterioration since the
previous tests were carried out at the beginning of the summer which
suggested a €60bn cash injection would be the worst-case scenario. </div>
<div class="secondPar">
<br /></div>
<div class="thirdPar">
Nomura Global Economics said in a note: "Our initial reaction to the
publication of those estimates has been negative. The announced figures are
well below the market expectations, which start at around €100bn, and, in
our view, not only fall short of bolstering market confidence but may
actually increase the risk of Spain losing market access."<br />
</div>
<div class="fourthPar">
Last week, the <strong><a href="http://www.telegraph.co.uk/finance/debt-crisis-live/9549698/Debt-crisis-as-it-happened-September-18-2012.html">Bank
of Spain said bad debts at Spanish lenders had risen to record levels</a></strong>,
with almost one in 10 loans in arrears. It is the highest bad-loan ratio
since central bank records began in 1962.<br />
</div>
<div class="fifthPar">
In June, Mariano Rajoy, the Spanish prime minister, negotiated a deal that
secured lending from Brussels of up to €100bn to recapitalise the banks.
Experts now think that it will not be enough. Amid soaring borrowing costs
and a stricken economy, Spain has come under intense pressure to ask
Brussels for a full sovereign bail-out.
</div>
</blockquote>
My own view is that the latest calculation of the losses is still probably way off the mark of the real scale of the losses. This uptick is just that. I am very confident that, in few months time, the figures for toxic debt are going to be raised even higher, and the size of the potential bailout will grow again. I suspect that those doing the audits will be fully aware of this, and that any figures given are there to try to make the scale of the bailout that would be needed less dramatic, by implementing it in small increments. However, we shall see. Unknownnoreply@blogger.com2tag:blogger.com,1999:blog-7820485130017459619.post-41794208927804303772012-09-21T23:28:00.000-07:002012-09-21T23:28:56.502-07:00The US Election: Economic Policy - do not vote for Romney or ObamaI have already written one post today, and thought I would start some research for another post. The subject of the next post was; analysis of the economic policy of Obama and Romney. The plan was a detailed analysis, point by point. It was going to be a lot of hard work.....or so I thought.<br />
<br />
I thought it would be hard work, right up to the moment I visited the official websites for each of the candidates. On arriving at each of the sites, I looked at the links and clicked on the links for 'Jobs and the Economy' (identical names for both sites). I fully expected to find some soundbites, and some general waffle on the section home pages. They are both, after all, politicians.<br />
<br />
What I did not expect was that both of the official sites go no further than waffle and soundbite. They are instead filled with vague and unsubstantial content that fails to tell you what you should know; the actual detail of their economic policy. Whilst some might argue that I should trawl through speeches, the endless commentator analysis, I would say one thing; an official website for a candidate for the US presidency should absolutely include the detail of the policy that they plan to enact. It is their official website, and should have, in 'black and white', details of their policy.<br />
<br />
If I was a US voter, my answer is simple. I would not vote for any candidate who fails to give an accountable and clear description of exactly what they plan to do on economic policy, and they should do so on their own official campaign website. Neither candidate passes this test. <br />
<br />
If you doubt what I am saying, take a look here for <a href="http://www.barackobama.com/economy?source=primary-nav" target="_blank">Obama</a>, and here for <a href="http://www.mittromney.com/jobs" target="_blank">Romney</a>. <br />
<br />
Although I say vote for neither, their official websites are not equal. Whilst Obama's site is horrifically bereft of any substantial content, at least Romney makes some attempt to flesh out his economic policy.This pathetic discussion is typical of the Obama website:<br />
<br />
<blockquote class="tr_bq">
<h3>
Made in America</h3>
<div class="forward">
forward</div>
President Obama has a plan to bring jobs back to the U.S. by
eliminating tax breaks for companies that ship jobs overseas, and
creating incentives for businesses to bring jobs back to America.</blockquote>
Perhaps pathetic is too kind. This is an insult to the intelligence. A further insult is that the links to the policy sections is titled 'get the facts'. It reminds me of Obama's first presidential campaign. Whilst so many people around me were lauding him, I kept asking the same questions; what will he actually do? From my perspective, it appeared that Obama was going to be elected without any real policy commitments and/or would be elected with policy commitments that shifted with the audience for his speeches. His official website follows this pattern. Sorry if it sounds partisan, but it it pathetic.<br />
<br />
As for Romney, I have said he is somewhat better. By this, I mean better than pathetic. Not much so. Instead of barely a paragraph of soundbite, there is some 'half-substance'. On the home page, there are some links to policy areas, and some detail of the policy discussion in each area. I have copied 'Mitt's Plan' on trade below in full as an illustration:<br />
<br />
<div class="mitt-plan">
<blockquote class="tr_bq">
Mitt Romney believes that free trade is
essential to restoring robust economic growth and creating jobs. We need
to open new markets beyond our borders for American goods and services
on terms that work for America.<br />
<div style="text-align: center;">
<strong>Opening New Markets</strong></div>
Every president beginning with Ronald Reagan has recognized the power
of open markets and pursued them on behalf of the United States. George
W. Bush successfully negotiated eleven FTAs, encompassing sixteen
countries. He also had the vision to commence negotiations with a number
of allies around the Pacific Rim to expand significantly the
Trans-Pacific Partnership. All told, these agreements have enabled
people across the world to come together and build a better future.
Economists estimate that the agreements have led to the creation of 5.4
million new American jobs and support a total of nearly 18 million jobs.
Looking beyond just our FTA partners, our total exports support nearly
10 million American jobs. These are not just jobs; they’re good jobs,
paying significantly above average, and more than one-third are in
manufacturing.<br />
<ul>
<li>Reinstate the president’s Trade Promotion Authority</li>
<li>Complete negotiations for the Trans-Pacific Partnership</li>
<li>Pursue new trade agreements with nations committed to free enterprise and open markets</li>
<li>Create the Reagan Economic Zone</li>
</ul>
<div style="text-align: center;">
<strong>Confronting China</strong></div>
<div style="text-align: left;">
China presents a broad set of problems
that cry out urgently for solutions. It is time to end the Obama
administration’s acquiescence to the one-way arrangements the Chinese
have come to enjoy. We need a fresh and fearless approach to that trade
relationship. Our first priority must be to put on the table all
unilateral actions within our power to ensure that the Chinese adhere to
existing agreements. Anyone with business experience knows that you can
succeed in a negotiation only if you are willing to walk away. If we
want the Chinese to play by the rules, we must be willing to say “no
more” to a relationship that too often benefits them and harms us.</div>
<ul>
<li>Increase CBP resources to prevent the illegal entry of goods into our market</li>
<li>Increase USTR resources to pursue and support litigation against unfair trade practices</li>
<li>Use unilateral and multilateral punitive measures to deter unfair Chinese practices</li>
<li>Designate China a currency manipulator and impose countervailing duties</li>
<li>Discontinue U.S. government procurement from China until China commits to GPA</li>
</ul>
</blockquote>
Well, there is some kind of half-substance in this. In the original document, the bullet lists are in the the colour normally used for links; I mistakenly assumed they were actual links that would take me to more detail.....but 'no', above is as much policy detail as you get. Not far from useless. For example, for point three of the last section, what punitive measures, under what circumstances, and under what legal framework? We have no idea, just a vague commitment to so something 'punitive'.<br />
<br />
So, given a choice, who would I vote for; neither. With a gun to my head, I would prefer Romney, as at least I have some vague notion of his official economic policy. But I emphasise, 'with a gun to my head'. As such, if you do not have said gun against said head, do not vote. You do not know what you are getting, and have no official 'in 'black and white' position to hold these comedians accountable. This is not democracy, it is a popularity contest with the depth of American Idol. For US readers, think hard about your political system; it looks broken. Don't support it with your vote. <br />
<br />
Note: I have seen discussions in the media of their economic policy. Yes, they make speeches, they chatter, they answer interview questions, but where is the 'black and white' detail. The 'this is what I will do' presented in clear terms, as an official position.<br />
<br />
If I have missed the location of this detailed policy plan, let me know, and I will correct this page. However, why would they not put such detail on their official campaign sites? Also, neither website declares itself as an 'officially' endorsed website, but they certainly appear to be the official sites, and I have therefore treated them as such. <br />
<br />
<br />
</div>
Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-7820485130017459619.post-13994163123663428952012-09-21T18:30:00.001-07:002012-09-21T18:30:26.613-07:00The Pressure on Osborne<br />
George Osborne is undoubtedly under pressure and from two directions; firstly there are those who will be demanding stimuli, and secondly those who will be noting and concerned about the failure to meet the borrowing targets that he set. For the former, I have discussed the flaws in the thinking at length, and will not repeat the arguments here. Instead, I will look at some key indicators for the state of the UK economy. <br />
<br />
<br />
In reviewing an economy, I consider one of the key elements is the balance of trade. It is a good indication of whether an economy is self-sustaining for its overall standard of living or whether it <i>needs</i> credit to sustain the standard; in simple terms, whether the value of what is being purchased exceeds the value of what you are earning. As ever, the UK current account remains in the red (from the 2012 '<a href="http://www.ons.gov.uk/ons/rel/bop/united-kingdom-balance-of-payments/2012/index.html" target="_blank">Pink Book</a>'), and the balance of trade can be seen below (from <a href="http://www.ons.gov.uk/ons/rel/uktrade/uk-trade/july-2012/stb-uk-trade--july-2012.html#tab-Key-figures" target="_blank">ONS</a>):<br />
<br />
<img alt="£billion, seasonally adjusted" src="http://www.ons.gov.uk/ons/resources/01fig1balanceofuktrade_tcm77-278517.png" title="£billion, seasonally adjusted" /><br />
<br />
The trend line is fairly clear. The UK is overall consuming a greater value of goods and services than it sells. If looking at the CBI Industrial Trends Survey, <a href="http://www.cbi.org.uk/media-centre/press-releases/2012/08/manufacturers-report-weakening-in-total-and-export-orders/" target="_blank">August</a> saw a dire outlook for exports, whilst <a href="http://www.cbi.org.uk/media-centre/press-releases/2012/09/moderate-boost-to-output-prospects-as-order-books-improve/" target="_blank">September</a> saw a less dire outlook. The variability in the sentiment makes a firm position difficult to guage, but overall it is not encouraging. And there is good reason for this, with this from the <a href="http://www.economist.com/node/21551073" target="_blank">Economist</a> for the trade weighted exchange rate:<br />
<blockquote class="tr_bq">
<div style="clear: left; float: left; margin-bottom: 1em; margin-right: 1em;">
Sterling's is at a 13-month high. This partly reflects the Euro's
weakness: the euro area accounts for 49.3% of Britain's trade-weighted
exchange rate. </div>
</blockquote>
<img alt="" class="imagecache imagecache-290-width" height="320" src="http://media.economist.com/sites/default/files/imagecache/290-width/images/print-edition/20120324_INC814.png" title="" width="244" /> <br />
<br />
I will take a little aside from the main thrust of this blog, as I have been looking for charts to show absolute cumulative government net debt, and it is something that has become an increasingly frustrating process over time. There are plenty of charts that show debt as a percent of GDP, but no charts that show the same thing as 'money'. I have noticed that, over time, this simple statistic has become ever harder to find. I stumbled on this complaint from Steve Keen's <a href="http://www.debtdeflation.com/blogs/2011/12/31/debt-britannia/" target="_blank">blog</a>, and have to agree:<br />
<blockquote class="tr_bq">
<br />
The UK data source, the <a href="http://www.ons.gov.uk/ons/index.html" target="_blank">Office of National Statistics</a>, is almost impenetrable by comparison—it’s the statistical system that <a href="http://en.wikipedia.org/wiki/Humphrey_Appleby" target="_blank">Sir Humphrey Appleby</a>
would design. It gives the appearance of accessibility, yet either
drowns you in so much data in response to any query that you give up, or
which, when you get to what you think you want, returns rubbish.<br />
<br />
For example, you’d think following the sequence “Economy—UK Sector
Accounts—Financial Assets and Liabilities” would actually take you to
something resembling the <a href="http://www.federalreserve.gov/releases/z1/Current/data.htm" target="_blank">USA’s Flow of Funds</a>, wouldn’t you?<br />
<br />
Guess again. Figure 1 shows what it returns you: no data, no
publications, but links to four methodology papers on Investment Trusts.
“<a href="http://en.wikipedia.org/wiki/Bernard_Woolley" target="_blank">Well done, Bernard!</a>“</blockquote>
I find it a concern that data that I could readily find when starting this blog becomes ever more difficult to find. Steve Keen's main focus is on global debt bubbles, and his comment reassures me that it is not that I am just not looking in the wrong places. I have looked in a wide range of sources, but a chart (and/or usable/straightforward figures to make my own) that reports the figures I want is elusive, and becomes ever more elusive as time goes forwards. When starting this blog, the figures were easy to find. The Office for National Statistics was particularly useful. Perhaps it is incompetence, but it seems odd that simple statistics are now so hard to find. Unfortunately, even Steve Keen's site does not give the statistics or charts that I need. This is one of his charts:<br />
<br />
<br />
<br />
<br />
<img alt="" src="http://cdn.debtdeflation.com/blogs/wp-content/uploads/2011/12/123111_0028_DebtBritann4.png" /><br />
<br />
As regular readers will know, I do not like the use of GDP, which includes activities of the consumption of debt, thereby making the figures of debt as a percentage of GDP useless. In particular, the more you borrow, the higher the GDP. I would normally expect that the <a href="http://www.ifs.org.uk/fiscalFacts/fiscalAggregates" target="_blank">Institute for Fiscal Studies</a> would give transparent figures, but they are also obscure, notably with the figures for national debt suddenly stopping in 2003. However, they do give figures for debt on the basis of 'General government gross debt on a Maastricht basis', and this will have to do. I will confess that I am unsure of the details of how the 'Maastricht basis' is calculated, but have found some basic information <a href="http://epp.eurostat.ec.europa.eu/statistics_explained/index.php/Structure_of_government_debt" target="_blank">here</a>. Nevertheless, this appears to be the best and most reliable figures I can find, and I have converted the figures into the chart below:<br />
<br />
<img alt="" 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" /><br />
<br />
The figures for 2012-23 are estimates, and the latest reports on the public finances <i>presumably</i> mean that the year will end higher than shown. The relentless upwards march from the period when the economic crisis became apparent is relentless. Despite so-called austerity, the debt pile is growing. Despite the massive government borrowing and spending, people are getting <a href="http://www.telegraph.co.uk/finance/economics/8909797/Average-salary-falls-3pc-in-face-of-high-inflation.html" target="_blank">poorer</a> overall:<br />
<br />
<blockquote class="tr_bq">
<div class="firstPar">
The <a href="http://www.ons.gov.uk/ons/rel/ashe/annual-survey-of-hours-and-earnings/ashe-results-2011/ashe-statistical-bulletin-2011.html"><strong>Annual
Survey of Hours and Earnings</strong></a> from the Office for National Statistics
(ONS) shows that the average gross salary for full-time employees was
£26,200 in 2011, an increase of 1.4pc from 2010.<br />
</div>
<div class="secondPar">
But in the face of CPI inflation rates above 5pc this represents a fall of
over 3pc in real terms.
</div>
</blockquote>
I have argued that the government has stepped in to fill the void in the growth of private debt growth, and this is apparent in the <a href="http://www.thisismoney.co.uk/money/cardsloans/article-1714095/How-personal-debt-grew-to-14-trillion.html" target="_blank">statistics</a>:<br />
<br />
<img alt="Total UK Personal Debt £BN Graph" border="1" height="392" src="http://img.thisismoney.co.uk/i/pix/2011/03/PersonalDebt_468x392.jpg" width="468" /><br />
<br />
From the same source as the chart, the pain that sits under the statistics is apparent, describing the the high levels of personal bankruptcy and debt rescheduling and property repossessions. And for the <a href="http://www.bbc.co.uk/news/business-17398014" target="_blank">non-financial corporate sector</a>:<br />
<br />
<br />
<br />
<br />
<br />
<br />
<img alt="Private sector debt chart" height="304" src="http://news.bbcimg.co.uk/media/images/59111000/jpg/_59111568_chart2.jpg" width="304" /><br />
<br />
It is not a complicated picture. The UK was booming on credit growth. When the credit growth in the private sector stopped, the government filled in the hole with state borrowing. In doing so, the government has continued the overall debt accumulation, where the UK consumes more than it can earn. But it is still not enough to maintain the standard of living of the average person in the UK. The country is getting poorer right now, and the accumulation of debt means it will be even poorer in the future.<br />
<br />
What happens if the government were to really stop borrowing? To actually start to reduce the debt? Again, it is not a complicated picture. Even with the government borrowing, incomes are declining. What happens if that borrowing disappears from the economy? Sure, the UK government can keep borrowing for a little longer; it has been able to despite the underlying problems that are apparent in the UK economy. But for how long can this continue? When is the point when the UK is finally viewed as the bad bet that it actually is. This is a chart from <a href="http://www.debtdeflation.com/blogs/2011/12/31/debt-britannia/" target="_blank">Steve Keen</a>:<br />
<br />
<br />
<br />
<img alt="" border="0" height="238" src="http://cdn.debtdeflation.com/blogs/wp-content/uploads/2011/12/123111_0028_DebtBritann2.jpg" width="320" /><br />
<br />
<br />
<br />
<br />
How long? That is the question that nags. George Osborne may still have time to address the problems, but maybe not. There are some deep seated questions, and those are about what the real standard of living in the UK would be without debt accumulation. A key question is to ask what the government can <i>really</i> afford to do.<br />
<br />
For example, can a system continue that sees large numbers of the UK population non-productive, sitting at home on benefits? How can the long term unemployed be put back into work in a tight labour market? Can the numbers of students going into higher education be sustained, when many graduates go into jobs that do not really require a graduate? Both of these are linked questions; a student at university is not 'unemployed' but might be unemployed if not continuing into higher education. Higher education reduces the numbers of unemployed, but does so at a cost. Is the cost and the education worthwhile; does it really add value to the UK economy overall. I give these thoughts as examples of the complexity of how to figure out what is affordable and trying to rectify the structural problems in the UK economy. The problems of how to transition to a lower cost economy are not easy. Nevertheless, a transition must take place at some stage.<br />
<br />
The alternative is just not there. An economy can only sustain itself on debt growth for so long. In particular, there is no global recovery around the corner, a recovery that might (just might) help to lift all boats. The opposite appears to be the case, with red warning lights flashing across the world (see last post). Even were the current world economic situation not to get worse, the UK is already getting poorer and more indebted. I therefore make the same point I have now made for several years. The sooner the UK government really acts to address the problems, the better. The problems have not gone away, are not diminishing, but steadily growing. They may be difficult, the reforms may be complex, but carrying on as before becomes ever less tenable. Hard choices must be made, and they will not be easy and they will see a very tough period for many ordinary people. But that is, in any case, the future. <br />
Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-7820485130017459619.post-78290289814898112132012-09-15T17:16:00.000-07:002012-09-17T12:40:17.975-07:00The World Economy: The State of PlayFirst of all, I would like to apologise for the lack of posting for
so long. I have several times sat down to start to post, but was
somewhat at a loss as to where to start. I had a quite a long period in
which all I had time for was a major project, and returning to posting
has been difficult in the face of an ever more 'odd' world economic
situation. Too much cries out for attention, and this is the problem;
each of the many stories that are ripe for discussion do not make sense
in isolation. As such, I will try to give a selective overview, and do
so in the context of my underlying thesis of the causes of the world
economic crisis.<br />
<br />
[Note: as I have pressed forward in the post, I have limited references/links, and also digressed from my original purposes for the post. I hope that it still remains a coherent view.] <br />
<br />
First of all, I will briefly outline
my explanation of the crisis in the world economy. One of my discussions
of the underlying cause can be found on <a href="http://www.huliq.com/1/82005/underlying-economic-crisis-caused-financial-crisis" target="_blank">Huliq</a>,
and I recommend reading this if you are new to the blog (there is a
more detailed version somewhere, with more figures, but I forget where
it is). The short version is that, with the entry of economies such as
India into the world economy, there was a huge supply shock. The labour
available to the world economy (by which I mean with capital and
connected into the world economy) has approximately doubled. Even whilst
this was taking place, the supply of many commodities failed to keep
pace with the expansion of the labour force and, for other commodities
that did expand in supply, the demands of building new infrastructure in
places like China saw demand explode to a degree that commodity
supplies still struggled to keep pace with demand. <br />
<br />
The
result of the labour supply shock, in conjunction with the problems of
commodity supply, saw what I term hyper-competition. I dispute the idea
that the 'financial crisis' was the cause of the economic crisis, but
argue that it was instead a symptom of the supply shock (see the Huliq
article for why). The economic crisis is resultant from
hyper-competition, and the shift of limited resources towards the
'emerging' economies. From this underlying thesis, I have argued that
the result will be that there will be a re-balancing of wealth around the
world. Contra to the argument that the emerging economies would grow in
wealth whilst the developed world continued to be wealthy, I have
argued that the world economy would grow overall in wealth, but that the
growth in wealth of the emerging economies would, due to redistribution
of limited resource, come at a cost to the developed world. Whilst the
emerging economies grew in wealth, the developed economies would
generally see an erosion of wealth.<br />
<br />
In the Huliq
article, I link to my early posts on this thesis in 2008. Time has now
passed, and we can start to see the outcome of the labour supply shock.
An interesting example can be found in the many stories coming out of
the US describing the shrinking of (and often described as the the
'<a href="http://www.huffingtonpost.com/2012/09/13/middle-class-dying_n_1878362.html" target="_blank">death of</a>') the American middle class.There are questions about what people might call the middle classes, but there is a clear picture in which median incomes and the quality of life of 'the middle' in the US is moving in <a href="http://www.cnbc.com/id/48998081" target="_blank">the wrong direction</a>. At the same time, <a href="http://www.foreignaffairs.com/articles/67046/robert-c-lieberman/why-the-rich-are-getting-richer" target="_blank">stories</a> abound about the 'rich getting richer', along with rafts of figures supporting this point. That this is taking place is unsurprising; if there is a massive increase in supply of one of the factors of production, then it should be expected that the price of the factor will go down. As labour prices have gone down, this in turn increases the potential for those with capital to make greater profits and those with capital reap the benefits of cheaper labour.<br />
<br />
A similar story can be found in the UK, where incomes have been described as being 'squeezed' by the Governor of the Bank of England (sorry, no link) and reports of <a href="http://www.lendingnews.co.uk/uk-incomes-biggest-drop-decades-87/" target="_blank">ongoing declines</a>:<br />
<br />
<blockquote class="tr_bq">
People in the UK saw their incomes squeezed in 2010-11, despite a
modest recovery in the wider economy, according to a new report.<br />
<br />
Data
collated by the Institute for Fiscal Studies (IFS) has revealed that
median household income fell by 3.1 per cent after accounting for
inflation during this period, wiping out five years of minor growth
within 12 months and setting income levels back to those seen in
2004-05.<br />
This represented the largest single-year decline in income levels since 1981, with earnings falling across all parts of society.<br />
<br />
According
to the IFS, these figures can be attributed to rising inflation and the
delayed effect of trends seen during 2008-10 at the height of the
recession.</blockquote>
The situation in Europe is complicated by the Euro crisis, with the crisis an additional factor that is influencing the wealth of individual countries throughout the European Union. Nevertheless, the picture is one in which, for much of the EU, the economic situation can only be characterised as dire. The Euro crisis just complicates the picture. Perhaps the most interesting example in relation to my thesis are Australia and Sweden, which have largely <a href="http://www.smh.com.au/business/is-time-running-out-for-the-lucky-country-20120911-25qmb.html" target="_blank">been immune</a> from the economic crisis that has been felt in the rest of the developed world.<br />
<blockquote class="tr_bq">
Unlike Britain, it is sometimes said, Australia and Sweden are
advanced economies that have managed to get their public policy agenda
broadly right, and as a consequence now reap the rewards.</blockquote>
<br />
<blockquote class="tr_bq">
Both economies sailed through the credit crunch pretty much
unscathed, unemployment is at or close to an all-time low, and unlike so
many other ''rich'' nations, public debt is under control.<br />
<br />
But while inspired policymaking has no doubt played its part,
much more important is that both Australia and, to a lesser extent,
Sweden are rich in natural resources. Sweden also has an abundance of
relatively cheap hydroelectric power.<br />
<br />
The blessings of nature, not the brilliance of policymakers,
offer the better explanation as to why these countries have done so
well.</blockquote>
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Similar <a href="http://www.cnbc.com/id/47608840/Sun_to_Set_on_Commodities_Super_Cycle_Morgan_Stanley_Strategist" target="_blank">stories</a> can be told for other commodity rich economies such as Brazil and Russia. The success of these commodity rich economies are exactly what might be expected in the era of hyper-competition. I have also <a href="http://cynicuseconomicus.blogspot.co.nz/2011/08/round-2.html" target="_blank">argued</a> that the world economy would be dominated by commodity supply and prices, saying that: </div>
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<blockquote class="tr_bq">
In an earlier post, I presented an analogy. I described commodities as a
moving brick wall to growth, with the world economy running behind this
wall of constraint. As the economy runs forwards, it hits the wall and
tumbles backwards. The world economy then gets back on its feet, and
once again runs towards the wall only to eventually bounce back again. [sorry, I forget where I first wrote about this].</blockquote>
This has been the pattern that has emerged since the world economy fell into crisis. But, it may be that the situation may be about to change. The first element that needs to be considered is the energy revolution that has resulted from 'fracking', which has allowed an explosion in natural gas output. It is not a direct substitute for oil, with more limited uses, but it has changed the overall picture of energy supply. This is not to say that the constraints of oil supply have been removed but they have been ameliorated. However, this is nothing compared with the potential for the Chinese economy to <a href="http://www.business-standard.com/india/news/is-thisendthe-commodity-supercycle-orpause/483875/" target="_blank">impact</a> on the commodity situation:<br />
<blockquote class="tr_bq">
Sharma is heard with respect when he gives an opinion on something
concerning emerging economies. At the same time, the commodity
supercycle standing for a very long-term surge in prices may or may not
have run out of all its steam. Unarguably, bulk commodities and metals
subject to stagnation in the two decades preceding 2000, subsequently
started experiencing regular spikes in prices on the back of
unprecedented demand growth in emerging markets.<br />
<br />
If China stood out for its ravenous appetite for raw materials, a big
market opened up for their suppliers, benefiting emerging economies,
like Brazil and Russia. In the beginning of the cycle, demand for raw
materials was ahead of supply and buyers in China and India (for coking
coal) were constrained to pay ever rising premium prices. Raw material
price spikes left huge surpluses with the mining groups leading them to
invest heavily in capacity expansion to take care of the world hunger
for minerals. This is bringing about a balance in demand and supply and
as a result, a southward push to prices of raw materials and
collaterally to metals.<br />
<br />
Unlike Sharma, many others argue that rises and falls in commodity
prices happen in waves lasting 20 years. If it is to be accepted that a
supercycle has a life of 20 years, then there is no running away from
the fact that halfway, the market is taking a hard look at slowdown in
all emerging economies from where the bulls in the first place drew
inspiration. The Chinese double digit growth rate is in the past and as
the world’s second largest economy is aiming at a soft landing, it grew
at 7.6 per cent in the second quarter of this year. China has now
lowered its 2012 growth target to 7.5 per cent from the earlier eight
per cent.<br />
<br />
As for India, Moody’s says the combination of a sharp and broad-based
slowdown, a poor monsoon and a government that has “badly lost its way”
will restrict the country’s growth at 5.5 per cent this year and six
per cent in 2013. Growth deceleration in the two BRIC (Brazil, Russia,
India and China) nations will set off a chain reaction. Fall in China’s
raw materials import growth rates in particular will be hurtful for
resource-rich and export-dependent Brazil and Russia. Australia, a major
supplier of a host of minerals to the world, is taking a hit because of
a downturn in commodity prices. Retreat by bulls is also due to
discouraging industrial output data from Euro zone countries. Their main
concern is Europe’s manufacturing hub Germany, which after sustaining
growth through the European debt crisis is now feeling the impact of the
Euro zone storm. No wonder the German manufacturing PMI in July was at
its lowest for more than three years. Bulls are further disheartened by
the Bank of England warning the UK economy would grind to a complete
standstill and the US Federal Reserve and European Central Bank refusing
to introduce new stimulus packages.</blockquote>
For a long time, I argued that China was playing its cards superbly. They played the developed world players off against each other, stole intellectual property, and used their currency in support of mercantilism trading policy. From the ravages of Maoism, when China commenced opening up to the world economy, the massive investments in infrastructure were easy 'hits' for creating infrastructure with significant economic returns. However, even in my <a href="http://cynicuseconomicus.blogspot.co.nz/2008/07/predicting-economic-future.html" target="_blank">early post</a>s, back in July 2008 I said the following:<br />
<blockquote class="tr_bq">
The first point is that it is quite possible that China has a
construction bubble. Whilst I was in China I noted that there were lots
of apartment blocks being built, and that it was very popular for these
to be purchased by investors. In many cases the investors were leaving
the apartments empty (Chinese people like to buy property brand new,
once it has been lived in the value falls), and they were holding on to
the apartments in an expectation of increases in value. In addition to
this there has been a boom in the construction of shopping malls, and I
noted that they were already (back in January) starting to exceed
demand. If the Chinese economy is pulled back due to world demand for
exports dropping, it is likely that such investments will lead to a
bust. It is also worth considering the state of the Chinese banks. If
they are lending into construction in this way, will there be a repeat
of the previous Chinese bad lending problems of a few years ago? What
other bad lending is buried in their books?<br />
<br />
Set against this is
that the finances of the Chinese government are very healthy, as are the
levels of savings in China. The real question with China is how much
their continued growth is reliant on exports, and how much growth can be
sustained within China. I will readily admit that I am not sure on this
at all. I am not sure that anyone is. My best guess is that China will
also hurt, and hurt badly, with a significant potential for civil unrest
as a result.</blockquote>
The final paragraph; I was wrong, and China did pull through and in part because of the spending binge of the developed economy governments maintaining demand. However, it is now four years later, and the situation I described with housing and other real estate <i>was indeed</i> taking place, but no bust took place. Analysts have recognised what I saw on the ground all those years ago, and have similarly been predicting a bust in the last couple of years. That bust may, or may not be in motion now, but the curious question is why it was that the bust has been evaded so long. The answer is simple; the Chinese have nowhere else to put their money, except for the casino Chinese stock market, in state bank accounts with pitiful returns, or in places like Wenzhou in very dubious private corporate lending. </div>
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With regards to the finances of the Chinese government, they still remain relatively healthy, but only if you discount the provincial and local government. A combination of corruption and ineptitude has seen large investments being made in construction projects, in preferred state companies, and real estate. The result is massive investments in capital projects, including dubious infrastructure projects and real estate. As time has moved forwards, the easy investment 'hits' have diminished, and the result increasingly dubious investments. These investments are, in turn, linked into the state banking system, which will undoubtedly be sitting on low grade debt that will sour at some point in the future. In a previous post, I have detailed the cities being built with no people to live there, and this is just a very visible tip of a large iceberg. </div>
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The Chinese government sought to engineer a soft landing from the real
estate boom, restricted credit, and the result may be a hard landing. I mentioned Wenzhou earlier, as it is the exemplar of how this tightening of credit led to a big bust in the private 'grey' credit markets; the limited access to credit in the state banks fed into a bust for many of the unregulated private lenders, often with horrendous results for small investors. However, in the face of dramatic drops in growth, the restraints on credit have been pulled, and a new round of large capital investments has been unleashed. The problem is that the re-loosening of the credit taps will see more malinvestment. It may (or may not) be too late to reverse a bust. The problems that are taking place in China are likely to be exacerbated by the problems of the EU economies weakening demand for goods, and the so-called '<a href="http://newyork.newsday.com/news/nation/fiscal-cliff-nears-as-u-s-avoids-government-shutdown-1.4003227" target="_blank">fiscal cliff</a>' in the US:</div>
<blockquote class="tr_bq">
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<a href="http://newyork.newsday.com/topics//U.S._Congress">Congress</a>
is moving to quash the threat of a government shutdown, but the
prospect of a one-two punch of tax increases and slashing, automatic
spending cuts will still confront lawmakers when they return to
Washington after Election Day.<br />
<br />
The House on Thursday passed a
six-month stopgap spending bill to keep federal agencies running past
the end of the budget year, the elections and into the spring. It
effectively scratched a major item off of <a href="http://newyork.newsday.com/topics//U.S._Congress">Congress</a>' to-do list heading into a potentially brutal postelection, lame duck session.</div>
</blockquote>
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<blockquote class="tr_bq">
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The bipartisan 329-91 House vote for the measure sent it to the <a href="http://newyork.newsday.com/topics//U.S._Senate">Senate</a>, which is expected to clear it next week for <a href="http://newyork.newsday.com/topics//Barack_Obama">President Barack Obama</a>'s
signature, capping a year of futility and gridlock on the budget
despite a hard-fought spending and deficit-reduction deal last summer.</div>
</blockquote>
Nobody can predict at this stage how the 'fiscal cliff' will play out. If it does kick in, the US economy is likely to be hit hard, and this may explain the feds renewed bout of printing money; it is front-running the potential fallout from the fiscal cliff. In the meantime, the mess of the Euro continues to stagger forwards with compromise and delay, but with no real resolution. It is a crisis that simply refuses any resolution. It is almost becoming dull to watch the back and forth between crisis, and temporary bouts of market relief. As time goes forwards, it becomes ever more apparent that we are watching King Canute seeking to turn back the tide. We are just left with the hanging question of when and how the tide might finally overwhelm the desire that it be held back. <br />
<br />
The problem is that, if China really does go into reverse, this will have knock on effects in the countries that have been sheltered from the economic crisis through the commodities super-cycle. The new bout of investment may just lift the Chinese economy enough to keep the economy from a bust, but it is far from certain in the face of wider economic headwinds.<br />
<br />
There are some things which remain resolutely unchanged. The global 'too big to fail' banks still sit like time bombs within the global financial system, but post-crisis are even more 'too big to fail'. Although there have been vague and weak attempts to address some of the problems of these banks, central banks continue to support bust banks, and do whatever is needed to shore up the banking system. As I have discussed in previous posts, parts of the EU bailouts have been directed towards shoring up insolvent banks, and in return the insolvent banks have propped up insolvent governments. It is the same story I have discussed previously; banks are magic entities which are the foundations of economies. Somewhere along the way, the regulators and politicians lost sight of the purpose of banks as a support for the rest of the economy, and now the rest of the economy is a support for the banks. <br />
<br />
Then there is the government borrowing. In the developed economies, the debts of governments just keep on growing. Whether financed through the printing presses, or financed through dubious credit lines of central banks, developed world governments just keep on borrowing and spending. The poster boy for the borrowing and spending approach is, in my view, the UK; they proclaim austerity whilst continuing to borrow and spend at astonishing levels. I am not going to discuss this subject in detail, as the blog is replete with discussions of individual economies, and general principles.<br />
<br />
However, I will re-emphasise that this is a prolonging of the problems of the developed world. The shift in the world economy represented by the labour supply shock was hidden by huge expansion in credit. This allowed the diminishing levels of wealth in the developed world to be hidden for a while. Even though less wealth was being generated, lifestyles were maintained as if wealth generation was increasing. The 'financial crisis' was simply the 'bust' of this paradigm, and the developed world governments replaced the private credit growth with government credit growth. What the governments failed to recognise was that the private credit growth had restructured their economies to service credit growth, and that they are retaining that structure through the use of government borrowing. In the end, credit growth cannot be sustained forever, and any structure built upon ongoing credit growth must eventually collapse. <br />
<br />
The point is this; the great labour supply shock has taken place. It is there in front of our eyes. It is not possible for the entire world economy to become richer if the rate of labour entry exceeds the increase in the rate of available commodities. It is a situation further complicated by the resource intensive growth in infrastructure needed to grow a developing economy, but it is a simple and logical formulation. If 10 people share access to 10 litres of oil, each can have a litre. If the number of people increases to 15, and the available oil only increases to 12 litres, it is not possible for each person to have a litre. What then happens is that those who want a litre of oil, as they had before, must compete intensively with the newcomers if they want to keep their oil. The newcomers, unsurprisingly, would also like to have a litre of oil. Welcome to hyper-competition.<br />
<br />
It is a situation which is now being recognised. This from a <a href="http://www.telegraph.co.uk/finance/comment/jeremy-warner/9534227/Is-time-is-running-out-for-the-lucky-country.html" target="_blank">conservative commentator</a> in the Telegraph:<br />
<br />
<blockquote class="tr_bq">
In his seminal study of business cycles, the Austro-Hungarian economist,
Joseph Schumpeter, explained these long – or Kondratieff – cycles as the
natural result of particularly high periods of technological innovation.
This seems plausible, even though the latest phase of innovation is of
course mainly about communications, little if any of which originated in
China.<br />
<br />
Modern communications has none the less reduced Western advantage in many
commodity industries to virtually zero. The major beneficiary has so far
been China, where dissemination of Western technology and globalisation of
trade has driven a remarkable economic transformation.<br />
<br />
Western economies have in a sense shot themselves in the foot. Their own
innovation has made them relatively less competitive and therefore less well
off than they used to be. One of the manifestations of this shift is that we
have to pay a lot more for our commodities – be it food, oil or metals –
than we used to. Speculation, Western money printing and ultra low interest
rates have turbo-charged the bubble.<br />
<br />
But even assuming that China avoids the much feared hard landing, there is
good reason for believing the present super-cycle may already have peaked.
The iron ore price has fallen nearly 40pc in the past year alone.<br />
<br />
As in 2008-09, the fall may be a blip, but equally, it may a presage a
much-needed shift in the composition of Chinese economic growth away from
commodity intensive investment and capital accumulation to consumption.
China’s investment and export orientated model is proving just as
unsustainable as the West’s consumption driven approach to growth. China
knows it must change if it is to keep growing. There’s no relief to be had
from once buoyant Western export markets.</blockquote>
People are starting to get it. It was never a financial crisis for the developed world - it was a fundamental economic crisis - a shock that was buried in a credit make-believe. All the actions of policymakers and governments, including politicians and central banks in particular, has been a pretense that 12 divided by 15 can equal 1. The response has been to hide from the reality that the figures just do not add up.<br />
<br />
We have seen the Chinese economic miracle, and to a lesser extent the other emerging economies, dominate the shape of the world economy. Rather than confront the challenge that was represented by this new challenge, the answer was to pretend that all could go on as before. Rather than adapt to the new and emerging reality, the answer was to preserve the structures of another time, even though they were increasingly impossible to maintain. In trying to preserve the existing economic structure, the policy response has been to create a new world in which governments are now in the driving seat of markets, are now taking an ever larger role in the economic activity of the world, and consuming ever greater proportions of the available resources. This action is supposed to 'save' the world economy.<br />
<br />
But is is not. In the developed world, most people are getting poorer and poorer. Even as governments grow their debts ever larger and larger, people are still getting poorer. And those debts must one day be repaid. Then there is the money printing, and the market sugar rush that follows each bout of printing money. I reported on an analyst's view of this some time ago. His advice; invest when money is printed, and get out before the effects wear off. In other words, the markets are no longer about underlying economic drivers, but are responses to policy actions alone. It is hardly a basis for future economic growth. The same analyst gave five years of this paradigm before it all collapses horribly. And then there are the banks. Protected at all costs, wealth flows from the rest of the economy into the banks. Every bout of money printing helps them; they get access to capital for the carry trade. So far, they remain as the winners, albeit with some ups and downs. In the new paradigm, they are protected at the cost of everyone else. The economy now services the interest of the banks, not the banks servicing the interests of the economy. <br />
<br />
For me, this is how I see the world economy. In some respects, it is a rambling discourse. However, there is a theme running through. Something changed, and there was a failure to respond. Something is changing now. The miracle of China is running its course, and there is a turning point. I am not predicting an immediate economic bust but rather that the corruption and ineptitude of the Chinese system is now starting to overwhelm the raw potential that was unleashed with the reforms of Deng Xiao Ping. This might have been an opportunity for a resurgence of the developed economies. However, when looking at the state of the developed economies resultant from the policies of the last few years, it is not clear that there is the foundation for a resurgence. That is the tragedy of the last few years. We are now at an inflection point, and the developed economies may be too weak to respond.<br />
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Note Added 16/09/12: The first comment has my thesis 'smashed' - I suggest for those who doubt the thesis, take a look at oil output over the last ten years, and consider this in the context of the growth of emerging economies. The idea that commodity prices are all controlled by speculation is a myth; it is possible to play markets for a while....but in the end the values are driven by demand for the actual product (with some obvious exceptions such as gold). I have no doubt that some will not accept this, whatever is suggested. <br />
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Note Added 18 Sept, 2012: I have just published a comment below, but it nearly went in the delete pile. You will guess which one. Whilst robust comment is good, please refrain from personal attacks and insults. Unknownnoreply@blogger.com9