Who will be Paying the Bills?

My last two posts have prompted a lively debate on the blog, and it is interesting to see how the debate parallels that which is taking place around the world. The G20 and G8 summits appear to be seeing the same divisions, with Obama on one side encouraging continuance of massive deficit spending, and the Canadian and many Europeans (e.g. Merkel, Cameron, Borroso) saying that the deficit spending has gone far enough (or perhaps already too far). This is from the Guardian:

Signs of deep rifts at the G8 and G20 summits in Toronto over how quickly governments should cut deficits added to financial market jitters today, with the Americans warning of the dangers of a double dip recession if all countries started to rein back spending at once.

The leading European economies, especially Germany, are putting a new emphasis on cutting back government spending, and there is a possibility that a G20 communique, due to be released on Sunday , will set out an indicative timetable of how far and fast countries should retrench spending.

David Cameron, making his first appearance at a world summit and packing in a frantic round of bilaterals to start building personal relations, was praised by the summits' host for his deficit slashing budget earlier this week.

The Canadian prime minister, Steve Harper, said that he welcomed Cameron's responsible and difficult decisions, saying the British prime minister's budget "had raised the very fiscal consolidation agenda that we are trying to steer the G20 towards".

Canada wants the G20 to endorse the idea that national deficits should be halved by 2013.

I highlight this, as the gap between the US approach to deficit spending and that of (for example) Germany can not be wider. There is a major fracture in the perspectives on economics between different countries.

The problem is that, there is no opportunity for either side to ever prove itself right, except through enacting their different approaches. However, in one respect, the Obama camp will be proven correct. That is, if there is a major move towards cutting of expenditure, a recession will almost certainly be the outcome. This will then give them an opportunity to say 'I told you so' and blame the problem on the cuts.

What we will never actually see, is what happens next if countries continue to rack up huge deficits, and the dangers that might flow from this enactment of policy. It will allow history to be rewritten to say that, had the spending continued, then the world would economy would have recovered, and all would have been well.

Set against this, I would point to the following article, which points to the underlying change in the world economy, a change which I have continually highlighted on this blog as inevitable, and the real driver behind the economic crisis:

Ten years ago, the world’s richest countries accounted for a significant majority of the globe’s economic activity. But the pendulum is swinging in the other direction, according to the Organization for Economic Cooperation and Development.

A new O.E.C.D. report finds that rich countries and poor countries now each contribute about an equal share of the global economy. And by 2030, developing countries will account for 57 percent of world G.D.P.

This has been at the heart of the thesis of this blog. The world has changed; the distribution of wealth in the world is changing, and it means that the developed world is no longer in the position where it might assume eternal wealth. We are now at the stage where month by month, we can see the reality of the change, and the attempts by many developed countries to turn back the reality failing. My argument, since before even starting to write this blog, has been that, for over a decade, we have misconstrued apparent economic growth for real economic growth. This is the view of the Economist:

Throughout the 1980s and 1990s a rise in debt levels accompanied what economists called the “great moderation”, when growth was steady and unemployment and inflation remained low. No longer did Western banks have to raise rates to halt consumer booms. By the early 2000s a vast international scheme of vendor financing had been created. China and the oil exporters amassed current-account surpluses and then lent the money back to the developed world so it could keep buying their goods.

Those who cautioned against rising debt levels were dismissed as doom-mongers; after all, asset prices were rising even faster, so balance-sheets looked healthy. And with the economy buoyant, debtors could afford to meet their interest payments without defaulting. In short, it paid to borrow and it paid to lend.

I was one of the doom-mongers when I first started writing about the economy. I was seen as (at best) a part of a mad fringe, but today we see the Economist saying exactly what I was saying long ago. However, even now, the problem remains that growth in debt is still mistaken for economic growth, and I despair of the mainstream ever 'getting' the distinction.

At this stage, it is worth offering a perspective on the scale and depth of the existing levels of debt in the developed world. The Economist has a special feature on indebtedness and produced the following chart which ranks countries by debt sustainability (sorry about the size):

I strongly recommend taking a look at the interactive debt chart at the Economist here (sorry, can not be reproduced here). They follow their chart with this commentary:

THE headlines are all about sovereign debt at the moment. But that is only part of the problem. Debt has risen across the economy, from consumers on credit cards, though industrial companies borrowing for expansion and financial companies using debt to buy risky assets.

The interactive graphic above [in the Economist article] shows the overall debt levels for a wide range of countries, based on data supplied by the McKinsey Global Institute. In theory there is no maximum level for debt relative to GDP, but Ireland and Iceland (not on this map) found the limit in practice when they hit eight-to-ten times GDP.

The massive debt accumulation does not tell the whole story. What we can see is that the debt is simply being used for consumption. It is not creating growth, but is leading to diminishing returns in growth - in other words, the real growth is taking place outside of the developed world, and the developed world is just living off that real growth. The chart below from the Economist tells the story:

What this chart shows is the reality that has long been the subject of this blog, including in a recent post on post-Keynesianism. The money that is being borrowed and thrown into developed world economies is not producing a return. I made a comparison with China, where the government spending can make a return. It is very clear from the chart that borrowing more is not the answer (I know that the post-Keynesians will claim that their kind of borrowing and spending will be different....but see my post for why it will not).

However, it is quite possible for the US, for example, to continue to borrow from the new wealth creating countries and the oil states and appear to continue to be relatively prosperous. However, underneath such apparent prosperity is the reality that there are now the emerging economies that are being coming increasingly competitive, and taking a greater share of global wealth. Countries like China and India commenced with low end, low added value goods, but are rapidly rising up the value chain, and are starting to compete in the higher added value segments. The emerging economies will increasingly be meeting the developed world in the market for higher added value goods and services, and the developing world will win market share.

This leads to the question of whether there will be a miracle of a return to the pre-crisis 'normality'. Can the developed world return to past levels of wealth, at the same time as new and aggressive entrants are entering into more segments of the world market. The Obama solution is built on the believe that, at some point in the future, growth in the economies of the developed world will return, and this will then allow for the existing economic structures to be maintained, and at the same time producing enough growth to repay debts accumulated now. After all, this has been what has taken place following previous recessions.

This view ignores the changes that are taking place in the apportionment of wealth, and also ignores internal factors that will further diminish potential for wealth creation, as well as the problem of structural entitlement programmes that will push up costs and diminish the ability to pay down debt. The first problem is one I have already discussed, the second and third are resultant from the basic demographic problem of ageing populations. In order for developed countries to simply stand still, there would need to be a significant productivity miracle, which will allow a shrinking workforce to support a growing population of retired people. The problem is that the developed world is not standing still, but is falling backwards.

If government borrowing and spending is removed from the equation, it is apparent that the economies of most developed countries are facing reversals in wealth as a result of the competition from the emerging economies. I think I might now be in a position where, when discussing the economic growth in the pre-crisis decade, few would propose that there was an underlying increase in the wealth, but rather an illusion of wealth created by debt. Since the crisis commenced, governments have replaced this debt with government debt, and this can only be sustained for so long. What this creates is a moment in time where existing economic structures might be retained, but no more than that.

In order for the changes in both the internal and external environments to be accommodated in the medium to long term, something must change. On the one hand, in response to the internal changes, there is the choice of using ever greater taxation to pay for the costs of a growing pool of retired people from a diminishing workforce. This would place a significant burden on the upcoming generation, whose potential for a 'good' lifestyle would be diminished through significantly higher taxation. Alternatively, the structure of the economy might be reformed through the reduction in entitlement programmes, or through allocation of funding now to support future entitlement programmes. At present, however, the assumption is that 'growth' will allow these entitlement programmes to proceed without any action now, or negative consequences on the upcoming generation.

Furthermore, when considering these future increases in costs from a shrinking tax base, they will also need to service the debts that are being accumulated in the present. As such, in addition to having to service the cost of a growing retired population, the shrunken tax base must also apportion more of their income in order to service debt. As such, there seems to be a huge assumption that either the upcoming generation are going to be hugely more productive than the previous generation and / or they will be willing to see much higher tax levels than the previous generation.

Furthermore, developing economies such as China are also major lenders into many of the developed economies, meaning that, as they continue to develop, they will have access to future resources and output of the developed world as they continue their growth, possibly allowing for an accelerated rate of growth. The upcoming generation must therefore achieve all of this as the emerging economies continue to grow their share of the economy, and move ever further up the value chain in competition with developed economies. I am now not alone in this point of view, and again from the Economist:

But in parts of the rich world such optimism may now be misplaced. With ageing populations and shrinking workforces, their economies may grow more slowly than they have done in the past. They may have borrowed from the future, using debt to enjoy a standard of living that is unsustainable. Greece provides a stark example. Standard & Poor’s, a rating agency, estimates that its GDP will not regain its 2008 level until 2017.

Rising government debt is a Ponzi scheme that requires an ever-growing population to assume the burden—unless some deus ex machina, such as a technological breakthrough, can boost growth. As Roland Nash, head of research at Renaissance Capital, an investment bank, puts it: “Can the West, with its regulated industry, uncompetitive labour and large government, afford its borrowing-funded living standards and increasingly expensive public sectors?”

Some of the commentators on the blog might note the use of the expression Ponzi scheme, as there has been a debate in the comments section of the blog on just this subject. The point is that there is no way in the world that the current economic structure of the developed world can be maintained. I have asked, and asked and asked where the real growth might come from to support developed world economies. It now seems that even the mainstream is coming to this question, and it is about time.

As such, when we look at the current debate, we can see two simple divisions. On the one side, there are a series of assumptions that there will be a growth miracle that will outstrip the results of demographic change in a world of increasing competition. On the other side is an assumption that something must be done now to accommodate the changes in the world. The consequence of the former, barring a miracle in productivity, is that the upcoming generation are going to be saddled with huge burdens, even assuming that the borrowing might be sustained into the near future.

On the other hand, the consequences of cutting now is to commence a process of realigning the economy to the actual wealth creating potential of the economy, and starting to face the problems that are rapidly accumulating. At its most basic, it is accepting that there needs to be a restructuring now, rather than imposing a huge (and probably in reality an unsustainable) burden on the future. I believe that, in the past, I commented on another Economist article that pointed out that, in the future, there will be a conflict of interest between the generations. The current debate about continuing of spending versus cutting now is in reality exactly this debate.

I have always realised that, if governments cut now, the consequence will be shrinking economies. I have never seen any way out, except to take this 'pain' sooner or later. However, I have always argued that sooner is better than later, as the accumulation of debt can only compound the existing problems. No doubt, if governments manage to really cut now (and that is still uncertain), then we will later see retrospective history claiming that the cuts were responsible for future problems that will indeed arise. However, such a perspective would be to ignore the real changes in the world economic structure, and these changes are not of the sort that can be wished away or ignored. The choices are simple, and the choices are 'who pays, and when?'

Notes:

A long time ago I wrote some posts which proposed reforms which would try to maintain the essential underlying principles of several entitlement programmes in the UK (e.g. NHS, Education and Benefits) . I wrote them from a basic principle; that we could not afford the current structures going forwards. I sought to balance the underlying social and political demands with the coming shrinking of wealth. What we are now seeing is the discussion of necessary cuts, and I can only hope that these are undertaken in conjunction with the necessity for reform of the systems themselves.

What I would like to see is that, in the recognition of the difficulties ahead, that those in the future might enjoy something similar to what we (in the UK) have grown used to. In other words, the same underlying protections but pared down to achieve the original basic principles at the time of the establishment of the benefits. In addition to cuts, it is therefore necessary to reform, and I hope that this is the next phase in the transition. Unfortunately, since the time of writing the proposed reforms, governments have racked up ever greater debts, making it ever less possible to achieve this goal. This is why I have, since the start of this blog, argued against government borrowing.

As a further note to US readers, the examples of reform I give might seem to be puzzling in the context of the US experience. I am a firm believer that safety nets, education, and health care should be available to people, and you will see in the examples methods that might allow for these to be achieved in the context of the UK's history and situation.

Obama's Budget - From where will the money come?

The news at the moment might be described as worrying. Today, we have the story of the 'Obama' budget, which is simply quite staggering. The link I have provided will take you to the Times version with plenty of detail, but I rather like this from the Telegraph, which illustrates the scale of the spending:

If the $3.552 billion budget is divided between all 138,893,908 American taxpayers – the 2007 US Internal Revenue System figure, the latest available – then it will each one $25, 573.48.

The Republicans are up in arms (despite their own prior fiscal incontinence), with their concerns ranging across many areas. However, their focus appears to be on taxation, rather than the idea of deficit spending (Ron Paul is a notable exception).

Inevitably - the promised return to shrinking deficits is apparently going to happen at some point in the future. In order to achieve this, there is very little detail:

Mr. Obama’s first budget was light on proposals to cut spending, despite his statement at the White House on Thursday that the government would be “cutting what we don’t need to pay for what we do.” (NY Times)

Of particular interest as illustration of the lack of clarity is that one of the ways proposed for balancing the budget is to increase taxation on higher earners. This raises a question of how many higher earners there will be, and how much they will be earning, as the economic shake-out progresses. The news reports do not give the details of how calculations have been made, but I would guess that such 'details' have not been considered. For example, this is from the NY Times:

He says he would shrink annual deficits, now at levels not seen in six decades, mostly through higher revenue from rich individuals and polluting industries, by reducing war costs and by assuming a rate of economic growth by 2010 that private forecasters and even some White House advisers consider overly rosy. [italics added]

In other words, the return to fiscal continence looks rather improbable. Perhaps the most worrying part in all of it is the proposals to tax business and increase business costs:

He would remake the energy sector to reduce reliance on foreign oil and address global warming, by requiring industries to buy permits to emit the heat-trapping gases that contribute to global warming. The revenue would pay to develop alternative energy sources and to provide tax relief for Americans facing higher prices from utilities and industries passing on their permit costs. (NY Times)

At a time when the US is on its metaphorical economic knees, this is a proposal to increase the costs of businesses that provide employment. Whatever your views on man made global warming, such action will have an impact on those industries, and will see their competitive position erode, and the businesses that rely on such industries erode in many cases (e.g. if US energy costs increase, so will the cost of steel produced in the US).

Above all else, on top of all the other borrowing and activity that has been undertaken, there is an assumption that the money will be available for borrowing. The US has managed to continue to fund its borrowing due to the 'flight to safety' towards the $US, but Hilary Clinton's visit to China with a begging bowl clutched in her hands illustrates the fragility of the situation.

Regular readers will know that my belief is that a situation of the world (and in particular China) continuing to fund US deficits looks ever more improbable. What we now have is the US attempting to raise $US trillions to finance government, the same in the UK, the same across Europe, the same in many places in the world. Governments across the OECD are going on a binge of borrowing and spending. If we then think of the creditor countries, the countries that potentially have the savings to fund such borrowing, we see that their priorities are to deal with their own troubles.

China and Japan are both in a situation in which the rapid contraction in exports are hitting them hard, and they need to rapidly act to restructure/transition their own economies away from exports. As an article in the Economist points out, there is severe pain in the Chinese industrial heartlands, and a Chinese government fearing social disorder. This is a government that must use their own resources for their own needs, not use the resource for further lending into collapsing world economies. At this point I will digress slightly, as I have seen a contrary view from an individual whose views I respect. Niall Ferguson has the following to say:

The line is very clear from China. They've consistently made their position clear. They want the status quo. They do not want this thing to break down. They were kind of appalled when Geithner said the ‘m' word. And they took full advantage of Hillary Clinton's visit to smooth ruffled feathers and restate their commitment. It's a very good bilateral relation. That bilateral will is important here. The Chinese believe in Chimerica maybe even more than Americans do.

As for my views on the situation, Niall Ferguson believes that China and the US are locked in a perverse economic embrace. However, we differ in the belief that the embrace can be maintained. My reason for disagreement is that, even if China pours more money into the US, an insufficient amount of that lending will be returned to the US through consumer purchasing of Chinese goods, as the wallets of US consumers are snapping shut. In addition the US is printing money, and the possibility of repaying debt in anything other than more useless paper looks increasingly improbable. In such a situation, China is giving large amounts of output for free, and that will in any case be unsustainable.

With regards to Japan, I find the country quite a puzzle to understand. Whilst familiar with Asian culture, and Japanese business, I find the country as a whole a genuinely difficult one to understand. I promised an article on Japan long ago, but never managed to have enough confidence to plunge into the muddy waters of this subject. Some things we do know, which is that the Japanese export machine is grinding to a rapid halt, the economy is falling off a very big cliff, and the only salvation for Japan is in the huge savings of the Japanese individuals. I have read somewhere (sorry no reference) that the Japanese have started to eat into those savings to fund their day-to-day expenses. Again, in such a situation, it is hard to imagine that Japan will ride to the rescue of the West.

The big oil producers are returning to the hard realities of life in an environment of cheap oil. Even in December 2008, there were reports of problems in the finances of Saudi Arabia (although their problems might be considered slight when viewed against the problems of the West), and reports of diversification of petro money away from US treasuries in November of 2008. I believe that I have also given some further examples of an increasing cynicism towards Western investment in the last few months in several articles. As a source of finance, the petro economies look unlikely to be willing to dip into their deep pockets.

For Germany, it has its own problems due to falling exports, and is faced with the potential for disaster in the Eastern and Central European countries turning into massive losses across Europe, as well as the troubles in the evocatively named PIIGS countries (Portugal, Ireland, Italy, Greece, Spain). As a result, the future of the Euro is starting to look threatened (something I discussed as a possibility long ago), and Germany will be focusing resources into their own troubles as a priority, and the Euro area troubles as a second priority.

The essential problem is this. All around the world, economies are in free fall, and resources directed to problems at home will be the absolute priority of each country. In such circumstances, the possibility of countries being able to finance their deficits through overseas borrowing looks to be so unlikely that it remains close to impossibility. In the case of the US and China, the Ferguson thesis looks to be the best explanation for how lending might occur, but the insanity and unsustainable nature of the imbalance must be apparent to China. I just do not believe that they will continue to finance US profligacy in return for increasingly worthless pieces of paper. However, I can offer no clear evidence for this, though I have previously posted articles in which China has been hinting at their unwillingness to do so.

Regular readers will have noted my continuing campaign for clarity on the Bank of England's policy on quantitative easing (QE, printing money), and my suspicion that the Bank will be using this to directly fund government operations. I have not, as yet, looked as closely at the situation in the US, and will look at this in the future. However, bearing in mind that there just does not appear to be the money 'out there' to borrow, my suspicions that the US government is doing a 'Zimbabwe' is very strong indeed. Further discussion to follow....

Note 1: I had a comment from 'Red' pointing out that I am putting flies in the ointment in my requests for clarity on the BoE policy on QE. As one anonymous poster put it, better to get the truth out sooner than later, before the real damage is done. Another commentator suggested that I am fear mongering. To this I would respond by saying that, rather than fear mongering with no justification, I have sought to gain a clear understanding of what the BoE is up to. As such, I am giving them the opportunity to assuage my fears, and hopefully the fears of those who share my concerns. Their evasion to date suggests that they have something to hide. I have today sent an email asking them to acknowledge my email, and am still awaiting any replies to my questions. We will see...

Note 2: ChasH has sent a letter to his local Conservative MP, and received a reply. The reply really says very little at all, and as ChasH points out, it looks remarkably like a 'form' letter. The letter can be found at the bottom of this post in the comments section, and I would be interested to hear if others have had similar replies. It is a little worrying that the reply appears to be so complacent and could be summarised as 'wait and see'. As I have stressed, this may be the most radical economic policy every undertaken, and we have no idea about any details of the policy....

Note 3: I have had some interesting comments on my article on deflation, and can not reply to them all. However, I would like to some points.

A few people have suggested that division of a unit of currency into smaller units is expanding the money supply. This is a very different process, as you are not changing the number of units of the actual currency. If we were to imagine that we followed the idea of a fixed money supply, and imagined that we froze it at £1000 units of currency (for the sake of illustration), we could have the following:

We start with £1 units of currency with a total of £1000 units as £notes. As deflation occurs, we subdivide the currency into each £1 = 100 pence. In practical terms, if we imagine that £1 at the start buys 1 litre of milk, and as deflation occurs it is not possible to use that £1, because the price of milk is now £0.5. We have a problem. How can we exchange the currency for the milk, if we only want 1 litre? We can now only exchange the £1 for 2 litres.

To overcome the problem, we are not diluting the value of the £1, we are merely allowing it to be chopped up into smaller units, for example coins. If you hold a £1, the £1 will still buy 2 litres at £0.5 each. Alternatively, if you decide to exchange your £1 for 100 pence in coins, the £1 will be replaced by 100 pence. Any holder of £1 is not losing anything, as this has absolutely no effect on the £1 that they hold. The important part is that, as the new units are called upon, each 100 pence issued sees the removal of a £1 note. The money supply remains the same, and is always equal to £1000. At any time in the future, although it would become an increasingly impractical unit, you could return to a bank, and exchange the 100 pence back into a £1 note.

However, if you want to really increase the overall supply of money, you would print £1 notes. In this case, every holder of £1 sees the £1 erode in value, because there are now more than 1000 £1 notes. When the new £1 notes are printed, some of the value of those notes is transferred to the new £1 notes. In this situation, if we start with our £1 litre of milk, and more £1 notes are printed, there are more £1 notes chasing the milk, and the price of milk goes up, thereby reducing the value of each £1 in exchange.

The example I give uses physical notes and coins for ease. However, if we think of this in terms of electronic currency, in terms of accounting, large numbers of pence will still be accounted for as £s. All sub-units of currency are measured against the fixed number of £1000 that were there at the start. That number never changes. Whatever happens the number of 1000 x £1 never changes.

I hope this answers the question? Let me know if not.

On a related issue, I have had comments on the fact that this is another fiat currency. The answer is both yes and no.

It is not fixed against an individual commodity, but is fixed against the total output of an economy. Fiat currencies make this claim, but the ability to increase the units means that they can, and actively do, produce more units of currency than the growth in the value of output. In fixing the units of currency, you fix the value of the currency against actual output of value. If output increases, then the value of the currency increases, and if output decreases the value of the currency decreases.

As such, in the example I have given, each £1 = 1000th of the total output of the economy. In normal fiat systems, each £1 = 1000th of output but we would have to add that it would need the proviso that the value would be a feature of time, such that the value is determined not as fixed, but as measured against time (inflation). In other words, the value will become £1 = 2000th of the value of output at some stage in the future. In the fixed money system, whatever happens, £1 = 1000th of the total value of output.

I hope this is clear...

With regards to commodity currencies, they also have inflationary potential (e.g. new gold source found) but are better than ordinary fiat systems, as they create some kind of constraint on the expansion of money. Moreover, they offer a default value as a contract, such that whatever happens you can exchange this money for x amount of gold. A standard fiat currency simply implies that at some point in the future, it may be exchanged for 'something', including another unit of the same currency. However, as we may be about to find out, it may be useless to exchange for 'things', because the value is destroyed by oversupply of units of money. In the case of the fixed money supply, there is a contractual commitment that (staying with the 1000 unit example) you will be able to exchange the £1 for 1000th of total value of output. That is a strong contractual commitment.

Barack Obama or John McCain - Who Will Address the Reality of Economic Crisis?

It is impossible to ignore the US election, and whoever wins will face the current economic crisis. As such, how do the economic policies of the two candidates stack up? This from the Economist back in October:

'Both plans are costly. Long before this week, Mr Obama had proposed sending cheques to the middle class, to be partially paid for with a tax on oil companies’ “windfall profits”. But with the collapsing price of crude, the package’s net cost has now shot up from $50 billion to $115 billion. Jason Furman, Mr Obama’s economics director, estimates the latest round of proposals will take that up to $175 billion over the next two years. Mr McCain’s pre-existing tax plans would have caused the deficit to balloon more than Mr Obama’s, and his campaign says his latest proposals will cost another $53 billion. The timing is awful: the Treasury announced on October 14th that the government’s fiscal 2008 deficit was $455 billion, not the $389 billion projected in July.'

In other words, both candidates have their own version of continuing the delusion that government borrowing is the solution. The Economist also gave a more detailed briefing on their respective economic policies, but I will not detail their policies here as their policies are unlikely to be realised. The situation is such that, whatever they say on the stump will have to be adapted to the realities that they are about to confront, which is the ongoing collapse of the US economy. In such a situation, what their individual policies have been, becomes irrelevant. What matters is who is better able to adapt, be pragmatic, and accept the reality of the situation.

This comes down to a judgement call about the character of the individuals, and I have no insight on this subject that I can offer readers, and therefore will remain neutral on the subject. I can only suggest that, for US readers, you ignore what the candidates said they will do, and ask yourself how they might respond to an ever worsening economic situation. Will they bury their heads in the sand, or will they confront the reality, and devise a policy that will address the fundamentals of the economy. Are they likely to heed the populist calls, or will they have the courage to lead the US people and confront them with a need for real and fundamental change? This is a question of realism and character, rather than an analysis of their policy record.

As I have said, these are judgement calls about the character of the individuals in question. I am happy to offer my opinions on questions of economics, but in no way feel that I have any greater insight than anyone on this question. I only know the right question to ask, but do not know the answer.

I have had some interesting comments in the last day or two. In particular MattinShanghai offered an insightful comment on the change in the common understanding of wealth as follows:

'What seems to be happening in developed countries is the taking over of the real productive economy by rent-seeking finance capital, which basically tries to "squeeze" it for all its worth. This applies to companies (via M&As and LBOs), prospective landlords (via mortgages) and individuals, who are encouraged to take on ever-increasing levels of personal debt. According to current economic orthodoxy, asset stripping, outsourcing and offshoring, "creates wealth", so its all for the best, isn't it?'

Matt's discussion is based upon the thinking of Adam Smith, and you can read the comment he makes in full at the end of 'A funny view of wealth'. To all of the readers of this blog, I would strongly recommend a reading of Smith's 'The Wealth of Nations'. I have always felt that all the economists since Adam Smith have been trying to fight with his ghost. It has been a long while since I have read 'The Wealth of Nations', but it was an inspiration for me, and is probably the inspiration for much of my thinking on economics. In other words, if you find that this blog makes sense, then you would almost certainly appreciate the work of Adam Smith (I may reread it myself, and see how much my thinking actually is founded in his impressive work).

Ignatius also made the following comment, regarding 'A funny view of wealth' (it is heartening to see that people are still reading it):

'A critical remark, though: You argue that immigration as well as emigration is bad for the UK economy. Obviously, ceteris paribus, both statements cannot be true at the same time: You either have too many or to few young workers - given the age distribution of the "native" UK population, I'd rather vote for the latter ...'

The key difference is that immigration is often from countries which are economically less developed than the UK. As such, they are likely to be providing remittances to their country of origin, thereby removing wealth from the UK to their country of origin. I also divide immigration into 'good' and 'bad' (I am simplifying here). In particular all temporary migration is bad, as the migrant is likely to return home with a large cash sum, removing wealth from the economy. UK workers going to another country to work, and returning home with a lump sum is a positive for the UK. The trouble is that much of the recent emigration from the UK is to settle permanently in another country, and they take their wealth with them, thereby removing wealth from the UK. By contrast, immigrants from less developed economies are unlikely to be bringing such wealth with them (excepting the super-rich 'non-doms'). Also, emigration from the UK is to countries such as Australia, where entry requires high levels of education/skills meaning that most of the migrants are exactly the people that are a positive for the economy. Equally, immigration of unskilled migrants into the UK is a bad thing, but immigration of highly skilled/educated migrants is a good thing on balance. These are generalisations, and do not do the subject justice, but a re-reading of my original post will hopefully clarify the matter. As such, I recommend reading the original essay. With regards to the age distribution, the introduction of an effective points system, and actively promoting immigration of highly educated and highly skilled workers would be a partial way to address this problem.

I hope that I have covered the criticism, but would also like to emphasise that I welcome any criticism, as it helps me to focus on any weak points in my analysis or my communication of that analysis. Therefore, thank you Ignatius for your comment.

Two anonymous posters have asked what will happen if the UK defaults on debt, and focus on the external consequences rather than the internal. This is a very large question.

I have previously detailed the options for governments in the case of no longer being able to borrow, and it is not a pretty picture. With regards to countries that trade with the defaulting government, there are some obvious consequences. One of those is that lending to the government would probably continue, but come with hefty (IMF-like) strings attached, and would probably require rescheduling of previous debt under onerous terms including rescheduling in a different currency. The default would also make trading with the defaulting country high risk, as the currency would be considered unstable. In these circumstances, trade would not be conducted in the domestic currency, but in another more stable currency. This would be a way of shifting the currency risk towards the country in default. It is a short answer, but I hope that it suffices. In other words, the reform that should anyway be undertaken within, will be forced from without. A better solution is/would have been to implement the reforms now. This would allow for a more gradual and less painful adaptation to the changed world economic circumstances and would be a controlled reform rather than a shock.

In both cases the country would have to learn to live within its means, but internal reform offers the opportunity to make the transition with less pain. As I have long argued, it is only reform now that will allow creditors to continue to support economies such as the UK economy as it makes the transition to a leaner and more competitive economy. Every day that goes by with ever more borrowing just digs a deeper hole, and governments desperately need to reduce expenditure such that the depth of the hole is minimised and allows that we can eventually climb back out. If creditors can see that we are reducing borrowing, and can see the prospect of an eventual return to surplus, then they will keep lending. Instead, what they see is an increase in the size of the deficits, and will be wondering at what point the deficits might ever reverse.

For those that doubt that the creditors are getting cold feet, this from the Times:

The domestic priorities of Saudi Arabia could well be put before helping Western economies, which have been put at risk by global economic turmoil.

“Saudi Arabia does not want to be seen as a milch cow,” said a senior British government figure. At a three-hour meeting with King Abdullah on Saturday night, Mr Brown secured his agreement to attend the summit on November 15 to discuss reform of the international financial system. The pair dined, then talked long into the night through an interpreter

This is the question that I raised some time ago. The creditor countries are faced with tough choices. Do they keep throwing good money after bad? If they stop lending, they see the market for their products/commodities collapse, but if they keep lending, they are effectively subsidising the wealth of the West with their own wealth. More from the same Times article:

Privately Saudi officials have acknowledged that in recent decades the state has failed to invest in the country’s infrastructure and public services and now want to rectify this. They intend to invest in education and skills, as well as to improve the living conditions of ordinary families.

In other words, bailing out the Western economies comes at the price of denying their own people the benefits of their wealth. It is very much as I have suggested before. The big question is how they will chose to proceed. If they cut the lending, then they will suffer, and if they keep lending they have to live with the idea that they must just continue to support the wealth of others at the expense of themselves. It is a classic 'rock and a hard place' situation. However, it illustrates how fragile the current economic situation actually is. As a note, thanks to Stephen for the link on the subject of the visit to the Gulf by Gordon Brown.

Jim G, on a related subject asks the following:

'I now watch Gordon Brown, smug faced, tell everyone that the UK's debt is lower than most if not all of the Europeans. Is this true? Is he including in his figures, the off book stuff, such as nuclear decommissioning, PFI deals etc. Is the UK really in a better position than the rest of Europe or is this another "no more boom and bust" statement? I've looked for some stats, a report, anything but can not find any comparisons between countries.'

This is a very pertinent question. There are two issues. One is that the measure of debt is made relative to GDP, and as I have argued previously, GDP is overstated by around a third (a 'guesstimation'). With regards to the real liabilities of the government, the Economist thinks that all of the liabilities would roughly double the real levels of debt. It also reports that 'Britain's deficit as a share of GDP was among the highest in the 15 old member of the European Union' (Economist print edition, November 1-7, 2008, 'So Long Prudence. We had Fun but....', p55-56). In other words, there is absolutely no comfort to be found in the UK debt situation. Also, even were it the case that we were not as bad as others, this would be a relative measure and would not alter the simple fact that the situation is bad. If one person has a broken leg, and another has a broken leg and arm, we would not say that either person was in a good condition to play a game of rugby.

This has been a slightly rambling post, and has covered a lot of subjects. I hope I will be forgiven for this, but there were a lot of interesting comments. Of all of the points in this post, I think the most important is that it appears that my belief that creditors are getting cold feet is correct. I have taken a single comment in an article as the basis for this, which is hardly overwhelming evidence, but I think that it may be a good indicator, and fits with my previous speculation.

In the meantime, no doubt, everyone will watch the outcome of the US election with great concern. I do not know the right choice, and hope that the judement of the people in the US will be correct. The handling of the US economy will have a profound effect on the world economy as a whole, so that the choice made in the election will have profound effects for us all - for good or for ill.

Note 1: Death To Bubble Addicts posted a link to a very funny video. Whilst the situation is serious, humour about it is not a bad thing, so thanks for the link.