The Fed Criticises Bloggers?

Over the last couple of days, in reviewing the news, I have noted that there is an increasing sense of panic and chaos in the world economy. Today, it seemed particularly bad. I typically look at the Telegraph, the Times, the New York Times, the Guardian, and Reddit as a daily routine, and occasionally the Economist. Today, I was confronted with the following economics headlines in the Telegraph (selected examples):

• FTSE 100 Joins in Global Market Tumble
• Warnings of Double Dip Recession Flash Brightly Across the World
• Bank of England Starts to Dust off its Inflation Fighting Credentials
• Roubini: Greece Needs Orderly Debt Restructuring to Avoid Default

Perhaps most shocking was a headline for a commentary by Ambrose Evans-Pritchard titled 'Time to Shut Down the Federal Reserve?' The content of the commentary was not as radical as it appears, and is a response to a rather idiotic paper by Kartik Athreya of the Richmond Federal Reserve, in which he advises that people should not take economics blogs seriously, as the writers do not have a PhD in economics from a decent school. Ambrose Evans-Pritchard, quite reasonably, points out that the experts played a major hand in the development of the economic crisis. Zero Hedge offers an even more scathing reply to the paper, saying:

Alas, all Kartik achieves is to convince the general public that feeding Fed "economists" alcohol after midnight and letting them directly upload their resultant gibberish to the Fed's broad RSS feed the second they think they have a coherent thought , is generally a disastrous idea. In his piece, which has no other intention than to discredit and outright malign bloggers such as Matt Yglesias, John Stossel, Robert Samuelson, and Robert Reich, Athreya says: "In what follows I will argue that it is exceedingly unlikely that these authors have anything interesting to say about economic policy. This sounds mean-spirited, but it’s not meant to be, and I’ll explain why." Instead in what follows, the Fed presents 4 pages of thoughts so meandering, that the author's blood alcohol level must have certainly been well above the legal norm for the duration of the writing of this ad hominem pamphlet.

I am focusing on this paper by Athreya, as it contrasts nicely with the headlines. The Masters of the Universe, sitting in their ivory towers are clearly not in control. Instead, they pull their levers, enact their policy, and it all comes to nothing but more chaos. They propped up the financial system, supporting their selected 'too big to fail' banks, they printed money and poured it into the markets via their favoured financial institutions, and they aimed to drop interest rates to the floor. Despite this, we still see a world economy racked with volatility and close to panic.

That they had a role in the blowing of the bubbles that took a crisis and brought it to the point of disaster appears to be forgotten by people like Athreya. Their arrogance is quite astounding.

What we are now witnessing is that it is not possible for the Masters of the Universe to eternally prop up a system that is structurally flawed. They can continue to pour money into the system, continue to prop up bankrupt financial institutions, but there is a limit to how long they can bury the underlying structural flaws. When money is invested unwisely, someone, somewhere is going to have to pay. It is only a question of 'who' and 'when'?

This is the problem. If you invest in a piece of commercial real estate at an inflated value of $1 million, and the value falls to $500,000, then somebody must accept the loss. For example, if it is a half empty shopping mall, it is not producing the expected return, and the valuation reflects this underlying reality. There is not enough demand for retail space out there. The capital that has been invested in the shopping mall has been misdirected. Workers have input their labour, materials and energy have been consumed, and there it is; a half empty shopping mall built with borrowed money and no prospect of returning that borrowed money. Somebody, in the end, is going to lose their money.

The only way that the shopping mall will recover is if consumers go on another debt fuelled spending binge. If they were to do so, it would only be a matter of time before the debts, wherever they originate, will finally become due, and the problems will return. If consumers are spending 110% of their income, there must come a time when they can no longer spend. If a government is spending 110% of its income, there must come a time when it can no longer spend. We have seen this happen, so why will it be different this time?

If we think of our half empty shopping mall, it should never have been built. The actual demand for shopping malls is, in reality, aligned with actual income, not income + borrowing. Whilst it is possible to build shopping malls based upon income + borrowing, the long term viability of the shopping malls finally comes down to income without borrowing. If the shopping malls are built upon an assumption that income + borrowing is an eternal state of affairs, at some point the investors must lose money. Too many shopping malls will be built, as they are servicing both present income and future income, at the cost of less income in the future. They are building capacity based upon an unsustainable structure.

The unsustainability must finally lead to a point in time where the shopping mall lies half empty. At that point in time, whoever invested their money in the shopping mall will face a loss. Whether a bank, or an individual investor, they are faced with holding an asset, one which has taken labour, energy and materials to build, and which can not return the money that it took to build. How is the money going to be paid back? Who takes the loss?

The essence of the actions of the central banks has been to enact policy to stop anyone taking the loss. However, it does not matter how much they try, there will still, in the end, be far too many shopping malls in relation to the actual income of consumers. What the central banks can not do is the only real solution, which is to jump back in time, and stop the building of the shopping mall or the borrowing of consumers that was the driver of the investment in the shopping mall in the first place. So you come to a point in time where the shopping mall is there as a physical reality, but the demand for the services of the mall are not there.

And what of all of the people who were employed in the shopping mall, or employed in services that supported the shopping malls' operations? The shop assistants and managers, the shop fitters, the security companies, the importers, and so forth. All of these jobs will disappear, with each new unemployed person's training and skills rendered useless (or at least less useful). They must retrain, find new employment in a sector that does not have over-capacity. However, they are not alone, as all over the economy, other sectors built upon the income + borrowing paradigm are in the same position. So it is that the consumer demand falls as unemployment rises, leading to even more contraction of the demand for shopping malls.

How is it possible for the Masters of the Universe to turn back this tide? In their arrogance, they actually believe that they can do so. Pulling this policy lever, or that policy lever, they seek to change the world such that the economy is not structured around actual income and the ability to service past borrowing. They deny that the shopping mall was built upon an unsustainable structure, and try to hide the reality that it represented excess capacity.

Returning to the PhD economists of the central banks, the Masters of the Universe, they have their mountains of theory, they have their magic formulae, they have their policy levers, they have their belief that they can control the system - but - can they really make a world in which nobody loses when an economy has been subjected to structural failures, where investments were directed into sectors that were intrinsically unsustainable?

As each day goes by, it becomes ever more apparent that the Masters of the Universe are, in reality, delusional and impotent. At best, they can delay restructuring. However, in doing so, they will just continue with the investment into unsustainable sectors of the economy, and contribute to further structural flaws in the economy. The more they seek to turn back the tide, the greater the ongoing mis-allocation of resource. And they have the arrogance to criticise those of us who do not have their approved qualifications?

Note: I use shopping malls as my example as they are an easy target. However, this is just a convenience, and does not reflect the extent of the structural problems. There are a multitude of sectors facing the same problems, with each sector with overcapacity having a plethora of downstream overcapacity.

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.

UK Office of Budget Responsibility

I have a semi-finished post on the Keynesians, but could not help but comment on the report from the Office of Budget Responsibility (OBR). The OBR seems to be a good idea but, as you will see, the OBR starts with assumptions and projections that are highly questionable. I will start with their preamble, which is as follows:

In the body of the report we describe certain departures from previous forecasting practice and we emphasise three in particular. The first is our stress on the uncertainty of the forecasts, particularly of the fiscal forecasts. We illustrate this principally by the use of fan charts. The second is that we have based the range of fiscal outcomes around our central view of prospects. The previous Government used deliberately cautious assumptions for some key variables in its fiscal projections. We have departed from that practice and, as we have said, have used other methods to illustrate uncertainty.

So far so promising....

We then move onto to their central forecast for economic growth, which shows the following GDP growth forecasts (for the purposes of this exercise, I will pretend that GDP is a meaningful metric, but you may wish to see my discussion of US GDP to see why it is a dangerous measure):

2011 - 2.6 %
2012 - 2.8%
2013 - 2.8%
2014 - 2.6%

It seems that, the UK is about to enter a period of relatively high growth. However, before we all become too excited, I thought it might be a good time to look at the 'economic growth' achieved during a massive credit bubble (chart from ONS).

Perhaps I am missing something, but it seems that, somehow.....the UK will achieve GDP growth rates that are close to those achieved during a massive credit fuelled bubble. It looks rather problematic, does it not? Where will the growth come from?

If we look at the forecast assumptions, it all starts to become somewhat dubious. First of all, there is that wonderful concept of the 'output gap'. What they do not explain is an output gap of what? The FT definition of the output gap is 'the difference between an economy's current output and the estimated maximum potential output (full capacity)'. This is how the OBR calculated the gap (see appendices of report for details):

1. the productivity gap accounts for around ½ percentage point, reflecting both the large fall in actual output per hour over the recession and a judgement that underlying trend productivity has been adversely affected by the financial crisis;
2. the fall in average hours in the recession implies an average hours gap of just over 1 per cent;
3. just over 2 percentage points is attributable to the employment rate being below its estimated trend level. This is broadly consistent with the degree of spare capacity implied by indicators of recruitment difficulties.

These are some almighty assumptions in there, and the report does not say a gap in output of 'what'? To their credit, they do acknowledge that this is a somewhat difficult metric to calculate, but nevertheless they do not explain what sectors have the 'output gap'. Whilst there might be a notional maximum output, it is not clear how this translates into future output. If we think of the 'growth' during the bubble period, as I identified in my essay 'A Funny View of Wealth', there was no increase in output of genuine wealth creation, just 'growth' associated with debt fuelled consumption.

If we think of the way in which the economy grew, to service debt fuelled consumption, this implies that the 'output' that is not being utilised is in these sectors. For example, where consumer spending has fallen, there will be underutilised capacity in the retail sector (e.g. empty commercial property). How can this output be returned towards its notional maximum? The only way that this output might move to its maximum, in the short to medium term, would be if there was another credit boom - a highly unlikely scenario. The point is that, the output gap assumes that there is capacity in the right sectors ready to expand towards maximum capacity, but what if the capacity is in the wrong sectors?

Even if looking at, for example, employment, are the unemployed in a position to rapidly transition from their experience in one sector into another sector. For example, if we look at the expansion of the government pay roll (estimated at about 1 million over the last ten years), if reducing that payroll, what kind of retraining would be needed to make these workers productive in other sectors of the economy? Equally, how easy is it to take a person who has worked in the service sector, for example a shop supervisor, and redeploy them into manufacturing? That person may have potential for 'output', but in what?

Then there is the macro-picture provided by the OBR. They have noted that the emerging economies are looking stronger than the US or Europe, and that Europe is the UK's main trading partner. I will quote their analysis in full, as it is actually very vague:

The forecast for UK export markets growth (a measure of world trade weighted to reflect the geographical pattern of UK exports) is weaker than that for world trade throughout the forecast period, particularly in 2010 and 2011. This reflects the relatively weaker outlook for advanced economies compared with emerging countries and, in particular, the UK’s main trading partner, the euro area. UK export markets are forecast to grow by 4 per cent in 2010, 4¾ per cent in 2011, and by close to 6½ per cent thereafter, in line with its long-run average.

If Europe continues its turbulent ride, with potential for yet further weakening of the European economic situation and weakening (or collapse) of the Euro, where this ongoing growth might come from is not specified. Is it going to be the US, Asia or where? They later suggest that, they have based their assumptions on survey evidence, but there is no clarity on the 'where to?' question. On this, the report offers no explanation, which suggests this is nothing more than an optimistic guess, based upon currency devaluation. Whilst agreeing that devaluation has potential to drive exports, how will this work in a world of a devaluing Euro? Our most significant trading partners are seeing their own devaluation, and they are also significant competitors in export markets. Is the devalued pound enought to pull the UK out of its problems, when the US is still in trouble, the EU is in trouble, and even China is now slowing.

Then we come to domestic demand, and I have to start with a quote from their report:

The central GDP forecast embodies a rebalancing between external and domestic sources of demand. Private sector demand contracted sharply in the recession, while government spending contributed positively to GDP growth. Although recent data suggest that private sector final demand has started to recover, we expect it to remain relatively weak in 2010. For this year it is government consumption and inventory accumulation that make the largest contribution to growth. Over the year as a whole, we expect GDP growth to remain subdued, with output rising by 1¼ per cent. On a quarterly basis, growth increases from 0.3 per cent in 2010Q1 to 0.6 per
cent in Q2 and holds in the 0.6-0.7 per cent range throughout 2010 and 2011

That's right, government debt fuelled consumption is a major contributor to GDP 'growth'. This is, yet again, debt fuelled consumption being measured as 'growth'. Sure, we can keep on borrowing more and more, and sure, that borrowing will (in the short term) create lots of activity. But it can not be sustained, as borrowing has to be finite. However, the picture becomes seriously muddy in the following paragraph:

GDP growth rises to 2½ per cent in 2011 and again to 2¾ per cent in 2012 as credit
conditions ease and uncertainty subsides. All components of private sector demand are expected to strengthen, while government expenditure detracts from growth. Private consumption growth is forecast to rise from ½ per cent in 2010, to rates slightly below its long-run average and below the rate of GDP growth. Investment remains weak in 2010, but then recovers strongly as the recovery in business and dwelling investment gathers pace. Investment is expected to grow by around 8 per cent from 2012. This, together with a relatively stable household saving ratio, means the private sector financial surplus eases slightly throughout the forecast, as the government deficit contracts.

The first point in the above is a grand assumption. Why will credit conditions ease and uncertainty subside - we do not know because it is simply given as an assertion. What follows is built upon this assertion. For example, dwelling investment means (presumably) a return to significant growth in the property market, meaning that (once again) the UK economy is going to be built upon residential property. But where will the money for growth in this sector originate from?

If you view their projections for employment, from 2010 - 2011, they are forecasting an increase in employment from from 28.8 million to 29 million, and thereafter increases by 300,000 per year. There is no substantive reason given for this increase in employment, except that presumably this will follow from GDP. However, although it is not absolutely clear in the report, presumably the increase in employment is calculated in the GDP growth. If so, we have a partially circular calculation.

With regards to the corporate sector, they are placing a considerable weight on business investment to drive GDP growth upwards. In a chart of GDP expenditure share, they show net trade as an ongoing negative, government spending in decline, consumer spending in decline (and argue that consumers will increase savings), and that business investment spending will be on the increase. As an explanation for why, they offer a chart that shows business investment in the recovery from the 1980s and 1990s, implying that business investment will plot the same course in this 'recovery'. There are two problems here; first they assume they are seeing a recovery (when the economy is still being propped up by government debt based spending), and secondly they are assuming that we are in the same world as the 1980s/90s.

With regards to the latter, the world in the 1980s and 1990s was not in the midst of a global crisis. Our next door neighbours in Europe, our main trading partners, were not on the brink of crisis. The world was a very, very different place. At that time, there were not the massive emerging economies creating a hyper-competitive environment. As such, why should a pattern of activity from a completely different set of circumstances apply now?

Whilst they present a case that consumer savings will present a growth in the funds available for investment, the question of 'invest in what?' is not addressed. One problem is that there is no certainty that such savings will be invested in the UK. Another is that, before a business invests, it must see opportunities for profitable investment, and it is not clear where these might be. By the OBR's own reckoning, export growth is going to be relatively small, presenting few opportunities for investment, and again we come to the question of the output gap. According to their arguments, presumably, there is considerable slack in capacity for exports, and this slack will need to be utilised before any further investment.

Then there is domestic demand as a potential driver of business investment. However, if consumers are moving from consumption to saving, then it is not clear that this sector would encourage business investment. In fact, quite the opposite will take place. The same goes for government expenditure, which will be reducing over the period of their forecast. Again, there will be no impetus for investment from this source.

We then come to housing. Is this going to be the source of business investment? If so, then it appears that we are destined to repeat history, and have an economy built upon residential property investment. This is, of course, an unsustainable investment path, and offers no long term route out of the problems that are apparent in the UK economy. The route for the UK to pull itself out of trouble must be the export of goods and services, the route to generating income with which to pay debts owed to creditor countries.

What we can see in this report is an assumption that the world is simply going to return to the pre-crisis economic system. The assumption that the UK will follow the same path out of the current economic problems as took place in previous decades says it all; nothing has really changed and the economic crisis is just a blip in the path of normality. The assumption that underpins this report is that everything will return to 'normal', despite the fact that the structure of the world economy has changed, and is in the process of further change. It is a naive and forlorn hope.

Whilst applauding the principle of the OBR, I can not help but return to the chart above which shows the GDP growth in the credit boom of the pre-crisis years. If, we are returning to such growth levels, there must be a new factor that explains where such growth might come from. On reading this report, I can only conclude that the OBR thinks this will happen, because it will just happen. The lack of acknowledgement of the structural problems in the UK economy, and the world economy, makes the report questionable. The UK economy, over a period of over ten years, has seen 'growth' being built upon credit (both government and private), and this has left the UK economy structured to accommodate this credit based consumption. A decline in the value of the pound is not going to see a magic restructuring of the economy in the way that they imply. At some point, the credit fuelled structure must go, and that must mean a period of painful transition.

Is it really possible that the UK economy will just return to 'normal'? I do not believe so. After all, normal was conumption of more than was produced.