Thursday, June 4, 2009

Green Shoots of Reality

As time moves forwards, it is possible to see that the mainstream media eventually catches up with the underlying realities of the current economic situation. It is interesting to watch how they take cautious steps, with a few commentators daring to speak the unspeakable, before eventually the rest of the 'herd' follows suit.

We are once again at a point where this process is accelerating, and the realities are starting to finally sink in. In this particular case, the solvency of the US and UK are now finally being questioned in a trickle of articles, hyper-inflation is being considered seriously, along with the end of the $US as a reserve currency.

The first article that is of particular interest was passed on in a comment on my last post by 'anon82', and is an article by Willem Buiter. I have highlighted this article as the author is part of the financial establishment, and therefore his opinion might be considered to carry a considerable weight. Throughout this crisis, he has veered a fine line between the delusions of conventional economic wisdom, and the heresy of accepting economic reality. In his latest article, he discusses the state of the UK economy, and is effectively accepting that the UK is structurally bankrupt. I strongly recommend the full article, as the excerpt below does not do the article justice:
As the government deficit explodes over the next few years, the actual primary surplus is likely to be primary deficit of around 8 or 9 percent of GDP. As the economy recovers, tax receipts will rise and cyclical public expenditure will decline, but the rest of the public expenditure programme (health, education, pensions) will keep on rising in real terms and as a share of GDP. It is easily conceivable that when the output gap is closed again, in 4 or 5 years time, there will still be a primary deficit of five or six percent of GDP. That means that a permanent reduction in the primary deficit will be is required of between 6.5 and 7.5 percent of GDP.
Essentially, Buiter has realised that the government is simply spending more than it can ever repay, and is accepting that the only realistic way out of the problem is to inflate away the debts. However, even with such an analysis, he is still not fully understanding the severity of the structural problems, as he still overestimates the underlying position of UK GDP. He is not accounting for the fact that, even now, GDP is being flattered by the activity that follows from the government's ongoing massive borrowing. As regular readers will know, GDP measures economic activity, which includes the activity created by debt based consumption (if this is new to you, you may want to read this post from October 2008).

I first wrote of the UK being structurally bankrupt in July 2008, and expected that the market would quickly realise that this was the case (I thought it would take six months). The point I was making in my article was that government deficits were going to balloon. I realised at that time that, as the downward economic spiral took place, revenues would collapse and expenses would explode. This would combine with a structural deficit, and plunge the UK economy into a deep crisis as creditors to the UK took fright.

At the time I wrote the article, I had not imagined the extreme policy that government would take in reaction to the crisis, and now believe that the final outcome will be worse even than I envisaged at that time. However, the important point about Buiter's article is that he is starting to recognise the structural nature of the problem. He is starting to see that this is not a short term economic crisis but rather a crisis in the very structure of the economy.

Buiter is not alone in starting to question economic assumptions. I have long been highlighting the similar points about the US economy as for the UK economy. Ever more analysts are likewise starting to question the sustainability of the US economic policy, and this questioning is emerging in the mainstream. In particular, the bland acceptance of the reserve status of the $US is finally being questioned, which has been a theme of this blog. In January of this year, I devoted an article to the subject - a response to reading on so many occasions that the reserve status of the $US would save it from collapse. It is not a post that is amenable to a short quote or summary so, if you have not read it, you may wish to read it now (see here - it is a long post!).

Since writing the post I have been tracking the moves of China to replace the $US with the RMB as a reserve currency (e.g. here). The latest news is that that Russia is again proposing development of a new reserve currency (SDRs - see here) to the BRIC economies (Brazil, Russia, India, China). The $US was immediately hit by the talk, indicating the inherent weakness of the $US.

The important point here is that there is now an acceptance that the reserve status of the $US is not a fixed feature of economic reality. Reserve status needs to be rooted in underlying economic strength if it is to be maintained, and more and more questions are being raised about the nature of the US economy. For example, there is a recent article in the Wall Street Journal that asks 'Is Your Portfolio Ready for Hyper-Inflation?', and in another article by CNBC, the many risks in the US economy are laid bare. In other words, the talk of hyper-inflation is seeping into the media, along with the increasingly dire prospects for the US economy (I have long been discussing the potential for hyper-inflation e.g. December 2008).

What is finally happening is that the mainstream media are starting to accept that the current activity of government and central banks will, in the end, have negative consequences. It is no longer a few lone voices - bloggers, conspiracy theorists, and the occasional maverick - but mainstream commentators, nation states, politicians and economists who are increasingly questioning the sustainability of the Western economies.

I have previously written about the mainstream 'getting it', in the follow on from the UK budget. However, the endless talk of 'green shoots' drowned out the cynicism. What we are once again seeing is the 'green shoots' of acceptance of reality. I suspect that this time the momentum, and the withering of the green shoots of recovery, will carry the acceptance of reality further forwards into the mainstream.

I have just completed an article for Huliq and a further article of Trade and Forfaiting Review (both submitted today for publication, so not yet available). The two articles take very different approaches, but both emphasise that something profound has taken place in the world economy. That profound change has been the theme of this blog.

Whilst it is positive to see that the mainstream are now finally accepting that the situation, and the responses of government, are leading towards disaster, the problem remains that they are still fixated on the wrong explanations for the economic crisis. In particular, they still actually believe that the financial crisis caused the economic crisis, rather than seeing that an underlying economic crisis caused the financial crisis.

This is a matter of ongoing concern. Without an accurate understanding of what went wrong, of the underlying causation, a recognition of the severity of the situation will still not necessarily lead to solutions that might resolve the crisis. In particular, there is a need to recognise that the entry of China and India into the world economy has seen the world labour force double, and that such an input of new labour (one of the key inputs of economic activity) is at the heart of the crisis. As I have explained elsewhere in this blog (e.g. my most recent discussion can be found here, or an earlier discussion here), this has created an era of hyper-competition, and the traditionally wealthy countries have yet to adapt to this situation.

As such, whilst it is encouraging to see that there is a greater acceptance of reality, there is still a risk of continuing to pursue solutions that fail to address the underlying problems. In particular, the only long term solution is to adapt the economies of countries like the UK and US to meet the challenges of hyper-competition. The only way that might be achieved is through deep structural reform of the economies. As Buiter recognises in his article, there will be strong resistance to such reforms, but without such reforms there can be no eventual recovery.

In short, the recognition of the depth of the crisis is a start, but there is still a long way to go before we might start to see solutions that might make a real difference. My worry is that it will take the full severity of the crisis arriving before the world finally addresses such solutions. I further worry that, at that time, it will be too late.....


  1. An interesting article in the Telegraph can be found here:

    "The more worrying prospect is that the bond market has lost faith in the British and American governments' ability to pay the tab. If investors do not believe that the political will exists to reverse today's extreme policies in a timely and decisive manner inflation could surge long before recovery has taken hold and bond yields could soon be at levels where they could do real damage to both the economy and shares."

    It is finally sinking in. I link to an article in July 2008 in the post. This is a quote:

    "It is like a household that has been borrowing to pay back previous borrowing. The household has been based in a good neighbourhood, and the household has continued to enjoy holidays, new cars, and all the luxuries of modern life. All this has been paid for with every increasing borrowing. Every month, more borrowing to pay back previous borrowing. Every month, the burden of debt has risen, but still the spending remains the same. Finally, the lenders will look at the household and notice that the amount of borrowing is creating a need for repayments that is exceeding earnings after expenditure. Do they throw good money after bad? The answer is, of course, 'no'. At some point they know that they must cut their losses."

  2. A quick note: Sorry for no responses to the later comments on the last post but, as you may have noted, I have just completed this post and two other articles for external publication. As such, I hope I will be forgiven this neglect, which is simply due to lack of time.

  3. Very good.

    However it still baffles me that you believe "the underlying economic system is fine" (paraphrased from an earlier post) alongside the hyper-competition of the markets which is creating hundreds of million if not billions of new economic "losers". How much hyper competition would it take for you to accept there underlying system no longer works?

  4. Hi CE, greatly enjoying the blog.

    My question is about the big issue that, even assuming Western leaders/intellectuals/media open their eyes to the structural impossibility of our economies, what broad steps need to be taken to restore sustainability and make the "traditionally wealthy countries" adapt to the new reality?

    Just thinking spontaneously -

    1) an end to 'consumer capitalism' and living beyond your means

    2) end the mirage of the useless service economy and reassign labour to necessary sectors (agriculture, manufacturing?)

    3) lower excessive regulatory demands on manufacturing in order to be globally competitive? (N.B. if this is even possible without bloodshed?)

    4) promote self-sufficiency and enterprise like that which you have praised in the Chinese worker

    5) make the nation-state more efficient and limit its task to mitigating the suffering of those who need it, rather than over-interfering with everything?

    6) address the Western demographic time bomb caused by a system which requires constant growth in order to maintain government spending, pensions, stock markets etc. but with a dwindling population?

    Anything else?

  5. Many thanks CE and you are entirely forgiven on the lack of replies!!

    It does feel an increasingly odd time at the moment. Who knows when things will finally come to a head.

    Another thing I'd value your and other people's comments would be the campaign for complete tas reform to a tax based on land most pushed by people like Michael Hudson

    and Fred Harrison

    As I understand it, its advocates argue it would be a much fairer tax, removing income and other tax entirely therefore making employment more cheap and attractive and lessening the danger of asset booms.

    Clearly those in power in society utterly hate it so it's political dynamite but with the way things are heading I think lots more options might be on the table.

    I'm skirting around it at the moment but would be interested in people's thoughts.

  6. Cynicus,

    It all reminds me of this quote:

    "All truth passes through three stages. First, it is ridiculed. Second, it is violently opposed. Third, it is accepted as being self-evident."
    - Arthur Schopenhauer

    Luckily we have trailblazers like you to make the whole journey a little easier.


    PS, Thank you for your comment on my latest post (it's always like a visit from Blogging Royalty!). I will reply when time allows.

  7. Interesting article on Latvia

    If it no longer can fund itself through bond auctions, could a default cause other European states to crumble?

  8. The Western economies will close their eyes and ears to such obvious truths for as long as they feasibly can. For the solutions are not electorally acceptable. Would you vote for a politician promising higher taxes, lower public spending and lower standards of living? For a politician telling the truth - that we have had 50+ years of living on other peoples money, which has finally run out, and that we have to live on what we can earn instead?

    The only way the necessary reforms to the Western way of life will take place is when they are forced upon the populace by events. When the bond market eventually refuses point blank to lend any more money to overly indebted nations. When the currency drops to a fraction of its old value. When a country can no longer afford to buy food and goods from abroad, and shortages are widespread. When the govt runs out of cash to pay its client state.

    Which is why this whole situation will end in tears. There will be no managed plan to wean the nation from debt, to reduce the amount of GDP taken and spent by the govt, to rebalance the economy away from consumption to saving and investment in productive assets. There will instead be a blank refusal to face the facts until the Barbarians are at the gate, at which point it will be every man for himself.

    Adam Smith said 'There is a lot of ruin in a nation' - we may postpone the day of reckoning for decades, it may come this year or next. But be assured, it will come.

  9. The economic crisis stems from the fact that even governments cannot borrow year after year indefinately without the same bankrupt consequences of any individual. The only difference is that because they print money this bankruptcy occurs through hyperinflation that will not even pay off their current deficits due to their never ending spending commitments.

  10. A note of congratulations for Steve Tierney, one of the regular commentators on the blog, who has won a seat in the Cambridgeshire elections, with nearly 50% of the vote.

    This blog does not affiliate with any political party, but I am nevertheless pleased on a personal basis to see Steve elected. I would imagine that other regular readers, regardless of political affiliations, would feel the same.

    Congratulations, Steve!

  11. Thanks CE. My win wasn't 'nearly 50%, it was 53% (a small, but significant, difference.)

    I'm pretty excited and very tired. I'll be reading, commenting and blogging again soon.

    But first I need some drinks and then a good long sleep.

    Great post, by the way. Even though I'm absolutely knackered, I still found time to read it. Wouldn't miss a CE post for the world.

  12. Steve,

    Though I have never voted Tory in my life (and probably never shall!), it's always encouraging when someone with both integrity and insight makes it in this system.

    So, congratulations!


  13. Rebuilding manufacturing in the US and the UK will only come about Through Industrial Policy

    In particular, the only long term solution is to adapt the economies of countries like the UK and US to meet the challenges of hyper-competition. The only way that might be achieved is through deep structural reform of the economies

    Does this mean adopting free trade and slashing government funding of R&D? If so, that will just make the disaster worse. The only serious solution is industrial policy and making multinationals shift their manufacturing back to the US and UK.

    A complete nationalisation of the banks is the first step to audit them and make them stop wasting tax payer money.

    The West should follow Sweden's model for fixing the banks:

  14. World Bank Economist: Deflation A Global Concern

    Deflation is a concern for the global economy, Justin Yifu Lin, World Bank chief economist and Vice-president said Thursday.

    "Of the two, deflation is a bigger concern," Yifu Lin told a news briefing in Warsaw when asked if he saw inflation or deflation as a greater concern.

    He said that low capacity utilization, running at 50%-60% in a number of large economies was an underlying reason.

    "When capacity is underutilized deflation becomes a risk"

  15. The Threat of Inflation

    This article points out that there was a sharper increase in the expansion of the US money supply at the end of early 1980s. Hyperinflation did not result.
    Also, the velocity of money has collapsed.

    Inflation From Money Creation Isn't A Problem

  16. Mark,

    Very good (as usual) piece. I'm watching the unfolding situation with great interest from the sidelines here in China. There does seem to be a "surge" in fake optimism (green shoots and so on), but if your analysis is correct, this will soon end in tears.

    @ Steve Tierney
    Congratulations on your electoral victory! I wish you all the best.

    @ Matt
    I see you have stumbled into the Great White Elephant which all economic schools are determined to ignore i.e. the "single-taxers". Their movement is still alive, but leading a kind of underground existence. Michael Hudson, in particular is a very interesting thinker. From a strictly rational perspective, I believe that truth is largely on the Georgist side. Their main weakness is not so much theoretical, as practical. Unlike other economic movements, they do not have any "natural" constituency which would allow them to exert influence in the real world. Neo-liberalism has the rich people on its side, the various socialistic movements have organised labour and class-conscious workers, social democracy has enlightened middle classes, the single-taxers have only common sense. This is not enough, especially since they also have deeply entrenched vested interests violently opposed to them.

  17. Neo-Keynesian Economists on Money Supply and Inflation

    I have recently read a fascinating alternative theory of money supply and inflation.
    It takes a Post-Keynesian view of how money is created and follows the "Endogenous" theory of the money supply.

  18. Well done Steve!

    Best wishes to you, your constituency and Britain overall. I hope you can prove me wrong and show that the framework of party politics will allow you to keep and use the many excellent personal qualities you obviously have.



  19. smash the systemJune 6, 2009 at 3:46 AM

    Tiberius said:
    "Though I have never voted Tory in my life (and probably never shall!), it's always encouraging when someone with both integrity and insight makes it in this system."

    What good is that if the whole system itself is corrupt? And the fact he's stood for the tories indicates a serious lack of integrity and insight as far as I'm concerned.

    The herd will have to learn everything the hard way.

  20. @ Matt
    Oh, I forgot to mention that some forms of a land-tax have been tried in various places in S.E. Asia. As far as I can remember, the govmnt. of Hong Kong raises about 40% of its revenue from land taxation (and has done so for several decades). Also in the PRC, there is no private land ownership, and a large percentage of state revenue is generated through land rent. I suspect that the light tax burden here is attributable to this fact. So not only does the idea seem sound, but actually appears to work in practice. Unfortunately this form of taxation would hit very powerful interest groups (most of the wealth of Western states is in real estate, not factories etc.) and it does not seem possible to overcome this (hence the almost total silence about the entire concept).

    @Lord Keynes
    Steve Keen's web site, recommended by you, is very interesting, and I would recommend it also to anyone interested in heterodox trends in economic thought. He is an Australian academic economist, who has been opposed to the neoliberal orthodoxy since the '70s, and has many fascinating perspectives on the subject.

  21. @Matt

    re "Land reform, Land Value Tax"

    Are excellent ideas - but, as you allude, also revolutionary ones that will be strongly (violently?) opposed by the vested interests. They don't even want us to know who owns the land let alone show a willingness to start paying tax on it.

    I would strongly recommend Kevin Cahill's Who Owns Britain. and reading the excellent Amazon review by William Podmore which contains this:

    "Landowners' wealth is a parasite on Britain, the least productive part of the economy, with the most state support. Their wealth comes not from farming, nor even from renting, but from trickling land onto the urban housing market. They sell land to property developers, at an average price per acre of £404,000 in 1999. The clearing banks and building societies strip our industries of investment capital, then support their clients the landowners by running the rigged and overpriced land market.

    Britain needs land reform. "Windfall gains on development land should be made subject to windfall taxes." We should also tax land and stop the owners avoiding tax through offshore trusts; this could raise £17 billion. The European Convention of Human Rights says there should be no confiscation without compensation. Haven't landowners had enough compensation already? We need more land for housing. This would cut land prices, free more to invest in good quality, spacious homes and gardens, and revive the building industry."

    The book was written in 2002 so some of the figures will be out by now, but the grassroots inequality remains.

    @smash the system

    re "What good is that if the whole system itself is corrupt?"

    By that logic, one could aruge that there is no point in a journalist with any intergrity trying to get work for our mainstream media. I would agree that it is difficult for such people, but that our situation would be far worse should they not even try and sometimes succeed (though, of course, be willing to make compromises along the way).

    re "And the fact he's stood for the tories indicates a serious lack of integrity and insight as far as I'm concerned."

    I think you make a fundamental error in believing that anyone who does not think as you do lacks integrity.

    Personally, I disagree with almost everything New Labour stands for, but I would never accuse someone like, say, Diane Abbot MP (who often opposes the party-line, was vocally against the war, and has yet to be caught up in the expenses scandal) to be lacking 'integrity'.

    If you want to remain ideologically-pure in your ivory tower, that is fine too : but as Chomsky says on the matter of opposing all State structures, "that is just to divorce yourelf from any human concern, in my view. And I don't think that's a reasonable stance for anarchists or anyone to take".

    All that being said, I am always pleased to talk to people who hold to a more revolutionary line than I do, and would be genunienly interested in your feedback on my lastest post.

  22. Nice bit of "Graph porn" here showing the differences between the Great Depression and the present crisis in the world as a whole.

    The "Green Shoots" appear to be rather thorny.

  23. @ Tiberius and Matt in Shanghai

    Thanks for the comments. Yes, it is fascinating and I was waiting to hear some objections.

    The fact those objections reflect political reality rather than economics is hardly surprising, even if familiarly depressing!

    Still, I am trying to remain optimistic that, with everything like to happen over the next 10 years, different solutions will have to be found (even if that means more than persuading those vested interests to give up power)

  24. @Matt

    re "Still, I am trying to remain optimistic that, with everything like to happen over the next 10 years, different solutions will have to be found (even if that means more than persuading those vested interests to give up power)"

    Keep your faith in God, but keep your powder dry!

  25. Hi Cynicus,

    thank you for taking the time to write such an interesting blog.

    I have a question if I may.

    Having watched the Zeitgeist movie I understand the idea of fractional reserve that you put forward.
    My question however refers to where the money comes from in the first place.
    According to the film, the money printed by the Federal Reserve in the U.S, is obtained by exchanging government bonds. Once these are exchanged the Fed then give the government the monetary equivalent, I understand that this is a loan which also incurrs interest. Meaning of course that all 'original' money is concieved in debt. Also from the film my understanding is that the Fed Reserve is in fact a privately owned bank.

    Sorry bit long winded but I can't seem to find any information as to how the system works in the UK.
    Who actually owns the Bank of England?
    Does it exchange government bonds for a loan with interest or is there a straight exchange?
    Also I wonder if you know anything about The Bank of England Nominees Ltd and what the purpose of this is.

    I would very much appreciate it if you could break down the process.

    my best wishes,



You are more than welcome to comment on the posts, but please try to stay on topic....I will publish all comments, excepting spam and bad language, and my moderation of the comments is just to exclude these.

Please allow up to two days for the comment to appear.

I have had a request for an email address for the site and have created the following:


I have ommitted the @ symbol to avoid spam....

For general purposes I would suggest using the comment form, but will occasionally look at this email account. Please be clear what is for publication and what is not, though I will also not guarantee publishing of email comments, unlike the comments through the form! Thanks.