Thursday, June 25, 2009

Mervyn King Identifies the Problem, then Avoids the Solution...

Some of the readers may have seen a Telegraph article that summarises some of the key points from Mervyn King, the Bank of England Governor, from the May Inflation Report. His thinking is very much in accord with much of the mainstream in supporting the efforts of governments and central banks to support their economies. However, there are some contradictions in his points that suggest that he is having grave doubts about what is taking place. In effect he is trying to square a circle. I will quote at some length from his comments:
The scale of the deficit is truly extraordinary. 12.5pc of GDP is not something that anybody would have anticipated even a year or two ago and this reflects the scale of the global downturn. But it also reflects the fact that we came into this crisis with fiscal policy itself on a path that wasn't itself sustainable and a correction was needed.

The speed of which the fiscal stimulus should be withdrawn has to depend on the state of the eocnomy. There is no point in presenting a profile for the reduction of deficits that is independent of the state of the economy.

There will certainly need to be a plan for the lifetime of the next parliament, contingent on the state of the economy, to show how those deficits will be brought down if the economy recovers to reach levels of deficits below those which were shown in the budget figures.

In other words the deficit is very worryingly large, but it has to be endured, and action needs to be taken in the medium term to shrink the deficit. So far, so conventional. However, it is in his later discussion that the underlying contradiction becomes apparent:

To ensure a sustainable recovery and prevent a repetition of the crisis we must reform the international monetary system. The United Kingdom and other deficit countries will now be aiming at more sustainable levels of domestic demand.

If we look at the earlier comment and this comment, it is apparent that there is a contradiction in the argument. On the one hand the suggestion is that the fiscal stimulus is necessary, and on the other that there needs to be a change to 'more sustainable levels of domestic demand'. If we actually view the nature of the objectives of the stimuli, and the underlying reason for the government deficit spending, it is exactly the opposite of sustainable domestic demand.

From this document of the Treasury Select Committee in February, we can find the following quote from Mervyn King (key section highlighted):
I think this goes back to what I call the paradox of policy. I think it does not make sense to engage on a national campaign to raise savings rates in the very short run; we will need to do so once we get out of the crisis. In the short run we have to engage in measures to ensure that spending returns to more normal levels in order to prevent significant falls in output and rises in unemployment. Once we have got through that immediate problem, then the challenge will, indeed, be to raise the national savings rate, both public and private. [answer to question 5]
The question here is the question of what normal might be. Is it debt fuelled spending, which is unsustainable, or is it the reduced spending indicative of sustainability? It does not matter whether the deficit is originating in consumer spending or government spending, the current domestic demand is not sustainable. In both cases, the country is in aggregate consuming more than it produces, and this is not sustainable. Why delay the shift to sustainable demand? Why not make the shift now?

What we are seeing here is a recognition of the underlying problem, but a refusal to act to rectify the problem. It can not be put more simply than this. If we are consuming too much now, we surely need to stop. Now.

To use a metaphor, Mervyn King has diagnosed the illness, but does not have the courage to suggest taking the unpleasant medicine now. Instead, he is proposing letting the illness run on even longer, even though it will do even more damage to the body in the meantime. I just hope that he goes further, and actually has the courage to call a halt. He may actually be in a position to have the influence to actually achieve this.....

More on the Bond Smuggling

I have been keeping an eye on the bond smuggling story (see here and here), and have noted that absolutely nothing is being added to the story. There is still no official word from the US, other than stories repeating the comment that, from pictures seen on the Internet (???), an official suggested that they were fake. As yet, no official report on the authenticity of the bonds. Nothing has come out of Italy.

This story is surprising in the respect of the complete lack of any definitive information from official sources. Bearing in mind the level of speculation about the story, it would be reasonable to expect that some kind of official statement would be made.

I have also been thinking about the breaking of the story. I do not know how the Italian police operate, but usually, whenever there is a major 'bust' the police arrange a press conference. I can think of no larger bust than foiling a $134.5 billion counterfeiting plot. What I would normally expect from such a story is a crowded press room, the chief of police smiling at the press and introducing those who caught the criminals, followed by a sample bond (in a plastic bag) held aloft for the photographers. In short, the bust should have been presented as a triumph. The police are not normally so shy of promoting their success....instead, nothing....

In short, I keep coming back to this story as it is all very odd. I find the ongoing silence to be a continuation of the oddness. In particular, why nothing from the Italian authorities? The only explanation, and it is quite a reasonable explanation in principle, is that there is an ongoing investigation. However, how does that fit with the story of the smugglers being released?

I will continue to update you if there are any developments. However, if there are no developments, then I think that we might conclude that there really is more to this story than meets the eye. After all, why would there be such silence on the largest counterfeiting operation ever?


You may have noted that I have not been very responsive to comments of late. It is, unfortunately, one of those times when real life is rather busy, and I am therefore extremely short on time. I have also been trying to devote time to the fixed fiat currency idea, which is very long and complex, and have also been preparing a post on QE (hopefully to follow shortly). Apologies for this, and I hope that I will be able to devote more time after a week or so.


  1. Mervyn King no doubt believes that the threat of deflation was a worse problem last year and earlier this year.
    He himself published an article called "Debt deflation: Theory and evidence," European Economic Review vol. 38(3-4): 419-445.
    This follows the groundbreaking work of Irving Fischer (1933, "The debt-deflation theory of Great Depressions," Econometrica) which argued that unexpected and severe deflation from 1929 was a major factor contributing the depth of the Great Depresssion (also argued by Steve keen of Debtwatch).
    I would say that his fears were perfectly justified.

  2. I think Mr King is exhibiting two realisations at once.

    The first is a dreadful sinking feeling that he's stood by while disastrous economic mistakes have been made. His response is to try and position himself so that the future regards him more positively.

    The second is an appreciation of the way the political wind is blowing and a move to ingratiate himself with a possible incoming new administration.

    If I'm right about that then I think its a sad indictment on the quality of leadership at the Bank of England.

  3. China argues to replace US dollar..

  4. Everybody wants to go to heaven......but not just yet!

  5. Lord Keynes: I am a bit short of time, but a quick note to say that the deflation and QE questions will be considered in the next post.

  6. The New York Times on the bond smuggling:

  7. Off topic again, but could someone help me with this question:

    In recent years it has made economic sense to farm out jobs to far away places like India where the same work is done for, say, a fifth of the price it would cost in the UK or US. This has major impacts on the employment of people in the developed countries' economies.

    We hear that China pursues policies which keep its people poor and its currency at a low value. Does India do the same?

    If India is 'innocent' of this charge, what is it that accounts for such large disparities between wages for the same work? Why does the price for a particular job not quickly settle to a uniform level across the world?

    If we had a single global currency would (could) such large disparities still occur?

  8. Here is a very interesting article I found about the state of Interest state swaps - a form of derivate which has grown alarmingly in that last few years, dwarfing others in the same class, and how some banks have massive amounts of these derivatives, including HSBC and Goldman Sachs (which has 1056%! of exposure)

    From the article:
    ...while the total derivatives basket has grown at an astounding rate, from $33 trillion to over $200 trillion over the same period, it is the interest rate (specifically swaps but also futures and forwards) category that is the biggest culprit here: growing from $24.8 trillion to $164.4 trillion! This represents over 80% of the total underlying derivative notional currently in existence according to the OCC (and about 10x Obama's optimistic projections for U.S. GDP).

    Is GS Tempting The Interest Rate Black Swan With 1,056% Risk Exposure?

    Lefty Feep

  9. Lemming asked:
    "If we had a single global currency would (could) such large disparities still occur?"

    Your looking for an answer to a problem in which economics overlaps with biology.

    IQ and Global Inequality

  10. Lemming:

    the world is waking up to the fact that there are few good reasons for the discrepancy. A computer programmer in London might earn £35,000 pa while someone in an emerging market will do the same work for a tenth of that.

    Market forces mean that the wage pressure is of course downward which is a death knell for the Western way of life.

    CE has written at length about the oversupply of labour. Point is elaborated further here.

  11. Re: link for Lemming


    there's a pay-wall on the rge site. Article also available here:

  12. @Norman W

    I don't think the view of a hateful eugenicist like Richard Lynn will find much currency here.


  13. What is CE proposing when he says that we schould reduce consumption now.Should I eat once a day now instead of three times a day? Or travel less and stop bying stuff?By reducing our consumption we are not going to solve anything. The problem was created by outsourcing production not by our consumption. We were perfectly able to produce, and produce even more than we could ever consume without any technological help from outside the West. Untill clever leaders came up with a brilliant idea to expand production even more to make a little extra money from 3billion strong market, which was impossible without massive transfer of production capabilities and knowhow. With limited labour you can produce only so much. Massive production needs massive labour. So the process of globalization took off with its dire consequences for the West. Our farsighted leaders got us in this mess. The only way out is to bring back industries and meticulously guard all new technologies.

  14. Lord Sidcup and Norman W

    Thanks for the interesting links.

    I'm not sure whether I'm asking a stupid question or not.

    It occurs to me that if India suddenly discovered some gold, it wouldn't sell it at a bargain price to the 'developed world', and the 'developed world' wouldn't expect to pay less because it was merely 'Indian gold'.

    Individuals' labour seems to be different.

  15. "I don't think the view of a hateful eugenicist like Richard Lynn will find much currency here."

    A pompous remark. Get a fuzzy warm feeling of moral superiority when you write that tosh do you? Why is eugenics hateful? Would you prefer a dysgenic society where the feckless, criminal and stupid outbreed the intelligent and responsible? And is it just possible that Richard Lynn is right - IQ does differ between races and goes far to explain the varying economic success of the planet's peoples.

  16. @AgainsTTheWall

    "A pompous remark."

    Actually I think it's a fairly banal one

    "Get a fuzzy warm feeling of moral superiority when you write that tosh do you?"

    Hardly. If there was any 'moral superiority' implied, I clearly gave the benefit of it to the rest of the commentators on here. Obviously I overlooked the self-described "ethno-nationalist" in that assessment.

    "Why is eugenics hateful?"

    I didn't say it was. I suggest you reread the sentence.

    Eugenics is just an idea - an idea which is is utter, utter garbage, and which fails under even the simplest amount of intellectual scrutiny- but an idea nonetheless. However it is also one that is used ideologically to try and offer a veneer of scientific respectability to the views of hateful people (essentially 'fearful' people) who, in the final analysis, are simply racists looking for intellectually cover for their racism.

    "Would you prefer a dysgenic society where the feckless, criminal and stupid outbreed the intelligent and responsible?"

    Prefer it to what? A society where people like you decide who gets to live and breed? Fuck yes!

    "And is it just possible that Richard Lynn is right - IQ does differ between races and goes far to explain the varying economic success of the planet's people."

    It's possible - but almost certainly in the opposite way to what which you imply.

    Tribal peoples lack what you would call 'economic success' but perform significantly better on (less culturally skewed) versions of IQ tests because their environments are more dangerous (and therefore more highly selective). You think your more 'intelligent' than a Kalahiri bushmen? I suggest you go spend a month living with them - let's see how your internet-smarts hold up.

    To be logically consistent, Lynn and his disciples should be promoting the dissolution of Western society in favour of nomadic cultures, but (quel surprise!) they instead adopt a barometer of IQ that is contigent on 'economic success' and so favours the "White man" at this snapshot of history (and lets just overlook that the Chinese, Middle Eastern and Meso-American cultures have all had advanced civilizations while we were living in mud huts shall we?).

    As Matt succinctly put it the last time you decided to share your views on this blog: "We all started in Africa mate. Get over it."


    PS, Given your difficulty understanding basic statements and your propensity for oversimplistic explanations, might I suggest that your own 'intelligence' isn't quite what it could be; are you therefore going to consider sterilising yourself?


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.