Friday, August 5, 2011

Round 2?

The underlying and fundamental problems in the world economy are once again bubbling into view, and the headlines are filled with panic. Stock markets have fallen around the world, and it might be that the slide will continue on Monday. Or perhaps not. I am not sure whether this is the start of the final act of the economic crisis at this stage, but it certainly has the potential to be so. In particular, there is a growing sense that the so-called recovery is nothing more than an illusion. There is a growing sense that the central banks and politicians cannot fix the problems, and have not fixed the problems. There is growing sense that the macro economists do not know what they are doing. In other words, there is a growing loss of confidence in those who think that they control the economy.

Somewhat predictably, Krugman takes a partisan stand, and calls for more government intervention. According to Krugman, government can just make new jobs, and all will be well:

Well, it’s time for all that to stop. Those plunging interest rates and stock prices say that the markets aren’t worried about either U.S. solvency or inflation. They’re worried about U.S. lack of growth. And they’re right, even if on Wednesday the White House press secretary chose, inexplicably, to declare that there’s no threat of a double-dip recession.

Earlier this week, the word was that the Obama administration would “pivot” to jobs now that the debt ceiling has been raised. But what that pivot would mean, as far as I can tell, was proposing some minor measures that would be more symbolic than substantive. And, at this point, that kind of proposal would just make President Obama look ridiculous.

The point is that it’s now time — long past time — to get serious about the real crisis the economy faces. The Fed needs to stop making excuses, while the president needs to come up with real job-creation proposals. And if Republicans block those proposals, he needs to make a Harry Truman-style campaign against the do-nothing G.O.P.

As is usual with Krugman, it is the evil republicans blocking more spending and, if only money was spent on job creation, the economy would grow. More government action is the solution, not the problem. Similar arguments are appearing from less heavyweight commentators, for example Polly Toynbee in the Guardian:

Faced with a new crisis, it stretches credibility to imagine Osborne invoking the spirit of Roosevelt's New Deal, but that's what's needed, with a job guarantee for every young person. That investment would be every bit as cashable for the future as roads or railways, since the great social debt now accumulating will be more burdensome for future generations than mere financial debt. No one is counting the social deficit, the costly damage done to this generation of young people, though the evidence shows that a workless youth does life-long harm, some never finding their feet again, becoming the workless parents of the next generation.

Today's Guardian editorial suggests that:

But even in the US and the UK, governments have all but removed their stimulus policies – with the result that both economies are now stuttering. The result may look like a financial crisis; but it is really a failure of government.

Apparently, the crisis is due to a lack of stimuli. However, in both the UK and the US, governments are continuing to borrow and spend at a shocking rate. Even if it were true that the US debt deal were really going to deal with the monstrous deficit (which it will not), this has had no impact yet. However, even the prospect of some fiscal tightening is being blamed for a new crisis. If this is the start of the final act, the actuality of ongoing massive spending and borrowing will be forgotten by the economics profession, and the economic crisis will be turned into a narrative of simultaneous tightening causing an economic crisis. The mantra will be, 'if only the governments had not simultaneously undertaken austerity measures....'

However, even Krugman has got something right:

It’s not just that the threat of a double-dip recession has become very real. It’s now impossible to deny the obvious, which is that we are not now and have never been on the road to recovery.

For two years, officials at the Federal Reserve, international organizations and, sad to say, within the Obama administration have insisted that the economy was on the mend. Every setback was attributed to temporary factors — It’s the Greeks! It’s the tsunami! — that would soon fade away. And the focus of policy turned from jobs and growth to the supposedly urgent issue of deficit reduction.

Regular readers of this blog will already know that there has never been any kind of real recovery, just lots of chatter - lots of optimism that is continually dashed with reality. All the policy and chatter did was to paper over the cracks, whilst the problems of the foundations saw the cracks widening even as new paper was being added to hide the consequences. In the mainstream media, it is becoming apparent that some commentators are starting to realise that there is a real very fundamental problem. This from a Telegraph editorial:

It is equally vital, as the pressures grow, that the world stays true to the free market principles which have been the cornerstones of post-war prosperity. The crisis of the last four years is not the fault of free markets as such, but of the way they have been distorted and corrupted by public policy and the unchecked excesses of finance.

In the search for the underlying causes of today’s rolling series of debt crises, it is hard to ignore the extreme trade and financial imbalances which have grown between countries, fed both by the mercantilism of China’s dash for growth and the absurdities of the single currency. The resulting build‑up of external indebtedness among deficit nations is now tearing the world economy apart.

Yet the pretence continues that somehow or other, we can just carry on as we are. Political leaders must find the courage to tell the truth about the fix we are in, and the painful choices that must be made to deliver a sustainable future.

They are groping towards the reality that has been the theme of this blog. They have still not fully grasped the nature of the change in the world economy; that the joining of China and India and other (so-called) emerging economies into the world economy had dropped a massive pool of new labour into world markets. The resulting hyper-competition is driving the current crisis, and the response of much of the Western world is denial of this reality and the consequences and impacts of this massive economic shift.

The answer of the Krugmans of the world is for greater government borrowing, printing more money. How these will address the problem of hyper-competition is never discussed, because the actuality of the hyper-competition is never acknowledged. They think that the massive disruption of the massive input of new labour into world markets is not the cause of this crisis, but rather it is a financial crisis caused by irresponsible banks. It is impossible to deny that the banks played a role, but as I have argued elsewhere, the banking crisis was a symptom of an underlying cause:

The summary of the situation is that the emerging economies lent their new found wealth from their increasingly large workforce into the West, and in doing so allowed the emergence of the so called 'service economy', or 'post-industrial economy'. The lending was built on an unfounded belief that, because the West had been economically dominant for so long, it would always be in a position to pay back the lending. The problem with the lending was that there were no productive wealth creating opportunities to soak up the money, (e.g. investment in manufacturing was being directed towards the emerging economies themselves) such that the money pouring into countries like the UK and US was directed into asset price inflation (real estate), consumption and consumer credit, and excessive government borrowing.

In the post, I argue that the world economy was being constrained by the limits of resources. With emerging economies soaking up huge amount of resources for infrastructure, and with supply constraints on commodities such as oil, the world economy was sharing a limited supply of resources over an ever increasing number of workers. In an earlier post, I presented an analogy. I described commodities as a moving brick wall to growth, with the world economy running behind this wall of constraint. As the economy runs forwards, it hits the wall and tumbles backwards. The world economy then gets back on its feet, and once again runs towards the wall only to eventually bounce back again. Below is a chart of oil production and consumption from the Economist and a chart of oil prices that tells the story.

China alone has increased oil consumption by over 4m barrels per day in the last decade. It is a picture of the brick wall. Note the upwards spike in 2007, and the upwards spike leading up to the current crisis. I have to emphasise, that other commodities have seen greater increases in output, but that the infrastructure demands of the emerging economies is a countervailing force, such that prices are reflecting the high demand.

The worrying part is that economies such as China are still going through the process of integration of their labour into the world economy. The process is not yet complete, and the problem is that the bounce backs will therefore continue, and the competition will become even more intense. For example, China is engaged in a process of seeking surety of supply of key resources around the world. This is a chart from Foreign Policy, representing 2005-9:

It is a trend that has been accelerating. Somebody in China seems to know the nature of the game that is being played out in the world economy. The Chinese development of a blue water navy also tells the story. In the end, economics is about recovery of resources and application of labour to add value to resources. With constraints on the volume of resources and massive increases in the volume of labour, this must lead to hyper-competition. It is really not that complex.

When thinking of the Krugmans of the world, we see no discussion of this simple idea. If you increase the workforce by 10% but only increase the resource by 5% then something is going to happen to the distribution of resources. Government spending on 'creating' jobs, or money printing, they claim can make a difference, but it does not address the underlying and substantive problem. More government action is the solution proposed.

Another problem with the commentary I am reading is the belief that this is a crisis of capitalism. Today's Guardian has a picture of an evil capitalist monster, and it is a view that is gaining currency. However, the real reason for this crisis is not capitalism, but the actions of communist and socialist governments before they started the process of opening their economies. They created barriers to the integration of their labour force into the productive and enriching capitalist world economy, and then suddenly started 'dropping' the labour into the world economy at a rate that the capitalist system could not absorb. It is why we see the increasing divide in incomes between the rich and the rest. It is not the evils of capitalism, but rather the last terrible contribution of years of rejection of capitalism in countries like China and India. They created a flood of new labour into the world economy, and the result is that labour has been devalued.

What we have in so much commentary is policy that is blind to the causes of this crisis, and solutions which replicate in varying degrees the fundamental causes of the problems; government constraints and interference with free market capitalism. Whatever anyone does, short of cutting of the supply of new labour, the situation cannot go back to the old 'normal'. The only way to deal with the crisis is to accept and embrace the hyper-competition, and that means addressing the structure of economies. When competition was less fierce, it was possible to have many luxuries in economic structures; for example, cradle to grave welfare or expending resources on any number of unproductive activities. The question that needs to asked is what can each economy really afford based upon their real productivity (i.e. not borrowed money). What are the real priorities within the constraints of the actual competitive position of the economy? Each economy must address this question, and address the question reflecting upon the hyper-competition that now characterises the world economy, and their relative strengths and weaknesses.

I do not know if this is the start of the final phase of the economic crisis; the moment when the reality that borrowing and spending and printing money are part of the problem not the solution. I hope that this is the moment, as the longer the denial of reality continues, the worse the problem will get. The crisis should have taken place a long time ago but, against my expectations, governments and central banks have buried the problem for longer than I ever thought was possible. Perhaps they have some last measures that they might yet deploy to 'save' the situation (but which will just create an even bigger problem in the future)? At this stage, I do not know, but we will see how events develop over the coming months.


  1. As somenone who was born and lived for 30 years in a former communist country in eastern europe I can say with certainty that there was no difference between communism and capitalism as for underlying economic principles.Both were market economy systems.What communists did overnight in a straight way, the capitalists took decades in a roundabout way.That is centralizing capital in few hands and exploiting the labour.This was the reason for the divide between the rich(ruling party) and the poor(classless society) in former communist bloc.And now we see it in the west(just different names) between the capital holders(ceos,politicians,bankers etc) and the labourers.Same divide is growing in the west regardless what socioeconomic system they have.
    I agree principles of economics are simple, it is only interplay between 3 factors of production-people,earth,knowledge.While third world before integration lacked the third factor(knowledge),Russian and American blocs did not.Hence there was so much ideological competition between the two, both applying these 3 factors to their advantage.Both relatively isolated systems from each other and both having ample resources(earth) in relation to their labour(people) and both on relatively level playing field as for people/earth/knowledge.
    With the onslaught of the global economy thanks to new technologies,the situation has changed in the way that there are unlimited labour resources and limited earth to service them.Ironically both Russian and American blocs rushed to the Third world to provide the massive labour with knowledge so they could enjoy the same standard of living not thinking of dangerous consequences for both blocs.Since the global economy means that earth resources flow where more people are or to use economic terms where huge markets are,more powerful become those parts of the world with the 'virtue' of bigger labour .Western knowledge which empowers them rides on the vehicle of free market economy system towards them.
    Now with this global scenario how can one with no vested interests be in favor of freemarket economy system , when this is the system which created the hypercompetition.We can still in the West enjoy welfare economies and high living standards, the only way is to change the very economic system from free market system to utility economy system.We will not have to compete with the rest at all simply by guarding the earth resources and sealing the knowledge which is the only artery through which the blood of capital and earth resources escape from the West.The only obstacle is the stubborness of those who hate the brick wall of limited labour resource of the West.

  2. I feel it is worth stressing that money and wealth are not the same thing. Wealth is the stuff that makes life comfortable - in the UK we are wealthy compared to Botwana because we have clean water, houses, food, heating, entertainment, means of travel, medicines and all the other things that make life more comfortable. Having more cash does not deliver more wealth unless it can be converted into more wealth. Merely adding more cash to the system has no real effect other than to dilute the value of the cash we have already, it does not, of itself, create greater comfort.

    It is for this reason, I believe, that the Krugmans and Toynbees are mistaken - underlying their analysis is the assumption that greater turnover means greater wealth, an assumption easily made these days when increased GDP is the Holy Grail.

    A job for every school leaver is something all right thinking people want to see but it cannot be an end in itself. We have to ask what they will do and whether it will increase or dilute wealth. If the latter, it will do more harm than good - the classic example is a team of thousands employed on an eight hour morning shift to find places to dig holes, a second team spending an eight hour afternoon shift digging them and an eight hour night shift team filling them in again. The day is filled with people being paid and being busy, but nothing substantive is achieved. Borrow the money to pay them and the whole economy faces a loss of wealth through having to forfeit the interest on the loan. GDP goes up but wealth goes down.

    For many years the UK has been enjoying a level of comfort significantly above what it an afford. Not surprisingly, politicians are too scared of the electoral consequences of policies designed to correct the problem.

  3. There is no recovery because there was never meant to be a recovery. Period. Green shoots couldn't be peddled any more, let's try fragile recovery, that might do it.

    Our civilisation is going back to the future, to a sustainable future, to a progressive redistributive future, to a communitarian (big society) future, to a global future.

    We're all in this together, shared values and all that.

    The media are in on it up to their necks, wheel on Hugh Pym, wheel on Stephanie Flanders, Robert Peston, uncle Tom Cobley and all.

    Their convoluted spin is never challenged and they get away with it every time. (LOL) Beam me up Scottie.

    Spin, good news/bad news, the numbers are up but the underlying trend is down. If you can make head or tail of anything they conclude, then please let me know how you do it.

    House prices are up, house prices are down. Economic bad news is eclipsed by polar bear.

    Unemployment is down but job seeker applications are up.

    Are there still riots on the streets of Greece? If there are, I don't see them on TV anymore.

    How can you get growth when austerity is the watchword (LOL)

    Europe's sovereign nations are being taken down along with America.

    America is heading off a cliff.

    Global problems need global solutions. The EU problem is the sovereign state, they can't agree, we must have closer fiscal co-operation, we're all in this together.

    Why can't they just keep printing money or adding noughts on the computer screen, like they already have.

    Did you mention inflation?

    Cynicus, what in your opinion is the endgame going to look like?

    What is your vision of the climax of this global economic crisis?

    Some say, New World Order. Order out of chaos. A totalitarian world where the surfs below are the slaves of the elite above.

    I'll be back.

  4. This once excellent blog once described reality, now it pedals worthless ideology.

    Blaming communism for the global oversupply of labour is idiotic. Is India a communist country?

    Did communism force the West to take on delusional levels of debt?

    Is communism preventing global leaders, across the political spectrum from, grasping reality and acting intelligently?

    You might as well blame Islam or the Catholic Church.

    If the labour had been more smoothly integrated, the final result would have been the same, a huge oversupply of labour and the super-concentration of wealth.

    The right blames the left ... Zzzzz
    The left blames the right ... Zzzzz
    The Telegraph is wrong/right ... Zzzzz
    The Guardian is wrong/right ... Zzzzz

  5. There is no just way out of the present mess.

  6. "Perhaps they have some last measures that they might yet deploy to 'save' the situation (but which will just create an even bigger problem in the future)? At this stage, I do not know, but we will see how events develop over the coming months."

    Hi CE

    It's funny, but a couple of years ago when you were suggesting that the dollar might collapse within weeks, my gut feeling was that it wouldn't just yet, and even the legendary 'Lehmans' Moment' didn't feel like the end of the world to me - not that I had any real knowledge to base those judgements on! But then, I always thought that the exact timing would be a minor detail in the scheme of things.

    This time, however, to my mind's woolly grasp of things it feels as though we really are reaching the end of the road. Every day brings some new scheme for bailing someone out, and it incrementally distances us from any semblance of the free market. I'm not convinced that free market capitalism ever was 'the answer' because I don't think that perpetual growth is what we should be pursuing - who decided it should be? - but I can see it has a ruthless (theoretical) logic to it, and the idea of feedback and self correction is a strong one. But now we have neither central control (which also has a logic to it), nor the discipline of the free market. As you say, it is hard to see where any future growth might come from, even if we somehow sorted out the immediate mess.

    So is there a free market capitalistic system that could work without growth? Or is the only answer some sort of central global government?

  7. A Real Black PersonAugust 20, 2011 at 10:01 PM

    "Global problems need global solutions. The EU problem is the sovereign state, they can't agree, we must have closer fiscal co-operation, we're all in this together."
    The problem is the global perspective. The interdependency is what is causing the problems. The solution to complexity cannot be more complexity because it's not sustainable. The human mind's ability to navigate social complexity is limited, especially if it involves a lot of anonymous people ( people you don't know. In a large global system, there is more opportunity for people do be dishonest since there are more strangers interacting with another.
    Since there's a greater level of competition occuring at a global scale, the chance of fraud occuring must be higher than a smaller scale of human organization. I'm going to give you a thumbs down on "global solutions." and suggest instead that we need "local solutions to global problems."


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