Friday, April 27, 2012

Positives and Gloom

Please accept my apologies for the long time since my last post. As ever, the choice of subjects for discussion is overwhelming. As such, I thought I would write briefly on several subjects.

Richard Duncan's Presentation

A commentator recently left a link to a talk by Richard Duncan, and it proved to be very interesting. I strongly recommend it, and this section will only make sense if you have watched it (start at the 10 minute mark to save watching a dull introduction). The most interesting point about the talk is the dispassionate approach to the current and future situation. He simply accepts that, in a few years time, the world economy will have a horrendous crash, that states are now fully in the driving seat of the world economy, and most importantly that investment choices should now be based upon state action rather than market drivers. In simplistic terms, whenever a government prints money, his answer is buy, buy, buy!

The talk has been weighing on my mind since I saw it. I am not sure about his timescales, but much of his analysis is very good. However, what has been weighing on my mind is his call to enjoy the investment opportunities in the lead up to the big crash, alongside his advice on how to not lose everything when the crash comes. Put another way, you can make pots of money now, and later on you can hold on to a large proportion of what you made, and protect yourself from the various and different terrible potential outcomes that will follow from state action. It is a hard and cynical approach. The reason it has weighed on my mind is that I wonder if what he is saying explicitly is what many others in the financial industry believe. Certainly, there are many analysts in the financial industry who have expressed concern with state policy, but there is a strong incentive for the financial services industry to play along with the current 'game', with individuals ensuring that they are buffered against the eventual crash. As long as they get the timing correct, they can play the markets based upon state action, and can still come out at the end significantly richer (albeit they will lose some proportion of their gains).

In short, the longer that states continue their current policy, the greater the damage in the future. However, fFor those who understand the nature of the game, the longer the game continues, the more time they have to secure wealth to insulate against the inevitable crash. It is a worrying thought, as the financial industry has an out-sized influence on government policy.

A Positive Note

Longstanding readers of the blog will know my thesis that one of the factors underlying the economic crisis was the growth in the world labour force in relation to a lack of commensurate growth in the supply of commodities (see here for a fuller explanation). This, I argued, led to an emergence of what I termed as 'hyper-competion' for the limited supply of resources.

One of the examples I have used to highlight the problem was the lack of sufficient growth in the supply of oil during the entry into the world of the (then) emerging economies such as China. For a while now, I have been reading about and watching the results of the shale gas revolution. The US has embraced this new source of energy and it has resulted in an astonishing drop in natural gas prices, as shale gas extraction has increased. Although it is not a substitute for oil, it does provide a source of cheap and plentiful energy, and this increase in the input of energy into the world economy is a major positive. However, there is a lot of 'politics' surrounding the process of extracting the shale gas, and this means that it has yet to be exploited everywhere. If the political questions can be resolved, shale gas has the potential to make a major positive impact on the world economy by increasing the supply of energy into the world market. I would not go as far as saying that it will resolve all the problems of energy, but it certainly ameliorates the problems.

Another problem I identified was that, even though some commodities did increase significantly during the period of 'economic emergence', one of the problems was that the emerging economies (and in particular China) growth was infrastructure intensive. Building of new highways, factories, rail lines, cities and so forth, all created a massive demand for basic commodities requiring a larger increase in supply than actually took place. In the case of China, many analysts have noted that the infrastructure heavy growth of China may be coming to an end, or at least will slow down significantly (Richard Duncan discusses this in relation to industry if I recall correctly). The result of slowing infrastructure development should start to ease the pressure on the supply of many commodities, and this in turn may see some reduction in commodity prices. Much depends on government policy, in particular in China where the desire for social stability may see ongoing investment in infrastructure (whether needed or not) to maintain employment and social stability. However, if there is a reduction in intensity of infrastructure development, this is also good news for the world economy.

If demand for resources reduces, and supply of other resources such as energy, are now starting to move in a positive direction, the outlook for the world economy should (in principle) improve. The 'hyper-competition' should return towards 'competition' and that would be major a positive. The only problem with this idea is that, since the economic crisis became visible, states have now taken ever greater and ever more risky policy decisions. We are now saddled with the consequences of these decisions, and the interventions are ongoing and will create ever greater problems going forwards. As such, despite the possibility of the underlying causes of the crisis starting to be ameliorated, the actions of states in response to the crisis will have to be paid for regardless of these positive developments. In other words, what should be a bright outlook remains bleak, albeit slightly less bleak than before. 

How History will View the Economic Crisis.

In recent posts, I have discussed the criticism of so-called austerity. In particular, I have highlighted how ongoing borrowing is being used to support the repayment of previous government borrowing, creating an unsustainable cycle of needing to borrow ever more. The logic of those who argue for more and more state borrowing appears sound until you examine what they really mean. If you would like to grasp the problems, you may wish to look at the post here, and also take a look at the insightful comments at the end.

The reason I talk about how history will view the economic crisis is because the economists who are calling for ever more borrowing (Krugman comes to mind as an exemplar) will argue that the depression that is here/about to arrive (depending on your reading of the current situation), was the fault of 'austerity'. If only governments had borrowed and spent more......all would have been well. The interesting thing about this is that, if you read the analysis of the causes of the Great Depression, there is a similar retrospective analysis. This then guides economic analysis of the current situation, as the aim of the borrow and spend economists is to use policy to avoid another Great Depression. However, just as in the future the analysis of the borrow and spend economists will be wrong, so is much analysis of the Great Depression that now guides their policy advice. Nevertheless, these economists have influence, with Bernanke for example being a 'scholar' of the Great Depression.

If the analysis of the Great Depression is as wrong (and I would argue that it is) as some economic analysis of the current situation, then their policy advice commences on flawed foundations. Furthermore, the current situation is very, very different from the period of the lead up to the Great Depression, such that using it as a guide is in any case questionable. For example, the rapid entry of the emerging economies into the world economy is a quite unique event. This is not to say that nothing can be learned from this period, but it must be remembered that the circumstances today are very different. Overall, it is therefore worrying that much of the policy advice today is founded on analysis of the Great Depression, and that analysis of the Great Depression will one day determining the analysis of the current crisis, and the analysis of the current crisis will then be used to support the previous analysis of the Great Depression. I am not sure I am making my point as well as I might, but I hope that you get the gist of it.


  1. Some years ago I read a fascinating book called "The great reckoning" written by William Rees Mogg and David Davidson. Basically it foretells of the next global depression and links the Kontratief long wave cycle to what we are going through now. It's striking how accurate it has been so far.

  2. Steve Keen at INET:

    INET: Financial Instability Mini-Documentary

  3. Glad you found the Richard Duncan talk useful. I found it oddly haunting, and have watched it a couple of times.

    This is the first note of optimism I can recall seeing on CE, however it seems that the prospects for energy/economics are pretty dismal.

    Of the goldbugs I find Chris Martensen most convincing on Economics and Energy
    I found this 2011 talk very interesting;

    He gives a much more pessimistic view on Shale’s energy returns -- the amount of energy (in barrels of oil) to produce the equivalent of a barrel of oil. We started at 100 to 1 for the easy-to-get stuff in Saudi Arabia in the early 20th Century, but sources such as Shale /Deepwater horizon are closer 3 to 1, which are not an economically viable solution for the economy.

  4. You mention commodity shortages in your article, how far do you think these are also affected by resource shortages?

    See The limits to growth
    Global mineral reserves

    Obviously we will not run out of resources entirely but each tonne will cost more and more if reserves are becoming depleted.

    1. That's a really good point John. And whilst many talk about energy, read the 2011 Q2 commentary from Jeremy Grantham of GMO. He things it will be ag fertilizer shortages that is the greatest threat to civilization. A facinating read.


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