The latest economic news from the UK and the US is hardly inspiring. Further, detailed examination of the sectoral balances in the OECD nations reveals a massive drop in private demand since 2007. The mirror image of that spending collapse has been the increase in public deficits via the automatic stabilisers (discretionary stimulus packages aside). These swings are just signs that economies are adjusting back to more normal relations (private saving, public deficits). The sharpness of the swings reflects the atypical period that preceded the crisis where growth was fuelled by private debt in the face of fiscal contraction. It will take some years for the adjustment to be completed and the danger is that ideological attacks on the fiscal deficits will derail the process. But when the sectoral balances return to more normal levels in relation to GDP then guess what? We will still have budget deficits and we all better get used to it.
In that context, I can see the development of a new industry – psychological support services for deficit terrorists – which will help them make the transition back to happiness once they realise deficits are here to stay. Any entrepreneurs out there want to licence this idea from me? (-:
Anyway, to the data first …
The news from the UK is that it “may not have emerged from recession after all”. The revised GDP figures come out today and based on yesterday’s investment data there is a real possibility that the UK has remained in recession during 2009 despite the earlier positive growth figures for the fourth quarter.
So while we have been thinking a double-dip is on the cards, particularly as the electoral cycle drives mad fiscal austerity programs, the fact is you cannot double-dip until you have finished dipping once!
The UK Office of National Statistics released the Business investment, Provisional results – 4th quarter 2009 yesterday (February 25, 2010) which showed that:
Business investment … for the fourth quarter of 2009 is estimated to have fallen by 5.8 per cent from the previous quarter and is 24.1 per cent lower than the fourth quarter of 2008.
The following graph shows real business investment in the UK (seasonally adjusted) since the first-quarter of 2007. This is a lengthy and dramatic decline in spending. In case you don’t realise the significance of this – that spending supports output and jobs – it has gone!
One of the implications of this investment free-fall is that the growth in potential capacity will be much lower when the overall economy finally resumes growth. This is the hysteresis effects that I outlined in this blog – The Great Moderation myth.
It is one of the costs of not ensuring that your fiscal interventions are large enough to restore private sector confidence. So when all these political leaders have been falling into the deficit hysteria mantra and assuring us that they would be invoking fiscal austerity strategies in the coming year – all that was telling private investors (that is, the real investors who build productive capacity) was that demand would probably deteriorate even further and so why create new productive capacity.
It becomes a vicious circle – private spending declines – the automatic stabilisers drive up the public deficit – the deficit terrorists go crazy and because they have control of the media create political pressures for the government – the government runs scared and announces austerity – private spending declines further on the news – the automatic stabilisers drive up the public deficit and so on.
What this also means is that private UK economy will not be able to respond rapidy when the rest of the world starts growing – Why? because they have trashed significant volumes of productive capacity.
And imagine what is going on in Greece, Ireland and Spain? How are they going to get out of the spiral that their artificial monetary system (the EMU) has imposed on them? Not without significant human suffering and deaths that is for sure. And all for a lousy and mindless monetary system that the economic gurus told the citizens was in their best interests. It never was in their best interests even in the growth period. Now the citizens are seeing that they are still being spun the same lies from the technocrats in Frankfurt and Brussels who wave reports from economists in their face as authority.
On the other side of the Atlantic, the US Bureau of Labor Statistics released (February 23, 2010) its latest mass layoffs data which showed that:
Both mass layoff events and initial claims increased from the prior month after four consecutive over-the-month decreases.
In other words, not a lot is happening in that labour market that is positive. A double-dip is very likely now without further stimulus support.
Other headlines today – among others:
“Downgrade from Moodys could prevent Greece from swapping its bonds with the European Central Bank as collateral for loans” – (Source).
“Investors spooked as Fed says it is investigating role of Goldman Sachs and other companies in Greece’s debt dilemma” (Source).
“More than 20,000 people took to the streets of Athens to demonstrate against the Government’s austerity measures (Source).
Conclusion: there is nothing in the financial and economic news that is signalling that the crisis is over yet which brings me to a piece written last Tuesday (February 23, 2010) by Financial Times economics writer Martin Wolf entitled – The world economy has no easy way out of the mire.
To which a three word response might suffice – no there isn’t. But you will want more from me than that.
Anybody who looks carefully at the world economy will recognise that a degree of monetary and fiscal stimulus unprecedented in peacetime is all that is prodding it along, not only in high-income countries, but also in big emerging ones. The conventional wisdom is that it will also be possible to manage a smooth exit. Nothing seems less likely …
He then referred to the following graph (which I captured from his article). It is from the OECD Economic Outlook and shows that the private sector in many nations “is now spending far less than its aggregate income”. This is one of the sectoral balances I refer to regularly.
Wolf summarises the OECD analysis of the graph saying that:
… in six of its members (the Netherlands, Switzerland, Sweden, Japan, the UK and Ireland) the private sector will run a surplus of income over spending greater than 10 per cent of gross domestic product this year. Another 13 will have private surpluses between 5 per cent and 10 per cent of GDP. The latter includes the US, with 7.3 per cent. The eurozone private surplus will be 6.7 per cent of GDP and that of the OECD as a whole 7.4 per cent.”
That is a massive reversal from the period that preceded the crisis. The shifts shown for the period 2007 to 2010 are dramatic and unusual by historical standards but just as dramatic and atypical was the period that preceded it when private sectors gorged themselves with debt.
And … just as dramatic and atypical … was the fact that this debt fuelled economic growth (in construction and real estate etc) which generated tax revenue beyond normal levels and allowed national governments to run budget surpluses.
So while all the tecnocrats in the EMU, the IMF, the OECD and in economics departments around the World were applauding the budget surpluses and proclaiming an end to the business cycle – problem solved – the Great Moderation – the reality was very different and these goons were too ideologically blinkered and stupid to realise it.
All the macroeconomic trends in the last decade or so have been atypical and we are now seeing the adjustment swinging back to more normal sectoral balances – except in the process of adjustment we are getting very large opposite swings – like the move back into overall private sector saving shown in the graph, which is very strong.
The resulting swing in public balances (into deficit) have also been very quick and large by historical standards. But modern monetary theory (MMT) understands these swings are part of the adjustment back to normality – painful as it is.
The swing to private saving was of depression-creating magnitudes. Any economist with job tenure or similar who claims the fiscal interventions were unnecessary (as in Barro yesterday) should offer to resign immediately if they cannot tell us how unemployment would not have risen even more sharply in the face of this private spending contraction. What would have filled the spending gap if not fiscal policy is the question they have to answer?
And … they should therefore tender their resignations and join the queue to see how much they like the “pursuit of leisure” (which is how they characterise unemployment in their textbooks).
So the adjustment process we are undergoing – some private debt payback, private saving and public deficits – which is the normal pattern for a healthy growing economy – will have to continue indefinitely.
Wolf however is concerned with how we exit the malaise. He considers that you need to understand “how we entered” the malaise to fully appreciate the solution. I definitely agree with that.
He then discussed whether loose monetary policy caused the lax credit and resulting asset bubbles which is one of the mainstream claims. I provide a critique of those claims in this blog – Monetary policy was not to blame.
The claim is also tied into the current mis-debate about the likelihood that the buildup in bank reserves will be inflationary. They will not be and I cover that argument in this blog – Building bank reserves is not inflationary.
The point is that the growth strategy based on increasing private sector debt, “the explosion of the balance sheet of the financial sector and increase in its exposure to risk” and the “soaring consumption of durables in high-income countries and booming construction of housing and shopping malls in countries such as the US” etc – was never sustainable despite what governments and their economic lackeys were saying during the “boom”.
It is also clear we cannot go back to that strategy. Private deleveraging has to continue and private spending has to be supported through income rather than credit growth.
If we allow the financial sector to go back to past behaviour then it will just foreshadow the next major financial and real economic crisis.
So what then?
Wolf says that:
I can envisage two ways by which the world might grow out of its debt overhangs without such a collapse: a surge in private and public investment in the deficit countries or a surge in demand from the emerging countries. Under the former, higher future income would make today’s borrowing sustainable. Under the latter, the savings generated by the deleveraging private sectors of deficit countries would flow naturally into increased investment in emerging countries.
Under either scenario, fiscal deficits are here to stay as they should stay given the historical behaviour of the sectoral balance that are now being reasserted most brutally.
The only way that the large nations can grow again given the return to overall private sector saving is for that saving to be supported. What does that mean?
An explicit shift to higher saving directly impacts on aggregate demand. This will cause inventories to accumulate and soon enough firms start cutting back production and employment and the process of output-spending losses them multiplies as the rising unemployment becomes a deflationary force in itself.
The only way the shift to higher saving can be realised without the descent into recession and even depression is for fiscal intervention to fill the spending gap.
The higher incomes support the saving and the deflationary impacts of unemployment are avoided.
The typical pattern of advanced nations is to run current account deficits and support private saving with public deficits. In a modern monetary system that combination of sectoral balances is entirely sustainable and will support economic growth levels that are sufficient to maintain high employment levels.
This growth pattern is also the best for emerging economies who rely to some extent on strong export markets for growth.
But we have to be absolutely clear that this does not mean “exit plans”. It does not mean that we plan to go back into budget surpluses as soon as all the shouting has died down. It means permanent deficits will be required and the public has to be made aware of that and understand that this strategy is the only one that sustain steady growth.
Where a nation can exploit a strong net export position, then surpluses are possible (depending on the strength of the external position and the strength of the desire to save by the private domestic sector. But not all nations (obviously) can run external trade surpluses. So it is a special case.
Continuous public deficits is the general and normal case and they should be directed and building strong public infrastructure include first-class education and health systems. Investing in people is the only durable investment.
And for the Chicago and Austrian School types that are now whipping up inflation fears consider Japan – again – they have growing deficits and are still fighting deflation.
Wolf concludes that:
Most people hope, instead, that the world will go back to being the way it was. It will not and should not. The essential ingredient of a successful exit is, instead, to use the huge surpluses of the private sector to fund higher investment, both public and private, across the world. China alone needs higher consumption. Let us not repeat past errors. Let us not hope that a credit-fuelled consumption binge will save us. Let us invest in the future, instead.
You will appreciate that I agree (mostly) with this summation.
Where I disagree is with his depiction of the causality between the sectoral balances. MMT tells us that public deficits help fund the huge private sector surpluses (through the mechanisms I outlined above) – not the other way around.
Part of the problems were are enduring is that commentators like Wolf continue to reinforce the erroneous notion that national currency-issuing governments are financially constrained and need to be “funded”. They don’t and as soon as we understand that we will be able to see more clearly why the crisis occurred – that is, the role played by the budget surpluses – and how we stay clear of crises in the future.
The FT graph demonstrates clearly the way policy has to go. Budget deficits will be required indefinitely and we better get used to it. All the exit plans in the world cannot deny this reality.
Austerity packages will just be the acts of ignorant vandals who are committing crimes against humanity by unnecessarily impoverishing their citizens and increasing suicide rates and all the rest of the pathology of unemployment.
What is desperately needed in all economies (EMU included) is a very substantial new fiscal injection. Several percentage points of GDP will be required in most countries including Australia.
Failure to do that will ensure very slow growth if at all and the real danger of slide back into recession and more havoc.
Meanwhile … back in Washingon
Bernanke spills the beans!
The US central bank boss appeared before the House Committee on Financial Services on Wednesday, February 24, 2010.
After various speeches and presentations were made, the Q&A session started and at 41.05 minutes into the televised proceedings you will see and hear this interchange:
Chairman Barney Frank: We hear this threat that the rating agencies might reduce our debt rating because of the deficit … Do you think there is any realistic prospect of America’s defaulting on its debt in the foreseeable future?
Bernanke: There certainly … Not unless Congress decides not to pay which I don’t anticipate. I don’t anticipate any problem …
Chairman Barney Frank: There is not a fear of default!
Okay, sovereign governments will not default on its national debt unless the legislative body “decides not to pay”.
Major deficit terrorism scare put to bed!
Counselling support services will be needed to help them adjust to this!
End of story.
Meanwhile in the banking sector
Consider the following scenario – in 2002 an organisation is “censured” by the authorities for money laundering. In the ensuing years it becomes a major predator in its industry causing havoc to other firms.
The organisation then posts record losses and the government assumes 84 per cent ownership as a strategy to stop the industry collapsing due to the incompetence of the management of this and other firms like it.
It is also reported that the organisation is under investigation by the regulative authorities for money laundering and suspicious funding of take-overs and poor handling of customer complaints.
A major real crisis then emerges as a result of the incompetence and dishonesty of the management in this industry – major unemployment arises – poverty rates increase, whole countries face serious austerity campaigns, and the mainstream economics profession goes into hiding (but as you know they emerge soon after the government has stopped the free-fall – and are as arrogant as ever).
Since being publicly-owned the current management of this organisation also fail to meet the own lending targets agreed with government as part of the bailout.
And … at the height of the losses in the organisation … the public reads this headline in the national daily newspaper – Bank loses £3.6bn – but finds £1.3bn to pay bonuses.
That is about as crazy as it gets. It must be some bad dream!
But The Times article reported that:
More than 100 bankers at Royal Bank of Scotland will take home bonuses of at least £1 million even though RBS, 84 per cent-owned by the taxpayer, made a £3.6 billion loss last year.
At least two employees in RBS’s investment bank will receive about £7 million each, the bank revealed yesterday as it reported a near-doubling of bad debts to £13.9 billion in 2009.
And what did RBS say by way of defence? The chairman claimed they were conflicted by “being deeply loss-making and relying on government handouts” but also having to face the “realities of running the business.”
And what might those realities be – given they are not really running any business but supervising public money and transferring significant portions of that public money to their own bank accounts via share bonuses?
The RBA chairman also said they were only trying to pay:
the minimum necessary to retain and motivate staff …
Here is some logic to help us work through this imbrolgio.
In economics there is the concept called economic rent. The rent component of a person’s remuneration is the difference between their current pay and the minimum amount that they would supply their labour for to do what they are doing at present. If minimum pay is lower than the current remuneration then the worker is receiving rents which are unnecessary to elicit supply.
Eliminating the rent component – for example, by a tax – would thus not alter the supply of labour.
Question: How many financial market workers would be prepared to go to the office on a daily basis and make extravagant gambles that they had no chance of assessing properly; create ridiculously complex products and foist them onto innocent third parties just to maximise return; and wave ten pound notes out their windows to demonstrators who were just expressing their concern for the future of the planet – and – receive lower pay?
Answer: (its only a Barro-type guess) … lots.
Implication: The claim by the RBA chairman that there are zero rents in this industry – given his statement above – is likely to be false.
Solution: impose substantial taxes on them to eliminate the rents.
I had this old-fashioned idea that “performance bonuses” were paid if you did a good job. You know – make a profit if you were a capitalist firm, or helped society in some way by increasing employment and reducing poverty.
But I admit now I was totally wrong. It is clear that peformance bonuses vary in some inverse way with the level of incompetence you bring to your job and the amount of damage you inflict on others through the products you create.
And finally … poor Peter
… should have stuck with Midnight Oil.
Yes, another week down and its nearly time for the Saturday inquisition. Look out for it some time tomorrow.
That is enough for today!