I am covering a few topics today, given that I used yesterday's post space to…
Over the last week, a Londoner and a Glaswegian have publicly embarrassed themselves with statements made about the current economic situation. One is an academic historian who hasn’t fully understood history. The other a politician who is seeking to deny the obvious and somehow blur his own culpability in driving the British economy back into a double-dip recession. I guess the smokescreen approach works if yesterday’s Greek vote is anything to go by. I saw a headline in Bloomberg this morning which said that “Greece avoids chaos …”, which prompted me to wonder what chaos might look like if it is not hospitals unable to get access to essential supplies, a government killing its private sector by cutting spending and not paying legitimate bills, and an unemployment rate creeping towards 25 per cent and 50 per cent for youth. The Greeks were bombarded it seems with wilful lies and even then the conservatives on just led the vote count from their main anti-austerity rival. In all the denials and bluster, what I know categorically is that in the real world where we all live – sustaining rates of youth unemployment above 50 per cent – is definitely not protecting the grandchildren.
Taking things in chronological order – on June 14, 2012 – the Chancellor of the Exchequer gave the annual speech at the – Lord Mayor’s dinner for bankers and merchants of the City of London – at the Lord Mayor’s residence, appropriately named “Mansion House”.
I have had trouble finding out who pays for the dinner and how one gets invited but it is one of several banquets that the Lord Mayor holds throughout each year. I haven’t been able to find a Lord Mayors dinner for the unemployed and downtrodden though.
He said that the challenge for his government was:
… to keep the British economy safe in the … financial storm raging around us.
I would think the challenge was to ensure unemployment drops dramatically and the economy sustain growth. The way in which the conservatives keep emphasising the financial and downplaying the real economy is very prominent. Its their way of deflecting criticism of their policies which are directly damaging the real economy – where all of us live and rely on to generate jobs and stable (growing) incomes.
He immediately attempted to justify “the British Government’s macro-economic strategy” in the context of the “eurozone crisis” and said that the:
The common theme is an underlying problem of excessive debt – banking debt, government debt and private sector debt. And the common challenge is how to manage the difficult process of balance sheet repair and deleveraging in a way that creates the conditions for sustainable growth and new jobs.
If we lose sight of the central role of debt in this crisis we will come to the wrong conclusions about how to respond.
Of all the major economies Britain was one of the most extreme examples of the imbalances that contributed to the problems the world now faces.
We had among the most leveraged banks of any country, a house price boom as large as America’s or Spain’s, and higher levels of household debt than any other country in the world.
The bank debt accumulated during the property boom binge and now backed by degraded assets with many banks probably on the brink of insolvency. The debt-buildup was driven by greedy managers and executives who have volume-based bonuses dependent on the growth in the real estate market. Then overlay a complex pattern of derivatives associated, initially, with the securatised mortgage packages, and the problem deepens.
The solution is to first recognise that the only useful thing a bank should do is to faciliate a payments system and provide loans to credit-worthy customers. Attention should always be focused on what is a reasonable credit risk.
In that regard, banks should only be permitted to lend directly to borrowers. All loans would have to be shown and kept on their balance sheets. This would stop all third-party commission deals which might involve banks acting as “brokers” and on-selling loans or other financial assets for profit. It is in this area of banking that the current financial crisis has emerged and it is costly and difficult to regulate.
Further, banks should not be allowed to accept any financial asset as collateral to support loans. The collateral should be the estimated value of the income stream on the asset for which the loan is being advanced. This will force banks to appraise the credit risk more fully. Banks should never be allowed to trade in credit default insurance. This is related to whom should price risk
As a further safeguard, banks should be prevented from having “off-balance sheet” assets, such as finance company arms which can evade regulation.
Banks should be restricted to the facilitation of loans and not engage in any other commercial activity.
If all else fails, nationalise them but most of all governments should remember that if they issue their own currency then there is never a reason for a bank crisis (run etc). There should always be publicly-guarantee deposits enforced via compulsory deposit insurance schemes.
But overall, how quickly the banks recover depends on how quickly the overall economy recovers. One of the reasons the banks have increasing volumes of toxic debt is because the assets are being degraded by unemployment and the associated private sector income loss. If the governments had have responded earlier and cosnsitently maintainted its fsical stimulus while the private sector stabilised its dangerous debt levels then what is now considered to be a toxic loan would have, rather, been considered to be a performing asset.
So if the Chancellor really wants to deal with the bank debt issue he must surely realise that austerity is the worst path of reconstruction.
The Chancellor claimed that managing “the difficult process of balance sheet repair and deleveraging in a way that creates the conditions for sustainable growth and new jobs” requires “tight fiscal policy and loose monetary policy” because maintaining “low market interest rates … smoothes the process of deleveraging”.
One of the great lies the Chancellor chose to rehearse – and one commonly perpetuated by Treasurers including Osborne’s Australian counterpart – is the notion that the fiscal austerity is the reason interest rates are so low in Britain compared to Spain and Italy – two nations he explicitly mentions.
Osborne is plain wrong when he claims virtue by saying that:
Indeed it is our fiscal credibility that has created the space for the Bank of England to undertake QE on a large scale.
In one way this statement is correct. But only if you interpret this as a tragic admission of failure. The low interest rates are because the Bank of England is deeply concerned about the recessed state of the British economy. The latter is directly to do with the fiscal stance the British government is taking.
So you might say – that by deliberately undermining the real economy via harsh fiscal policy – the British government has forced the central bank to lower interest rates out of fear of escalating unemployment and lost incomes – and has “created the space” for QE.
But it is the use of the term “space” that is where the inference fails. The Bank of England didn’t need any space to create bank reserves in return for the purchase of specific financial assets. And it would not have thought the need to do that necessary if the Treasury had supported growth through its fiscal settings.
Osborne also tried to claim that their fiscal strategy:
… has been rewarded in the markets, and we are today benefitting from safe haven inflows despite our large deficit and huge banking system.
The expression “safe haven inflows” tells you everything.
His comparisons with Italy and Spain are simply inapplicable because those nations use a foreign currency (the Euro) whereas Britain issues its own currency. Despite all the bluster of the politicians and conservative financial commentators including academics, the bond markets know the difference between a currency-issuing government and a government that has to borrow in a foreign currency.
The reason why bond yields are low in Britain and high in Italy and Spain is because the “markets” know the Euro nations can go broke in that currency and they also know their funds are default risk-free in Britain.
In May 2010, the UK’s cost of borrowing tracked Italy and Spain; today Spain’s borrowing costs hit a record 7%, and Italy is borrowing at more than 6%, while our ten year gilt rates are just 1.7%.
Of course low long-term interest rates are determined by several factors, including expectations about monetary policy, but it would be perverse to argue that the credibility of the UK’s fiscal consolidation has not been a crucial factor.
He further intoned that the last British budget “better supports businesses, wealth creation and new jobs” but admitted that there has been a poor growth performance over the last 18 months. He actually called it “low growth” whereas the fact is that anyone else would call it “negative growth” – for at least 2 quarters already.
His three reasons (aka denials) for this growth performance:
1. “there is a larger than anticipated impact of our financial crisis and deleveraging on potential output”.
2. “there has been the global commodity price shocks, exacerbated here by our depreciated exchange rate.”
3. “there is the ongoing uncertainty in the eurozone …”
The first “reason” should be read as – the private sector is not spending despite the claims by the Government (and their economist lackey mates) that households and firms were Ricardian in behaviour and would increase spending once the fiscal austerity was invoked – why? because they would then have less fear of future tax increases, which, in turn, reduced the need for them to save.
This nonsense, of-course, ignored the fact that they needed to save to reduce the excessive private debt levels and all the evidence has always pointed to the fact that households are cautious in their spending when unemployment is high, persisten and rising. In turn, firms will not invest if households are not spending because they know they can supply all current (and expected) demand via the existing capital stock.
The crisis has once again demonstrated that households and firms are not Ricardian which negates much of the logic that appears in mainstream macroeconomics textbooks which has been applied by the British Chancellor and Prime Minister to justify the fiscal austerity.
Please read my blog – Pushing the fantasy barrow – for more discussion on this point.
The other supposed avenue for recovery that was touted by the British government was exports. That hasn’t worked in part because of the deteriorating conditions in other nations. Which just substantiates the obvious that if every government pursues austerity and relies on net export-led growth they will fail because the austerity kills national income which kills imports which … Yes, kills exports.
But even in that context, the lack of responsiveness to the depreciated sterling has been notable.
The Trade data showed that the trade deficit was widening with real exports falling 7.1 per cent (excluding oil and erratic items) and imports falling 3 per cent. The terms of trade deteriorated with export and import prices falling.
So the export sector is not proving to be the hoped for growth machine. Which is no surprise given that around 50 per cent of British exports go to the EU.
But even though the Eurozone is now the preferred whipping-boy/girl – the non-EU exports also fell sharply – and by a greater percentage than the EU exports.
All of that is understandable in a context of widespread fiscal austerity. Please read my blog – Fiscal austerity – the newest fallacy of composition – for more discussion on this point.
But if you put the pieces together so far you have a private domestic sector attempting to reduce their balance sheet exposure (run down debt) and the external sector draining growth because the export markets are weak because other nations are following the austerity path.
In that context, what should a responsible government do? Answer: promote domestic growth via government net spending. A favourite target is the construction sector because that benefits from large public infrastructure projects which are ideally suited for times when there is slack demand for labour resources and a lull in private spending overall.
The Construction data was appalling. Real (not seasonally adjusted):
… construction output in April 2012 is estimated to have been 8.5 per cent lower than in April 2011.
The data shows that “new work fell by 9.5 per cent and repair and maintenance fell by 1.4 per cent” and the:
… largest decreases were new public non-housing excluding infrastructure (22.4 per cent) and new public housing (22.1 per cent)
That is, the fiscal austerity is causing a very sharp decline in construction at a time when it could have saved the British economy from the growth drains coming from private deleveraging and export market decline.
What that means is that when the June-quarter GDP figures come out for Britain, expect the double-dip recession to be extended. Real GDP already fell by 0.3 per cent in the December-quarter 2011 and then a further 0.2 per cent in the first-quarter 2012. It clearly has continued on that negative path.
The Chancellor should use the correct word – negative growth rather than “low growth”.
He moved on to attacking those who advocate expanding the deficit to meet these spending challenges and said:
But that argument ignores a crucial fact: inflation in the UK has been significantly above the Bank of England’s 2% target since the end of 2009.
That is due to a combination of commodity price shocks, the lagged effects of a lower exchange rate and a worsening underlying productivity performance, and it has very important implications for fiscal policy.
Looking backwards it means that over this period looser fiscal policy would almost certainly have been offset by tighter, or less loose, monetary policy.
The Bank of England clearly has defied the demand that they put interest rates up when the inflation rate was above its target. They knew that most of the factors were transient and that the state of the real economy was deflationary in character.
There is no evidence that interest rates would have been higher if growth was higher as a result of
There is something wrong with the balance of economic policy if the treasury has to further entrench already high unemployment and cause a major recession just to have interest rates a few basis points lower.
Why doesn’t the Chancellor release the cost-benefit modelling of that strategy. How much income is being lost daily by the British economy as a result of operating well below capacity relative to the income gained from having lower interest rates?
The answer will definitely not be in his favour. Massive versus miniscule (if any) is the relativity.
He then went on to promote fear about “the cost and risk of discretionary fiscal loosening”:
Our gross debt is already forecast to peak above 90% of GDP, a level above which the evidence suggests higher debt tends to reduce growth.
And the situation in several European countries today provides an example of how high levels of gross debt can themselves leave a country vulnerable to unstable market dynamics.
We can see across the eurozone that rising market interest rates and market instability are catastrophic for the process of recovery.
These risks are very real, not imaginary.
They are imaginery for a currency-issuing government who, in tandem with its central bank, can always control bond yields and interest rates. That these sort of governments play the game that the bond markets rule is testimony to the fact that they choose to lie to the public rather than correctly articulate the choices.
Please read my blog – Who is in charge? – for more discussion on this point.
To repeat, there is no applicable comparison between the options facing the UK and those facing the Eurozone member states. The latter issues debt in a foreign currency and has to do that to cover net spending. The former never needs to issue debt and the bond markets ultimately know that.
Later in the Speech he used the Eurozone in a way that would negate his earlier use of it as an example justifying austerity. I suppose the bankers and merchants were by this time well-fed and “watered” and were unable to see the contradiction.
He said that the:
… eurozone need to follow the “remorseless logic” of monetary union” towards much greater fiscal integration.
Otherwise, in the absence of the flexible exchange rate and independent monetary policy that we enjoy in the UK, the economic and political strains of deleveraging and balance sheet repair in the eurozone periphery may prove unbearable.
The solution in the eurozone doesn’t have to be a full-blown United States of the Eurozone but if it is to be successful it is likely to include most of the mechanisms that make other currencies work in countries such as the UK and the US:
Which is why he and “many others campaigned against UK membership of the euro”. I think the British were very wise to avoid going into the Euro.
But see the contradiction – “market other currencies work”, “flexible exchange rate and independent monetary policy” – which he thinks means the central bank is independent of the treasury but actually means in the day-to-day world of funds flows that the government is at the top of the monetary system which uses the currency it issues. All players know in this case that the government is always solvent.
It means that austerity is not required to keep the “markets” at bay as it is in the Eurozone given the appalling relinquishment of a growth agenda from the ECB (which is clearly the “federal” treasury and central bank rolled into one in the Eurozone).
He concluded by claiming the government:
… can and we will keep Britain safe in the storm.
It is a pity that they are already in a tempest … the storm passed in 2010.
Which brings me to the Glaswegian and I will be terse.
The Beeb has really descended into propaganda by inviting Niall Ferguson to deliver the latest Reith Lecture (June 17, 2012) – Why the young should welcome austerity.
The lecture series goes back to 1948 and was named after the first director of the BBC. Some great minds have given talks – see list.
Ferguson is one of the no-so great minds to have been given the podium.
His principle argument is that governments are lying to us about the “size of their debts” and that “young voters would be wise to get politicians to pay them off as soon as possible”.
His thesis is that the debt buildup is not “a sterile argument” about “austerity” and “stimulus” but rather “a consequence of a more profound malfunction”. I agree – the malfunction is neo-liberalism – an ideology that Ferguson subscribes to which is systematically eroding the future prospects of our youth and the generations that follow.
He claims that:
… the heart of the matter is the way public debt allows the current generation of voters to live at the expense of those as yet too young to vote or as yet unborn.
The public debt buildup has been associated with a massive collapse in private spending, following a massive buildup of private debt. The consequences of that collapse has been to deprive millions of employment and access to satisfactory income.
That “current generation of voters” is living very poorly as will their children given the way in which jobless households create disadvantages which span the generations.
Ferguson claims that the lie is that governments will surely increase taxes to pay off the debt as the servicing of the debt “must inexorably rise”.
If the volume of debt rises and yields rise, then the interest servicing rises. That means incomes in the non-government sector rise. But that is secondary. If growth increases as a result of correctly targetted fiscal stimulus then the debt ratio will likely fall and the nominal interest servicing will be deflated into irrelevance.
We then were presented with the familiar Eurozone/Non-Eurozone conflation of sovereign debt which immediately tells you that the presenter does not understand the finer points of monetary economics or, alternatively does, and chooses to deliberately deceive.
Once again, there is no applicable comparison between the options facing Spain or Greece or Germany and those facing Japan, the UK or the USA. Two different monetary systems – a world of difference in options available to the government and the constraints it faces.
He also claims it is a lie not to include the:
… often far larger unfunded liabilities of welfare schemes like – to give the biggest American schemes – Medicare, Medicaid and Social Security.
The most recent estimate for the difference between the net present value of federal government liabilities and the net present value of future federal revenues is $200 trillion, nearly thirteen times the debt as stated by the U.S. Treasury.
And sharp minds will immediately reply that these are diversionary tactics. The only problem is whether the US government will be able to provide the real standard of living that the future generations expect.
The US government will always be able to purchase whatever real resources are available for sale in US dollars in the future to fulfil any medical and social security obligations.
That is not to say that the US health system is not in need of serious repair on efficiency and equity grounds. Please read my blog – The US should have universal public health care – for more discussion on this point.
But that is quite a different line of argument than focusing on the “US government will go broke” lie. The challenge facing the US is not financial. It is to ensure productivity grows fast enough to meet the challenge of the rising dependency ratio and the political demands required to divert real resources from one generation to another. But the political challenge is no different to diverting current resources between competing groups.
Ferguson though claims that all:
These mind-boggling numbers represent nothing less than a vast claim by the generation currently retired or about to retire on their children and grandchildren, who are obligated by current law to find the money in the future, by submitting either to substantial increases in taxation or to drastic cuts in other forms of public expenditure.
In a world where the politicians truly understood their options, then tax rates increases and/or cuts in public spending will occur in the future if the US government thinks it is necessary to reduce the purchasing power of the private sector because inflation is emerging.
If the politicians act as Ferguson predicts then he is just exposing a lack of education on the side of the politicians rather than any financial necessity.
But then the same politicians are imposing pro-cyclical austerity and deliberately causing recessions so we cannot expect much from that class.
Further, we need to distinguish between rising taxation revenue (as growth expands) and increases in tax rates. The former always accompanies growth because more people are in employment.
Ferguson then says that “the biggest challenge facing mature democracies is how to restore the social contract between the generations”.
I agree. Having youth unemployment rates at over 50 per cent which is the direct consequence of the sort of policies that Ferguson advocates is the single greatest travesty for our social contract between generations.
At a time when governments have used their fiscal powers to insulate the top-end-of-town from the crisis (largely), protected the bank managers who, in part, were the neo-liberal transmission mechanisms for this crisis, the youth are being asked to pay because the “government has run out of money”.
The unemployed youth know that is a lie. What they don’t know is that the longer the governments treat them with contempt the worse the intergenerational balance will become. What they don’t know is that their lives are already probably irrevocably scarred. And when they become adults their progeny will inherit that disadvantage.
The policies that Ferguson advocates have guaranteed that our children and their children will be resentful of those in decision-making positions now.
So statements like:
If young Americans knew what was good for them, they would all be in the Tea Party.
Are gratuitous in the extreme. The tea party members are being exploited by the ideological elites to support policies that cannot possibly make their lives better and that support is being garnered through a litany of well-rehearsed, well-produced, and widely-spread lies.
If the Tea Party was in charge of the US Congress then the unskilled and semi-skilled would have even less chance of sustaining employment than they have now. The inequality in the US would widen even further and the evidence is clear – inequality is inversely related to stable economic growth.
Ferguson calls for tight fiscal rules of the type they are implementing in the Eurozone – constitutional amendments to require balanced budgets to “reduce the discretion of lawmakers to engage in deficit spending”.
Which if this rule was enforceable would have guaranteed that the Great Recession would have become the Great Depression.
What I propose for Niall Ferguson is this rule: He loses his job if the national unemployment rate rises above its long-term average during growth cycles by more than 2 per cent. His pay is cut in half if it rises against this benchmark by more than 1 per cent.
Would he then propose a balanced budget rule? He might – but then we would know he is insane.
I have run out of my allotted blog time today. But I would just remind Niall Ferguson that the likes of him having been predicting – year-in, year-out the demise of Japan. But for around two decades they have been defying the logic presented by Ferguson and others. When they fell prey to it (1997) things turned sour again. As an historian, he displays a very poor grasp of recent history.
The same scaremongering has been with us for some years now – given the crisis is enduring. No sign of insolvency in the US, Japan, the UK etc. The signs all point to the fact that deficits are still too small. Governments are caught in a sort of bind – pressured by ideologues like Ferguson but with entrenched unemployment on their hands.
When the pendulum has swung towards the Ferguson angle, we have witnessed UK-style austerity and the economy double-dipping. When the pendulum remains poised (uncomfortably) we have Japan – growing on the back of deficits but with a conservative backlash growing.
What I know categorically – a fact not mentioned by either Osborne or Ferguson – is that in the real world where we all live – 50 per cent youth unemployment is definitely not protecting the grandchildren.
That is enough for today!