We still have the elephant in the room …

It continues to amaze me how humans lock themselves into constrained debating positions on almost every topic imaginable. In doing so we stand in denial of our history and therefore operate in a sort of “current ignorance”. But also we deny ourselves the adventure of thinking laterally about how new ways of proceeding might help us solve our problems. So we are neither backward or forward looking but churn our debates around and around within a tight set of ideas which we presumably think is safe. In macroeconomics, the problem is that most of these “safe” ideas are based on false premises and actually expose us to on-going danger of the type we are witnessing in this current global recession. I was reminded of this again today when I was reading the latest New York Times debate about Saving the World, Without U.S. Consumers.

The starting premise of the debate is that:

If Americans don’t start buying a lot of stuff again, can the world economy be saved? What’s the global Plan B? These are fundamental questions at the summit of the Group of 20 industrialized and developing nations in Pittsburgh. In previous global downturns, Americans have come to the rescue, getting out their credit cards and buying up what the rest of the world produces … But the American consumption option may not be available anymore and may also not be desirable. Is there another model, like the one outlined by the Nobel Prize-winning economists Joseph Stiglitz and Amartya Sen? Why have consumers in other countries – like China and Germany, which produce far more than they spend – failed to step up to the plate?

The model outlined by Joseph Stiglitz and Amartya Sen refers to the Final Report issued by the Commission on the Measurement of Economic Performance and Social Progress. The Commission was set up by French President Sarkozy to reflect on the adequacy of “current measures of economic performance, in particular those based on GDP figures”. It is claimed that societal well-being depends on broader issues such relating to “economic, environmental, and social sustainability”.

The essential message of the Report designed to condition the G-20 Pittsburgh debate is that an emphasis on economic growth as measured by GDP is misguided. This topic is a blog in its own right so I will only skim through this part to get to the main theme of today.

The disappearance of millions of jobs and the evaporation of the financial assets of countless persons in the current malaise have shown that a narrow focus on GDP as an indicator of social well-being is ill-advised. Stiglitz and Sen argue that we should base our policy settings on “new assessment tools” that adopt a broader view of human well-being. Implicit in their suggestions is the view that by pursuing growth at all cost, we allowed markets to self-regulate and failed to understand that this strategy would eventually fail.

The Final Report says:

What we measure affects what we do; and if our measurements are flawed, decisions may be distorted. Choices between promoting GDP and protecting the environment may be false choices, once environmental degradation is appropriately included in our measurement of economic performance. So too, we often draw inferences about what are good policies by looking at what policies have promoted economic growth; but if our metrics of performance are flawed, so too may be the inferences that we draw.

The Report says we should “shift emphasis from measuring economic production to measuring people’s well-being” which requires us to consider incomes and consumption rather than output per se. We have to also focus on the distribution of incomes and broaden our notion of income to include non-market activities.

Growth at all costs has been fuelled by unsustainable debt levels and a rapid degradation in our natural environment.

We continually fail to consider the social costs of unemployment and the public health impacts of the environmental damage we have caused. Our obsession with self-regulation of the private sector, allowed the financial system to become even more of a casino than it typically has been and this set us up for the massive crisis that we now are trying to clean up.

The full report is worth reading and I agree with a substantial part of it despite it sometimes lapsing into faulty macroeconomic reasoning.

So it is in that context that the NYT conducted this week’s debate, which they call a running commentary on the news. The responses of their panel are interesting because they reveal so much about the macroeconomic confusion that is out there in media and public commentary land. They also reinforce my current theme – where is the elephant?

That is, the comments reflect my view that we artificially constrain our debates (through ignorance or because of the tyranny of the dominant ideology) which means we end up by not producing real solutions.

The first comments came from sociologist Juliet Schor who is co-chairwoman of the board of the Center for a New American Dream and author of Born to Buy and The Overspent American.

She believes the US consumer should not be relied on to maintain robust world growth because the consumption in the past has been fuelled by debt and has undermined leisure time for all members of the typical US family. She says “before the crash, debt to income and asset ratios were stratospheric”.

Her argument is that American consumers will become more conservative and come to realise that the real problem they face is not the lack of goods and services but the need to “get serious about a low-carbon economy, and start expeditiously transforming our dirty energy, food and transport systems.”

Her solution is greater “investment, rather than consumption”, especially in new green technologies and practices.

It is interesting she draws no sectoral conclusions – Who is going to do the investment? Will this just transfer consumption-motivated debt onto investment-motivated debt across the private sector? What will be the reactions of the export-growth oriented countries like India, China and Japan to their largest external market reducing their demand for imported goods and services? Does she think the US government will be able to run sufficient deficits for long enough (politically) to finance the implicit saving that she is advocating.

The second commentator in the debate was one Bernard Baumohl, who is chief global economist at The Economic Outlook Group. He asked Will U.S. Prudence Force China’s Hand?.

He also focuses on the excessive borrowing theme and asks whether the US:

Should … remain perennial borrowers, where our life style continues to be dependent on the generosity of foreign lenders? Or has the time come for us to jettison our past shopping habits and instead focus on increasing savings and being more successful selling goods and services abroad?

He sees a problem in the “destructive cycle that saw American consumers gobble up underpriced exports from Asia. Indeed, the amount Americans consumers spend in one year is greater than the entire G.D.P. of China, India, Canada and Russia – combined!”

One wonders why this is a problem for the Americans, notwithstanding the urgings of Stiglitz and Sen. That is, from a narrow economic perspective why is it a problem for America if other countries choose to deny their own citizens of their valuable resources and instead ship them to the US in increasing quantities because they want to accumulate US-dollar denominated financial assets?

Remember exports are a cost to a nation and imports are a benefit. It is the real goods and services that are transferred between countries that change material standards of living.

What Baumohl is suggesting is that US should aim to cut its material standard of living into the future.

While it is probably true that around 45 per cent of the US spending on consumer goods was “was financed by borrowing and through the depletion of our savings” and that this “borrowing binge helped precipitate the greatest financial crisis since the Great Depression”, Baumohl presents no understanding of the role that fiscal policy had to play in this.

The US household only really dis-saved after the Clinton surpluses squeezed the liquidity of the private sector in the late 1990s. You might like to read this blog – Some myths about modern monetary theory and its developers which considers this issue. If the US government had have run sufficient budget deficits to finance the desire to save for the non-government sector overall, then the spending patterns would have been different (more public goods, less private goods) and the non-government sector would not have been forced into as much indebtedness.

Baumohl, goes on to consider China and considers that they have been conducting an:

… overt effort to keep its currency so cheap that no one could resist buying its products. Such active intervention in the currency markets enabled China to receive massive amounts of dollars earned from trade surpluses, much of which was then plowed back into the U.S. That, in turn, helped keep U.S. interest rates low and fueled even more spending and borrowing by Americans. It was a disastrous cycle that had to end badly. And it did … It’s hard to believe that China can still get away with setting the value of its currency so low.

First, China denied its own citizens the benefits of their own resources by following this strategy.

Second, the US interest rates were low because the Fed (central bank) wanted them to be low. The Chinese do not set interest rates in the US.

Third, if the US chooses to reverse its trade relations with China, then it will start to deny it own residents the benefits of using US resources.

The next commentator, one Michael Pettis, who is a senior associate of Carnegie Endowment and a finance academic at Peking University, also takes up the China angle. He considers that the US consumer will not resume their free spending but considers:

… there is almost no chance at all that Chinese consumers will be able to take up the slack. The Chinese save such a high fraction of their income largely because of long-standing policies aimed at promoting and subsidizing domestic investment and manufacturing.

The Chinese government also runs significant deficits to allow their citizens to achieve their saving ambitions without damaging drops in national income generation.

But you start to sense by now that their is a highly constrained debate going on here. It is either net exports or consumption that is being talked about as components of aggregate spending. The Chinese have shown in the current downturn that they can redirect spending dramatically towards the domestic economy by large-scale expansion of public spending (the elephant!).

Pettis does recognise that public investment in China has replaced the lost export revenue (given domestic consumption in China is constrained). However, he makes the following questionable claim:

As the U.S. rebalances its economy toward higher savings rates, China has no choice but to rebalance toward higher consumption rates. This can happen either because of a sharp pick-up in consumption growth or, more likely, a sharp slowdown in GDP growth. I worry that China will find it difficult to generate the kind of consumption growth that will take up some of the American slack, and we may be locked into a period during which the world adjusts by growing more slowly.

Well the Chinese government realises that its own net spending can play a significant role in filling the spending gap. There is also considerable scope to increase consumption in China overall if the poorer segments of society can receive higher incomes.

The next commentator was academic Lawrence Glickman, who authored Buying Power: A History of Consumer Activism in America. He argues that while a “return of thrift” is being continually advocated in the US:

Time after time, however, restraint has lost against pent-up demand following recessions and depressions.

Interestingly, he says that “our current economic problems are largely rooted in underconsumption, not only by individuals but even more importantly by local and state governments, which are hemmed in by constitutional balanced-budget provisions and a three-decade-old mantra of anti-taxism”.

So voluntary constraints on governments driven by a basic mistrust and ideological preference for market-based activities has hampered the production and consumption of public goods. That certainly also applies in Australia where we have allowed our public infrastructure and consequent consumption of the same to degrade over the last 30-odd years as governments became increasingly seduced by the neo-liberal budget surplus mantra.

In that context, Glickman says:

It is true that as a society we have not sufficiently distinguished among positive and negative forms of consumption, and therefore our metrics – in which the emphasis has been on economic growth at all costs – have not allowed us to confront ecological and other challenges. In the short term, the key will be assuring that our consumption is geared toward bettering the public sphere. Although it might be measured in the same way economically, a dollar spent on mass transit or public education serves the commonwealth more effectively – and in a more long-range fashion – than does a dollar spent on gas-guzzling automobiles.

And, as the music to my ears grew towards the crescendo, I read the words of Glickman … in disbelief:

If we need to spend our way out of this recession, in other words, let’s do so with an eye to sustainable and socially productive consumption. Here is where the federal government can play a role similar to the one it played in the post-World War II boom. But this time we can, with history guiding us, avoid the pitfalls of that boom, which have led to the problems highlighted by contemporary critics of the fetish of an ever-growing G.D.P.

Conclusion: there are some sensible people left.

But then we read that the problem is the “Selfish Germans and Chinese” according to Desmond Lachman, who works at the right-wing American Enterprise Institute and formerly was an investment bank and IMF economist. So steel yourselves.

Lachman says that:

As the G-20 heads of state ponder the policies that might be needed to support the global economic recovery, one consideration should be foremost in their minds. The U.S. consumer, long the world’s consumer of first and last resort, is no longer going to be the principal driver of the global economy. This prospect should focus the G-20’s attention on the critical issue of finding an alternate source of aggregate demand to keep the global economic recovery on track.

He recognises that real wages growth in the US have been “slow” (I would say appalling) and the only way that the US household could keep consuming was through the services of the financial engineers (that is, increasingly indebting themselves). Now that unemployment has sky-rocketed, it is hard to see the US consumer going back to the binge-consumption.

Although he doesn’t admit it, the recession has impacted very badly on low and middle-income Americans (a common trend around the globe) and this has dulled their capacity to drive growth. The strategy of suppressing real wage growth while productivity growth was booming and then relying on ever-increasing levels of private indebtedness to keep the growth train running was lunacy anyway. You might like to read my blog – The origins of the economic crisis – to understand more about these trends.

Which neo-liberals in the Lachman’s American Enterprise Institute ever noted that while they were railing us with their free market rhetoric over the last decade or more? They were part of the problem.

The reality is that any coherent recovery will have to involve a fundamental redistribution of national income to wage and salary earners across the globe and reduce the profit shares in national income as a consequence. Real wages will have to grow in line with labour productivity to ensure that consumption growth can continue without the need for the whole private sector to become increasingly indebted.

Lachman certainly recognises that rising unemployment and flat wages growth will stifle consumption. He also notes that:

… households are almost certain to continue to increase their savings in reaction to their record levels of indebtedness and to the large losses they have recently suffered on their equity and housing wealth holdings. Trying to save more when income is stagnating could lead to an actual decline in U.S. consumption levels going forward.

It might. But then that is a static assessment. Once again the elephant is ignored. More soon.

Lachman then concludes if the US consumer cannot drive world growth “the world economy has to find an alternate source of demand” to maintain growth. He then says that:

… one has to hope that the world’s major surplus countries, like China and Germany, recognize their responsibility to promote household consumption in their own countries to offset the prospective slowing in U.S. consumption. Sadly, if recent history is any guide, one should not expect either the Germans or the Chinese to rise to the occasion and to run policies in the global interest even if they have most to gain from a well-functioning global economy.

This is a common theme that I read regularly at present. Those rotten selfish Germans and Chinese are not consuming enough. I seem to have a mistaken view of the term selfish. Exports are a cost. Germany and China have adopted an export-oriented growth strategy which involves them sacrificing their real resources – the ones that actually enhance their material standards of living – in return for paper-claims on US-denominated financial assets (and other the currency-denominated financial assets of other importing countries).

The citizens in these countries are sacrificing their own “fun” for bits of paper. It is certainly misguided but I don’t think it fits into the realm of selfish. Unless you adopt a US-centric approach and think that expanding US exports is a good thing. I don’t think that approach has anything to run with.

This reminds me of a quote I read overnight from Tiger Management founder and chairman Julian Robertson who spoke to the US Network CNBC. He said:

The US is too dependent on Japan and China buying up the country’s debt and could face severe economic problems if that stops … It’s almost Armageddon if the Japanese and Chinese don’t buy our debt … I don’t know where we could get the money. I think we’ve let ourselves get in a terrible situation and I think we ought to try and get out of it.

He really needs help finding that elephant in the room! There is nothing one could say about this other than to presume his hedge fund was successful through random picks. He certainly has no understanding of the operational realities of the fiat monetary system.

Anyway, you will note that only one of the commentators understood that aggregate demand is comprised on private household consumption, private investment, net exports (export less imports) and … government spending.

It is clear that if the desire of Japan and China to stop accumulating US-dollar denominated financial assets was to wane then they would not be prepared to send as many boats crammed with real goods and services to the US relative to the boats that the US sends to them crammed with real goods and services. In other words, the real terms of trade would turn against the US.

That might present the purchasers of imports from those countries with a slight adjustment problem. Less plasma TVs! It might also prompt some entrepreneurial activity in the US to replace the imported products with locally-produced output.

But then Japan and China would face swings in their exchange rates that they might not be entirely happy about. Who know about that?

The net impact is not a catastrophe. The US government will face no constraints on its ability to spend as a consequence. If the US consumer desires to increase his/her saving then the US government has more space without increasing tax rates to expand public good provision. If the US consumer is saturated with private goods then their welfare will rise as the public good provision rises.

I suspect the idea that the US consumer is saturated is a middle-class assessment and doesn’t consider the inequality of access that is clearly present. But through appropriate tax policy changes and public sector job creation, considerable improvements could be made in equity which could not only expand public good provision but also increase the consumption of the lower income deciles.

None of that is particularly reliant on anything the Japanese or Chinese do.

So there is no real problem if the US consumer decides to save more. Household finances in the US will become less precarious. The parasitic financial services sector will get less commissions. And the scope for public sector spending and public goods provision will increase at current tax rates. Win, win, win.

You just have to identify the elephant to see these solutions. It doesn’t take much to identify it – just taking of the ideological (neo-liberal) blinkers will help.

The worry is that the blinkers will stay on and so as consumers stop spending and governments are bullied into cutting net spending … the W appears and things get deteriorate again.

None of what I have written here today should be taken as a denial of the introductory points about the urgency of a better conception of progress. I think that is another blog topic. I have been a long proponent of broadening our measurement of growth and biasing that measurement towards human welfare and the health of the natural environment.

But at any rate, an increase in public consumption should redirect resources away from activities that do not maximise human well-being towards those that do.

This Post Has 4 Comments

  1. I saw the Robertson interview live, and was appalled.

    Clearly his strategies for success must be “bottom-up”; one wonders how he can presume to advise on top-down policy orientation.

    Before stumbling across modern monetary theory, I was always struck by the fundamental error of the “what happens if foreigners stop buying our bonds” meme. It seems exactly parallel to the error made in assuming how domestic government deficits must be “financed” as per MMT. But in a way, it’s more graphic and easier to illustrate. The current account deficit is “financed” at precisely the instant that Wal Mart “exports” its bank account dollars to China. End of story as far as required quantitative balancing is concerned – a mere change in book keeping ownership. Everything else is United States liabilities transformation and reorganization. There are only two options from there – status quo, or liability transformation. It’s all about financial form and pricing, not funds sufficiency.

    Some of these international capital flows bloggers are of particular concern in this regard. Again, the nature of the error seems even more graphic and easier to illustrate than that of the more macro and more comprehensive net non government balances approach, which some may find somewhat abstract to absorb at first.

    So much education in economics is lost and even reversed by not realizing the mathematical and logical importance of double entry book keeping, and the fact that double entry book keeping is a closed system at the global level, or for that matter in any sector where definitions of sector interfaces are consistently constructed. All is lost if that is not understood. Accounting and closure of accounting is where what might have been independent suddenly becomes dependent. It’s the measurement, stupid.

  2. JKH: “Before stumbling across modern monetary theory, I was always struck by the fundamental error of the “what happens if foreigners stop buying our bonds” meme.”

    JKH, the problem is that those in control of the political economy in these nations have no plan for the future which isn’t based on the current paradigm. Obviously, if the current paradigm evaporates before sense (in the plotical, ideological, and economic realms) has had a chance to prevail, chaos will ensue.

    The meme of ‘foreigners own us’ is a guilt driven misunderstanding (given that the US deficit is only what – 28% foreign owned?), pushed by libertarian puritans.

    While I’m convinced bill’s economic reality check is sound, that means jack shit if the political consensus is still stuck in 1969.

    Bill – what can be the conduit for transmitting the economic sense of modern monetary theory to the real world post haste, if you will?

  3. I failed one of your quiz questions, and was directed here, but now I must comment. It’s an old thread, so it should be OK.

    “The citizens in these countries are sacrificing their own “fun” for bits of paper. It is certainly misguided but I don’t think it fits into the realm of selfish. ”

    I’m not sure how you can say this about China — the citizens have no say in the matter. One thing that struck me in reading this paper:

    …was that the gross household savings rate in China for urban households is 5% — same as in the U.S., and half that of the Eurozone average. In rural China, it is 3 times that, but there are a lot of uncertainties in rural China, particularly with the dismantling of the “iron rice bowl” services:

    “[…]urban households enjoy access to highly subsidized housing,
    education and health care benefits, and most are covered by generous (although
    unfunded) pension schemes through their employers. In contrast, few rural households
    enjoy these benefits, and most rely primarily on their own saving and their children for
    support in old age.” (p.12)

    So I don’t think you can argue that the Chinese people are voluntarily foregoing consumption in order to accumulate paper claims on U.S. liabilities — those are policies of the government, not the households. Adding both urban and rural households, household savings constitute only 10% of national savings, leaving about 26% of GDP as retained business earnings and government surpluses — the latter are primarily a system of “gray” (i.e. illegal) levies and fees that local officials impose on their charges, together with coerced “contributions” of employees in the urban areas.

    So the large savings within the Chinese economy has nothing to do with willing choices of Chinese households. Once you understand that many of these export firms are owned by local officials, or have local officials on the payroll, the “greed” and “selfishness” factors becomes apparent: use government taxation powers to subsidize well-connected exporters that have business relationships with the tax-collectors, rather than promoting the incomes of workers or providing a social safety nets in the rural areas.

    Moreover, I don’t think you can argue that a current account deficit is always a “net benefit” — again, disaggregation is required here. Perhaps if we were receiving low cost foreign brands that competed with U.S. brand manufactures in the open market. But the current account is at the level of outsourcing and suppliers — i.e. at the institutional level, not the market level, and the result is not visible at the retail level; how many Chinese brands can you name? It is absolutely visible at the level of wage-distribution, in that wages of the bottom 80% are shifted to the top 1% of workers, even as total labor costs remain the same, and prices of finished goods remain the same. And this contributes significantly to the appalling (as you point out) income stagnation of median households.

    So the typical American worker is only “enjoying the benefits” of losing 3% of GDP share a year in wages to bonuses of top management, in exchange for an ever-so-slightly lower consumer price index. She is not even given the option of a competing good to buy in the marketplace. The end result is a predictable series of domestic asset bubbles as long term rates are pushed down.

    In this sense, the current account can be seen domestically as an institutional phenomenon that plays the role of a conduit that converts the earnings gap enforced by wage arbitrage into asset purchases, which then fund household debt growth equal to the original earnings gap, so that demand can be maintained.


    P.S. Great Quizzes!

  4. I am coming to this late, but by now I guess by now it’s obvious that Pettis was able not only to get China very right, but also a whole series of balance of payments issues. The consumption share of China’s GDP is surely rising slowly, but only because GDP growth is slowing rapidly, pretty much at the pace Pettis suggested in I think 2010, about 2 years before China started to rebalance. If you read him you’ll see that there was only in theory “considerable scope to increase consumption in China overall if the poorer segments of society can receive higher incomes”, as you say. In practice this was really hard to pull off and it is still the great challenge facing the administration of Xi Jinping, the current Party Chairman.

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