The Labour Party will eventually get back in power again. There is a very good chance it will be led by David Miliband.
In the FT yesterday he wrote: “Framing the debate as a choice between the public and private sectors is certainly good politics, but it is bad economics. The Budget will force 600,000 public sector workers into unemployment”. You can see the full article here. This demonstrates that Miliband is a slave to the underconsumptionist crank Keynes. He does not understand the role of costs and savings in society that was recently explained so well by Prof Guido Hulsmann. I draw your attention to my notes explaining the two underconsumptionist “Elephants in the room.”
Mr Milliband, please note.
Slide 9
Sophism 1: A “leak” in the circuit of spending? – In Glory of Hoarding
To Keynes, an act of savings is a leak from the economy. If I choose to sit on all my money under a mattress then I increase the purchasing power of all the money in ownership of others not under my mattress. I enrich people by an act of hoarding as their money units have more command on the same level of goods offered for sale.
Sophism 2: “The Paradox of Savings” – Circular Flow of Income
One man’s spending is another man’s income. Save, i.e. cut back on spending in the economy as a whole, and the workers’ income will fall. This will cause a depression. If the arguments in the above do not solve this then you must add; what matters is not that income will fall, but the relative difference between the level of costs and profits is the thing that really matters. If incomes all fall and thus the costs of labour has fallen, companies’ costs positions go down in a greater percentage to their overall cost base so they remain profitable, then there is no system-wide depression as this adjustment process (bringing costs into line with expenditure and making business profitable once more) takes place. Relative cost and income matters, not absolute cost and income.
Milliband says:
I am an economic realist….The government also has no plan for jobs…. Instead, it should focus on the jobs deficit: the 2.5m people looking for work. Sweden made halving unemployment its priority during its 1990s fiscal consolidation.
Jobs for sure should be the centrepiece of any economic policy and I will come back to this later….
Sadly he demonstrates that his knowledge of economic history is very poor. For example:
Britain is repeating Japan’s response to its crisis: pulling stimulus too early, raising value added tax and relying too heavily on monetary policy – leading to unemployment and stagnation.
Japan has had the biggest increases in its money base and the largest sustained fiscal expenditures thrust upon it. It is the Keynesian belief in demand management that has all failed over the last 20 years. Yes – 20 years. This nation has been postponing its reckoning for two decades. When you find that the Imperial Palace in Tokyo (3.5 km sq patch of land) was worth more that the whole value of property in California, the word “bubble” comes to mind. For sure, there are still many system-wide adjustments that need to take place before that nation emerges out of its fiscal and monetary incontinence. With Miliband under such delusions we should be getting worried that this no doubt well-meaning politician could do so much damage to us as a nation, just like his old boss. That nightmare just finished and I do not want to go back there soon!
He has identified five steps to renew Britain.
Step 1: Create a British Investment Bank.
This is very irritating indeed; we have a whole slew of banks, private equity and venture capital. The last thing we need is the State becoming the allocator of capital. Professional investors or lenders lend to opportunities that have a very good chance of creating wealth. The only purpose of having a State owned bank is so that it can lend based on political criteria, otherwise why do it? This will cause more bad investment and slow down the process of the liquidation of the bad investments we have already. This really is far too important an area of society for the government to get involved with; they simply do not have the skill or understanding.
If he really wants to lift the lid off growth and release the true creativity of all entrepreneurs he should consider the following:
Abolish Corporation Tax in full so that all businesses can use their own retained profits to facilitate further investment in them and not be reliant on bank funding. This was how things were done in the Industrial Revolution.
Abolish Capital Gains Tax in full so that entrepreneurs are incentivized to create more businesses with our reward of getting a tax free gain. Sir Gus O’Donnell initiated, via Gordon Brown, the most favourable CGT regime in living memory. I was staggered at the time that a Labour government could actually have such great vision. It put the business community right at the heart of Labour. Miliband would do well to remember this, should he wish to get the support of business again.
Abolish Inheritance Tax in full. This will stop the crazy incentive of having to avoid tax by going into exile, or doing some very fancy and expensive tax planning so you can build great intergenerational wealth that is built upon and passed down through generations for the ongoing benefit of many people. This nation was built on great big industrial and financial fortunes created this way. The more the State confiscates and sets up perverse incentives to avoid and leave the nation, the more impoverished we will become.
This line of thinking applies to all of those taxes.
Corporation Tax is due to be around £35 bn and the other two raise approx £5bn in total. This is currently also what we pay in terms of interest payments for the national debt, a burden which significantly increased under the last Labour government.
This July the two big State owned banks, RBS and Lloyds, missed the lending targets set by their last political masters by nearly £17 bn.
We pay nearly 6 million people in this country to do nothing, being either unemployed or on incapacity benefit. What a colossal waste of human resources, and a staggering affront to human dignity. If each one of them with all their benefits was costing us £6,667 per year, this would be £40bn a year. If the private sector was released from the corresponding tax burden, it would have the means to create jobs and wealth. £40 bn a year more in the hands of businesses would prompt a jobs revolution that could well take most of these people off benefits and into work.
This is what Miliband and indeed all politicians should be brave enough to be thinking, but the Miliband plan shows no such enlightenment …
Step 2: Get 60% of people into University
This is often said by well meaning well educated middle class people. They want to see Oliver Twist blossom. There is, of course, nothing wrong with this, indeed all people should be encouraged to achieve their potential – but so should the Artful Dodgers. It is not possible for all people to be like the middle class, well-educated Miliband. Where is the respect for the artisan? Where are the technological colleges to educate our carpenters, butchers, mechanics, fishmongers, and plumbers. All these critical skills are severely undervalued and are being worked by an increasingly imported in work force which does value these skills.
Instead, Miliband should be thinking about doing the following:
Abolish the minimum wage for all people aged under 21 years old and let employers pay anybody anything if they can prove that they are putting a young person through a artisanal skill based training program that could well lead to a job. A young lad living with his mother aged 16 is largely no use to man nor beast until he has gained experience and at £240 per week (plus NI etc) a plumber would not bother to take him on as he would not produce that benefit for maybe a couple of years which would make it worthwhile to invest in the employment and training of this person.
The next gem from Miliband involves the magical mystery multiplier:
Step 3: Deploy the public sector “to invigorate local economies by maximizing the multiplier effect of public services
I tell you no lie! I will not even bother to comment on this suggestion. The thought of those crack troops of bloated inefficiency trying to organize a fairly lean private sector will send us into the dark ages.
Miliband would do well to read this article which also shows why the multiplier is a myth. Here is one quote from it:
If I have £100 and I spend it on goods and services, my demand to hold cash or my money demand goes down by £100 and I receive goods and services in exchange. The person(s) who sold me the goods and services receives the £100 in exchange for those goods and services and his demand for a cash balance, or money demand has gone up. Where is the multiplier in this? It does not exist
Meanwhile, back in Miliband land …
Step 4: Increase productivity “and the quality of work in low pay, low value sectors of the economy.”
I am not sure what this means but I could not disagree with the desire to increase productivity. This is the only aim of capitalist entrepreneurs. I try to use the existing factors of production in better and more efficient ways over time to get better products and services for my customers. The only thing that gets in the way of this is endless pronouncements and laws from various government departments here and in Europe. If Miliband is advocating a total abolition of all this garbage, then great. Somehow I suspect he is advocating better meaning meddling, which will have exactly the opposite effect.
I suspect the low quality and value sectors comment is political rhetoric. Needless to say, 100 years ago if you had electricity you were a prince among men. Now, I would think it is 99.9% of our country. The onward accumulation of wealth, built upon the shoulders of our ancestors via the operation of private business – and not government – ensures that the maximum number of people are lifted out of poverty. Not allowing the creative talents of people to freely express themselves, by having things like the minimum wage, is an affront to the Judeo-Christian ethic upon which this society is built and will ensure that Miliband’s objectives are hampered. If paying people more were the answer, we could stop poverty today by not just having a minimum wage of £5.93 per hour but £593 per hour. The absurdity of this is plain to see. However, not so plain to Miliband who is obsessed with the underconsumptionist fallacies mentioned above.
Step 5: Produce an industrial strategy, “marshalling the state’s tools of procurement, regulation, planning and taxation to attract the private sector where it is needed most”
He goes on to say: “We can learn from Portugal’s initiative on infrastructure for electric car-charging, a viable commercial case for investment in manufacturing. Germany’s renewable energy policy combined feed-in tariffs with regional development areas and research, creating more than 300,000 jobs. Israel’s incentives-based approach to commercializing university research has taken it to the top of the innovation charts. Globally, governments are helping to expand the economic pie.”
The government can only take what the private sector generates. It does not own factories producing things that create wealth. It spends wealth that would otherwise have been spent by the private sector on things that people actually value.
He concludes
At the last election Labour could not find a single business to support its economic policy. I am determined to put this right – and lead Labour into again becoming the party of spreading wealth creation, not just spreading wealth. It is not good politics to have bad economics.
Sadly for Miliband I suspect that that will still be the case should he get in power! I hope his period in opposition allows him to reflect on why the people have put him out in the cold. I hope he learns a bit of economics as well, and visits factories, enterprises, banks, and other businesses at the coal face, and talks to people who are involved in the creation of the wealth of our nation. I hope he asks them how they would go about creating more wealth. If he does this, and reflects sincerely, he must surely realise the secret to our nation’s future prosperity lies not in what government can do, but in what it can stop doing.
We are delighted to bring you a great letter exchange from history where in public debate Keynes traded economic blows with Hayek over causes and solutions to the Great Depression in the letter columns of The Times. A mirror image of this debate, sadly still raging some 80 years later, took place in the letter columns of the Financial Times and the Sunday Times between the fantastic biographer of Keynes, Lord Skidelsky and Prof Tim Besley of the LSE.
Why have we not learned anything? Why does this debate continue today? Who if anyone “won” and who “lost.”
Is this spectacular video summary of the older debate still relevant today?
Readers what do you have to say on the matter?
The Times, Monday, October 17, 1932 (p13)
PRIVATE SPENDING
MONEY FOR PRODUCTIVE INVESTMENT
A COMMENT BY ECONOMISTS
TO THE EDITOR OF THE TIMES
Sir, —On October 10 you gave prominence in your columns to a letter inviting
the opinion of economists on the problem of private spending. There are a
large number of economists in this country, and nobody can claim to speak
for all of them. The signatories of this letter have, however, in various
capacities, devoted many years to the consideration of economic problems. We
do not think that many of our colleagues would disagree with what we are
about to say.
In the period of the War it was a patriotic duty for private citizens to cut
their expenditure on the purchase of consumable goods and services to the
limit of their power. Some sorts of private economy were, indeed, more in
the national interest than others. But, in some degree, all sorts of economy
set free resources — man-power, machine-power, shipping-power— for use by
the Government directly or indirectly in the conduct of the War. Private
economy implied the handing over of these resources for a vital national
purpose. At the present time, the conditions are entirely different. If a
person with an income of £1,000, the whole of which he would normally spend,
decides instead to save £500 of it, the labour and capital that he sets free
are not passed over to an insatiable war machine. Nor is there any assurance
that they will find their way into investment in new capital construction by
public or private concerns. In certain cases, of course, they will do this.
A landowner who spends £500 less than usual in festivities and devotes the
£500 to building a barn or a cottage, or a business man who stints himself
of luxuries so that he can put new machinery into his mill, is simply
transferring productive resources from one use to another. But, when a man
economizes in consumption, and lets the fruit of his economy pile up in bank
balances or even in the purchase of existing securities, the released real
resources do not find a new home waiting for them. In the present conditions
their entry into investment is blocked by lack of confidence. Moreover,
private economy intensifies the block. For it further discourages all those
forms of investment — factories, machinery, and so on— whose ultimate
purpose is to make consumption goods. Consequently, in present conditions,
private economy does not transfer from consumption to investment part of an
unchanged national real income. On the contrary, it cuts down the national
income by nearly as much as it cuts down consumption. Instead of enabling
labour-power, machine-power, and shipping-power to be turned to a different
and more important use, it throws them into idleness.
Conduct in the matter of economy, as of most other things, is governed by a
complex of motives. Some people, no doubt, are stinting their consumption
because their incomes have diminished and they cannot spend so much as
usual; others because their incomes are expected to diminish and they dare
not do so. What it is in any individual’s private interest to do and what
weight he ought to assign to that private interest as against the public
interest, when the two conflict, it is not for us to judge. But one thing
is, in our opinion, clear. The public interest in present conditions does
not point towards private economy; to spend less money than we should like
to do is not patriotic.
Moreover, what is true of individuals acting singly is equally true of
groups of individuals acting through local authorities. If the citizens of a
town wish to build a swimming-bath, or a library, or a museum, they will
not, by refraining from doing this, promote a wider national interest. They
will be “martyrs by mistake” and, in their martyrdom, will be injuring
others as well as themselves. Through their misdirected good will the
mounting wave of unemployment will be lifted still higher.
We are your obedient servants,
D. H. MACGREGOR (Professor of Political Economy in the University of
Oxford),
A. C. PIGOU (Professor of Political Economy in the University of Cambridge),
J. M. KEYNES,
WALTER LAYTON,
ARTHUR SALTER,
J. C. STAMP
The reply was published two days later:
The Times, Wednesday, October 19, 1932 (p10)
SPENDING AND SAVING
PUBLIC WORKS FROM RATES
TO THE EDITOR OF THE TIMES
Sir,— The question whether to save or whether to spend, which has been
raised in your columns, is not unambiguous. It involves three separate
issues:—(1) Whether to use money or whether to hoard it; (2) whether
to spend money or whether to invest it; (3) whether Government
investment is on all fours with investment by private individuals.
While we do not wish to over-stress the nature of our differences with
those of our professional colleagues who have already written to you
on these subjects, yet on certain points that difference is
sufficiently great to make the expression of an alternative view
desirable.
(1) On the first issue—whether to use one’s money or whether to hoard
it—there is no important difference between us. It is agreed that
hoarding money, whether in cash or in idle balances, is deflationary
in its effects. No one thinks that deflation is in itself desirable.
(2) On the question of whether to spend or whether to invest our
position is different from that of the signatories of the letter which
appeared in your columns on Monday. They appear to hold that it is a
matter of indifference as regards the prospects of revival whether
money is spent on consumption or on real investment. We, on the
contrary, believe that one of the main difficulties of the world
to-day is a deficiency of investment—a depression of the industries
making for capital extension, &c., rather than of the industries
making directly for consumption. Hence we regard a revival of
investment as particularly desirable. The signatories of the letter
referred to, however, appear to deprecate the purchase of existing
securities on the ground that there is no guarantee that money will
find its way into real investment. We cannot endorse this view. Under
modern conditions the security markets are an indispensable part of
the mechanism of investment. A rise in the value of old securities is
an indispensable preliminary to the flotation of new issues. The
existence of a lag between the revival in old securities and revival
elsewhere is not questioned. But we should regard it as little short
of a disaster if the public should infer from what has been said that
the purchase of existing securities and the placing of deposits in
building societies, &c., were at the present time contrary to public
interest or that the sale of securities or the withdrawal of such
deposits would assist the coming of recovery. It is perilous in the
extreme to say anything which may still further weaken the habit of
private saving.
But it is perhaps on the third question—the question whether this is
an appropriate time for State and municipal authorities to extend
their expenditure—that our differences with the signatories of the
letter is most acute. On this point we find ourselves in agreement
with your leading article on Monday. We are of the opinion that many
of the troubles of the world at the present time are due to imprudent
borrowing and spending on the part of the public authorities. We do
not desire to see a renewal of such practices. At best they mortgage
the Budgets of the future, and they tend to drive up the rate of
interest—a process which is surely particularly undesirable at this
juncture when the revival of the supply of capital to private industry
is an admittedly urgent necessity. The depression has abundantly shown
that the existence of public debt on a large scale imposes frictions
and obstacles to readjustment very much greater than the frictions and
obstacles imposed by the existence of private debt. Hence we cannot
agree with the signatories of the letter that this is a time for new
municipal swimming baths, &c., merely because people “feel they want”
such amenities.
If the Government wish to help revival, the right way for them to
proceed is, not expenditure, but to abolish those restrictions on
trade and the free movement of capital (including restrictions on new
issues) which are at present impeding even the beginning of recovery.
We are, Sir, your obedient servants,
T.E. GREGORY, Cassel Professor of Economics,
F. A. VON HAYEK, Tooke Professor of Economic Science and Statistics,
ARNOLD PLANT, Cassel Professor of Commerce,
LIONEL ROBBINS, Professor of Economics
University of London, Oct. 18
Almost eight decades later, the debate over public spending continues:
The Sunday Times, February 14, 2010
UK ECONOMY CRIES OUT FOR CREDIBLE RESCUE PLAN
IT IS now clear that the UK economy entered the recession with a large structural budget deficit. As a result the UK’s budget deficit is now the largest in our peacetime history and among the largest in the developed world.
In these circumstances a credible medium-term fiscal consolidation plan would make a sustainable recovery more likely.
In the absence of a credible plan, there is a risk that a loss of confidence in the UK’s economic policy framework will contribute to higher long-term interest rates and/or currency instability, which could undermine the recovery.
In order to minimise this risk and support a sustainable recovery, the next government should set out a detailed plan to reduce the structural budget deficit more quickly than set out in the 2009 pre-budget report.
The exact timing of measures should be sensitive to developments in the economy, particularly the fragility of the recovery. However, in order to be credible, the government’s goal should be to eliminate the structural current budget deficit over the course of a parliament, and there is a compelling case, all else being equal, for the first measures beginning to take effect in the 2010-11 fiscal year.
The bulk of this fiscal consolidation should be borne by reductions in government spending, but that process should be mindful of its impact on society’s more vulnerable groups. Tax increases should be broad-based and minimise damaging increases in marginal tax rates on employment and investment.
In order to restore trust in the fiscal framework, the government should also introduce more independence into the generation of fiscal forecasts and the scrutiny of the government’s performance against its stated fiscal goals.
Tim Besley, Sir Howard Davies, Charles Goodhart, Albert Marcet, Christopher Pissarides and Danny Quah, London School of Economics;
Meghnad Desai and Andrew Turnbull, House of Lords;
Orazio Attanasio and Costas Meghir, University College London;
Sir John Vickers, Oxford University;
John Muellbauer, Nuffield College, Oxford;
David Newbery and Hashem Pesaran, Cambridge University;
Ken Rogoff, Harvard University;
Thomas Sargent, New York University;
Anne Sibert, Birkbeck College, University of London;
Michael Wickens, University of York and Cardiff Business School;
Roger Bootle, Capital Economics;
Bridget Rosewell, GLA and Volterra Consulting
The advocates of continued borrow-and-spend replied in the FT:
The Financial Times, Thursday, February 18, 2010
FIRST PRIORITY MUST BE TO RESTORE ROBUST GROWTH
Sir, In their letter to The Sunday Times of February 14, Professor Tim Besley and 19 co-signatories called for an accelerated programme of fiscal consolidation. We believe they are wrong.
There is no disagreement that fiscal consolidation will be necessary to put UK public finances back on a sustainable basis. But the timing of the measures should depend on the strength of the recovery. The Treasury has committed itself to more than halving the budget deficit by 2013-14, with most of the consolidation taking place when recovery is firmly established. In urging a faster pace of deficit reduction to reassure the financial markets, the signatories of the Sunday Times letter implicitly accept as binding the views of the same financial markets whose mistakes precipitated the crisis in the first place!
They seek to frighten us with the present level of the deficit but mention neither the automatic reduction that will be achieved as and when growth is resumed nor the effects of growth on investor confidence. How do the letter’s signatories imagine foreign creditors will react if implementing fierce spending cuts tips the economy back into recession? To ask – as they do – for independent appraisal of fiscal policy forecasts is sensible. But for the good of the British people – and for fiscal sustainability – the first priority must be to restore robust economic growth. The wealth of the nation lies in what its citizens can produce.
Lord Skidelsky, Emeritus Professor of Political Economy, University of Warwick, UK
Marcus Miller, Professor of Economics, University of Warwick, UK
David Blanchflower, Bruce V. Rauner Professor of Economics, Dartmouth College, US and University of Stirling, UK
Kern Alexander, Professor of Law and Economics, University of Zurich, Switzerland
Martyn Andrews, Professor of Econometrics, University of Manchester, UK
David Bell, Professor of Economics, University of Stirling, UK
William Brown, Montague Burton Professor of Industrial Relations, University of Cambridge, UK
Mustafa Caglayan, Professor of Economics, University of Sheffield, UK
Victoria Chick, Emeritus Professor of Economics, University College London, UK
Christopher Cramer, Professor of Economics, SOAS, London, UK
Paul De Grauwe, Professor of Economics, K. U. Leuven, Belgium
Brad DeLong, Professor of Economics, U.C. Berkeley, US
Marina Della Giusta, Senior Lecturer in Economics, University of Reading, UK
Andy Dickerson, Professor in Economics, University of Sheffield, UK
John Driffill, Professor of Economics, Birkbeck College London, UK
Ciaran Driver, Professor of Economics, Imperial College London, UK
Sheila Dow, Emeritus Professor of Economics, University of Stirling, UK
Chris Edwards, Senior Fellow, Economics, University of East Anglia, UK
Peter Elias, Professor of Economics, University of Warwick, UK
Bob Elliot, Professor of Economics, University of Aberdeen, UK
Jean-Paul Fitoussi, Professor of Economics, Sciences-po, Paris, France
Giuseppe Fontana, Professor of Monetary Economics, University of Leeds, UK
Richard Freeman, Herbert Ascherman Chair in Economics, Harvard University, US
Francis Green, Professor of Economics, University of Kent, UK
G.C. Harcourt, Emeritus Reader, University of Cambridge, and Professor Emeritus, University of Adelaide, Australia
Peter Hammond, Marie Curie Professor, Department of Economics, University of Warwick, UK
Mark Hayes, Fellow in Economics, University of Cambridge, UK
David Held, Graham Wallas Professor of Political Science, LSE, UK
Jerome de Henau, Lecturer in Economics, Open University, UK
Susan Himmelweit, Professor of Economics, Open University, UK
Geoffrey Hodgson, Research Professor of Business Studies, University of Hertfordshire, UK
Jane Humphries, Professor of Economic History, University of Oxford, UK
Grazia Ietto-Gillies, Emeritus Professor of Economics, London South Bank University, UK
George Irvin, Professor of Economics, SOAS London, UK
Geraint Johnes, Professor of Economics and Dean of Graduate Studies, Lancaster University, UK
Mary Kaldor, Professor of Global Governance, LSE, UK
Alan Kirman, Professor Emeritus Universite Paul Cezanne, Ecole des Hautes Etudes en Sciences Sociales, Institut Universitaire de France
Dennis Leech, Professor of Economics, Warwick University, UK
Robert MacCulloch, Professor of Economics, Imperial College London, UK
Stephen Machin, Professor of Economics, University College London, UK
George Magnus, Senior Economic Adviser to UBS Investment Bank
Alan Manning, Professor of Economics, LSE, UK
Ron Martin, Professor of Economic Geography, University of Cambridge, UK
Simon Mohun, Professor of Political Economy, QML, UK
Phil Murphy, Professor of Economics, University of Swansea, UK
Robin Naylor, Professor of Economics, University of Warwick, UK
Alberto Paloni, Senior Lecturer in Economics, University of Glasgow, UK
Rick van der Ploeg, Professor of Economics, University of Oxford, UK
Lord Peston, Emeritus Professor of Economics, QML, London, UK
Robert Rowthorn, Emeritus Professor of Economics, University of Cambridge, UK
Malcolm Sawyer, Professor of Economics, University of Leeds, UK
Richard Smith, Professor of Econometric Theory and Economic Statistics, University of Cambridge, UK
Frances Stewart, Professor of Development Economics, University of Oxford, UK
Joseph Stiglitz, University Professor, Columbia University, US
Andrew Trigg, Senior Lecturer in Economics, Open University, UK
John Van Reenen, Professor of Economics, LSE, UK
Roberto Veneziani, Senior Lecturer in Economics, QML, UK
John Weeks, Professor Emeritus Professor of Economics, SOAS, London, UK
This was written in 1826, when the government was trying still to pay for the Napoleonic War. Peel used what has now become the Keynesian mantra that we should not worry about the National Debt as it was all owed to ourselves, as Keynes in fact did argue in the next Century. Our very own Gordon Brown also uses this argument as we sadly know as he is also inspired by these quack doctrines.
The poem is light hearted on such a heavy issue: enjoy!
(SUNG IN THE CHARACTER OF BRITANNIA.)
“The Public Debt is due from ourselves to ourselves, and resolves itself into a Family Account.”–_Sir Robert Peel’s Letter_.
Tune–_My banks are all furnisht with bees_.
My banks are all furnisht with rags,
So thick, even Freddy can’t thin ‘em;
I’ve torn up my old money-bags,
Having little or nought to put in ‘em.
My tradesmen are smashing by dozens,
But this is all nothing, they say;
For bankrupts since Adam are cousins,–
So, it’s all in the family way.
My Debt not a penny takes from me.
As sages the matter explain;–
Bob owes it to Tom, and then Tommy
Just owes it to Bob back again.
Since all have thus taken to _owing_,
There’s nobody left that can _pay_;
And this is the way to keep going,–
All quite in the family way.
My senators vote away millions,
To put in Prosperity’s budget;
And tho’ it were billions or trillions,
The generous rogues wouldn’t grudge it.
‘Tis all but a family _hop_,
‘Twas Pitt began dancing the hay;
Hands round!–why the deuce should we stop?
‘Tis all in the family way.
My laborers used to eat mutton,
As any great man of the State does;
And now the poor devils are put on
Small rations of tea and potatoes.
But cheer up, John, Sawney, and Paddy,
The King is your father, they say;
So even if you starve for your Daddy,
‘Tis all in the family way.
My rich manufacturers tumble,
My poor ones have nothing to chew;
And even if themselves do not grumble
Their stomachs undoubtedly do.
But coolly to fast _en famille_,
Is as good for the soul as to pray;
And famine itself is genteel,
When one starves in a family way.
I have found out a secret for Freddy,
A secret for next Budget day;
Tho’ perhaps he may know it already,
As he too’s a sage in his way.
When next for the Treasury scene he
Announces “the Devil to pay,”
Let him write on the bills, “_nota bene_,
“‘Tis all in the family way.”
Do you think it is very worrying that not one government policy encourages the entrepreneurs of the world to create wealth?
Without wealth creation we are doomed to a long slow decline in the productive capacity of the economy. We are doomed to the stagnating to slow growth economy that all the policies of our Great Leader, Gordon Brown, is inflicting upon us. It is all because he does not understand how wealth is created and the role of entrepreneurship in society. Most politicians are the same, I am afraid to say, with a few shining lights and notable exceptions. This is desperately worrying for all of us.
How is Wealth Created?
I have said here on this site before http://www.cobdencentre.org/2009/09/can-the-manipulation-of-interest-rates-create-wealth/ “I would like you to absent the concept of money and consider a situation of barter. As a butcher, when I kill an animal, I may get for the sake of argument, 10 cuts of meat: this is my production. I only need 2 for my immediate consumption, so with the remaining 8 cuts, I trade with Andrew, a garment manufacturer, for some garments to keep me warm. I consume 2 cuts and I save 8 cuts in order to trade for other goods and services. I need to produce to consume: I need to save/invest to consume.
“If I wish to consume more of Andrew’s garments as I have a family to dress and keep warm, 8 cuts of meat may well not be enough to purchase these new needs and requirements of mine. At this point in time, I am faced with a choice, either my production has to increase so I can generate more cuts to exchange for other goods, or I accept my fate and stay where I am. I decide that I can invent a method of cutting up the parts quicker by using a sharper knife, thus I seek to invent the “steel” or knife sharpener that improves my productivity from generating 10 cuts in a day to 15. With these 5 extra cuts, I can get more garments.
“The problem is, that in order to get the steel built, I need to spend some of my time that would be making the 10 cuts. Thus, I have to save and forgo some consumption while I have the steel built. I also have to rely on my savings — those stored cuts of meat — that I have not consumed to keep me afloat. This is what an economist may mean when he says adding capital to an economy lengthens the structure of production. The steel in this example adds a stage to the capital structure of society, to make me more productive, so I can consume more things.
“To be clear, saving is the only thing that allows this to happen. In this example, my personal capital structure has gone from me with a knife in my hand consuming two cuts a day and exchanging 8 saved portions, to me and a knife and a steel to produce 15 cuts of which I consume 2 and exchange 13 saved cuts. Now Andrew will be doing the same, i.e. lengthening his structure of production to meet my new found desires for more goods. He will also have to save — i.e. forgo consumption — to invest with the sustenance that savings gives him, to become more “capitalistic” or capital intensive in his production structure, to meet my demand.”
In summary, during the passage of time, only an act of saving to invest in a longer capitalistic method of production can lead to more goods and services being produced and consumed.No amount of creating money out of thin air creates more goods and services.
The Austrian School Role of the Entrepreneur in Economics
Humans Act
One of the great contributions of Ludwig von Mises to our understanding of the world, in his book ‘Human Action’ is that humans act and they act purposefully to satisfy their most urgent needs and requirements. Absent action and you would not have a moving human society, but a static world with no existence at all. We rank our most immediate preferences first and our most remote preferences last, thus we always have a downward sloping demand curve for things.
Sub Categories of Action: the Entrepreneur
All men act, they are in economic theory either an entrepreneur, a capitalist, a landowner, a worker or a consumer. These are ideal types, ideal styles. The reality is that we are all a combination of more than one of the above.
In the real world everybody is an entrepreneur except the children and elderly we look after, and wards of state that we pay in various forms to do nothing, such as the unemployed and those on incapacity benefit.
Israel Kirzner shows us in his books ‘Competition and Entrepreneurship’ and also in ‘Perception, Opportunity, and Profit’, how the spontaneous discovery of new opportunities by alert individuals is a defining characteristic of entrepreneurship. For example, a man who is more alert than another to satisfying the most urgent needs and requirements of other men, such as Bill Gates in inventing Microsoft and its worldwide and world changing software is rewarded by his fellow consumer entrepreneurs more so than the man who comes and fixes the boiler as he is providing a more valuable and needed service. Gates’s unique ability over the years to be alert to the potential opportunity, to think, to create to make happen, makes him the richest man in the world.
The Economy as Dynamic Creative Process
De Soto, in his books ‘The Theory of Dynamic Efficiency’ and ‘The Austrian School, Market Order and Entrepreneurial Creativity’ shows us that as the economy is predicated by acting man seeking ways to satisfy his most urgent needs and requirements first, and with limited resources, everything in politics should be geared to letting the full creative talents of the most humble entrepreneur to the giants on entrepreneurship flourish. Past Popes such as John Paul the II and Leo XIII, in ‘Centesimus Annus’ and ‘Rerun Novarum’ have been wonderful in expressing the moral ethic of human being s able to express our own creativity unhindered so long as we hinder no one else.
To our current political class, astonishingly, it is never about creating, but about distributing: X, the group of more deserving persons, is going to get Y taken from them, and it will be promptly redistributed to the less deserving class. In most cases the less deserving class is the successful entrepreneur who has satisfied the most urgent needs of consumers the most and been rewarded for doing so by his consumers!
How the Political Class Understands Economics: the Neo-classical Way
Lord Lionel Robbins, a great early Austrian School economist from the LSE, sadly left us with a very negative legacy concerning entrepreneurship in his otherwise exceptional book, ‘An Essay on The Nature and Significance of Economic Science’. My copy is online here, http://mises.org/books/robbinsessay2.pdf This would be the starting point marking when economics is described as the science which studies the utilisation of scare resources which may be put to alternative uses in order to satisfy human needs. So the economic problem is a technical one of allocation.
This contrasts with the real world creative dynamic actors who are constantly alert to creating new means to satisfy new ends by using all their creative talents and those of others they can muster in order to satisfy the largest number of ends. This is entrepreneurship as a discovery process. No economics is about choosing between competing uses to satisfy set ends.
In the Neoclassical world – and we must remember the School of Keynes and Friedman, the Keynesians and the Monetarist are but subsections of the Neoclassical School – it is impossible for there to be pure entrepreneurial profit or genuine discovery, as they are enclosed in a world where there is call for intervention in the distribution of scarce resources. Technical allocation is the height of the Neoclassical Mission. The man who ‘discovers’ the wheel, the internal combustion engine, the computer etc are all acts of great creativity and are examples of where pure entrepreneurial profit is generated. To the technician/administrator/bureaucrat/resource allocator of the Neoclassical School, there is no role for this, but when it does happen, lo and behold there is a role of how to technically allocate its benefits!
The Role of Knowledge and Information
I was fortunate to study under Dr Robert Orr at the LSE who was a protégé of the outstanding political philosopher, Michael Oakeshott. I will never forget my first introduction to his 1962 classic book, ‘Rationalism in Politics’, where Oakeshott cleverly distinguished between “practical knowledge” and “scientific knowledge.” The former he describes as the dispersed know-how that we all have that allows us to do things that cannot be formalised, like the tacit knowledge a cook has when he/she cooks a fantastic dinner. Putting the food together in various combinations and heating for various times are, after all, simple acts that could be described in a very formulaic fashion. But how many of us have that practical, unquantifiable knowledge to cook an outstanding dinner? The former, formulaic knowledge, is the scientific knowledge or technical knowledge that we can formalise such as the knowledge of science itself. The study of entrepreneurship or economics in general is about the study of which entrepreneurs use this practical knowledge to bring about co- ordination and more goods and services by doing more things to satisfy more people. Scientific knowledge may boost this process as entrepreneurs exploit the information that the scientific knowledge produces. The danger is when the people who study economics and the application of entrepreneurship or the use of this dispersed practical knowledge or know how think they can scientifically manage it.
Harmony / Coordination and not the Creative Destruction of Schumpeter
Technical direction by the ‘enlightened’ entrenched administrators who dominate large parts of our lives is no match for the co-ordinating forces of entrepreneurship. The price mechanism throws up information that suggests opportunities to alert entrepreneurs to supply goods and services or solutions to satisfy peoples’ most urgent needs. This co-ordination can never be facilitated by administrators. Each time a profit opportunity is found and then satisfied, a creative and co-ordinating act has happened. Entrepreneurship is coordination. Each act of entrepreneurship in fact smoothes out dis-co-ordination in society. It is the most civilising act. This is very different to the creative destruction of Joseph Schumpeter who, in ‘Capitalism , Socialism and Democracy’ says that entrepreneurs enter established industries that start to exercise some monopoly power, thus allowing a smaller, nimbler competitor to enter and value-destruct and then value re-create something new and better. Schumpeter, unlike his Austrian contemporary, Mises, viewed booms and busts to be caused by innovation and not by excessive credit creation.
The Austrian Approach
So for the Austrian, we all act to satisfy our ends. Some do it better than others, some do it to many others, and these latter entrepreneurs are, in truth, the dynamic, creative, co-ordinating and above all harmonious drivers of the economy and facilitators of a peaceful society. This is in direct contrast with the homo oeconomicus of Robbins and the Neoclassical School, whose modern members are Keynesians and Monetarists. Resource allocation between competing needs is the name of their game.
They conflate scientific knowledge with the practical. This allows them to advocate constant spending by a thing they describe as a third party: Government. Government is meant to inject new money into the economy to get us all moving again. There is a horrible inevitability here: like a Greek tragedy, it is played out on epic proportions. There is no such thing as a government standing above and separate from us that can stimulate us. The government can only take from one section of the population and give to other sections of the population. When they spend money, they are spending the money you would have spent. The positive government spending multiplier is exactly negated by the negative spending multiplier from where the government has extracted the money in the first place. The net effect is zero extra spending. However. It does not stop there. For a great dis-co-ordination in the practical knowledge of people will take place when a government spends as the entrepreneurs will now be confused as to which activity in the economy will produce a sustainable outcome. Which bits of price information are driven by the most urgent needs of consumers that needs satisfying? Which are driven by the technical director of some government department directing who he thinks – or his political master thinks – the given set of resources should be allocated?
We are told we should print more money. I tell no lie, I witnessed one economist, Roger Bootle, see here http://www.cobdencentre.org/2010/02/policy-exchange-and-the-near-consensus-on-the-merits-of-qe/ say we should, if need be, print money indefinitely until people knew we were so serious that we would not allow a deflation! He equates a growing money supply with more wealth. But a growing money supply without more goods and services means a lowering of each money unit’s purchasing power! This has nothing whatsoever to do with the creation of wealth, as I have demonstrated above. Both endless spending and endless printing of money are the policies of the mystic and witch doctor!
In conclusion,the correct and urgent policy for the political class must be to remove all restrictions on the ability of each person to use their best entrepreneurial endeavours. Each person can then take advantage of the practical knowledge that is out there and create, ex novo, new combinations of the factors of production to produce new things. Abolish all laws that prevent and hamper business unnecessarily; pro-union legislation; employment law excesses; presumption of guilt by you, the employer, for anything your staff does, thus absenting you from any individual responsibility. Stop paying the people who abuse the benefit system, who form the massive, larger than the army size workforce we have idle on unemployment and or incapacity benefit. Stop wasting resources going to war. Stop printing money and creating confusion as it is harder for an entrepreneur now more than ever to distinguish between what is or is not a bubble supported activity that is never going to be sustainable. This latter disruption in the co-ordinating ability of entrepreneurs to bring about economic harmony is the worst part of the legacy that this current government will gift the next.
Until they understand the nature of entrepreneurship, we are in for a prolonged and rough recession.
On Tuesday, I spoke at the IEA’s The State of the Economy conference, participating in a panel discussion on Fiscal Policy and Government Expenditure with Edmund Conway, Sir John Bourn, Graeme Leach and Danny Alexander MP.
In discussions about when to begin cuts, I flatly rejected Keynesianism, explaining that capital-based macroeconomics gives a quite different set of tools for thinking about the economy. This generated interest from students and professional economists present so I have updated our primer, adding The Causes of the Economic Crisis and Garrison’s macroeconomics slides.
I also recommend these articles as a quick-start to rethinking money, banking and economics:
One of the most persistent economic fallacies that permeates economics and politics is the notion that by government spending money, there will be more prosperity.
It is said that if one man spends a £1 the other man who gets this £1 may save £0.10 and spend £0.90. We now have £1.90 of spending. This chain of events can go on forever and a day until the final penny is spent. £1 can become like magic: £10.
When this is said to you by journalists, media people, economists, politicians and other monetary quacks, you should ask them, if the multiplier works, why do we not eliminate world poverty today by just spending lots of money and letting the multiplier do its work?
The theory, simply put, is that if someone spends, say, £1m on building a new restaurant, the money will go to the contractors , so consumption will rise , aggregate demand in the whole economy will rise. The contractors will spend money on their suppliers and so-on-and-so-forth. If the economy is not performing well, it is held that the government can step in and spend money where the private sector is not spending. This will lift back up aggregate demand and hey presto! we will go back to a satisfactorily performing economy.
Most economists will argue that the multiplier is greater than 1 x, therefore it is the role of government to boost aggregate demand. This can be done as a fiscal stimulus as proposed by all governments around the world at present.
There is a whole great series of maths behind this notion that is used to justify a fiscal stimulus even by way of deficit spending . See the notes section [i].
I strongly support efforts for a second fiscal stimulus plan designed to help the economy by early 2009. Like the first stimulus plan, it should be temporary and not raise the long-term budget deficit. The plan should also be targeted to help lower- and middle-income households and smaller businesses that will use the help quickly and aggressively to stimulate the economy.
Highlights
Mark Zandi argues in support of the second big USA fiscal stimulus plan of that year and says:
Extending food stamps is the most effective way to prime the economy’s pump. A $1 increase in food stamp payments boosts GDP by $1.73. People who receive these benefits are very hard-pressed and will spend any financial aid they receive within a few weeks. Because these programs are already operating, increased benefits can be quickly delivered to recipients.
And
On the face of it, increased infrastructure spending appears to be a particularly efficacious way to stimulate the economy. The boost to GDP from each $1 spent on building bridges and schools is estimated to be a large $1.59, and who could argue with the need for such infrastructure? The overriding limitation of such spending as a part of a stimulus plan, however, is that it generally takes a substantial amount of time for funds to flow to builders and contractors and into the broader economy.1 Many infrastructure projects can take years from planning to completion. Even if the funds are used to finance only those projects that are well along in their planning, it is difficult to know just when the projects will get under way and when the money will be spent. Another complication arising from infrastructure spending is the politics of apportioning these funds across the country in a logical and efficient way. Despite these caveats, if projects that could be started quickly can be identified, they could prove to be an efficacious stimulus.
He even supplies a table of the multiplier rates.
Fiscal Bang for the Buck
One-year $ change in real GDP per $ reduction in federal tax revenue or increase in spending
Tax Cuts
Nonrefundable Lump-Sum Tax Rebate 1.02
Refundable Lump-Sum Tax Rebate 1.26
Temporary Tax Cuts
Payroll Tax Holiday 1.29
Across the Board Tax Cut 1.03
Accelerated Depreciation 0.27
Permanent Tax Cuts
Extend Alternative Minimum Tax Patch 0.48
Make Bush Income Tax Cuts Permanent 0.29
Make Dividend and Capital Gains Tax Cuts Permanent 0.37
Cut Corporate Tax Rate 0.30
Spending Increases
Extend Unemployment Insurance Benefits1.64
Temporarily Increase Food Stamps 1.73
Issue General Aid to State Governments 1.36
Increase Infrastructure Spending 1.59
Source: Moody’s Economy.com
So faced with this weight of applied maths expounded by the majority of economists, why are we just not spending and spending as they suggest?
If I have £100 and I spend it on goods and services, my demand to hold cash or my money demand goes down by £100 and I receive goods and services in exchange. The person(s) who sold me the goods and services receives the £100 in exchange for those goods and services and his demand for a cash balance, or money demand has gone up. Where is the multiplier in this? It does not exist.
Money has passed from one participant in the economy to another participant in the economy in exchange for goods and services.
What we must be clear to watch here is this physical exchange that money facilitates.
Following Mark Zandi and the table above where he asserts, for example, that spending on food stamps will raise expenditure for every dollar spent by an extra $0.73 cents. Here he asserts the impossible: that when $1 of taxation is levied (and this means one $1 less of exchange for goods and services has taken place in the private sector), then this dollar, now given to a welfare recipient, will command $1.73 of expenditure on goods and services!
You can hopefully see that all that has happened is that, in the private sector, the money demanded has fallen by a dollar by way of the taxing of this wealth and the goods and services that would have been bought are now being bought by the welfare recipient. Even if, in the private sector, this $1 was not going to be spent, but saved, it is only being saved to be spent on a good or a service in the future. Nothing new is ever going to happen other than one dollar exercising a command over goods and services in the private sector or, if taken by taxation, then in the public sector.
If the private sector is deprived of its savings, then no investment will take place leading to an impoverishment of society.
As I have said before, here, the only way to create wealth is by saving a portion of our production, investing in more productive ways of doing things and focusing or reorganising those factors of production in better ways and combinations to produce more goods and services that people want at better prices than before.
There is so much error concerning Alice in Wonderland concepts such as the spending multiplier, that few people can see the wood from the trees. I despair!
so present consumption is a function of past income (with c as the marginal propensity to consume). Investment, in turn, is assumed to be composed of three parts:
It = I0 + I(r) + b (Ct – Ct-1)
The first part is autonomous investment, the second is investment induced by interest rates and the final part is investment induced by changes in consumption demand (the “acceleration” principle). It is assumed that 0 < b . As we are concentrating on the income-expenditure side, let us assume Ir = 0 (or alternatively, constant interest), so that:
It = I0 + b (Ct – Ct-1)
Now, assuming away government and foreign sector, aggregate demand at time t is:
Ytd = Ct + It = c0 + I0 + cYt-1 + b (Ct – Ct-1)
assuming goods market equilibrium (so Yt = Ytd), then in equilibrium:
Yt = c0 + I0 + cYt-1 + b (Ct – Ct-1)
But we know the values of Ct and Ct-1 are merely Ct = c0 + cYt-1 and Ct-1 = c0 + cYt-2 respectively, then substituting these in:
or, rearranging and rewriting as a second order linear difference equation:
Yt – (1 + b )cYt-1 + b cYt-2 = (c0 + I0)
The solution to this system then becomes elementary. The equilibrium level of Y (call it Yp, the particular solution) is easily solved by letting Yt = Yt-1 = Yt-2 = Yp, or:
(1 – c – b c + b c)Yp = (c0 + I0)
so:
Yp = (c0 + I0)/(1-c)
The complementary function, Yc is also easy to determine. Namely, we know that it will have the form Yc = A1r1t + A2r2t where A1 and A2 are arbitrary constants to be defined and where r1 and r2 are the two eigenvalues (characteristic roots) of the following characteristic equation:
r2 – (1+b )cr + b c = 0
Thus, the entire solution is written as Y = Yc + Yp
It should be noted that Table 1 estimates the change in GDP one year after the spending occurs and says nothing about how long it may take to cut a check to a builder for a new school. [↩]
Equity Strategist Ewen Stewart makes the case that the national debt will within 5 years be over £150,000 per family of 4 with debt repayments of twice the present defence budget, up from £31 billion in 2008/9 to £70 billion in 2013/14. He explains the root causes of our difficulties and indicates a route to recovery.
It’s all over. What a fuss about nothing. The economy will soon be growing again and, look, the FTSE100 is up almost 50% since the March low. Even house prices, according to the Halifax, have risen 6 months in a row. The doom mongers were wrong. Central Banks and Keynesian public spending programmes, together with QE, have worked. Brown indeed has saved the world!
Well that would be one interpretation and a very short sighted one too, for this recovery shows all the hallmarks of a drug addict who claims to be going straight injecting a further mighty dose of the substance that has caused such decay in the first place to prolong the party.
The problem is that the underlying fault lines in the UK economy remain and, thanks to the Government’s response, are even more pronounced.
The underlying problem is, in my view, an addiction to debt, a banking system which is over-leveraged, and now government finances that are out of control. This country that has been living considerably beyond its means for a very long time. Artificial efforts to prop this up, through printing money or inappropriately low interest rates, at best are a short term delaying tactic and at worst risk stoking a loss of confidence and ultimately inflation.
It is my central conjecture that much of the economic growth over the last decade was less the result of genuine private wealth creation but more the result of a number of unique factors which were both unsustainable in their nature and damaging to long term growth. If this view is correct the scale of the over-leverage and the action required to alleviate the problem become even more pronounced.
Toby Baxendale exposes flaws in the economic thinking of the left, indicates the dangers of deficit spending and points to a better way to fund welfare while stimulating genuine commercial investment.
Published in the FT on Friday the 2nd of October under the title “A cool look at the current deficit hysteria”, we find an article by a respected economist saying that there is nothing to worry about running a deficit at the present and predicted size. Our predicted budget deficit of 12.4% of GDP in the current financial year, gradually declining to 5.5% in 2013-14 is no big deal. Coupled with the public sector debt itself, we see it leveling out at 76% of GDP. Sir Samuel says “Debt ratios of this size are historically far from unprecedented. In the Victorian period the ratio was nearly 200% and almost reached that level again in the early 1920s. In 1956 it was just under 150 per cent.” He goes on to add, “the debt was gradually reduced from the peaks mentioned above without any heroic gestures.” In a classic Keynesian tone, he concludes “The big error of the current discussion is to confuse the budget balance of individuals and companies with the government budget balance, which needs to be in deficit so long as attempted savings exceed perceived investment opportunities. Gordon Brown more or less understands this, and I wish he would use his talents to explain such fundamentals instead of stirring up an outdated class war.”
For our international readers, Gordon Brown’s speech to the Labour Conference 2009 was a class war-laced speech worthy of some of the most envy driven and hating sections of the Left. The full text is available here, if you want to take yourself back to the start of the last century. I presume this is what Brittan refers to in the last quote.
Also deficit spending — living beyond our means — in the language of the left is “investment.” There are 5 references to this type of activity in this speech. I recall a timely quote to remember from Ludwig Von Mises in Human Action (Scholar’s Edition), Page P.737:
At the bottom of the interventionist argument there is always the idea that the government or the state is an entity outside and above the social process of production, that it owns something which is not derived from taxing its subjects, and that it can spend this mythical something for definite purposes. This is the Santa Claus fable raised by Lord Keynes to the dignity of an economic doctrine and enthusiastically endorsed by all those who expect personal advantage from government spending. As against these popular fallacies there is need to emphasize the truism that a government can spend or invest only what it takes away from its citizens and that its additional spending and investment curtails the citizens’ spending and investment to the full extent of its quantity.
How is Wealth Created?
As I have said on this web site before, wealth is created on the factory floors, in the boardrooms and in the offices of people making their factors of production — land, labour and capital — work better for them in satisfying the needs and requirements of their consumers. Invariably, this means those factors need to be brought together in better combinations or made more productive. The latter is the most common way and this almost always needs savings — i.e. forgone consumption — to invest in the newer, more productive processes.
Governments do not create wealth, they can only take it from A and give to B.
What does an Interest Rate do?
As I have said before on this web site:
Simply put, you value more highly present goods of the same quality and quantity than you do future goods. Furthermore, the value of future goods diminishes as the length of time necessary for their completion increases. This sets up a price differential between goods now or goods later. This price differential is called an interest rate.
In reality it is also the rate of profit in the economy, as it is these saved resources that are the only source of future funding for investment and the associated return on that investment. So it is arguable to say that this is the most important metric in the economy.
To underscore this, it is the saved resources of all the economic agents in society that produces the goods and the profits of the future. The return (interest) on the savings can only be the additional component that allows the additional investment in making the production structure — all those activities mentioned above going on in factories and offices — that will produce the new goods and services. The rate of return on these savings must in-fact be the rate of profit of that which is lent to enterprises.
How do we Fund a Deficit?
The Government Bond
If the government has taken less in tax receipts than it gives out in transfer payments i.e. it has deficit, then it will raise the difference on the whole through the selling of government bonds or “Gilts”. These are promises that the UK taxpayer will pay back the bond holder at a date in the future.
It is important to note here that the savings and investment process that ensures that saved resources are put to their most urgent investment needs, as described above, immediately becomes distorted when a government bond soaks up resources to go into the government coffers for spending and not into productive industry. In short, at the very time today when we need our best wealth creators, the owners of all the businesses in this country, to be firing on all cylinders, looking at making themselves more productive and selling goods and services more in tune with the new demands today, in this post-boom world, we have a policy of running a deficit which will starve these wealth creators of the wherewithal to start lifting us out of this mess.
Contrast this with the Corporate Bond
A wealth creator may sell a corporate bond to fund his investment activities. Thus we must also observe that when you work producing wealth, you create a surplus.
You had capital of £X and, by the end of the year, you have capital of £X + £Y. You can give a return — coupon or interest rate — back to your investor. The merry-go-round can start all over again with a greater level of wealth accruing in society.
With the government bond, capital is taken away form the citizen and the interest is extracted via the taxation system to pay the bond holder. There is no wealth created, only at best transferred to another person and at worst totally destroyed.
When the proceeds of the government bond are issued to people on the dole (2.6m) and people on incapacity benefit (2.7m), capital is completely destroyed and the tax payer then pays interest on nothing!
A Note on Welfare Spending and the Future Funding of Welfare Provision
We currently rob Pater to pay Paul: that is, we fund a good portion of our welfare budget via the on-going issuance of public debt, the need for which has arisen as we are not prepared to live within our means as a nation i.e. less tax is taken than is spent by HMG.
The Rt Hon Ian Duncan Smith MP has produced a report here called “Dynamic Benefits: Towards Welfare That Works” that starts the process of simplifying the system for the claimant and the administrator. This is very welcome and long overdue. It also starts the reversal of the process whereby, over the last 12 years of Labour Government, benefits have become so rewarding — in the sense that if you are on welfare and you take employment, your net pay decreases — there is a great incentive never to get off them. All of this is welcome.
However, what you need to do, in the smallest local regions possible, is create an insurance scheme in a mutual or let the old Friendly Societies — see here for a brief account of their great history — take subscriptions from the people in the area to provide welfare to the people who need it when they fall on hard times. This has the effect of forcing the Society to invest in productive business activities to get a return on their investment to pay any welfare claims.
Contrast a bond paying interest on nothing (no capital) like a government bond with a corporate bond generating wealth (paying interest on capital) which the old Friendly Societies used: the latter is beneficial to the economy because investment takes place. Government spending can only ever be a redistribution.
Summary:
As Ludwig Von Mises says in the Scholar’s Edition of Human Action p770/1:
If government spending is financed by taxing the citizens or borrowing from them, the citizens’ power to spend and invest is curtailed to the same extent as that of the public treasury expands. No additional jobs are created.
So the message I am hopefully giving here, with the best clarity that I can, is that deficit spending totally undermines the wealth creation process.
If the government is urged to step in and spend where the private sector sees no opportunity, as Sir Samuel says, this will only lead to more general impoverishment. Does it need saying that only wealth creators create wealth and not wealth re-distributors, that is, the government?
This gives rise to the notion that a public debt is no burden because we owe it to ourselves. Now in fairness to Brittan, he is not saying this, he is just saying that in the absence of enough opportunities for savings to be fully utilized, then the government should spend instead. I hope in the above I have demonstrated that if funded by bonds (the majority way), then this is in fact a set-back to recovery.
Liam Halligan has kindly agreed to publication of the transcript of his address to the Cobden Centre/Libertarian Alliance dinner on 30 September 2009.
INTRODUCTION
Thank you for asking me to address this meeting of the Libertarian Alliance. I’m most grateful to Tim Evans for arranging this evening and for inviting me along. I’m Liam Halligan – Chief Economist at Prosperity Capital Management. I also write a weekly economics column in The Sunday Telegraph – and have done for the last six years or so. I’m happy to be here – and I hope you find my contribution substantive and worthwhile, even if what I’m about to say, I admit, is unlikely to be a bundle of laughs.
For I intend to discuss the somewhat uncomfortable question of how future historians will look back on the period we’re currently living through. How will the sub-prime debacle be judged, ten or twenty years hence?
Now, consider this quotation. Then consider where and when it was written.
“There is growing recognition that the dispersion of credit risk by banks to a broader and more diverse group of investors … has helped make the banking and overall financial system more resilient …”
“The improved resilience may be seen in fewer bank failures and more consistent credit provision. Consequently the commercial banks may be less vulnerable today to credit or economic shocks”.
That was written by the International Monetary Fund, in their flagship publication – The Global Stability Report. The date of publication was April 2006. Just three years ago – but, as we all know, in terms of what’s happened since then, it’s been a very long three years indeed.
I cite the IMF’s report with the benefit of hindsight, of course, and not in an attempt to be smug. My Sunday Telegraph column first foresaw “a US recession soon” and “serious turbulence on financial markets across the world” in January 2007 – caused by the bursting of “a liquidity bubble”, itself pumped up by the growing use of derivatives”1.
My point is that when the IMF wrote what it did the previous April, I didn’t violently object. Almost nobody did. If I’m honest, the dangers of sub-prime only crystallised in my mind in early 2007 because of a speech given at Davos by Zhu Min – an official from China’s Central Bank. “There is money everywhere,” he said. “You can get liquidity from the market every second, for anything. That means people are investing in assets with no idea of the risks they are taking”. Wise words. How alarming we only fully understand their implications in retrospect.
The main point I want to make here today isn’t that the Western establishment’s view, and resulting policy actions, were wrong in April 2006 – when the IMF published the Global Stability Report that it’s now so easy to pick to pieces. That’s obvious.
My point isn’t that the establishment’s view and policies remained wrong when the likes of Zhu Min – and some Western economists too – where issuing stark warnings in early 2007.
My point is that the Western establishment’s view remains wrong, even today, and what we’re doing to tackle this crisis – this massive, systemic threat not only to our economic and social stability, but to the West’s entire claim to global dominance – what we’re doing to tackle this problem is making our predicament far, far worse.
That’s the point I believe will cause future historians to wince, when they come to examine this sub-prime debacle … that what we’re currently doing will do nothing to help us escape this crisis and is, in fact, sowing the seeds of the next financial meltdown which may not be long in coming.
Future historians will be aghast at the extent to which our current, wild policy stance is also shouldering our children and grandchildren with ever more debt – as if the demographic realities of our ageing Western societies weren’t enough of a fiscal burden already.
This economic trauma has been of our own making. There was no external oil embargo, no trade union militancy, no all-consuming war. Sub-prime was a problem we caused – the Western financial and political elite. Future historians will condemn us for it. But they will condemn us even more, in my view, for how we’re now responding to the crisis, for the self-destructive nature of the current policy consensus. Quantitative easing. Zombie banks. And, in the pipeline, inflating away our debts. Have we learnt nothing?
But future historians will say something else too. They’ll judge what sub-prime meant for Western hegemony. For in my view this crisis has ENDANGERED, and our limp-wristed response is now SQUANDERING, the Western world’s long-standing role as the bed-rock of global finance, along with all the material advantages, influence and claim to leadership that role brings.
Compare our spiralling debt and deficit levels, our now meagre reserves, our money printing antics with the growing strength, stability and confidence of the emerging giants of the East. This is another clear trend that I believe future historians will identify – how the sub-prime debacle, and the related loss of confidence in Western institutions and markets – accelerated and accentuated an already on-going shift in commercial and financial prowess from the large Western economies such as our own to the fast-growing emerging markets.
WHAT THE WEST SHOULD DO
So, what should the Western world do? Cast your mind back to last April’s G20 conference – when Gordon Brown, in his own words, “saved the world”
“Today’s decisions, won’t solve this crisis immediately,” said our so-called leader. “But we’ve begun the process by which it will be solved”.
It is on reading these words that future historians will wince. Brown’s words, the glitz surrounding the G20 summit, and the related relief-rally on global markets, amounts to pure escapism.
Because there is nothing in the language of the London summit communiqué, or the subsequent Pittsburgh summit communiqué, or in any of the political utterances from any of our mainstream politicians that amounts to anything other than vague platitudes. There is nothing that Brown has said, or Osborne, or – heaven help us – Nick Clegg – that even begins to describe, let alone address, the scale of the problem we face. Future historians will surely reach for the prozac.
We’ll get “a stronger regulatory framework for the future financial sector”, we’ve been told. But there isn’t even the prospect of a debate on resurrecting “Glass-Steagall” – the Depression-era firewall that, for almost sixty years, prevented investment banks, for the most part, from recklessly gambling with taxpayer-backed deposits.
Yet since those measures were swept away in the 1980s and 90s, the world has lurched from crisis to crisis. Politicians are petrified, though, of re-building that crucial barrier, constructed during the early 30s after the last almighty credit bubble burst, lest they annoy the money-men and jeopardise future campaign finance.
The G20 has “an unshakeable commitment to work together to restore jobs and growth”. Really? So how about finally agreeing a new over-arching trade liberalization agreement? The “Doha round” has been stalled for almost eight years. If ever we needed a global trade round, it’s now.
If the big G20 players were serious about global recovery they’d have done a deal on trade at either London or Pittsburgh, taking out an insurance policy against the rising tide of protectionism. But so fixated are they by parochial domestic interests and pork-barrel politics, so unwilling to stand up and make the often uncomfortable but palpably necessary arguments for free trade at this pivotal point in history that they pledged only to “prepare for a conclusion to the Doha round”. How woolly can you get?
And then, on top of this cowardice, comes the biggest mistake of all – the wildly expansionary fiscal and monetary policies that have been unleashed in response to this sub-prime fiasco. In my view, and the view of almost every non-journalistic, non-Westminster village, non-Whitehall, financially literate person I know, the recent rebirth of Keynesianism, and the rash of debt-financed “stimulus packages” has done enormous harm to the Western world’s reputation for sound financial management, to our ability to eventually grow out of this crisis, to our future debt-service costs and, ultimately, to our all important credit-ratings.
“We used to think you could spend your way out of recession by boosting government spending but I tell you now, in all candour, that option no longer exists.”
So said a beleaguered Jim Callaghan to the Labour party conference in 1976.
“And in so far as it did exist, it only worked on each occasion by injecting a bigger dose of inflation into the economy, followed by higher unemployment as the next step”.
The lesson that Prime Minister Callaghan learnt 33 years ago was hard won. The UK was deeply indebted and, of course, had famously gone “cap in hand” to the IMF. And yet, we’re now far more deeply indebted. The UK is heading for a fiscal deficit that, even on growth assumptions that have been torn apart by independent observers, is twice as high as that shouldered in the mid-1970s.
Yet in the UK, and US too, our leaders show absolutely no sign of understanding of the lessons of history, of grasping that Keynesian fiscal boosts don’t work. The Western world, already weakened by huge deficits and spiralling debts, has reacted to this crisis by taking on even more debt. Our leaders have taken the line of least resistance – handing-out money to various interest groups, tearing up the fiscal rules. Media commentators and academia have done nothing to stop them, barely raising a whimper.
Yet the lessons of history are undeniable – debt-financed “pump-priming” is ultimately self-destructive – not least in countries that already have high debts and fragile currencies.
Rather than head-line grabbing fiscal boosts, Western leaders should be grabbing their banking industry by the scruff of the neck – forcing it to come clean about the extent of it losses, so thawing our frozen credit markets, and getting our economies moving again. Until we do, the Western world will keep haemorrhaging jobs and foreclosures will keep rising – as credit-worthy firms and households are denied access to vital working capital.
We need to tackle the entrenched vested interests that caused this ghastly episode, and which are doing everything they can to milk it for all it is worth. Simon Johnson, the former chief economist of the IMF, wrote a staggering article in the May edition of Atlantic magazine. “The finance industry has effectively captured our government,” he observed. “Recovery will fail unless we break the financial oligarchy that is blocking essential reform”.
Future historians will praise Johnson not for his insight – because what he is saying is obvious – but for his courage. Johnson has displayed the bravery needed to point to the madness of the current policy consensus. He is almost the only top-ranking economist to do so. Yet what he is saying is little more than common sense.
Why are we keeping fundamentally insolvent banks alive? That’s what future historians will ask. What happened to Schumpeter’s creative destruction? Yes, I know Lehman caused a collective nervous break-down – but that wasn’t because it happened, but that it happened in such a random, disorderly way. The markets think Lehman, in particular, was allowed to collapse not because it was any more insolvent than any other number of Wall Street institutions. They feel Lehman collapsed because the US Treasury Secretary at the time, among others, had a personal dislike for Lehman’s Chief Executive.
That’s the point – there wasn’t and isn’t any hard information about the state of each of our major banks. So informed, objective analysis of which banks are solvent and which aren’t is impossible. Given this information vacuum, there is only rumour and innuendo. And where there is a vacuum, the markets assume the worst – not least the inter bank market.
That’s why we need full disclosure. The numbers will be ghastly. Bank shareholders – rightly, I’m afraid – will lose their shirts. Perhaps next time they’ll take more notice of how companies they own are being run, rather than simply banking the dividends and ogling at the capital gains as balance sheet leverage is cranked-up. Bond-holders, too, will also take a haircut. But, under a credible threat of bankruptcy, many will be convinced of the wisdom of swapping their debt for new equity, so allowing genuinely viable banks to recapitalise themselves from within.
Of course governments must take systemic risk seriously. But shareholders should still face the consequences of the choices they’ve made. The state, should, in extremis, protect bond-holders up to some level – but only those in fundamentally solvent banks. And, crucially, banks should be legally forced to “fully disclose” and then “write-down” their potential sub-prime losses BEFORE any further taxpayer-funded recapitalisation.
The Swedes took this hard-headed approach during their early 1990s banking crisis – more pain now, but much better in the medium and long-run. The US and UK have adopted instead the head-in-the-sand Japanese-style variant – creating our very own zombie banks which are technically alive (allowing well-connected banking executives, for now, to save face and keep their jobs) but which are commercially dead and a drain on society given the weight of their toxic debts – not to mention the absolutely enormous moral hazard represented by their on-going existence.
“Quantitative easing” may sound like a clever way out. But the rest of the world is watching, alarmed at the inflationary fires we are stoking, mindful that our currencies are now extremely vulnerable, dubious – given these inflation and currency dangers, to say nothing of default risk – about buying any more of our debt. The music, at some point, will stop. That moment could soon be upon us.
So, we need a wholesale banking sector “shake-out” – despite the hard truths that will involve us facing. We need to re-instate Glass-Steagall – so commercial and investment banking are separated once more, preventing taxpayer-backed deposits from being levered-up and reckless-gambled.
We need legally-binding counter-cyclical reserve requirements – giving central banks the ability to rein in credit at the top of the cycle, and keep a close eye on leverage.
Saying all this is the easy bit. Doing it is tough. But at the moment, we’re not even saying it – admitting to ourselves that we have to change, that the party is over, that we need to exercise restraint.
And meanwhile, the world is shifting around us – in a way that is also hardly discussed now but will be the stuff of the broad analytical brush strokes that future historians will paint when this period is picked over, and the history of sub-prime is written.
WEST TO EAST
By early August 2007, seven months after I wrote the Sunday Telegraph column I referred to earlier, “sub-prime” burst from the business pages and into the mainstream. Global markets lurched, as Main Street was introduced to terms such as collateralised debt obligation and credit default swap.
That August, coming up for two years ago now, I wrote that the credit crunch was a “pivotal moment in the history of global capitalism”2.
Readers were asked to contrast the major Western economies – “squandering their role as the bedrock of global finance” – with “the relative stability of the emerging giants of the East”. The indebted Western world, I suggested two years ago, “is now far more vulnerable to financial meltdown than many of the nations we so recently used to deride”.
The likes of Brazil, Russia, India and China, I argued – with their huge reserves – were “better placed to deal with a global crisis than their Western counterparts”.
After all, back then these four so-called BRIC economies held between them two-fifths of the world’s total currency reserves. And now they hold half. The G7, minus Japan, holds a mere 6pc of total global reserves. And in a world stalked by the danger of systemic meltdown, reserves amount to power. On that basis, after the last decade of the West’s debt-fuelled over-consumption, using money leant to us by the East, the balance of power has firmly shifted.
Consider the contrast between the relative indebtedness of firms and households in the G7 compared to those in the emerging giants. In the US, UK and Japan, total personal, commercial and state debts easily exceed 250pc of GDP. In Brazil and India, the figure is less than 100pc. In Russia, it’s under 50pc. So the big EMs face much lower debt-service costs over the next few years, as the Western world “de-leverages”. They’ll be able to channel their resources into growth, rather than debt-service.
These were the reasons why I concluded, back in August 2007, that “when sentiments improve and investors’ risk-appetites return, there could well be a flight to quality – but away from the West and towards the economic powerhouses of tomorrow”.
So far this year, the world’s top-ten performing stock markets are all emerging markets. China’s main share index has gained 52pc since the start of 2009. Russian stocks are up 99pc and Brazilian shares 114pc. Meanwhile, the FTSE 100 and Dow Jones have managed only 20pc year-to-date rises, despite massive pump-priming, QE and a desperate attempt by the authorities to keep assets prices buoyant. And what happens when our state-sponsored sugar rush fades.
When future historians ponder the sub-prime debacle, this could be seen as the moment when the large emerging markets truly entered the financial mainstream. This has been happening for some time but this sub-prime fiasco is now accelerating and accentuating that trend.
One reason is that these nascent capitalist economies will grow faster for the foreseeable future, and from a lower base, than their “credit-crunched” Western rivals. The developed world will contract 3.3pc this year, says the IMF, with the EMs grow 3.4pc. The relative gap is vast next year too – with the West set to manage only 1.1pc growth (some hope) and the Eastern upstarts expanding 5.6pc.
As the threat of Western sovereign defaults rise, and our Keynesian boosts wither and die, investors will increasingly seek-out surplus countries rather than deficit countries. We now live in a world, of course, of huge Eastern surpluses and fast-expanding Western deficits.
So the emerging markets will grow much faster, and they have big surpluses. They’re less indebted, as I’ve said. In many such countries, firms have also financed their expansion not from debt, but retained earnings. Again, this means they’re well-placed to thrive – not least in relative terms – during this era of global deleveraging, a reality that investors are now starting to notice.
On top of all that, the West’s response to “sub-prime” – not just more debts, but “money printing” – also means serious inflation is now in the pipeline. The major Western currencies are being debased – the pound, in particular.
All these factors are generating interest in relatively simple, “tangible” investments in commodity-rich emerging markets, as asset-managers eschew the complex, derivative-driven strategies that have ruled the roost in recent years but have now ended in tears.
In 2007, the emerging markets accounted for half of global growth. Last year, as sub-prime hit the Western world, these nascent capitalist powers were home to three quarters of all global growth. In 2009, barring a late surge in Luxembourg or Switzerland in the fourth quarter, the emerging markets will account for ALL of global growth. And it won’t be long, at this rate, before they account for more than half the world’s total stock of GDP.
Yet these dynamic economies, despite their massive capital requirements, still play host to less than a fifth of the world’s portfolio investments. This anomaly is unsustainable. So, ultimately, it will not be sustained.
Yes, these markets can be challenging. But who could possibly say, after sub-prime, that’s not now equally true of the West – or even more so? Certainly, the big emerging markets have run better macro-economic and regulatory policies in recent years than their Western counter-parts so, to use a term de nos jours, can now point to superior “macro-prudential” management – alongside all their other advantages in terms of labour costs, productivity gains, market size and so on ….
That’s why, in my view, future historians will identify sub-prime as the moment when global capital flows shifted irrevocably … and that, when the smoke has clear, the Western banks have restructured and the stress tests come and gone, that will be the most important historic implication of sub-prime – as I said, the acceleration and accentuation of the re-balancing of the global economy away from the West and towards the East, along with all that that means in terms of the Western world’s hegemony.
Ultimately, sub-prime could help usher in a more stable global equilibrium – with activity, capital and influence spread more evenly between West and East. I certainly hope so. But that’s something else future historians will have to contest.
Because, in the here and now, the West’s political and regulatory system – driven by the prevailing commercial philosophies of the US and UK – has been found desperately wanting. We’re lurching from day to day in denial – unable to even admit the seriousness of the policy response required, let alone begin grappling with the technical, administrative, legal and ultimately political difficulties that surround its implementation.
THANK YOU
“It could be downhill all the way after Davos”, Sunday Telegraph, Business p.4, 28.01.07 [↩]
This crisis is by no means over yet”, Sunday Telegraph, p.23, 19.08.07 [↩]
