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By Steven Baker MP, on 1 November 10
October 2010 was our best-ever month, with over 24,000 hits.
Our top five downloads are:
Visitors came from most of the world but the top five countries were UK, USA, Canada, Spain and Germany. Courtesy of Google Analytics for the year to date, our visitor locations:
 All in all, quite satisfactory.
By Toby Baxendale, on 18 August 10
The Great Austrian applied and theoretical economist Dr Frank Shostak has allowed us to publish this small article that should give you a good understanding on how to approach an economic problem, what emphasis you should place on theory and what on empirics. How indeed to distinguish a good theory from a bad theory and how everything must be rooted in the study of the purposeful actions of man. For some of our readers this may be a boring subject, but it is about the foundations of what is and is not good economics, so I do urge you to persevere and read on. Our thanks to Dr Shostak.
Toby Baxendale
Government releases of various economic indicators such as GDP, the CPI, and unemployment receive wide coverage in popular media such as TV networks and newspapers. In a measured and authoritative voice, various economists and other experts who are interviewed discuss their views regarding the health of the economy. Thus, a rise in an indicator like GDP is interpreted as good news while a decline is seen as pointing to trouble ahead.
The experts’ opinions are not only confined to the health of the economy in general. They also offer their advice regarding various forms of investments. Some economists who present their assessments seem to be able to offer viewers not only qualitative but also quantitative analyses.
For instance, they will advise viewers that the economy is likely to grow by 0.6 percent in the next quarter, and thereafter the growth will jump to 1.2 percent. Or, they will state that low inflation makes it so much easier for the central bank to lower interest rates to strengthen economic growth.
These types of comments leave a deep impression on viewers that economists are really on top of the issues. But what are the tools that economists and financial experts utilise in their assessments of the economy? What is the basis of their framework of thought?
Making the Data Talk
In order to make the data “talk,” economists utilise a range of statistical methods that vary from highly complex models to a simple display of historical data. It is generally held that by means of statistical correlations one can organise historical data into a useful body of information, which in turn can serve as the basis for assessments of the state of the economy. It is believed that through the application of statistical methods on historical data, one can extract the facts of reality regarding the state of the economy.
Unfortunately, things are not as straightforward as they seem to be. For instance, it has been observed that declines in the unemployment rate are associated with a general rise in the prices of goods and services. Should we then conclude that declines in unemployment are a major trigger of price inflation? To confuse the issue further, it has also been observed that price inflation is well correlated with changes in money supply. Also, it has been established that changes in wages display a very high correlation with price inflation.
So what are we to make out of all this? We are confronted here not with one, but with three competing “theories” of inflation. How are we to decide which is the right theory? According to the popular way of thinking, the criterion for the selection of a theory should be its predictive power. On this Milton Friedman wrote,
The ultimate goal of a positive science is the development of a theory or hypothesis that yields valid and meaningful (i.e., not truistic) predictions about phenomena not yet observed.[1]
Is Everything Uncertain?
According to mainstream thinking so long as the model (theory) “works,” it is regarded as a valid framework as far as the assessment of an economy is concerned. Once the model (theory) breaks down, we look for a new model (theory). For instance, an economist forms a view that consumer outlays on goods and services are determined by disposable income. Once this view is validated by means of statistical methods, it is employed as a tool in assessments of the future direction of consumer spending. If the model fails to produce accurate forecasts, it is either replaced, or modified by adding some other explanatory variables.
The tentative nature of theories implies that our knowledge of the real world is elusive.
Since it is not possible to establish “how things really work,” then it does not really matter what the underlying assumptions of a model are. In fact anything goes, as long as the model can yield good predictions. According to Friedman,
The relevant question to ask about the assumptions of a theory is not whether they are descriptively realistic, for they never are, but whether they are sufficiently good approximation for the purpose in hand. And this question can be answered only by seeing whether the theory works, which means whether it yields sufficiently accurate predictions.[2]
Two Kinds of Economists
The view that our knowledge is tentative and that we can never be certain about anything, has given rise to two groups of economists. In one camp there are the so-called theoreticians, or “ivory-tower economists,” who generate various imaginary models and use them to form an opinion on the world of economics.
In the other camp we have the so-called “practical” economists, who derive their views solely from the data. Whereas the ivory-tower economists are of the belief that the key to the secret of the economic universe is via abstract models, the “practical” economists hold that if one “tortures” the data long enough, it will ultimately confess and the truth will reveal itself.
Economic theory, however, must have only one purpose–to explain the essence of economic activity. But statistical methods are of no help in this regard. All that various statistical methods can do is just describe and compare the movements of various historical pieces of information. These methods cannot identify the driving forces of economic activity. Likewise, models that are based on economists’ imagination are not of much help either since these theories are not ascertained from the real world.
Contrary to popular thinking, economics is not about GDP, or CPI, or other economic indicators as such, but about human activities that seek to promote people’s lives and well being. One can observe that people are engaged in a variety of activities. They are performing manual work, they drive cars, and they walk on the street and dine in restaurants. The distinguishing characteristic of these activities is that they are all purposeful.
Thus manual work may be a means for some people to earn money, which in turn enables them to achieve various goals such as buying food or clothing. Dining in a restaurant could be a means to establishing business relationships. Driving a car could be a means for reaching a particular place. In other words, people operate within a framework of ends and means; they are using various means to secure ends.
Purposeful action implies that people assess or evaluate various means at their disposal against their ends. At any point in time, people have an abundance of ends that they would like to achieve. What limits the attainment of various ends is the scarcity of means. Hence, once more means become available, a greater number of ends, or goals, can be accommodated–i.e., people’s living standards will increase. Another limitation on reaching various goals is the availability of suitable means. Thus to quell my thirst in the desert, I require water. The diamonds in my possession will be of no help in this regard.
Human Action Is Central
To undertake the identification of data, one is required to reduce it to its ultimate driving force, which is purposeful human action. For instance, during an economic slump, a general fall in the demand for goods and services is observed. Are we then to conclude that the fall in demand is the cause of an economic recession?
We know that people persistently strive to improve their life and well being. Their demands or goals are thus unlimited. The only way then for general demand to fall is via people’s inability to support their demand. From this we can infer that we have problems on the production side, i.e., their means are the likely causes of an observed general fall in demand.
Alternatively, consider the situation in which the central bank announces that increasing money supply growth, while price inflation is low, can lift real economic growth. To make sense of this proposition we must examine the essence of money. Money is the medium of exchange. Being the medium of exchange, money can only facilitate existing real wealth. It cannot create more wealth. Money cannot be used in production. It cannot be used in consumption. Hence we can conclude that printing money is not the right means to promote economic growth. It follows from this that the goal–of lifting real economic growth–cannot be achieved by means of printing money.
The knowledge that people are pursuing purposeful actions also permits us to evaluate the popular way of thinking that holds that the “motor” of the economy is consumer spending–i.e., demand creates supply. We know, however, that without means, no goals can be met. But means do not emerge out of the blue; they must be produced first. Hence, contrary to the popular thinking, the driving force is supply and not demand.
The fact that man pursues purposeful actions implies that causes in the world of economics emanate from human beings and not from outside factors. For instance, contrary to popular thinking, individual outlays on goods are not caused by real income as such. In his own unique context, every individual decides how much of a given income will be used for consumption and how much for investments. Whilst it is true that people will respond to changes in their incomes, the response is not automatic. Every individual assesses the increase in income against the particular set of goals he wants to achieve. He might decide that it is more beneficial for him to increase his investment in financial assets rather than to increase consumption.
Numbers Do Not Explain
Without the knowledge that human actions are purposeful, it is not possible to make sense out of historical data. On this Rothbard wrote,
One example that Mises liked to use in his class to demonstrate the difference between two fundamental ways of approaching human behavior was in looking at Grand Central Station behavior during rush hour. The “objective” or “truly scientific” behaviorist, he pointed out, would observe the empirical events: e.g., people rushing back and forth, aimlessly at certain predictable times of day. And that is all he would know. But the true student of human action would start from the fact that all human behavior is purposive, and he would see the purpose is to get from home to the train to work in the morning, the opposite at night, etc. It is obvious which one would discover and know more about human behavior, and therefore which one would be the genuine “scientist”[3].
The popular view that sets predictive capability as the criterion for accepting a model is absurd. Even the natural sciences, which mainstream economics tries to emulate, don’t validate their models this way. For instance, a theory that is employed to build a rocket stipulates certain conditions that must prevail for its successful launch. One of the conditions is good weather. Would we then judge the quality of a rocket propulsion theory on the basis of whether it can accurately predict the date of the launch of the rocket? The prediction that a successful launch will take place on a particular date in the future will only be realised if all the stipulated conditions hold. Whether this will be so cannot be known in advance. For instance, on the planned day of the launch it may be raining. All that the theory of rocket propulsion can tell us is that if all the necessary conditions will hold, then the launch of the rocket will be successful. The quality of the theory, however, is not tainted by an inability to make an accurate prediction of the date of the launch.
The same logic also applies in economics. Thus we can say confidently that, all other things being equal, an increase in the demand for bread will raise its price. This conclusion is true, and not tentative. Will the price of bread go up tomorrow, or sometime in the future? This cannot be established by the theory of supply and demand. Should we then dismiss this theory as useless because it cannot predict the future price of bread? According to Mises,
Economics can predict the effects to be expected from resorting to definite measures of economic policies. It can answer the question whether a definite policy is able to attain the ends aimed at and, if the answer is in the negative, what its real effects will be. But, of course, this prediction can be only “qualitative.”[4]
The fact that people consciously pursue purposeful actions provides us with definite knowledge, which is always valid as far as human beings are concerned. This knowledge sets the base for a coherent framework that permits meaningful assessments of the state of an economy. In contrast, analyses that rely solely on statistical correlations cannot be of much help, for they are totally groundless. Hence comments made by various experts who rely on such frameworks are arbitrary. All that these experts can do is repeat already-known data and simply offer a baseless view – they can tell us nothing about the essence of economic activity.
Fanciful Assumptions
Similarly, we must reject all the comments that are based on “purely” theoretical models, which derive their foundation from economists’ imaginations. A model, which is not derived from reality, cannot possibly explain the real world.
For example, in order to explain the economic crisis in Japan, the famous mainstream economist Paul Krugman employed a model that assumes that people are identical and live forever and that output is given.[5] Whilst admitting that these assumptions are not realistic, Krugman nonetheless argued that somehow his model can be useful in offering solutions to the economic crisis in Japan.
Conclusion
The arbitrary nature of mainstream economics has given rise to the view that there is a gulf between theory and practice. A distinction is made between theoretical and practical assessments. Comments like “it is a great theory; however, I cannot make use of it” are often heard. Yet there is no such thing as a good but not applicable theory. To be applicable, a theory must emanate from the facts of reality, i.e., the fact that human beings are engaged in purposeful actions. Economists and various other financial experts who derive their knowledge of the economy solely from statistical correlations of various historical data run the risk of misleading themselves and their audiences. Even when they appear to be ‘right’ ie. their ‘forecasts’ prove ‘correct’, this is merely due to coincidence – they are ‘right’ but for the wrong reasons. Such an approach proves unsustainable as soon as the coincidental factors diverge again. Likewise economists who base their views on imaginary models are not in a position to say anything meaningful, and whatever they utter is just plain arbitrary.
[1] Milton Friedman, Essays in Positive Economics, Chicago: University of Chicago Press, 1953.
[2] Milton Friedman, ibid,
[3] Murray N. Rothbard preface in Theory and History by Ludwig von Mises.
[4] Ludwig von Mises, The Ultimate Foundation of Economic Science, p 67.
[5] Paul Krugman, Japan’s Trap May 1998 in Krugman’s website.
By Steven Baker MP, on 25 May 10
 In their working paper Assessing UK money supply measures in the light of the credit crunch, Toby Baxendale and Anthony J. Evans provide a better measure of the money supply. In this article, Steven Baker explores the background to the paper and indicates some key findings.
This article was originally published in October 2009.
Many people know the Bank of England is creating new money through quantitative easing but if the quantity of money is being increased, how is that quantity being measured? What is counted as money?
As the Bank of England explains:
When the Bank is concerned about the risks of very low inflation, it cuts Bank Rate – that is, it reduces the price of central bank money. But interest rates cannot fall below zero.
So if they are almost at zero, and there is still a significant risk of very low inflation, the Bank can increase the quantity of money – in other words, inject money directly into the economy. That process is sometimes known as ‘quantitative easing’.
But when I consider quantitative easing, I am concerned with the following problems:
- It is not clear that the Bank of England has a useful definition of the money supply. The present measures do not correspond to economic activity — which is what the Bank is trying to increase with new money — and this crisis was famously not foreseen.
- As commentators have reported, “the Bank’s Governor, Mervyn King, seemed pretty confident that QE could work. But even he would admit he has no idea how long it will take – or how much money he will have to print to get there.” This uncertainty seems less than ideal given the risk of price inflation.
- As the end of the present round of QE approached, it appeared it was not working.
- According to Austrian-School economic scholars including Hayek and Huerta de Soto, injecting new money can create only a harmful illusion of prosperity.
As my colleagues point out in their working paper, the fact that the monetary authorities have turned to increasing the quantity of money will focus attention on how that quantity is measured. This article provides some background information and indicates Baxendale and Evans’ key findings.
Continue reading “What is money?”
By Toby Baxendale, on 24 February 10
FOX Business Network’s Brian Sullivan speaks in this interview with famed economist and fmr. Chilean Labor and Social Security Minister Jose Pinera about the Social Security problem in the United States. See the video link at the bottom for the audio version. Thank you to Sean Corrigan for pointing this out.
This does beg the question as to what would the number for the UK be?
BRIAN SULLIVAN, FBN ANCHOR: We are very honored to be joined by Jose Pinera. He is the founder of the International Center for Pension Reform. He is the former labor and social security minister of Chile and a distinguished senior fellow at the Cato Institute. Up from Santiago into D.C., which is where we are. Jose, it’s a pleasure. Thank you very much.
JOSE PINERA, FOUNDER, INTERNATIONAL CENTER FOR PENSION REFORM: Good morning. Thank you very much, Brian.
SULLIVAN: Last week, we hit hard on the program the latest Pew Center study showing that states have about a trillion dollars gap in their — just state — pension plans. How do we solve that?
PINERA: Well, that is a very serious problem and I’m extremely worried about all the debt America has.
But you have a much bigger problem, Brian. You have a 100 trillion-dollar problem. Look, this is something published by the American government, saying that the present value of the obligations on health and Social Security amount to a 100 trillion dollars…
SULLIVAN: OK, wait a minute. We were talking about 3-point-something trillion, 1 trillion underfunded. You are saying we have 100 trillion dollars. Where is that number coming from? How do we get to 100 trillion?
PINERA: This comes from the government. This is not recognizing the public debate, but this is the real debt of America. This amounts to 700 percent of GDP. This is a gigantic liability that basically you are legislating and will be paid by your children and your grandchildren.
SULLIVAN: Let’s walk through what that is, OK? Because these are new numbers. These are big numbers. These are coming from the CBO, correct?
PINERA: These are coming from government, from the U.S. government. These are net, liabilities of the health, Medicar,e and Social Security system. This is the present value of what Americans will have, one way or another, to pay, unless they default on their obligation to the citizens.
And that is the future. And I’m extremely worried because it is like you are passengers in the Titanic. The Titanic is going towards the iceberg of aging populations. The populations that feel entitled to all the huge benefits that the politicians have promised the people. But they have not funded the benefits for the future. So how are you going to pay them? That is the big issue. The big domestic problem facing America.
SULLIVAN: One of the big stories today is the president unveiling his own healthcare plan. On this piece of paper, again from the CBO, $35 trillion in hospital insurance for current and future. $34 trillion for Medicare Part B, about $18 trillion for drug benefits and Social Security.
So, actually Social Security, which we’re going to talk about later on — that is actually a big hole, but it’s smaller than health care. How are we going to pay for this? How does the U.S. cover a 100 trillion dollars, Jose?
PINERA: Brian, the problem is what I call the entitlement state. The problem is that there is gigantic disconnect between what people want the government to pay them in the future, in health pensions, and what the people want to pay in tax. And because the entitlement state is based on promises for the future, you don’t have to pay it today.
This is growing, because to win elections, politicians offer benefits to people that will be paid in the future. So, this big hole is not only a problem in America. It’s exactly the same problem in Greece today, in southern Europe, eventually in France, in Germany. The West will go bankrupt until and unless you reform deeply the entitlement state. This was created by Prince Bismarck (ph) in the 19th century. You are all prisoners of Prince Bismarck (ph). Prisoners of a system…
SULLIVAN: Otto von Bismarck?
PINERA: Yes.
SULLIVAN: Because he created…
PINERA: He created the unfunded tax-and-expense system. You said, he simply said if you tax workers a little, we can pay the pensions. But then the unintended consequences has been with the aging of population and the extended life, you have been accumulating this huge liabilities that eventually be bankrupt the government. A huge fiscal crisis is coming to the West unless you face it and confront it directly by completely changing the entitlement estate. That’s the root of the problem.
SULLIVAN: I want to get more on Social Security in just a bit. But for pensions — OK. State and federal pensions. The gap between retirement ages between private and public is growing wider. The gap between the amount of money being given in pensions is growing wider.
How do we just solve the pension crisis on government workers, federal and state? And is it unsustainable as it is?
PINERA: It is totally unsustainable. You either will have to raise taxes big-time in America, or you will have to cut benefits. But it’s extremely difficult to do that in a system in which you have people entitled to all these things.
That’s why what we did in Chile was to completely change the logic. In Chile, you save for old age. In Chile, we have sort of a Benjamin Franklin system, you see. You remember Benjamin Franklin, the thirteen virtues? You should save for the future, you should be self-reliant. We have instilled a culture of personal responsibility and saving.
Of course, we also have a safety net for the very poor. But 80, 85 percent of the population will finance their old age, health and pension with their own personal savings.
SULLIVAN: We are going to take a quick break, Jose. We will come back and talk about what you did in Chile, and what we might have to do here. Look at some of the pretty scary numbers around Social Security. And also what we can do about it.
Will the Chilean plan work here? How does it work? We are going to learn as we continue part two of our exclusive interview with Jose Pinera, right after this.
(COMMERCIAL BREAK)
SULLIVAN: Welcome back. I’m Brian Sullivan in Washington, D.C. today, and I am here because we are being very privileged to speak to Jose Pinera. He’s the architect of Chile’s Social Security reform. He’s the former labor and Social Security minister and the founder of the International Center for Pension Reform. It is an exclusive interview.
Jose, we’re very happy to have you. Listen, although some of the numbers you are throwing around are pretty frightening, there have been — there’s a lot of debate in this country about whether or not our Social Security plan, our system is going to be there for people that are if their 20s and 30s. There’s a big debate about whether or not we will be solvent by 2040. Do you believe that the U.S. system as it is now can be solvent decades from now?
PINERA: Clearly not.
SULLIVAN: Clearly not.
PINERA: Clearly not. In only seven years, the Social Security system will begin to have a deficit. That is more money will have to be spent than money coming in.
And then you will face the very hard choices. You will probably have to increase the retirement age. You will probably have to increase payroll tax. You may have to cut benefits, unless you change the paradigm and you go to a system of personal accounts.
Personal accounts is very simple. You save for old age. And that saving gets accumulated rate of return, so you benefit from that extraordinary force of compound interest. When you reach 65, you are going to look whether the government is deficit or in surplus, you look at the balance of your account, and with that, you buy annuity for your life.
It is a system we had all over the world before Otto von Bismarck, a Prussian chancellor created this monster of the unfunded welfare estate that is bankrupting Europe and eventually the U.S.
SULLIVAN: That’s the problem with Social Security, right? Is that we are using money now. Instead of me saving for myself, the money that is taken out of my paycheck, out of everybody in this room’s paycheck, is being paid to current beneficiaries. You have described that as a Ponzi scheme.
PINERA: That is a Ponzi scheme. You could even call it a Madoff scheme.
SULLIVAN: Hopefully, the money is real somewhere.
PINERA: No, there is no money being saved for the future. There is no funding. There’s no trust fund. You are paying the money immediately to the retirees, and the problem is that with Baby Boom generation retiring, with the expectancy of life increasing every single year because of your great doctors and researchers, you will not be able to pay the promises.
So, the system will eventually default. Technically default in the sense that you will have to break the promises to the people, and that may create a lot of pain and a lot of anguish. That’s why you have to look into the future, do the responsible thing and begin moving towards a system of personal accounts. It’s the only long-term solution.
SULLIVAN: Seventy-one million people will be 65 in this country by 2030. 330 people turn 60 years old every hour right now. But they are expecting benefits. How would we implement a system like yours with everybody already expecting the current system to be there for them?
PINERA: The first decision that I took as secretary of labor and Social Security of Chile was to guarantee the benefits of the elderly. I call it we are not going to take your grandmother check away. We will find a way to protect the elderly.
So, the system has to be changed for the young people, for the future that are coming into the labor force or are already in the first years of the labor force. And the moment you change the dynamic and people begin to know that if they save more, they work more, they will get a better pension out of their own saving, then the whole system begins to…
SULLIVAN: Here’s the criticism will be that we are at 11-year flat line for the stock market. That if you have your money in the stock market for 11 years, you are basically flat. That’s what people will say. That the stock market has proven that it is not a wealth creator. At least in the short-term.
PINERA: The stock market is today the Dow Jones is around 10,000.
SULLIVAN: 10,300.
PINERA: Do you know how much it was when we began our system in Chile 30 years ago?
SULLIVAN: Thirty years ago. 1980 — 2 grand. Dow 2000.
PINERA: 900. The Dow Jones was 900. So — if you had began your system at the same moment that Chile began, you would have benefited enormously from the stock market.
SULLIVAN: Tenfold gain.
PINERA: OK. And you don’t have to put all the money in the stock market at all. We don’t put it all. You can have a very diversified portfolio of corporate bonds, of mortgages, of government bills (ph), of stocks international — you have to be very prudent with long-term management. That’s how we have been in Chile, and that’s why we have been able to give workers a rate of return of 9 percent above inflation for 30 years compounded.
So, the system works because in the long run, you see your economy is so strong. I do believe in America. And you must believe that workers by saving for old age would be much better than the government promise.
SULLIVAN: Instead of the 12.4 percent tax that we pay, like in Chile, they take 10 percent out, automatically put that into a private account that’s not for use for current beneficiaries it is our money; correct?
PINERA: Yes, correct. Your money is protected constitutionally. That money grows in your account exponentially compounded 45 years, so forget the…
SULLIVAN: Can the government tap into it?
PINERA: No, no…
SULLIVAN: If Chile if the government gets into — in Chile if the government gets into financial difficulty, can they go raid that money?
PINERA: No way. It is protected by property rights. This is your money, we have accumulated already seventy percent of GDP in that money. The capital markets in Chile have boomed, have increased. We are financing the new infrastructure, the new growth of the industrial, the forest, with this money.
Instead of Chile having a huge trillion-dollars debt, as you have, we have a huge funded system of retirement.
SULLIVAN: Jose Pinera, we are going to leave that here. But I know later on we will be speaking about European problems. Thank you very much for joining us, at least in this hour. And we’re going to see you more in a couple of hours. Jose Pinera of Chile. Thank you, Jose
PINERA: Thank you very much, Brian.
http://wallstreetpit.com/17422-jose-pinera-social-security-in-the-u-s-to-face-deficit-in-7-years
By Steven Baker MP, on 12 February 10
Our visitor locations for the three months to 12 Feb 2010:
 Visitor locations, 3 months to 2010 (Click to enlarge)
By Toby Baxendale, on 21 December 09
Sean Corrigan of Diapason Commodities Management packs more sound applied economics into this report than ever: Toby Baxendale provides a commentary. This is a great Christmas read for us all: download the report here.
 Bastiat's Iceberg On the Errors of GDP Accounting
- For the USA economy, Corrigan shows the utter futility of using the conventional GDP measure. The same applies for any of the OECD countries who use the same measure.
- Business spending in 2006 in the USA was $31 trillion vs a GDP of $13.4 trillion.
- Businesses were spending $4.30 for every $1 spend on personal consumption.
- Policy makers from around the world, if any of you are reading this article, please take note of the significance of this fact!
- This focuses on something that all Austrian economists know: the desire by the mainstream economists is not to double-count. In the end, they do not count much at all!
- As a catering fish monger myself, I buy fish off farms, boats and auctions around the world. I cut and prepare the fish and send it to my customers, the hotels and restaurants of the UK. Yet none of my spending exists in the GDP figures! My wealth and that of my suppliers does not exist as far as the authorities are concerned. I only wish that I could get the tax man to take this view like his economist colleagues in the Revenue Department!
- I had this discussion with a member of the MPC some months ago: how if my salmon was bought at the fish farm for £1 per kg and we put a £1 mark-up on after cutting it up and the end user put a £1 mark up on, it is double counting as far as he was concerned. He reasoned that to count all of the stages of production when it only finally gets sold for £3 would be an overstatement as the price of the inputs is in the final price of £3. They miss out the significance that I and my supplier have our profit to the spend in the wider economy after we have spent our companies’ resources on continuing investment and consumption. This is all real activity! This is the danger of having statisticians running the economy.
- All that matters, we are told, is that GDP is composed of 70% of final consumption expenditure. In reality, the final consumption element is more like a quarter of real GDP, once the production sector is included.
- As I have always said, the health of the production sector is driven by its ability to invest in replacement capital to make more efficient production techniques, to supply more goods and services to people at better prices and with better service levels. This is the essence of entrepreneurship, the essence of wealth creation and the essence of the recovery: magic tricks perpetrated by the economic witch doctors, who wish to pursue a policy of QE or similar, will only consume capital and not replace it with some better means of production.
Continue reading “Bastiat’s Iceberg: A Sean Corrigan Masterpiece for Christmas”
By Steven Baker MP, on 23 October 09
Via The Times Online, we learn that many economists ”revolt over surprise recession data”:
Economists today cast doubt on official data showing that British gross domestic product (GDP) contracted by 0.4 per cent between July and September, claiming the surprise fall is far worse than economic reality.
The shock figures from the Office for National Statistics (ONS) revealed that the country remained mired in recession during the third quarter — the sixth consecutive quarter of contraction, signalling the country’s longest downturn since records began in 1955.
Economists had widely expected that the country had emerged from recession between July and September.
Well, yes, many economists had expected that but as I have explained before, most economists allow themselves to be misled by a superficial reading of numbers distorted by central bank action.
We can and must do better.
By Ewen Stewart, on 16 October 09
 UK Household Savings Ratio (click to enlarge) 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.
Continue reading “Happy days are here again? Another view from the City”
By Toby Baxendale, on 31 August 09
The distinguished writer and economist for the Sunday Times, David Smith, on the 30th of August in this article wrote the following;
Why have stock markets risen so strongly? It has been a two-stage process. The initial spurt from the dark days of early March came with a realisation that the world was not entering a second great depression (third if you count the end of the 19th century) and that not all banks would have to be nationalised. Markets were priced for disaster and decided this had been averted.
The second leg has been driven by good figures. “Economic data generally continue to be better than expected, which suggests that we are emerging from the longest and deepest recession” says Bob Doll, chief equity investment officer at Black Rock.
So it would appear that to this economist the FTSE moves only because of expectations about the future. This may well be part of the case, but as I have argued here, it is the state of liquidity that determines the great movements in the stock market indices. The Bank of England has expanded its balance sheet by some 158% since September of last year. This massive amount of liquidity coupled with the £175 billion of Quantitive Easing, has to go somewhere in the economy. If people’s demand to hold money remains the same, those recipients of all this excess liquidity can only but spend it!
To recap, I wrote:
- “Money is the medium of exchange. It is the most marketable of all commodities that facilitates the exchange of one person’s goods and services for the other person’s goods and services.
- Since the economy has slowed, it must follow that there is less production of goods and services to exchange for money. This has the effect of suppressing the prices of those goods and services.
- Conversely when the economy is booming and more production is facilitating more demand for money to exchange for more of those goods and services, you would expect to see prices rising.
- If we have a given demand for goods and services, even if it is a suppressed demand, such as it is in the economy of today (in Recession / Depression) and there is a sudden increase in the supply of money, such as has happened with the stunning 158% rise in the Bank of England’s Balance Sheet, certain peoples monetary liquidity has dramatically risen. To start the process of eliminating this surplus liquidity, it would seem that money has moved into near liquid markets such as the various stock exchanges of the industrialized world when the practice of massive money pumping has taken place.”
I also wrote,
If more money exists today than yesterday then all other things being equal, we can deduce that there is a surplus of money in relation to money demanded. What happens to this surplus? The only way to get shot of a surplus of money is to spend it. This spending increase prices of the goods and services that it is being spent on. One of the most liquid places for you to spend this surplus is to put it in near liquid assets such as highly traded shares. As excess liquidity builds up all over the world, over and above money demanded, we see various stock exchanges rising. In a separate article, our colleague Sean Corrigan points out that the huge increase in M1 in China has set the Shanghai Composite reaching for the top of Mount Everest!
We should always remember that we describe as an asset bubble a large increase in the price of those assets. A price is the amount of pounds Sterling we pay for our assets. This is the same as saying an asset bubble is a large increase in the payment of pounds Sterling for these assets. So the larger the monetary footprint in the economy, the more Sterling paid for things. Certainly this was the case for the Housing Boom and if the FTSE continues in its rise, I strongly suspect that this is the case here.
David Smith then continues to say,
We should not read too much into share prices. One thing we have learnt during this crisis is that markets are skittish, and hugely influenced by confidence and mood. There are solid economic reasons why the stock market has risen, however. Cazenove, taking the bull by the horns, says there is still plenty of value in British shares and limited downside risks.
The key influences on markets will be surprises. On the plus side, markets have priced in a recovery, both in Britain and globally. On the minus side, that recovery is expected to be weaker than usual, because of the banking system’s long period of convalescence, tight credit and a throbbing fiscal hangover that will require years of tax increases and public spending cuts.
Where the stock market goes depends on where the news comes in relation to these expectations.
To a certain extent I do not disagree with this. I would qualify this by saying that the above sentiments are what causes the FTSE to extend from trend, but not the cause of the trend. So what is the cause of the large movements in the stock exchange?
My contention is that it is the rate of monetary pumping into the economy that creates excess liquidity. If you can actually define money and count it, you can see the effect of excess money pumping very clearly. My co authoured working paper cited here shows the correct way to count money and what the problems are with the traditional M0 / M4 measures. I am very glad we have created a lot of interest on the Social Science Research Network. We then introduce MA or Money Actual, sometimes called the AMS, Austrian Money Supply, it shows a very convincing correlation to GDP and retails sales.
 Changes in MA +24 months and GDP  Changes in MA and retail sales Here we add the correlation with FTSE:
 Changes in MA and the FTSE As you can see, the broad movements in the money supply effect the FTSE. As people have more liquidity in relation to their money demand, it moves into liquid markets. Liquid markets such as FTSE and as Corrigan shows, the Shanghai Composite, rise. This applies to virtually any of the stock markets of the world. The government is the monopoly issuer of money or currency and privately created bank credit can only exist on the scale it does by the granting of special legal privilege to bankers to not keep their creditors whole at all points in time. As these vital functions are controlled in full by the State, it should come as no surprise that the main influence on FTSE is the prevailing surplus liquidity of the day, first and foremost, then investor sentiment.
Further Reading
By Toby Baxendale, on 10 August 09
Sean Corrigan, Chief Investment Strategist at Diapason Commodities Management, has kindly agreed to the reproduction of his briefing “Material Evidence” by the Cobden Centre. For this, 29 July 09, edition, Toby Baxendale provides commentary on Sean’s preferred measure of national economic performance: rPNNPpc. Corrigan shows that real wealth in the USA is now back to pre-1995 levels.
As most Austrian-school economists are never given jobs by the mainstream in academia, they are forced use their knowledge to create wealth: they largely succeed. The linked PDF is from one of the great contemporary thinkers and writers in economics: Sean Corrigan.
 Sean Corrigan, Material Evidence, 29 July 09 Now, if governments — as the monopoly issuers of money — pump an additional 10% of newly-minted cash into the economy through ‘quantitative easing’, it will come as no surprise to find an increase in the number quoted as GDP.
This, of course, is just a game of smoke and mirrors. As I have pointed out elsewhere, it is only the forgoing of consumption through real savings that allows investment in longer and more complex — and thus more productive — methods of production to create sustainable, growing wealth. So, what we as eager participants in the economy want to know is not the value of some inflated figure, but what Corrigan calls Real, Private, Net National Product Per Capita or rPNNPpc.
What is “Real, Private, Net National Product Per Capita”?
Governments can only take wealth that has been previously created. They dispense this confiscated wealth at will, perhaps to people who are less productive, perhaps creating expensive capital projects, or perhaps even destroying people and wealth by waging war in other countries. Sean writes:
[L]et us discard the government portion [of GDP] since the economic worth of this is not only highly contentious ‐ being priced at cost, being involuntary in its provision, and arguably being composed of as many negative ‘bads’ as positive goods – but is also moot because it can only represent a forced redistribution of wealth already created elsewhere, in the private sector.
After excluding government, Sean then deducts capital consumption: this is just replacement of existing capital that has been worn out. You can then see the real wealth of the nation and work out a per capita amount based on population. Sean deflates his figure by the median Consumer Price Index for the time series to arrive at rPNNPpc:
[I]n the attempt to make a fair comparison across an era of a chronic erosion of the value of the unit of account – and cognisant of all the inherent distortions involved therein — we will deflate the result using the median CPI index. What this leaves us with may be rather a mouthful — being a measure of real, private, net national product per capita – but it is also a reasonable first estimate of the effective income flow experienced by the average person.
Emphasis mine. Corrigan’s plot of rPNNPpc is revealing:
Corrigan shows that real wealth in the USA is now back to pre-1995 levels, wiping out gains from the recent credit bubble as well as the preceding tech bubble. In comparison, the official data for GDP shows only the last couple of quarters in decline. Corrigan writes:
To get some sense of the scale of the collapse, the fall to date has been half as big again – and more than twice as rapid in its progression – as that suffered around the second oil shock of 1979‐82, otherwise the worst since WWII.
I suspect the figures for the UK would show a similar effect.
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All in all, quite satisfactory.
