RE: Economy growing?

From @LabourList

Here, LabourList publishes an email exchange that occurred this morning between our two resident economic commentators, Duncan Weldon of the Economics Matters column and Chris Cook of Economics 3.0. The exchange is about the news on the front page of today's Independent that "the recession has ended", and looks at aspects of government policy that have contributed to, and hampered, the sprouting of green shoots.

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From: Duncan Weldon
To: Chris Cook
Date: Thu, Jun 11, 2009 at 7:54 AM
RE: Economy growing?     

Chris,

What do you make of all this talk that the economy might be growing again? Is this the end of the recession?

I cautiously welcome it. As I said on LabourList three weeks ago, the worst of the recession in terms of growth is probably behind us but the worst in terms of jobs lies ahead.

Also we should remember that one quarter of growth could be followed by a relapse and that any recovery will be slow. But it does appear, especially with yesterday's industrial production numbers, that massive monetary and fiscal stimulus has had an effect.

Duncan

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From: Chris Cook
To: Duncan Weldon
Date: Thu, Jun 11, 2009 at 9:14 AM
RE: Economy growing?     

Duncan,

I think that the current position of the economy is analogous to someone driving too fast along a road when a lorry pulls out in front of them. Because the driver is not wearing a seatbelt, the first thing that happens is that he stamps on the brakes and hits the steering column. The lorry is still there though, and the car is going to hit it unless the lorry pulls back.

We have just had that initial shock, and are righting ourselves - bruised - off the steering column with the aid of recent measures. But the lorry is still there.

What we have just seen is the effects of the increasingly connected - but centralised and extremely vulnerable - economy, where shocks are rapidly transmitted through financial systems and supply chains. The discontinuity in the global supply chain has now righted itself, de-stocking has gone as far as is practical, and the Chinese are now buying as much real wealth (e.g. commodities) as they can lay their hands on in preference to US dollar IOUs.

In the financial world, governments have essentially replaced the private sector as providers of the unsecured credit that makes the world go around and allows circulation of goods and services. Wall Street and the City have been bailed out. A large part of Quantitative Easing is in fact a bail out of the already rich, replacing toxic and unsustainable debt with government money.

However, the long term secured credit and equity necessary for investment in productive assets is in increasingly short supply; it's not that the money isn't there - it is - but there is no way it will be deployed until asset prices and economic activity stabilise at a very much lower level than we currently have.

The sheer scale of the debt problem is evident here:

http://www.mi2g.com/images/offbalance.gif

As the recession spreads and pervades the productive sector we will see not only further defaults, as formerly "prime" borrowers lose their jobs, but we will also see a wave of insolvencies in commercial property and the huge raft of businesses unsustainably loaded with debt by private equity, e.g. the insolvency of Arcandor in Germany is indicative.

The collapse will recommence - at a slower pace - shortly, and has a long way to go. There is nothing new about the effect of the toxic combination of compounding debt and private property in land - it has been going on since Babylonian times  - it's just that this time it's an order of magnitude greater than ever before.

The problem is not a shortage of credit - governments can create that even if the private sector can't or won't through absence of capital or otherwise - it is a shortage of the creditworthy, because Wealth has become unsustainably concentrated in too few hands.

The only solutions are therefore fiscal, and there is no way in which the necessary policies for pre-distribution of wealth (e.g. a tax on land rental values) would ever be allowed, by the privileged who own the system, to be enacted. Turkeys do not vote for Christmas. However, my take on it is that the direct instantaneous connections of the internet will enable a new, decentralised but connected, and more resilient, economy to rapidly emerge.

I outlined how this might work at a Philosophy festival in Norway last Friday, here:

http://www.slideshare.net/ChrisJCook/money-30

IMHO there is nothing any government could do to prevent this process, other than switch off the Internet.

Best Regards,

Chris

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From: Duncan Weldon
To: Chris Cook
Date: Thu, Jun 11, 2009 at 10:50 AM
RE: Economy growing?     

Chris,

An interesting – although pessimistic – view.

I agree on the scale of the debt problem in the Anglo-Saxon world.

The economist Minsky was one of few macro-economists to realise how crucial debt was to the modern financial capitalist system. Stability – as we had with the entry of China into the world economy holding down inflation – is the fore bringer of instability. Corporates, and households, assuming things will be stable forever, take on debt and more debt. Eventually debt is used to pay interest costs.

We hit that ‘Minsky moment’ in 2007.

What we now have is the unwind.

The collapse of Lehman’s in September last year sent the world economy into tailspin. As credit seized up, trade finance unravelled. Q4 last year and Q1 this year represented a dramatic fall in global GDP.

I feared that deflation would set in as rising unemployment caused more loans to go bad and credit conditions to get tighter, leading to higher unemployment: a terrifying negative feedback loop.

I agree with you that the debt burden will have to be worked off – this will mean slower growth for the next decade at least.

Where I am more optimistic than you is the scale of the monetary and fiscal stimuli globally. It seems to have had the desired effect of stabilising the economy at a lower level. I think Government action has worked.

I still believe unemployment will keep rising and I still think that consumption, in the West, will fall. This will feel like a recession even if GDP is growing.

But I don’t think the system is going to collapse.

Duncan

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From: Chris Cook
To: Duncan Weldon
Date: Thu, Jun 11, 2009 at 11:43 AM
RE: Economy growing?     

Duncan,

I agree with much of what you say. I admire Steve Keen's stuff and he is another Minsky fan.

We've had the collapse, and what I see coming now in the absence of systemic fiscal reform is a continuing fall until a bottom is reached in a year or two, followed by a Japanese style non-recovery.

To use another analogy, the patient's visible wounds have been stitched up, but credit will continue to bleed out of the system unseen from the shadow banking system of investors whose capital pumped up the bubble. The cosmic scale of that continued internal bleeding is evident in the linked statistics. This bleeding of asset-based credit is a direct consequence of the continuing - and irreversible - fall in asset prices.

The G8 presumes that they can keep on pumping in new credit/money to replace that draining out of the system. This approach - which devalues the existing money relative to the productive sector -  is resisted as inflationary by the Austrian School headbangers who believe that the market should bring its magic, and that a short sharp Depression will do the trick. Fortunately, these Austrians have now seen their market economics blown out of the water, but of course will go to their graves convinced that it was government to blame, not their beloved private sector, and that it would have worked if only it had been tried in its full purity.

I digress.

The current inflationary approach pre-supposes that the people who own most of the existing IOUs demininated in US $, and other Western currencies will be happy with seeing their value destroyed, never mind to extend new credit to Western debtors to fund the investment and purchases which will enable a recovery.

This is where the G8 and the Bilderbergers (from what one reads!)  are living in fantasy land. How many barrels has the G8? There are few topics of conversation in the BRIC countries, and in many other places, other than how the dollar could be replaced as a reserve currency.

The centre of economic power has moved East and South, and within 12 months the Western nations are going to have to meet their creditors with better proposals than the fantasies they now cling on to.

So there won't be a collapse unless the creditors pull the plug, but the best we can expect until a real (as opposed to fantasy) Bretton Woods II sorts things out from first principles, is an indefinite recession from the low base we are at least a year away from reaching.

Chris

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From: Duncan Weldon
To: Chris Cook
Date: Thu, Jun 11, 2009 at 11:56 AM
RE: Economy growing?

Chris,

I think on the narrow question of green shots in the UK economy – yes it is stabilised. It will not grow very quickly from here, but neither will it continue to plummet.

I agree that the relationship between Western debtors (especially the UK/USA) and eastern creditors (especially China) is key. But China now finds itself in the old fashioned dilemma of being a creditor which has lent too much to one debtor.

China’s 2 trillion dollars (!) of US debt holders are as much China’s problem as America’s. We now have mutually assured financial destruction if either tries to reverse the relationship.

I agree that a Bretton Woods II is  required. The huge global imbalance between Western borrowing and Eastern Saving needs to be righted. But righting this requires a gradual transition. Not a sudden move.

The G20 meeting was the first step in this process.

To conclude, in the short term Britain is not facing a severe depression, instead we are looking at a gradual recovery followed by slow growth. What is needed now is a global process to rebalance the world economy. China needs to start consuming, rather than simply exporting and we need to rebalance our own economy away from finance, property and consumption.

I think we agree more than we disagree, although I feel you may be slightly more pessimistic than me.

Duncan

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From: Chris Cook
To: Duncan Weldon
Date: Thu, Jun 11, 2009 at 12:53 AM
RE: Economy growing?

Duncan,

I wouldn't rule out a Depression, but maybe that's only a definitional point.

I think that - at best - the UK economy is about to slide again, and will then bump along the bottom indefinitely. At worst, our creditors will pull the plug and we'll get "Stagflation" driven by higher import prices.

While I agree that China and other creditors should invest their credit balances in Nordic-style social and other (eg renewable) infrastructure, increased consumption of stuff is not something that the world needs more of.

Current global trade imbalances may be addressed by massive investment by China and other creditors in the US and other debtor nations aimed at building out a new generation of energy infrastructure. Such investment could not take place within the current Twin Peaks financial capital market paradigm of Debt and Equity, but is nevertheless possible. You don't have to sell ownership of assets if you unitise (not securitise) and sell production.

The US have had their End of Empire "Suez Moment" - when the economic plug was pulled on them by their creditors a couple of summers ago, I believe - and under Obama I think that it would be possible for them to embark on a massive "swords to ploughshares" programme. I am sure that the rest of the world would be only too happy to finance a move away from their increasingly baroque hardware and vastly profligate network of bases.

So please do not think that I am a pessimist other than in respect of the existing system , which IMHO is irretrievably broken. I am hugely optimistic as to the future, as I think that there are massive emergent changes taking place below the radar screen. Five years from now, the global financial architecture and economy will look very different, I think.

Thanks for the chat!

Chris