By Ann Pettifor
Together with the Prime Minister of Greece, Mr. George Papandreou, I am going to give evidence to the EU’s Special Committee on the Financial Crisis in Brussels this Thursday, March 18th.
So today’s leaked report from the EU, arguing that Labour’s plans for cuts to public spending are not "ambitious enough", has got me really het up.
Labour, it appears, is just not ambitious enough about its goals for cutting investment and exacerbating unemployment. It does not have punitive enough targets for cutting benefits to the poor and services for the mentally ill and frail.
In the "imbecile idiom" (to quote Keynes) of today’s financial fashion, the EU, it seems, would prefer for unemployment to rise, for people to live in hovels, and for government "to shut out the sun and the stars" – so that we conform to an arbitrary number set in Frankfurt by a group of bankers, under a pact unwisely signed by an earlier British government.
The EU’s so-called Growth and Stability Pact has not led to stability in Greece, Portugal or Ireland and the East European economies. And it has not led to much growth in demand in Germany, an export-oriented economy that threatens to sink first Greece, then Spain, and then the European Project.
No, this pact is simply a banker’s pact; a revival of that barbaric relic, the Gold Standard – only modernised. Bankers frightened that public spending might ‘crowd out’ private investment. Pretty ironic at a time when private investment has collapsed by a massive 10% in the EU.
The economic ideas that underpin the Growth and Stability Pact are archaic, but pervade all of the economics profession, as well as the British establishment.
Keynes tried hard to rid the economics profession of these ideas but, sadly, failed. If we compare Keynes’ revolution in economics to Darwin’s breakthroughs on evolution (and they are comparable British geniuses) then what has happened to economics would be comparable to a return to pre-Darwinian ideas of evolution. Yes, the Growth and Stability Pact is as archaic as that.
Though it pains me to do so, let me explain the logic of this outdated economic theory. I summarise crudely:
"There are not enough savings in the bank. [Which is true, we have been spending and consuming, and not saving.] There can be no investment, no finance, no economic activity, no more employment, without savings. We must now retreat to a proverbial dark cave; suffer hunger and starvation; halt economic activity - until we have hoarded/accumulated enough savings. Only after an agonising process of economic bloodletting, when we have cut our ‘economic weight’ down to a minimal size, can we come out into the light, engage in economic activity, and once again revive the economy."
The profound flaw at the heart of this theory for economic bloodletting is this: it assumes that we need savings to generate economic activity. We don’t, and we never have. Not, that is, since the Bank of England invented Quantitative Easing in 1694.
“We can afford what we can create”, to quote Keynes again. We are all capable of economic activity – especially the 2.5 million people unemployed. All we need is a little something to get economic activity started.
And, hey presto, it’s to hand. It is something quite magical. It’s called credit, and it takes the form of bank money. Bank money is something that you and I deal with every day – but it’s intangible. We never touch it or see it (except perhaps on our bank statement at the end of the month.) But it is wonderfully powerful, which is why it must be rigorously regulated in the interests of society and industry.
It exists, or can be issued into existence (think QE) out of thin air. For, contrary to most orthodoxy, credit creates economic activity. Credit, believe it or not, creates savings. Credit creates deposits. And not the other way around.
Get your head around that if you can. Most economists can’t.
Of course, credit creation has to be regulated. If it is used for speculation and gambling (as has happened since de-regulation in 1971) then it is inflationary (as it was in the 70s, 80s and 90s). Just think of the massive inflation of assets (to which the bankers turned a blind eye) that helped the rich get richer over the 90s and noughties.)
And if more credit is created than there is potential for economic activity, it becomes inflationary again. But when there is a vast crater of economic inactivity, then credit creation will not be inflationary. In fact, it will halt a deflationary spiral.
It can be used as it has been under QE to finance the British government deficit. The BoE out of thin air, issued £200bn of ‘gilts’ (govt bonds) and other asset purchases in 2009. Private banks bought them – and by doing so, helped finance the government’s £177 billion deficit.
If QE is combined with government investment on public works (not bailing out banks) – economic activity will be stimulated. It boils down to: credit to generate economic activity + income (from that activity) to pay the debt.
This explains why government spending pays for itself; because government budgets are not like household budgets. Tell that to the Tories. When households spend, suppliers drain their bank accounts. They don’t get anything back.
When the government spends (e.g. on subsidies for insulating homes) new employees pay income tax; they have money to spend so pay VAT in the shops; and shopkeepers then pay tax on their profits. So when government invests in productive activity, income returns to government in the form of tax revenues. Add to this, savings from cuts in welfare benefits, and hey presto, government spending pays for itself.
Something that the economists at the BBC, the Tory Party and the EU still have not got their heads around.
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Jo
Cannabis factory at 35, Tiverton Road
I blame the current Labour Government and the EU
When did they start?
Today's PMQ's was clearly a 'child to child' interaction!
What DO you say after you say 'hello'.
Brilliant analysis of the imperative mode. Since these utterances are singularly unlike to convince anyone left of centre, and are alienating for anyone who floats in between, one can only assume it's some kind of inner imperative, an increasingly hectoring attempt not to let doubt, other points of view, or reasonableness into the debate.
Perhaps this is a fair reflection of the state of Tory Party thinking at the moment, a kind of Freudian repressive analysis: the superego in the form of DC keeps trying to track some kind of thin lipped high ground, but the contradictions are too great, and the unreformed ID of the party keeps on breaking through in a Tourette's like display of anger, venom and an element of self-loathing. Certainly, these two see sawing voices seem to cover most the Tory/Libertarian comments on here.
Or we can rely on transactional analysis, which is more to my tastes. The "parent", "adult" and "child" aspect of our psyches.
Very effective tools when understood.
Yes, even better. This imperative form our pet Tory takes is therefore the harassed adult hectoring his own inner child.
Your analysis is deeper than mine, which is rather shallow. You are obviously a scholar of the human psyche.
Pentland Firth and Orkney wave energy generation scheme
now commissioned
And as for your observation that the Eu wishes our Government to ram through spending cuts without popular support is not a new stand, it didn't bother the EU when it forced the Lisbon treaty on us!
As for the £178 billion deficit, how does that compare against the following:
Cost to the UK of the EU's 8,500 quangos now £167 billion pa, confirmed by the Cabinet Office.
The annual cost of EU regulations to UK industry, £100bn pa.
EU contributions and CAP, £26 billion pa. (£8bn net annual contribution increased by the loss of the £3bn rebate to £11 billion + CAP @ £15bn = £26bn)
Annual cost of EU immigration??
So that's around £300 billion a year total loss from the UK economy BEFORE finding cash for the national debt.
The EU wants VAT raised to 20% and the Lib/Lab/Con will do as ordered.
When will all you sleep walkers start to grasp just how bad the EU is for this Country. They have taken our Industry, most of our Manufacturing,Fishing & Agriculture, Foreign Companies now own all of our services such as Water, Electicity, Gas and nearly every famous British Brand.
Whats left for us? The City which is bust and living on borrowed time and now the Bankers are getting obscene bonuses from the QE and at the same time loading even more debts onto the British People, it stinks.
But I know the majority on LL will defend this stinking undemocratic monopoly and simply cannot see how the EU is destroying this Country, and assisted by our corrupt Politicians who want to get on the EU gravy train.
Though I disagree with your position on Labour not cutting benefits to the disabled (they are by reducing the no of claiments and increasing the number of appeals). I agree with you on many points.
I agree, major public works and sensible infrastructure development is essential to carefully begin to grow our economy.
We need increased communications links on many levels, serious thought to renewables and a serious look at our research base and how and where it is directed as it needs creativity and growth without sacrificing self-determination.
Nice read. Thanks now all I need to do is read through Chris Cooks comments on QE style investment.
"We are all capable of economic activity – especially the 2.5 million people unemployed." Spending fairy money is not "economic activity" in any useful sense.
"and hey presto, government spending pays for itself."
Bienvenue à l'hôpital psychiatrique, as they say in France
Spending fairy money is not "economic activity" in any useful sense.
Banks create fairy money and have since the early 18th century: where else do you think it comes from?
We need money created by the Good Public Fairy - and maybe managed by the Reformed Private Fairy - without the unnecessary overhead of Fatcat salaries to bank management and the dividends in respect of private capital that underpins private credit creation.
Until they were permitted/encouraged to go insane, the banks required collateral for the credit they gave. Brown's fairy money has no collateral. It merely dilutes the value of assets priced in Sterling already in existence, as the forex markets are vigourously demonstrating.
But I think this is inaccurate.
It can be used as it has been under QE to finance the British government deficit. The BoE out of thin air, issued £200bn of ‘gilts’ (govt bonds) and other asset purchases in 2009. Private banks bought them – and by doing so, helped finance the government’s £177 billion deficit.
The Treasury issues gilts, not the Bank of England, and it is the BoE's purchase of gilts - via the banks - with newly-created credit=money which currently constitutes QE.
The outcome is that the Bank of England receives interest from the Treasury in respect of the £200bn of gilts it owns on the one hand, and pays 0.5% on banks' reserves on the other.
The difference is a nice little earner - getting on towards £5bn so far - but since the BoE's profits go to the public then the overall result is that the Treasury has a £200bn overdraft from the banks at 0.5% - via the BoE as its agent.
The difference from our bank overdraft is that this one is at the Treasury's option, not the Banks'.
Also, if the Treasury were to end QE by selling its gilts to the market it would lose many billions at the current price. But this won't happen - for tens of years, if ever - because the banks will never be able to afford to let that credit drain out of the system.
It is not, it is spending.
As for Spain, Ireland, Portugal and Greece, they have plans to cut their deficit by three quarters in three years
Labour has been found out and every single deficit reduction forecast made by Darling and Brown since 2005 has been totally and completely wrong.
As for Keynes, what a pity Labour didn't listen to create a surplus during the boom times to damp aggregate demand.
Finally QE. QE do not and was never meant to be used to create or invest in public assets. It was originally meant to buy government and commercial paper on a ration of 2:1. It bought government paper on a ratio of 99:1. It has merely inflated asset prices and done nothing more than that. Inflating the price of illiquid assets and precious little real liquidity in terms of broad money supply has happened.
Labour's stimulus was a house of cards and it's about to collapse.
What part of the deficit is funding investment?
Very little, and that is increasingly a problem.
As for Spain, Ireland, Portugal and Greece, they have plans to cut their deficit by three quarters in three years
Which is complete, catastrophic Voodoo economic bollocks.
It has merely inflated asset prices and done nothing more than that. Inflating the price of illiquid assets and precious little real liquidity in terms of broad money supply has happened.
Quite right. And that is what is wrong with it.
It has to be spent or lent into the real economy: nothing else will do.
Labour's stimulus was a house of cards and it's about to collapse.
There barely was a stimulus. Massive stimulus is needed, and professionally managed.
It's amazing, Mike, that you correctly determine that the doctor is spooning down snake oil, and then you propose to apply leeches to cure a patient bleeding internally.
One minute you propose that QE should be used to create productive assets, the next to inject direct into the economy. Which is it?
A direct injection of QE into the economy as liquid cash is Weimar economics at best and Mugabean economics at worst. 'Investing' QE into productive assets will achieve little to nothing other than dilute the collateral and wealth of the wider economy.
There are usually two means that Labour deploy to recover from a recession.
1. Debase the currency.
2. Stoke up inflation to devalue the debt.
At the moment, Labour has chosen Option 1. Sterling is in retreat, theory dictates that exporters should be able to take full advantage. They are not, exports are not rising. Instead, as a lot of UK manufacturing is now value-add, it is hiking up the price of unfinished goods or raw materials. It is also hiking up the cost of oil, traded in dollars.
This is stoking inflation especially the cost of importing oil and energy.
Which brings me onto Option 2, inflate the debt away.
Fine if your debt is collateralised in long term gilts, a disaster for asset values held by UK residents and those living on fixed incomes. We already have negative real interest rates. It is a devaluation by proxy and also an incredibly crude means to encourage consumption by fact of devaluing savings.
If there was a time when more credit is needed, it is not now. What is required is a period of de-leveraging.
The largest component of UK indebtedness is in households not in government. What the government is not doing is making it easier for people to deleverage their debts by compounding ever more taxes upon them.
Why are the government not making it easier to help households deleverage?
Because they are paying through the nose to repair the bank's balance sheets as well Look at the base rate, then look at the economic interest rate. Mortgage SVRs are eight times the base rate, personal loans thirty times and credit cards higher.
Hence the reason for reducing government spending, if government spending is allowed to increase, taxpayers are going to be asked to pay more towards it. This will slow this deleveraging effort and delay a return to economic growth by damping aggregate demand through private consumption.
If this period of indebtedness continues, interest rates carry a risk component, a risk of default of any lender. It is a pooled risk. The public and government are ridiculously over-leveraged. The UK is the second most indebted nation on the planet.
A longer period of QE will only delay the inevitable as QE has shown, all it has done is permit the government to issue new debt as the BoE hoover up the old debt. It has merely bought time, nothing more. Looking at the BoE balance sheet, it holds a record level of 'assets' now, unwinding that alone places a massive risk on the economy as it now. Adding more to that would economic madness jeopardising medium and long term economic growth and suppressing asset values for years.
Is that what you want? Diminishing returns for decades because that means only one thing, higher interest rates for a very long period of time which will damp economic growth for years and years to come.
The EU, BBC and Tories really do get it, Labour are simply stealing future economic growth to stave off a heavy defeat. That is the ultimate in political contempt for the every people it claims to care so much about.
Cheap shot, Mike.
I must have distinguished half a dozen times between Bernanke's helicopter drop - which is just distributing money - and investing in public and private productive assets, which as you well know, is what I advocate.
But even with Bernanke's helicopter drop - which I do NOT advocate at this point - I think it is unlikely to lead to inflation in the UK at the moment since most people would use their Citizens' Dividend (to coin a phrase) firstly to pay off debt, and secondly to invest/save....you know, like the rich do. It would take a while to 'trickle down' into the economy, I think.
The point you miss about Zimbabwe, by the way, is that the principal reason their currency went down the toilet is that their obligations were not in their own currency. Ours are in sterling, and it makes a big difference.
Investing' QE into productive assets will achieve little to nothing other than dilute the collateral and wealth of the wider economy.
What planet are you on, Mike? QE is not debt - it is credit.
How is that if bank's create credit which is loaned to create productive assets or spent on fatcat salaries and dividends then that's OK and not inflationary, but if the Treasury/BoE were to do it - at half the cost or less - then that's not OK?
Your opposition to public credit is purely ideological with no basis in reality at all. Public credit is backed by the UK people and commonwealth - private bank credit is backed by two thirds of bugger all.
To ensure that the necessary credit is available for the circulation of goods and services and the creation of new productive assets is a key government function. It never should have been outsourced to the private sector 300 years ago, but there is no reason why it should not now be professionally managed by the private sector.
Such Public Credit creation - supervised by a Monetary Authority -would be a Win/Win - especially for banking as a profession, since Banks' capital requirement will be cut drastically because all they need is enough for operating costs.
If there was a time when more credit is needed, it is not now. What is required is a period of de-leveraging.
Unfortunately in a deficit-based economy deleveraging drains credit out of the economy, leading to depression. If the private sector deleverages, public credit must fill the gap, and that was the positive achievement of QE, at the cost of bailing out the rich by inflating financial asset prices, as you well understand.
The solution, IMHO, is a Debt/Equity swap, and an equity solution is not just proposed by the likes of Nassim Taleb and Willem Buiter, but even by an FT leader article this week - so I think I'm in good company.
Hence the reason for reducing government spending, if government spending is allowed to increase, taxpayers are going to be asked to pay more towards it.
You know my views on tax. There should be a drastic shift to tax unearned income from privilege rather than income earned by people; but since the privileged own and run the country that will not happen.
There is another way of skinning the cat, and achieving structural reform, however.
unwinding that alone places a massive risk on the economy as it now.
Unwind it? They will shortly have to increase it. There is absolutely no need at all to unwind it - it's not debt is it? As recently as 1960, QE equivalent (ie notes and coin) was >30% of our money supply.
Is that what you want? Diminishing returns for decades because that means only one thing, higher interest rates for a very long period of time which will damp economic growth for years and years to come.
Money created as credit has no cost at the time of creation.
There is never any need - in relation to circulating credit - for interest rates to exceed the level necessary to cover system operating costs and defaults. For credit used in relation to productive assets, the cost need only cover asset depreciation and system operating costs.
What I want is massive QE investment - probably running to hundreds of billions a year pretty quickly until the economy is at full capacity - and one of the key initial components must be the investment in the UK people to build our capacity to do most of the development work ourselves.
The EU, BBC and Tories really do get it,
They do not have a clue - since they've entirely swallowed the neolib Kool Aid - as have you, unfortunately.
Labour are simply stealing future economic growth to stave off a heavy defeat.
QE is the only thing that has prevented Depression, and increased QE invested into the economy is capable of fuelling the UK's re-generation. It's just a shame that the Treasury has been right by accident, and don't even realise what they should be taking the credit for.
Capital requirements, banking ratios.... you told me only a few weeks that these banking fundamentals no longer applied.
You cannot conjure money out of thin air without consequences.
So far the consequences have been:
1. A depreciation of Sterling with none of the residual benefits in the balance of trade.
2. No increase in the money supply, in fact it is still falling.
3. No lowering of economic interest rates.
(1) is what happens with QE.
(2) and (3) are meant to be the benefits of re-inflating the economy and re-introducing the take up of credit.
It has simply not worked. Buiter's Qualitive Easing suggestion is to add riskier assets to the QE portfolio. It is a mere footnote to the entire QE programme and discussion, no one is going to volunteer to risk trashing the balance sheet of the lender of last resort. That would be akin to putting your entire life savings on '00' of a routlette wheel.
The BoE should have stuck to its 67:33 ratio of public and private debt. That would have released £60bn directly into corporations to then invest.
Instead it's gone into the lowest risk, lowest return forms of debt and the banks have sat on the money. They have not increased lending, they have not extended existing lines of credit anywhere nearly enough. They have though increased the marginal rates of interest to almost record levels. All with the implicit approval of this government.
The BoE is sitting on a balance sheet the size of which has not been seen since the war. It is a certainty it will have to be unwound further depressing asset prices. It currently sits at 17% GDP which is a phenonomal amount of collateral, how it is going to release that back into the economy is anyone's guess.
Chris, households account for £1.2 Trillion of debt and whilst the de-leveraging efforts are slow, it is happening. There is little to no propensity for credit because there is little to no confidence. De-leveraging is a natural occurence of any recession and the quicker is it allowed to happen, the quicker growth can return.
This government is actively pursuing policies to prevent that from happening and that is their gravest mistake.
Here's lies the rub Chris, the BoE is now openly telling the banks to deleverage now as well.
Your QE to buy productive assets does not achieve any of the three points QE is meant to address either. It has merely delaying the deleveraging efforts, government pursuing its deficit agenda also flies in the face of economic sense.
The banking system is and always has been based upon conjuring money out of thin air, because our money IS credit, and credit creation by a Private Bank; a Central Bank (QE) or Treasury (Social Credit) are all based on little more than faith.
1/ Certainly market perceptions of the UK economy are negative - but to say QE caused the fall in exchange rate is just an assertion with no basis in fact. Which does not make you wrong.
2/ Indeed the money supply is still falling, here and in the US, and that means more QE will inevitably be necessary to prevent recession or worse.
3/ Central Bank setting of interest rates is entirely irrelevant except insofar as low rates may enable banks to increase profits and save their balance sheets from further deterioration.
QE has worked to save us from Depression, but not otherwise, as the money simply bails out the financial economy and not the real one.
It is a certainty it will have to be unwound
It is certain that conventional economics dictates - for purely ideological reasons - that it should be unwound, but there is no practical reason why the BoE's asset base should not increase further.
The question is what those assets should comprise. There was a time when the Bank of England furnished almost the entire stock of money in circulation.
In my view that's the principal function of a central bank, if you must have one, and Hong Kong, of course, doesn't and it has done them no harm.
Here's lies the rub Chris, the BoE is now openly telling the banks to deleverage now as well.
Indeed, we agree on the problem, but not the solution.
Your QE to buy productive assets
I must correct you here.
I wish QE to be used to create new productive assets.
Existing productive assets should be the subject of a debt/equity swap on a cosmic scale - starting with distressed property, and the refinancing of quasi-public debt eg housing debt.
The very operation of QE will devalue a currency, look up how it works and then repeat your assertion again.
The very operation of QE will devalue a currency, look up how it works and then repeat your assertion again.'
Since I've been out, I've had no opportunity to respond, but I see that CC has already answered. Only a pure monetarist would argue that there is direct causation. Well, the world isn't like that. Sterling was overvalued for a start. This simplistic MV=PT perpetrated by Fisher and taken on by others is theoretical, not real.
The point is almost universally missed by economists - and not just the Voodoo tendency - that the credit created to acquire productive assets - particularly land (which backs more than half of the $ and £ credit/money in existence)- is tied up in legal claims such as mortgages and is essentially static.
In other words, only that relatively small amount of credit based upon people's 'Labour' (ie manpower and knowledge) -either individually or collectively through business - is actually dynamic and in circulation at any given time.
So most of our deficit-based credit=money doesn't actually circulate at all - which doesn't do much for MV=PT, I suspect.
If money is used to acquire assets, then the price of the assets gets bid up, and asset price inflation (or support) is the result.
That's what happened with the property bubble.
Velocity of circulation is bollocks. A canard.
Economists do not make the necessary distinction between the credit used to facilitate the circulation of goods and services - and to create new productive assets - and that used to acquire existing productive assets.
By far the majority of money in existence was created to purchase pre-existing assets - and does not circulate or create new productive assets. It remains 'tied up' or static in the conflicting legal claims of equity and secured debt.
This fact is ignored as inconvenient by mainstream economists whose assumptions are purely ideological.
"If money is used to acquire assets, then the price of the assets gets bid up ...."
Agreed - and one person makes a handsome profit, while the counterparty is left looking at an asset that is overvalued, compared to economic fundamentals.
That's also the paradox of pension funds - current holders like to see high "asset prices", without realising that current purchasers are at the same time "buying high" and compromising the long-term performance of their pension fund.
It escapes them that what their pensioners will actually need in retirement is a flow of funds and not the results of a series of bets in a casino.
Any "extras" can be financed by personal saving in whatever investment vehicle the individual decides - without tax relief.
I did write on this last year :
http://www.labourlist.org/labour_needs_bold_state_retirement_pension_peter_barnard
"As a matter of interest, which asset prices have inflated?"
Equities - or, rather, the bits of paper representing equity stakes.
It'd be interesting to know what Tobin's "q" is at present, on both sides of the Atlantic.
Any idea - either you or Chris C?
Thanks - but if you look at the two articles, one is very recent (Bill Gross) and the other at the back end of 2008 (the other feller).
Based on history, the "other feller's" musing that the S & P could dip to 400 has been seen twice since 1929 : in 1942 and 1982.
Forty year cycle, anyone?
This one didn't. Hence the mess.
However this caught my eye:
" It does not have punitive enough targets for cutting benefits to the poor and services for the mentally ill and frail."
Got a link for that?
I agree that (under Kinnock) its a bit rich for the EU to talk about financial probity when it can't even get its own accounts signed off but isn't it worrying when even they are raising serious concerns over our level of debt?
I saw on the news today that we won't be 'back on our feet' until 2032 - I do like the sound of investment and building an economy at last, when's Gordon going to start?