#76. The point of no returns


Bonds trading at negative yields now equate to almost half of all Western sovereign debt. Government bonds, offering both safety and a reliable income, have traditionally been the bedrock of pension systems, so the elimination of returns is destroying the provision of pensions across the world.

In Britain alone, pension scheme deficits are reported to have reached almost 50% of GDP after the latest knee-jerk cut in policy interest rates.

The destruction of pension provision is just one example of how reckless monetary policy is undermining the real economy. By keeping otherwise-failed businesses afloat, monetary largesse has undermined the essential “creative destruction” required to free up both market share and capital for new entrants. Markets are no longer able to put a price on risk.

Markets distorted by reckless polices are no longer capable of meeting the business investor’s key needs, which are to weigh risk and return.

Making an epic disaster

A couple of years ago, I was contacted from Hollywood with a somewhat unusual request – a scriptwriter was looking for help with the plot of a disaster-movie on the theme of economic catastrophe. I was on holiday at the time, and I don’t know if my cursory thoughts helped him.

But I realise now that no flights of imagination were necessary – all he needed to do was watch the conduct of the economy under today’s powers-that-be, and then extrapolate into a not-very-distant future.

After this beginning, you might expect me to remind you that an addiction to debt, and to countering the dangers of excessive indebtedness with cheap money, have turned the global financial system into a gigantic Ponzi scheme which is destined to end as all such schemes do. You might expect me to point out the consequences of deliberately-induced hyperinflation in asset markets.

I’m not, though, because readers know all this. It is surely obvious that the financial system is heading for policy-induced disaster. It is equally obvious that potential crash-triggers are proliferating across the system.

Instead, my focus here is on the consequences for the real economy of the grotesque mismanagement of the financial system. The mad magicians of monetary policy, not content with trashing their own financial bailiwick, are wreaking havoc in the real economy of goods and services as well. A string of mechanisms, vital to the functioning of the real economy, are being destroyed.

Killing the future

Here are two striking figures which illustrate the consequences of monetary madness. First, and according to the Financial Times, the $12.6 trillion of bonds now trading at negative yields equate to almost half of all Western sovereign debt. This sovereign debt is the bedrock of private (including employer) pension schemes around the world, because pension schemes require both the security provided by government debt, and the regular and predictable income received from fixed-income investments.

Amplifying this point, one consequence of the Bank of England’s latest (and surely unnecessary) rate cut has been to increase the deficit in British private pension provision to £945bn (which, incidentally, is about 50% of GDP).

Both of these numbers are gigantic. If half of all sovereign debt delivers negative returns, pension provision right across the West is no longer viable. The British private pensions deficit is in addition to a shortfall, generally put at about £1,000bn, in unfunded public employee pension provision. In theory – though the practice might be problematic – the taxpayers of the future are likely to be bled white just to keep the pension promises that governments have made to their employees. This may or may not be possible, but it surely rules out any taxpayer bail-out of private pension provision.

The British pensions issue is part of a broader national malaise which is looking increasingly existential. A forthcoming article will explain why, in my analysis, the British economy as a whole is looking increasingly unsustainable. Here, I focus on the global (or, at least, the pan-Western) consequences of monetary madness. One of these consequences is the destruction of our ability to provide for old age.

We are not simply dismantling the system of pension provision, which is bad enough in itself. Even worse, policy madness is stealing the future security in which millions of people have already invested.

The point of no returns

This problem is a wholly logical, direct and entirely predictable consequence of “low or no” interest rate policies. Interest rates determine the returns that investors make on fixed-income instruments. Pension schemes rely on these returns to meet future pay-out requirements. So “no returns” means “no pay-outs”. Well done, policymakers – you have just destroyed the futures of millions of people.

Some of this was already pretty obvious. For a start, annuity rates collapsed when rates were first slashed in 2008-09, and monetary policy has been destroying savers’ wealth ever since. But only now are the full implications for pension provision emerging.

Obviously, if someone buys a bond yielding 5%, his return is pretty much 5%, plus or minus any capital gain or loss that he makes on the principal. So a 0.5% yield equates to a 0.5% return – and you cannot run a pension system on that. A zero yield means a zero return, putting the final nail into the lid of the pensions coffin. A negative yield means that capital is being cannibalised.

Adios, pensions.

Of course, an investor in a nil- or negative-return instrument can still make a profit, but he can only do so on the basis of “greater fool” theory. This says that buying something overvalued can be profitable if you can sell it on to someone else (the “greater fool”) at an even more overvalued price. Buying a bond yielding -0.1% can be profitable, then, if you can sell it on to someone else at a yield of -0.5%.

This profit, however, is purely fortuitous, and is not the same thing as a return. It is not a reliable, predictable and continuing return on investment, on which stable pay-outs can be based. Rather, it is a purely incidental gain delivered by the continuity of policy excess.

Forgive me if I seem to be labouring the point, but we do need to be clear about this. If a pension fund (or any other investor, for that matter) is deprived of returns, it cannot meet a requirement for income. The ability to make a capital gain depends entirely on the indefinite continuity – indeed, implicitly the acceleration – of monetary looseness. This distinction between investment returns and investment profits is absolutely critical to what is happening.

Investors? Kindly get lost

Destruction of future pension provision around the world is only one aspect of the massive real-economy distortions being introduced by the mad monetary magi whose only answer to every challenge is to pour in more liquidity.

For a start, this policy is making rational investment impossible. Just like pension funds, both financial and industrial investors need returns, and they need at least some visibility on future returns. This they do not have in a situation of induced hyperinflation in asset-markets. They know that capital put into existing paper assets will continue to escalate in nominal value for as long as the one-trick ponies control the monetary system. They cannot predict the date of the eventual implosion, even if they are aware that this must happen. Critically, though, they cannot project returns on investment in new business ventures either.

One reason why they cannot do this is that monetary madness has undermined “creative destruction”. In the normal course of events, over-leveraged, out-dated or simply badly-run businesses go bust, which both creates space and frees up capital for new entrants. This isn’t happening, because ultra-cheap money keeps throwing lifelines to businesses which, under normal conditions, would have failed.

In this sense, the monetary authorities have created a gigantic welfare system for the world’s worst-run businesses. Like any welfare system, somebody has to pay for it, the “somebody” in this instance being both the owners of viable businesses and the would-be entrepreneurs who should be creating the next generation of enterprises.

A market which cannot supply returns, and which keeps failed businesses in being, obviously cannot fulfil its required function of putting a price on risk. The investor’s main objective, which is weigh risk against potential return, is thus stymied on both sides of the equation. He cannot realistically anticipate returns in an environment in which returns have virtually ceased to exist – and he cannot calculate risk in markets which have priced risk down virtually to zero.

On top of this, the investor might well wonder what happens when the ageing demographic collides with the inability to provide retirement income. Of course, people denied retirement incomes may well have to stay in work for longer – but all this is likely to do is to put further downwards pressure on productivity, especially in the feeblest economies.

The final question (for now)

Since we have seen how lethally destructive the central banks’ addiction to ultra-cheap money has become, one question remains. Why are they doing this?

(Or perhaps there is a second question – are these people complete idiots?)

Beyond following a momentum that they themselves have created, central bankers seem to be behaving in this nihilistic way for three main reasons.

First, they are trying to help the financial system cope with a global debt mountain that has become far too big even to service, let alone ever repay. They are doing this because they are – probably wrongly – more fearful of a one-off cascade of defaults than they are of the on-going destruction of the value of money.

Second, they really believe that stimulus can shock the world’s real economy back into sustainable growth. No amount of evidence or logic, it seems, can cure them of this delusion.

Third, they are delivering monetary stimulus – the only weapon in their arsenal – because the alternative of fiscal stimulus is not being provided by global policymakers. The explanations for this inaction by governments are, first, that they entered the post-2008 world with fiscal deficits that were already gigantic and, second, that politicians have largely abdicated from the economic arena, dropping the whole mess into the laps of central bankers.


Though I regard central bankers and their associated cheerleaders as “the mad magi” of monetary largesse, it is pretty clear that they are acting as they are as much out of lack of alternatives as out of an ideological commitment to recklessness.

The reasons for this madness, however, are secondary to its consequences. For so long as this recklessness continues, people will be robbed of the ability to provide for retirement, whilst the economy will be undermined by the inability of investors to project returns and put a price on risk.

On the capital side, we are caught between Scylla and Charybdis or, in the modern idiom, between a rock and a hard place. If asset market hyperinflation continues, it will inflict ever greater damage on an economy already trying to function with a concept of returns, without the vital pricing of risk, and without critically-important “creative destruction”.

If (meaning when), on the other hand, asset market hyperinflation ceases, it will crash the system in a tidal-wave of defaults.

Pension savers in particular, most of whom have yet to realise that their futures have been stolen, desperately need the restoration of returns – and so does the broader economy.



#75. Britain – old, new, borrowed, blue


After the weighty material we’ve dealt with in recent discussions, the subject-matter here is the (relatively) lighter matter of Life After Growth. By this I refer both to the book, which has reached a paperback edition, and to the practice of coping with an ex-growth economy.

The latter, whether she knows it or not, is the primary task facing new British premier Theresa May. Though I wish her luck – and she will need it – Mrs May would not have been my first preference. For a start, she opposed Britain’s decision to leave the European Union (EU), which has been supported by modest but decisive majority of voters, and, pretty clearly, by a larger majority within her own party. Second, and more seriously, she is another “moderniser”, seemingly every bit as committed to that cause as outgoing Prime Minister David Cameron.

Back to the future

For those with better things to do than follow British politics, a brief explanation of “modernisers” is in order. With the kind of irony with which politics abounds, “modernisers” are really stuck in a time warp, existing in a 1990s Britain when Tony Blair was popular, and his policies seemed progressive.

Back then, Mr Blair changed his party fundamentally, even renaming it “New” Labour to underline the transformation. Left-wing economic ambitions were ditched in favour of what amounted to an accommodation with neoliberalism, but this was combined with a commitment to social policies traditionally associated with the Left. Government was both centralised and casualised, the latter typified by the term “sofa government”. PR, or “spin”, was elevated to new heights of prominence.

Though the economic policies of “New” Labour were comfortable for the opposition Conservatives, Blair’s social agenda was more challenging. Party opinion divided between those who supported “traditional” Tory values, and a faction, known as “modernisers”, who advocated adopting the Blairite social agenda as well. Theresa May was one of the most prominent “modernisers”, and indeed described her party to its face as “the nasty party”.

The enthronement of David Cameron marked the triumph of this faction, and the accession of Mrs May reinforces the modernisers’ control of the Tory machine. If one single attitude defines the “modernisers”, it is a crusading belief in “equality”, though a cynic might argue that it is an “equality” cleverly defined to exclude equality of wealth and income.

Mrs May has promised to tackle this, and it will be a major achievement if she does.

Essentially, the Conservative “modernisers” decided that, if they couldn’t beat Blairism, they would copy it.

“The future isn’t what it used to be”

Unfortunately, the problem with this combination of economic neoliberalism and social crusading is that it doesn’t work. Of course, the social dimension is a matter of personal opinion, though the rising tide of coercion (including restrictions on free expression) does sit oddly with a so-called “liberal” philosophy.

The economic agenda seemed successful under Blair, but only because his government was presiding over an economic “boom” which amounted to nothing more than the spending of borrowed money. The hollowness of the economy was laid bare in 2008, with massive fiscal deficits, the near-collapse of a bloated banking sector, and a 25% slump in the value of Sterling, to an index weighting of 74.4 at the end of 2008, from 98.3 at the start of the year.

David Cameron, in coalition with the Liberal Democrats, steadied the ship, but didn’t – or rather, couldn’t – fix the holes below the water-line.

For a start, Britain remains massively indebted. “Real economy” debt, at £4.65 trillion or 250% of GDP, may not sound too onerous, but this excludes the financial sector, which adds a further 183% to this ratio, establishing the United Kingdom very firmly in the category of “debt-ravaged economies”. Nor is this all – the British government has massive off-balance-sheet “quasi-debts”, with its commitment to government employee pensions alone standing at about 55% of GDP.

More seriously, the British economy remains addicted to debt, with little or no growth remaining once incremental borrowing is stripped out. Nowhere is this more stark than in the current account, where an enormous deficit – a completely unsustainable 6% of GDP – is bridged by a combination of selling assets and borrowing from overseas, currently at a combined annual rate of £100bn, and rising. Though trade remains in deficit, the big change since 2008 has been in the income part of the equation, where outflows of profits and interest now massively exceed the equivalent sums coming in.

A frightening spiral

This, of course, is a circular equation – the more a country borrows, and sells assets, to meet short-term funding shortfalls, the bigger will the net financial outflow become in the future. The British establishment seems not to have noticed this, but what they lack in economic understanding is compensated by a preternatural determination not to upset public opinion – they are not, then, about to tell the voters to start living within their means.

A debt-addicted economy tends to use housing finance (as well as consumer credit) as a conduit for pouring more debt into the economy. This has resulted in bloated property values, which are socially distorting as well as detrimental in the sense that the property sector is a nil-return “capital sink”.

Worse still, speculation has increasingly trumped innovation as the route to individual prosperity. If there is a single measure that government needs to implement without delay, it is to rebalance the equation by taxing all short- and medium-term property gains, and using the proceeds to remove the burden of Business Rates from small enterprises. Needless to say, this is completely outside the realm of practical politics.

Of course, it is perfectly possible for a country to “earn” its way out of such problems, especially when its exchange rate weakens. But Britain has precious little scope for increasing exports, because globally-marketable output (GMO) has fallen steadily, combining shrinkage of manufacturing with the relentless decline in energy production. Energy has been another area of cluelessness on the part of the governing elite, which has done little or nothing to invest effectively in replacement sources of supply. Britain relies on French and Chinese investors to fund its next generation of nuclear power stations, preferring to ear-mark its own resources for schemes like the HS2 rail link, and buying a new nuclear deterrent.

Meanwhile, the use of asset sales and overseas borrowing to bridge a current account deficit requires both that a country is seen as a reliable borrower and that its assets are desirable.

This in turn depends on global confidence in its currency…..

No way out?

Anyway, so much for this intrusion into private grief. With the opposition Labour party divided between Blairites and a resurgent Left, the Conservatives pretty much have the field to themselves. Another pro-EU “moderniser” was exactly what the doctor didn’t order, but Mrs May has the job, and the best that can be done is to wish her luck.

To end on a more – well, relatively more – cheerful note, my publishers have given me a publication date for the paperback version of Life After Growth, which will go on sale on 3rd October. However, they actually expect to have some copies well before that, possibly even before the end of July, which can be pre-ordered here. Though the text itself is unchanged, the paperback includes a new introduction and after-word, reflecting on what has happened since first publication in 2013.

Of course, I hope you will read Life After Growth, if you haven’t already. It might be a good idea for Mrs May and her colleagues to read it, too – but there’s not much chance of that……………

LAG2-3D cropped

#74. An Age of Unreason


Whilst I have no intention of adding to the mountain of commentary about “Brexit”, the British decision to leave the European Union (EU) is an extreme example of broader and more important trends developing throughout the Western world. Essentially, governing elites are not just ignoring the unpopularity of their policies, but seem blind to the spectacular failures of those policies as well. Is this simply arrogance and idiocy – or is something more fundamental happening?

This question matters, because this is no time to leave the lunatics in charge of the asylum. The global economy has stagnated, the financial system is stretched, and political and social tensions are growing, yet all too many of those entrusted with the levers of power seem sublimely detached from what is going on.

Remarkably, they seem wholly unaware that their favoured doctrine of economic neoliberalism has been holed below the waterline, and that continuing to cling to it can only mean sinking with it.

A troubled world

As regular readers will know, the surplus energy approach to economics leads to a conclusion that the global economy has reached a plateau, after which a steady decline is to be anticipated. Meanwhile, the financial system has become a gigantic bubble, along Ponzi lines, because the system of money and credit has been allowed to expand far too much in comparison with the underlying economy.

Thus far, a financial crash has been averted – or at least delayed – only by the use of increasingly surreal monetary expedients. Money newly created for the purpose has manipulated yields down to near-zero levels in line with policy interest rates, and bonds worth more than $11 trillion now trade at negative rates. The main calming effect of ZIRP (zero interest rate policies) has been to ease the pressure of servicing gigantic global debts, whilst repayment, too, can be rolled over in an environment of unprecedentedly loose monetary policies.

Even so, areas of tension are multiplying throughout the system, exacerbated by the virtual disappearance of growth in an environment dubbed “secular stagnation”. Tranquilisers may calm nerves, but they aren’t exactly conducive to the taking of effective action.

These disturbing economic and financial patterns have political corollaries, a recent example being the popular revolt against the establishment which was sufficient to swing the British electorate against continued membership of the EU. Of course, with its governing Conservatives leaderless whilst the opposition Labour party tears itself apart, the British political situation is more chaotic than most. But tensions are increasing across much of the Western developed world, with many emerging market economies (EMEs) in deep political trouble as well.

What is abundantly clear is that the backlash against the elites is closely tied to the troubled state of the economy. One of the main reasons for this is that many Western countries have pursued an economic philosophy variously known as “neoliberalism”, “the Washington consensus” and “the Anglo-American model”.

Whatever name is used, this philosophy is turning out to have been a disaster, not just in economic terms but politically and socially as well. The choice facing the ruling elites lies between, on the one hand, abandoning neoliberalism and, on the other, sticking with it and being swept from power.

A very British shambles

Because of its dysfunctional, insufficiently-democratic system and the abject inadequacy of its political class, the United Kingdom is obviously somewhat exceptional, but it is an instructive example nonetheless. In essence, and under successive governments, Britain has pursued policies which have undermined the economy whilst driving a wedge between governing and governed.

A glaring example of this is that, whilst affluent bankers were rescued from the consequences of their own folly, no such help has been given to workers in industries such as steel-making and retail, whilst savers (including those investing in pensions) feel they have been sacrificed in the rescue of the feckless. This seems unfair – and is.

No ruling elite which treats the public with such arrogant disdain can expect to retain popular legitimacy, which is one reason why dire official forecasts for the economic consequences of “Brexit” failed to convince voters to remain in the EU.

Yet neither of the major parties shows the slightest sign of having learned from this experience. Many Conservative MPs want to choose as their leader Theresa May, another “moderniser” in the Cameron mould who, like him, who opposed “Brexit”. Meanwhile, Labour MPs keep insisting that they know better than the party membership which elected Jeremy Corbyn as leader. They might succeed in getting rid of Mr Corbyn or, with the help of the members, he might get rid of many of them. Either way, Labour is crippled.

Neither party seems remotely conscious of the need for fundamental reform. Worse still, many of those who opposed “Brexit” still seem to be in denial. As well as asserting that the millions of people who disagreed with them are xenophobic idiots, some have advocated ignoring the popular decision, holding a second referendum, or hoping that the Scots (9% of the British population) can somehow stymie departure from the EU. Any of these expedients would cause a crescendo of anger, and rightly so. The voters have decided, the “metropolitan elite” has lost, and the only adult response is to accept the fact, and respond accordingly.

European unreality

The leaders of the EU have grounds for resenting British action, but it is at the behaviour of the British government, rather at than the decision of the electorate, that they should vent their spleen. At a time when the economy and migration needed to top the EU agenda, David Cameron instead made a series of spectacularly ill-judged gambles. Having first wasted EU leaders’ time with demands for “reforms” which he failed to get, he then called a referendum for no very obvious reason, and duly lost it.

But the EU should not dismiss this as “a little local idiocy”. For a start, dissatisfaction with the status quo is by no means confined to the United Kingdom. A popular backlash against the elites is particularly visible in France, the Netherlands, Austria, Spain, Italy, Greece and Poland, whilst even Germany is witnessing the rise of the radical AfD, partly in response to Angela Merkel’s advocacy of an “open doors” policy on immigration.

Part of the EU’s problem is the euro, an economically-illiterate attempt to combine a single currency with a multiplicity of budget processes. The only way to resolve this problem would be fiscal union, but any such idea has a zero chance of popular acceptance. It seems wildly implausible that the EU will ever contemplate reverting to national currencies, despite the imperative need of many Eurozone members for devaluation. Because conventional devaluation is denied them, weaker Eurozone economies have instead had to opt for “internal devaluation”, which means pursuing greater competitiveness by driving labour costs down. As well as fanning unpopularity, this hasn’t worked, because an obvious by-product of this “austerity” route to competitiveness has been the undermining of demand.

At the same time, weaknesses seem to be emerging across much of the Eurozone’s banking system, with a huge flight of capital out of banks apparently contributing to upwards pressure on the prices of such “safe havens” as German government bonds. The sharp fall in the prices of bank shares is instructive, and started long before the British decision to leave the EU.

Global paralysis

More broadly, the capital created by ultra-loose monetary policies is swirling around the globe in pursuit of (relative) safety, and worried investors are now prepared to pay “safe” borrowers for the privilege of lending to them. Of course, the “safety” offered by lending to blue-chip borrowers provides no guarantee against losses of value through inflation, a material consideration, particularly where long-dated bonds are concerned. At the moment, the dominant price pressure is deflationary, reflecting a moribund economy, but ultra-loose monetary policy is obviously capable, under certain conditions, of triggering an inflationary spike.

In any normal world, borrowers pay lenders for the use of their money, whilst investors expect to earn positive returns. One reason why this is not happening is the apparent paucity of investment opportunities. Though ultra-cheap money is available in abundance, big companies prefer to buy back their own stock rather than invest in new ventures. This judgment may be logical, particularly in a world with massive capacity surpluses (most obviously in China), but it underlines quite how weak the economy has become.

Obviously, if the economy is moribund, and the generality of the population is suffering hardship, the rich should not expect to keep getting ever richer. Their opponents are not simply articulating “the politics of envy”, though this is certainly an influence. The real problem is that the lives of millions of working people are plagued by uncertainty, with many corporate bosses treating employees as expendable, and companies as counters in a crap-shoot. Further enriching the already rich has the politically and socially dangerous by-product of creating a “precariat”, a risk to which ruling elites seem oblivious.

It may be human nature to pursue ever greater wealth, but what is remarkable is the willingness of governments to assist. The way in which QE (quantitative easing) has been enacted typifies this. Since using newly-created money to drive up asset prices is bound to be a hand-out to those already asset-rich, logic surely suggests accompanying QE with higher taxation of capital gains – yet no government has done this. Many governments still treat capital gains as the reward of effort, even where they are self-evidently the result of speculation or good luck.

At the same, and whilst the rescue of banks may have been necessary, the rescue of bankers clearly was not. Despite the obvious social strains and inefficiencies (not to mention the risks) that arise from inflated property prices, no government has sought to prevent this bubble, or even to impose higher taxes on its beneficiaries in order to compensate its victims.

The investment playing-field has been tilted decisively in favour of speculation and against entrepreneurship, yet governments profess themselves baffled by deteriorating productivity.

No-one is as blind as someone who refuses to see.

Why persist?

Many theories might account for the continued adherence of governing elites to failed nostrums, and their inability or unwillingness to look facts in the face. One of these is a long-standing failure to block the “revolving doors” between government service and corporate wealth. Another, probably more important influence is a simple reluctance to admit to failure, a reluctance bolstered by the arrogance always engendered by the trappings of power.

The irony is that, before Western leadership cadres embraced the destructive theories of neoliberalism, we already had most of the tools necessary for the effective management of the economy. Adam Smith revealed the critical importance of competition, and the damage that is inflicted where monopoly and oligopoly are allowed to prevent its effective operation. John Maynard Keynes explained how to manage macroeconomic flows, whilst long experience should have taught us the dangers of excess, and of allowing speculation to trump innovation.

What neoliberalism brought to the party was a new emphasis on immediate gratification, together with an intellectually-spurious justification for inequality. This was typified by the mishandling of globalisation through an approach which relied on cheap and abundant credit to bridge the gap between ever-rising consumption and the haemorrhaging of well-paid jobs. This in turn led seamlessly into reckless deregulation of financial services.

All of this has rendered the elites incapable of facing up to the facts. Even if they cannot grasp the theory of the eroding energy basis of the economy, or understand the implications either of climate change or of demographic shifts, they should have become aware by now that the economy has ceased to deliver reliable growth.

The established business model – which involves pushing ever-greater consumption as a route to ever-expanding sales and ever-growing profitability – is heading for extinction. No amount of speculative finance, or of monetary manipulation, is going to revalidate this failed philosophy.

What is really frightening about this state of denial is that it has contributed to a dramatic weakening in our ability to provide security in old age. Pension investment has been ravaged by the deterioration of growth, and by the undermining of longer-term thinking. It is implicit in a philosophy of immediate gratification that it undermines preparedness to provide for the future. When the public comes to realise that the future security of the many has been sacrificed on the altar of immediate enrichment for the few, their fury will know no bounds.

An astute response would involve rebalancing, checking speculative excess, re-emphasising equity, and building bridges between governing and governed. Tsar Nicholas II was too half-witted to realise this, just as King Louis XVI was too closeted in Versailles to know what was really going on.

Today’s elites are exhibiting the characteristics of both.


#73. The faltering economy


Since my previous article, German bunds have flirted with joining a group of negative-yielding bonds which already exceeded $10 trillion in value.

This means that investors are prepared to pay “safe-haven” borrowers (including the German and Swiss governments) simply to hold their money for them, in some instances for as long as thirty years. This “safe-haven” ploy simply means getting back the nominal amount, of course – and it has to be highly probable that some at least of that value will erode through the devaluing effects of inflation, particularly where long-dated bonds are concerned.

Such, today, is the sky-high price of a “safety” that is only relative anyway.

If you think about it in a detached way, any kind of negative interest rate situation is insane. Thinking through the concept of negative interest rates as they might apply to, say, mortgages, or saving, will quickly convince you that the very idea is something straight out of Lewis Carroll, Edward Lear or Monty Python.

More broadly, investing now means, at best, acceptance of a tiny income in return for a very high level of risk, whilst the likelihood of capital gain seems to rest entirely on the “greater fool” theory of central banks making money even cheaper than it already is. The normal relationships between investment and income, and between risk and return, have been destroyed.

If we take our thinking one stage further, we arrive at two unavoidable conclusions. The first is that we are trying to reinvent the financial system as we go along, in order to cope with gigantic debts that can never be repaid.

This can be likened to a blindfolded person on a bicycle trying to carry out brain surgery with a spanner.

Second, we wouldn’t be in this mess if the economy was growing. Clearly, therefore, it isn’t. The acceptance by the powers-that-be of the reality of “secular stagnation” reflects a dawning recognition that the economy is ex-growth.

We’ve examined the financial system at length here, but now it’s time we looked at the real economy – the economy, not of money, but of goods and services, of resources and labour.

The real economy

As most readers will know, my measurement of economic output and performance is based on the principles of Surplus Energy Economics (SEE). For those new to this approach, SEE adjusts output for the trend Energy Cost of Energy (ECoE), recognising that all economic activity is in the last analysis a function of energy, and that accessing energy has a cost in terms of the energy consumed in the access process.

This cost has been rising relentlessly for decades, reflecting the interplay of two factors. The first is the depletion of existing sources of fossil fuels, where declining output from old sources is replaced by supply from more recent sources which tend to be ever costlier because of smaller resources and higher costs of access.

The second factor, which offsets the upwards pressure of resource depletion, is the steady improvement of technology, but the effect of this is limited by the laws of thermodynamics. For example, technology has enabled us to access resources, such as shale oil, which we were not able to exploit twenty years ago. But what technology cannot do is to make shales and other newly-accessible resources as cheap to access as the giant, conventional oil fields of the past.

Much the same applies to renewables. Improved technology has brought the cost of – for example – solar power down dramatically. It may already have made solar, in particular, cost-competitive with the new oil and gas fields being developed today. But what solar can not do is replicate the economics of giant fields like Saudi Arabia’s Al Ghawar.

Renewables, in short, may stabilise ECoEs in a “post-giants” world, but they are not going to bring back an era of ultra-cheap energy produced from huge, technically very straightforward and readily-accessible sources of fossil fuels.

Of course, in the economy as we measure it in money, the costs of accessing energy are included, not least because, for example, an oil company’s costs are a contractor’s revenue. But the cost of accessing energy isn’t remotely a zero-sum game, for two main reasons. First, of course, money spent on developing energy sources is money that cannot be spent on anything else (roads, say, or hospitals). Second, our calculation of economic output does not account for the “economic rent” levied by the resource set, much as it also fails to account for the rising economic rent imposed by environmental constraints.

Taking stock: a surplus energy assessment of the economy

The impact of rising ECoEs on the global economy is shown in the first chart. This displays, as the financial economy, a measure known here as Standard Constant GDP (SCGDP), which is calibrated in market-rate dollars whilst measuring component growth in terms of purchasing power parity (PPP). (SCGDP has been a tricky concept to develop, and the detailed methodology is not something that I disclose).

The second line on the chart shows the real economy, after adjustment for trend ECoE. As you will see, the previously-small impact of ECoE has now become a major drag on economic output, to the point where the global real economy has hit a plateau and is facing impending decline.

The financial and real economies – global aggregates

SEEDS 2016 mod 1 world

Critically, the gap between the financial and real economies, which is measured as ECoE, is also the extent to which measured GDP overstates the underlying reality.

By basing our assessment of GDP on numbers which exclude ECoE, we have allowed the financial economy to become larger than the real one. And, since the financial economy of money and credit does not exist independently – it consists entirely of monetary “claims” on the real economy – we have been creating claims that cannot be met. These “excess claims” are the reason why the financial economy has become successively more abnormal, and has accumulated “excess claims” that are now big enough to bring down the financial system. This is a topic to which this discussion will return

The second chart applies the same approach to the United States. In common with many other mature developed economies, the US faces a steeper decline curve than the global aggregate.

The financial and real economies – the United States

SEEDS 2016 mod 1 US

The outlook for China, shown in the next chart, is for only very gradual deterioration, though this will be felt as a shock when contrasted with the spectacular growth previously enjoyed by China.

The financial and real economies – China

SEEDS 2016 mod 1 China

The striking feature of the Japan chart is the gap that already exists between the financial and real economies. The very large accumulation of “excess claims” provides corroboration that Japan’s very high debts are by no means some kind of statistical error, or are in any way irrelevant. The Japanese financial economy has created huge claims in excess of the capabilities of the real economy.

The financial and real economies – Japan

SEEDS 2016 mod 1 JP

The United Kingdom chart, shown next, is grim, indicating that the real economy has commenced a serious and seemingly relentless decline. The reasons for this are not obscure, and are a combination of bad luck and bad management.

Though Britain’s ECoE (on a consumption basis) is not out of line with global trends, the sharp decline in domestic energy production is already having a very deleterious effect on the overall ECoE. The gap between the financial and real economies is fairly modest thus far, but a policy of denial over what has been happening to the real economy could easily result in a ballooning of excess claims.

Though the decline curve in North Sea oil and gas output has long been known, successive governments have failed to respond effectively. Plans for the replacement of Britain’s ageing nuclear fleet should have been decided by the second half of the 1990s at the latest, but nothing was done. Now, the UK has committed to costly and problematic technology as an adjunct of wanting others to pay for it. Investment in renewables has concentrated excessively on offshore wind, which increasingly looks like the wrong choice.

The on-going deterioration in net energy trade suggests that the already-severe current account deficit (around 6% of GDP) could worsen significantly, and could exhaust the expedient of covering this shortfall with asset sales and overseas borrowing.

The financial and real economies – the United Kingdom

SEEDS 2016 mod 1 UK

The ‘black hole’ in the financial system

Finally, we need to consider the accumulation of “excess claims” which are created whenever the financial economy is larger than the underlying real economy.

Until relatively recently, excess claims were only being created at a relatively modest rate, and the accumulated pile of cumulative excess claims was not particularly dangerous. In 2000, for example, but expressed at 2015 values, excess claim creation stood at $2.4 trillion, and the outstanding total was $23 billion. By 2015, however, the accumulated pile of excess claims had reached $70 trillion, and is growing at over $4trneach year.

At $70trn, the outstanding total remains smaller than global debt ($150 trn), but has grown to the point where almost half of all global debt is incapable of repayment. In short, Surplus Energy Economics identifies a $70trn black hole where claims created by the financial economy cannot be satisfied by the real one.

With real economic output now static, and seemingly due to commence a relentless deterioration, this black hole is going to grow even more dangerous unless action  is taken to remedy the habitual mortgaging of a future that is much less prosperous than the global authorities have yet realised.

Surplus Energy Economics, then, makes sense of an artificially-inflated financial system, and explains why maintaining the semblance of normality is already requiring remarkable monetary gymnastics.



#72. End-game


With their resigned but widening acceptance of “secular stagnation”, the powers-that-be are inching ever closer to a recognition that growth, at least as we have known it, isn’t going to return to previously-experienced levels. It seems a short step from “low growth” to “no growth at all” (which would not, of course, come as any great to surprise to the author of Life After Growth).

Indeed, when we factor-in the depressing effect of population expansion on per-capita GDP, even “secular stagnation” takes us into a new era.

Let’s reflect on what this means. Individuals can no longer assume that they are going to get better off over time, or that each generation will be more prosperous than its forebears. People and businesses can no longer take decisions on the assumption that wealth, or real asset values, or the size of the market, are going to keep getting bigger. Governments cannot plan on the basis of an expanding economy, or tax revenues that increase from year to year.

These are profound changes, not just in financial terms, but also in how we think about government and the economy.

That, and the importance of the subject, is why this discussion is longer than usual.

My aims here are as follows. The first is to look at the implications of a “low growth” (or even a “no growth”) economy. The second is to relate a slowing economy to a debt mountain that keeps getting bigger, and to ask what we are going to do about our debt burden now that we can no longer expect to “grow out of it”.

The latter question is the easier of the two to answer. I am more convinced than ever that a financial crash is inevitable. Moreover, I think we can begin to see, not only where it is likeliest to happen, but the form that it’s likeliest to take. As outlined later, we can now identify four directions from which the next crash is most likely to come.

As for the near-disappearance of growth, resulting changes are likely to include the ditching of the doctrine of economic “neoliberalism” and, as the price of failure, a further weakening of incumbent elites which already facing a popular backlash.

Low growth – the three causal factors

To start with, though, we need to examine why it is that growth has become so feeble. Once we are clear about the causes of weak growth, we can understand the role of theory and policy, and then move on to look at consequences.

Opinion is divided about why growth is so low. Some, even amongst the opinion-formers and decision-makers, are starting to question the efficacy of “neoliberal” economics. Sometimes known as “the Washington consensus” or “the Anglo-American model”, this doctrine has ruled the roost since it supplanted Keynesian economics in the 1970s. Of course, doubters in the upper echelons are few in number – so far, anyway – and most of them assert that neoliberal economics is solid and robust.

Well, to paraphrase Mandy Rice-Davies, “they would say that, wouldn’t they?”

The first cause of low growth is an escalating uptrend in the cost of energy. The key parameter here is the “energy cost of energy” (ECoE). As readers will know, energy is never “free”, but has a cost in terms of the amount of energy that is consumed for each unit of energy accessed.

Though market prices oscillate widely – largely in response to cyclical patterns – underlying trend ECoEs have been rising relentlessly for several decades, and have been acting as an increasingly heavy drag on growth since about 2000. In that year, according to SEEDS (the Surplus Energy Economics Data System), trend ECoE reduced GDP by about 4.2%, up from 2.8% a decade earlier but still small enough not to be noticed within normal margins of error when calculating economic output.

Today, however, SEEDS puts trend ECoE at over 8% of GDP, which is more than enough to explain the virtual disappearance of growth.

Still, nothing is ever so bad that policy mistakes cannot make it worse. The second and most obvious brake on growth has been escalating debt, which can, in large part, be traced to the mishandling of globalisation.

Because Western businesses chose to export skilled, highly-paid jobs without accepting a corresponding reduction in consumption, debt was driven upwards by the need to bridge the gap between weakening real incomes and rising consumer spending. The banking system made this resort to borrowing possible, aided and abetted by government and central bank preferences for impaired surveillance (under buzz-phrases such as “light-touch regulation”) and unduly loose monetary policies.

In addition to rising resource costs (measured as energy inputs), and the choice of policies geared to increasing debt, a third factor contributing to weak economic performance has been a loss of interest in growth. That governments and societies have chosen growth-reducing policies may seem such an outlandish idea that a brief explanation is required. Once explained, it becomes apparent that policy has sabotaged growth, to a very striking extent.

Essentially, there are two broad ways in the individual can pursue wealth. One is to invest effort and capital developing a business, pioneering new products and services. This is hard work, and is subject to considerable risk and uncertainty, but it is a major driver of economic expansion. It can be called the “entrepreneurial” route to betterment.

The alternative is the “speculative” route, which involves investing money in assets and profiting from a rise in their value. Whilst it can make individuals wealthier, speculation does not contribute to growth in the economy.

Obviously, therefore, the role of policy should be to ensure that the entrepreneurial route, rather than the speculative one, is followed as extensively as possible. This means ensuring that incentives favour innovation rather than speculation.

In short, policy can sabotage growth if it incentivises the speculative and deters the entrepreneurial, and this is exactly what all too many Western governments have done. Both regulation and taxation have made the entrepreneurial route unattractive, whilst fiscal and monetary policy has favoured the speculative. Governments have not only operated loose monetary policy, but have, through deregulation, made it easier to borrow. Additionally, capital gains tend to be taxed at lower rates than income, whilst states have demonstrated their preparedness to backstop property markets, reducing speculative risk to levels far below entrepreneurial risk.

In this way, Western governments have steered their populations towards speculation and away from entrepreneurship. No government which does this has much right to complain – though they still do – when innovation and productivity deteriorate, because incentives and risks have been skewed in favour of speculation and against entrepreneurship. To this extent at least, Westerners, at the instigation of their governments, have actively chosen a path of low growth.

Culpability? “Secular stagnation” and neoliberal economics

Given these three causal factors in the deterioration in growth, to what extent are neoliberal doctrines to blame?

It needs to be understood that, though avowedly a philosophy of market economics, neoliberalism actually differs a great deal from anything that Adam Smith would have put his name to.

For a start, neoliberalism puts much less emphasis on free and fair competition, and lacks Smith’s absolute loathing of monopoly and excessive concentration (which, famously, he called “a conspiracy to defraud the public”). It lacks, too, the logic implicit in Smith, which is that the state has a crucial role to play in saving capitalism from its own excesses. Neoliberalism is far more supportive of corporatism than Smith could ever have been, and, where Smith emphasised the benefits of competition to society as a whole, neoliberalism is a worshipper at the altar of unrestricted private profit.

Therefore, it is perfectly consistent for followers of Smith to castigate neoliberalism as a self-serving variant.

This is just as well, because it is pretty clear that neoliberalism has played an active part in driving growth downwards. This is not the only reason why the neoliberal consensus is heading for the shredder, but it suggests that populist opposition to neoliberal doctrines has a solid basis in logic.

Though neoliberalism cannot be blamed directly for the escalating trend cost of energy, even here there is some culpability. Countries most addicted to neoliberalism – amongst them, Britain and America – have all but abandoned the direction of their energy futures.

Shales have not conferred energy self-sufficiency on the United States and, even before the recent falls in prices and the near-collapse of investment, shale output was always expected by the authorities to reach peak output shortly after 2020. In Britain, where energy production has already halved over ten years, successive governments have dithered over nuclear power, finally selecting the costliest, least reliable technology on the table, and relying on overseas investors to fund its development. Softening regulation, and announcing “life extensions” for the existing nuclear fleet, may be safe enough – though I’m glad I don’t live anywhere a “life-extended” plant – but do not address the fundamental issue.

Where soaring debt is concerned, neoliberal doctrines are “guilty as charged”. Western governments have supported a form of globalisation geared almost entirely to the furtherance of corporate profitability, and have been complicit in the expansion of debt necessary to bridge the widening chasm between domestic production and consumption.

It is over the third growth-destroying trend – the loss of interest in growth – that neoliberalism is most culpable. Governments, citing neoliberal logic, have pursued policies which skew incentives in favour of speculation and against entrepreneurship.

On the entrepreneurial side, states have pursued ever-increasing regulation, sometimes for good reasons of safety and quality, but in other instances in pursuit of social policies dear to the hearts of the self-styled “liberal elites”. Taxation often bears much too heavily on small and medium enterprises (SMEs). This is typified by the British system of Business Rates, a tax which, being wholly unrelated to turnover, let alone profitability, is the small-business equivalent of a dose of strychnine.

In contrast to this, governments have favoured and incentivised speculation. They have made borrowing both cheap and easy-to-access, and have exacerbated this trend since the banking crisis, the logic seemingly being that economies can “borrow their way out of a debt problem”. In many countries, capital gains are taxed at rates lower than median incomes, and gains made on property are often exempt from taxation altogether.

Policies designed to boost asset prices – most notably the infusion of newly-created money through quantitative easing (QE) – should, at the very least, have been accompanied by the taxation of policy-created gains. Almost unforgivably, they were not. Governments have made no secret of their willingness to backstop property prices, thereby lending powerful support to the speculative route to wealth.

Nemesis #1 – the coming crash

So much for the causes of low (or no) growth, and the complicity of neoliberalism. What happens next?

Though few in authority seem to have made the connection – or, more likely, have decided not to talk about it “in front of the children” – “secular stagnation” further increases the already-strong probability of a coming crash. Put simply, the burden imposed by debt becomes much heavier if growth is much lower than had previously been assumed.

Such a crash is, of course, implicit anyway in the transformation of the global economy into a giant Ponzi scheme, where each dollar of reported “growth” comes at a cost of almost $3 in net new borrowing, and where most of the “growth” itself is phoney, since it amounts to nothing more than the spending of borrowed money.

Those entrusted with global economic and monetary policy seem wholly incapable of learning from past experience. The 2008 banking crisis came about because “real economy” debt (which excludes the purely inter-bank sector) increased by $38 trillion over a seven-year period in which nominal GDP rose by $17 trillion.

In the seven years after the crisis, when nominal GDP again increased by $17 trillion, borrowing rose to $49 trillion, from $38 trillion in the earlier period. In response to the crash, governments slashed both policy and market interest rates to prevent the burden of debt service from overwhelming the system. In so doing, they made borrowing far cheaper than at any point in financial history, which necessarily created huge asset bubbles whilst accelerating the rate at which we are mortgaging the future.

This has to end with an implosion, since this outcome is hard-wired into all Ponzi schemes.

Of course, “secular stagnation” ups the ante where a crash is concerned. Since the only circumstance in which a debt burden can become less onerous is where the income of the borrower increases, a deterioration in growth (to levels below prior planning assumptions) has the effect of making debt harder to service, and bringing the looming crash even nearer.

We can now identify four areas where the next crisis is likeliest to start. And, of course, if any one of these risks eventuates, it further increases the likelihood of sympathetic detonations elsewhere.

Risk 1 – China

The first area of exposure is China, where it is necessary to look behind the obvious. The “obvious”, of course, means faltering growth and escalating debt. Though the government claims that GDP is still growing at around 7%, it is very hard to reconcile this with volumetric and other data, the implication being that the real figure may in fact lie somewhere between 2% and 4%. That debt has escalated is beyond dispute, having increased from $7 trillion in 2007 to over $31 trillion today. Together, soaring debt and faltering growth are a nasty combination, and suggest that China may now be borrowing upwards of $4 for each dollar of growth. But the really worrying indicators are more nuanced.

For a start, and as we know from Western experience in 2007 (the “credit crunch”) and 2008 (the “banking crisis”), excessive debt tends to result in a credit crisis well ahead of a solvency one. In China, there is unmistakable evidence of “creditor drag”. Chinese businesses are finding it increasingly difficult to get paid by creditors, and average payment times are increasing markedly. Creditors tend to pay late, when they do so at all, and often pay with credit notes or post-dated cheques rather than immediate money. This inevitably stresses the system, because even a sound business can struggle to pay its staff or its own suppliers or, for that matter, service its debts, if its creditors do not pay on time. In short, expanding payment times are an early (but serious) harbinger of deepening problems.

Creditor drag” is just one of the warning signs that are starting to flash amber-to-red in China. Another of these, mentioned above, is falling debt efficiency, where more debt is needed for each incremental unit of GDP. This ratio seems to have risen to greater than 4:1, meaning that 4 units of new borrowing are required for each unit of growth. This is simply not sustainable.

A third warning sign is debt recycling, indicated by a rising proportion of new debt that is taken on simply to repay existing borrowings. A fourth lies in successive failed attempts to convert debt into equity. Meanwhile, Chinese banks’ bad debts appear to be rising rapidly, which in turn raises questions about capital adequacy, meaning that the ability of banks’ reserves to absorb bad debt losses is being undermined.

Another crisis-marker lies in capital flows, which have turned adverse in a very short time. Over the last year, in a drastic break with previous trends, the long-established flow of investment capital into China has reversed, with close to $600bn flowing out of the country during 2015, most of it in the second half of the year.

Unlike the West, where borrowing has tended to be channelled into boosting consumption and inflating the notional “value” of the housing stock, China’s folly-of-choice has been the use of debt to create capacity far in excess of realistically likely demand. The immediate effect of such behaviour is to drive down returns on investment, often to levels which are lower than interest rates on borrowed capital. This helps explain why China has tried to convert debt into equity – and also explains why it hasn’t succeeded.

There are, in short, increasingly persuasive reasons for anticipating a credit squeeze in China, with the likelihood being that this will segue, pretty quickly, into a full-blown solvency crisis.

Risk 2 – equity market exposure

It may, perhaps, not seem surprising that equity markets have risen strongly since the banking crisis, reflecting ultra-low interest rates and the injection of huge amounts of QE into the financial system. But I am indebted to Damon Verial  for flagging-up a potentially very dangerous downside risk, one which has gone largely unnoticed by market-watchers.

This risk lies in debt-funded stock buy-backs by quoted companies. This activity has been a huge contributor to market strength, particularly in the United States. The point that Damon Verial has noted, however, is that stock repurchasing correlates remarkably closely with borrowing. In other words, companies are taking on debt to fund buy-backs. He has likened this to the mechanism which created recessions in the US in the 1930s and Japan in the 1990s.

The overall funding pattern is unlikely to be noticed either by equity investors or lenders, both of whom focus on individual corporate leverage, not on overall trends in borrowing and buy-backs. But the combination of weak earnings and cash flows, and downwards trends in both borrowing and repurchasing, suggest that US equities could be heading for a huge (“meaning recession-huge”) hit to the market.

If equity markets do tumble, the effect on the broader economy is likely to be serious, particularly in a context of “secular stagnation”. The Wall Street Crash of 1929 triggered the Great Depression and, six decades later, a slump in over-valued stocks marked Japan’s plunge into a deep recession which continues to this day.

Risk 3 – capital flows and the $7 trillion gamble

Alongside China’s looming debt crisis and dangerous downside risk in American equities, the third crash-risk that can be identified with a high degree of confidence is the likelihood of disruptive currency flows.

This problem began in the aftermath of the banking crisis, when investors believed that there were two near-certainties on the medium-term horizon. The first was that interest rates in the United States were likely to remain low for an extended period, implying that the dollar itself would weaken. The second was that emerging market economies (EMEs), most notably China, would continue to grow more rapidly than the developed economies of the West. After all, they had been doing so already for an extended period, and were not, at that time, hobbled by the kind of debt burden that was weighing so heavily on the Western economies.

This suggested a straightforward strategy, which has come to be known as “the dollar carry trade”. The principle was simple – an investor who borrowed cheaply in dollars to invest in EME markets could anticipate that the secular advantage of higher growth rates would be leveraged by dollar weakness, ramping up the gains that would be made when the time came to move back into dollars and pay off the debt.

This logic seemed seductive at a time when it was fashionable to wax lyrical about the “BRIC” economies (Brazil, Russia, India and China). Since then, three of the four bricks have fallen from a great height. Brazil has suffered from a combination of weak commodity prices, economic deterioration, and corruption on a gargantuan scale. Oil prices and politics have likewise undermined Russia. Though growth apparently continues in China, it is not reflected in corporate performance, largely because the borrowing binge has been invested in so much surplus capacity that profitability and returns on assets have cratered.

Just as the EMEs have fallen from grace, the dollar has strengthened, not weakened. Investors in the dollar carry, in rushing for the exit, have rediscovered the old adage that “when everyone rushes for the door, the door gets smaller”. The unwinding of the carry trade probably has a lot to do with the unparalleled outflow of capital from the EMEs that gathered pace throughout 2015.

No-one knows with any precision the scale of dollar carry exposure, but the best estimate, which is of the order of $7 trillion, suggests that less than 10% of exposed capital has so far been reversed out.

This “gamble gone wrong” is, like the US equities risk, “recession-huge”.

Risk 4 – the failure of “kamikaze economics”

One of the most glaringly misleading terms in international economics is the “lost decade”, since Japan’s recession has now lasted for 25 years. In a desperate attempt to break out of the cycle of near-zero growth, escalating debt and widespread deflation, the Abe government has adopted a strategy of massive stimulus, including QE on a vast scale and rapid increases in government indebtedness. When we include household and business debt as well, Japan is one of the world’s most indebted countries, with a debt-to-GDP ratio in excess of 400%. Indeed, and compared to Japan, even Eurozone debt worries pale into comparative insignificance.

By deferring a planned increase in sales taxes out to 2019, Mr Abe has essentially conceded that “Abenomics” has failed. Deferring the tax was something that Mr Abe had previously insisted would not happen unless Japan was hit by a Lehman-type catastrophe or a serious earthquake. The country’s current predicament bears the hallmarks of both.

Once again, we need to examine nuances within the broader picture, which in this instance involves trends in Japanese government bonds (JGBs). Large fiscal deficits have resulted in the very substantial issuance of JGBs – but who is buying these new tranches of government debt?

The answer, rather shockingly, is that nobody is. Investors are not lending to the Japanese state. Instead, debt is being “monetised” – meaning printed – by the authorities. A country which reaches this situation is in the last-chance saloon where its credibility and creditworthiness are concerned.

Without burdening you with too many numbers, let me explain what’s been happening with JGBs. The central bank (the Bank of Japan or BoJ), as we know, has been engaging in QE on a huge scale, buying JGBs with money newly created for the purpose. This has resulted in an expanding BoJ balance sheet, and increasing BoJ ownership of JGBs.

None of this is surprising – but the actual numbers are.

Back in 2008, the BoJ owned less than 7% of all JGBs outstanding. But this number has since risen at an alarming rate. By the end of 2013, the BoJ owned 18% of JGBs. Today, this proportion exceeds 33%. By the end of next year, almost half of all JGBs are likely to be owned by the central bank.

These numbers are frightening in their implications. First, the BoJ is buying – meaning “monetising” – enough debt to far more than cover the annual budget deficit. Second, it is also monetising existing debt as it falls due for redemption. No one is lending to the Japanese government, and investors are big net sellers of government debt. Japan is moving rapidly into a situation in which it is simply printing its borrowing needs, be they for on-going public spending, debt redemption or the payment of interest.

If this continues – or as and when investors work out what is going on – both the yen itself, and yen-denominated markets, will collapse.

Nemesis #2 – the populist backlash

Just as crash risk rises everywhere – from Chinese liquidity to American equities, via a Japanese end-game and a Sword of Damocles hovering over capital flows – the powers that be in the global economy now recognise that the economy is trapped in “secular stagnation”.

None of this is surprising in itself. Even the most rudimentary knowledge of economics will tell you that, under normal circumstances, the vast stimulus injected into the system since 2008 should have caused growth to soar to the point of overheating, with inflation rising rapidly.

Instead, we have stagnant growth, and price indices hovering between zero and deflation.

If an animal that has been injected with huge quantities of stimulants fails even to twitch, the implication is that the animal is dead.

A fascinating side-effect of economic stagnation is a populist backlash against incumbent elites. This explains the popularity of Donald Trump, and also explains the rise of Marine Le Pen in France, Geert Wilders in the Netherlands, AfD in Germany, Eurosceptics in Britain, Podemos in Spain, right-wing nationalists in Austria, Syriza in Greece, and populist movements right across Europe. Even the Chinese authorities seem to have been rendered powerless to tackle the country’s debt problems by the fear of labour unrest.

Though the immediate flashpoints often concern migration, history shows that economic hardship generally does provoke social unrest, particularly when coupled with perceived unfairness. The migration issue itself has an economic dimension, because workers fear that an inflow of migrants depresses wages. Young people are trapped in a mesh of high rents, out-of-reach property prices, job insecurity and a dearth of well-paid employment. The deterioration in the real incomes of the majority contrasts sharply with the soaring wealth of those at the very top. At least one self-made American billionaire has warned of “pitchforks” unless glaring inequalities are addressed.

Whilst this may be – and probably is – unduly alarmist, the scale of the popular backlash in the context simply of “secular stagnation” must make one wonder about what the public response will be if, as seems increasingly likely, the financial system suffers a major shock.

= = = = =

Here are some charts on secular stagnation, from SEEDS

United States

SEEDS 2016 US F & R


SEEDS 2016 JP F & R


SEEDS 2016 CHN F & R

United Kingdom

SEEDS 2016 UK F & R




#71 – A flat-earth debate


Early on Friday morning, a spectacular blaze engulfed a fireworks warehouse in Southampton. As far as I’m aware, no cause has yet been discovered, but no matter – I’m sure the authorities can blame it on the prospect of “Brexit”.

I’ve had not much to say here about “Brexit”, in part because I’ve yet to be convinced by any of the economic arguments thus far put forward on either side of the debate. If I’m moved to comment now, it’s because the escalating scare campaign, dubbed “project fear”, is so starkly at odds with the absence of solid, reasoned, factual discussion of the issues.

Even the economic debate is stymied by the implicit assumption that the economy, whether bigger or smaller after “Brexit”, will remain the same as now in structural terms.

To assume a static structure when making projections is the economic equivalent of assuming a flat earth when making maps. If I cannot provide an answer to the structural issue here, then at least I can point out what the question ought to be.

For those fortunate enough to have escaped the deluge of scaremongering and name-calling which has been inflicted on the British electorate, I should perhaps explain that “Brexit” is an ugly shorthand term meaning “British exit” from the European Union (EU). (I mention this because the word actually sounds more like the name of a new snack-bar).

The campaign to frighten voters into the “remain” camp divides into two parts. The first, domestic part is that peddled by supporters of continued membership, whose ranks include the government and much of the taxpayer-funded, supposedly-impartial state machine. The second component comes from overseas, both from foreign leaders (such as Barack Obama) and from international organisations (including the IMF). International contributors tend to concentrate only on the economic dimension of the debate, whereas home-produced scare-stories know few bounds.

The non-economic frighteners

There is, undoubtedly, an economic debate to be had but, thus far, it hasn’t happened, as I’ll explain shortly. First, though, let’s deal with the non-economic fears which have been canvassed by British opponents of “Brexit”. In passing, it is interesting to note that the “leave” side has not – yet, anyway – descended to retaliation-in-kind by indulging in the same sort of fear-mongering practised by their opponents. Of course, the “leave” camp still has plenty of time in which to retaliate, and could yet play the immigration card, though it is profoundly to be hoped that they don’t.

The escalation of “project fear” has been remarkable, and has pushed the advocates of “remain” out to the farthest reaches of credulity. Most of the non-economic claims are outlandish enough to be dismissed summarily.

The assertion that a British departure could lead to war is simply preposterous. Mrs Merkel isn’t going to invade the Sudetenland, and France isn’t going to march into the Rhineland, if British voters give the EU the bird. The responsibility for maintaining peace in Europe rests with NATO – not the EU – and with international relationships, most importantly that which links Britain to the United States.

Here, a strategic mistake far bigger than “Brexit” has already been made, when Britain broke ranks and signed up to the AIIB, China’s rival to the World Bank, in direct defiance of US policy. This can only undermine the UK’s credibility in Washington, which is particularly regrettable at a time when American voters seem to be veering towards isolationism.

The claim that leaving the EU would weaken national security is a bit rich from a Prime Minister who has presided over a dangerous deterioration in conventional defences. Mr Cameron’s governments have slashed the size of the Army, failed to replace the RAF’s antediluvian Tornados, bulldozed Britain’s vital maritime surveillance capacity into scrap metal, failed to reinstate the Navy’s interceptor aircraft, decommissioned the aircraft carriers, slashed Britain’s submarine force and done nothing to bring the numbers of destroyers and frigates back up to necessary levels.

Fear, risk and credibility – eaten by the dog?

The sheer scale of the scare campaign, and its increasingly outlandish assertions, pose a clear risk of provoking derision in voters. Some people have already started to wonder whether “Brexit” is to blame for the failure of their geraniums. Others have quipped that “Brexit” might cause Earth to veer out of the solar system. It wouldn’t surprise me if school children start to claim that “Brexiteers” have stolen their homework, as a fresh variation on the old “eaten by the dog” excuse.

The margins of ancient maps were labelled “here be monsters”. Those navigating “project fear” surely know that its wilder fringes are labelled “here lies ridicule”. Assuming that they know this, why have the “remain” camp strayed so far into fear-mongering?

My supposition is that the pro-membership side is running scared. This would be consistent with an approach that has been bungled from the outset.

Mr Cameron went in to reform negotiations with the statement that he was quite prepared to campaign for a “leave” vote if he didn’t secure concessions. This makes it very hard for him now to explain why, if “Brexit” would be such a total disaster, he was so recently prepared to support it. Was he, until a few months ago, happy about the prospect of economic catastrophe, defence enfeeblement and European war? Or has he only lately discovered these risks? And, if “Brexit” would be such a catastrophe, why call a referendum at all?

The economic issue – a case not made

Thankfully, contributions to the debate from outside Britain have largely been confined to economic issues, where both foreign leaders and international organisations have reiterated warnings made at home by the commentariat and the representatives of big business as well as, most recently, by the Bank of England.

The problem with economic evaluations – as supplied by both sides of the debate – is that they are “flat earth” in nature. They have delivered projections based on an implicit assumption that there will be no structural change in the British economy.

The reality is that structural change has to happen – or, to put it another way, the British economy will be in very real trouble if it doesn’t. The government has itself, in the not-too-distant past, argued the case for “rebalancing”, though it has been noticably mute on the subject since it became apparent that rebalancing isn’t happening.

The best way to appreciate the need for structural change is to recognise that goods and services produced by the economy divide into two broad categories.

The first category is output that competes on global markets – even products actually sold at home fall into this category, if they have to compete with imports.

The other category comprises services which can only be consumed at home, and are not subject to international competition. Cars, refrigerators, steel and food are globally-priced, because the customer can always choose an imported alternative if it offers better value. There is international competition in some service areas, too, such as tourism, banking and insurance.

A customer cannot, however, employ an estate agent, book a taxi or order a takeaway meal from abroad, so competition and pricing in such categories is purely domestic. This has profound implications, not just for the performance of the economy but for how output is measured as well.

The real imperative – rebalancing

A long-standing problem, which Britain shares with many other developed economies, is that too much of its output is capable only of internal consumption, and cannot be marketed in competition with overseas suppliers. This is reflected in a bias towards sectors such as property and domestic financial intermediation, and inadequate exposure to globally-marketable sectors. This is becoming ever more of a problem because, as the real estate and similar sectors have boomed, production (including energy as well as manufacturing) has continued to shrink.

Current trends, notably both in oil and gas production and in manufacturing, suggest that things are getting worse – which in turn has adverse implications both for borrowing (which remains excessive) and for Britain’s current account relationship with the rest of the world (which has become dangerously negative).

Changing this imbalance is vital, and requires much more than pious hopes and vocal encouragement. What is needed most is innovation, and this tends to come from small- and medium-sized enterprises, not from the corporate giants which dominate so many UK sectors.

Would leaving the EU promote the cause of rebalancing, towards globally-marketable output and towards smaller, innovation-driven businesses? Or would continued membership be more effective in delivering these structural changes?

The only honest answer has to be “don’t know” – but even that is better than the position of both camps (“remain” especially), which seems to be “haven’t thought about it”

#70. Britain’s disappearing economy


There are times when the very sanity of those running the British economy has to be called into question.

If you think this verdict extreme, please consider the following.

1. Dependent on foreign creditors. The British economy is run “on tick”, in that the current level of consumption requires huge (and growing) subsidies from overseas creditors. In the latest quarter, these creditor subsidies reached a staggering 7% of GDP, and averaged 5.2% in 2015 as a whole.

2. A downwards spiral. This dependency on foreign creditors – which has totalled an enormous £350bn over just five years, and almost £200bn in 2014 and 2015 alone – has been funded by overseas borrowing and the sale of assets, each of which automatically creates streams of future financial outflows (in the form either of interest or of profits).

3. Economic illiteracy. Those who manage the British economy are quite incapable of distinguishing between the creation of value and the recycling of value. Thus, it doesn’t – in their opinion – matter one jot if a value-creating manufacturing job is lost, provided that it is replaced by a value-recycling job (such as a waiter, an estate agent or a “manager”).

4. The abdication of economic sovereignty. Dependency on foreign creditors imposes a straitjacket on policy – for example, and despite what is happening at Port Talbot, a British government that habitually grovels to China is reported to have opposed EU plans to impose anti-dumping tariffs on Chinese steel.

5. Delusions of grandeur. With both the government, and the economy as a whole, running huge deficits, Whitehall spends its time dreaming up extravagant projects – such as HS2, and the replacement of Trident – which the country simply could not afford, even supposing that either investment made sense.

6. Gross neglect. An impending energy squeeze is all but ignored, with the solitary exception of steadfast support for the folly that is Hinckley C.

Finally, the people responsible for this near-disastrous state of affairs actually seem to believe that this situation is indefinitely sustainable, so long as Britain keeps on borrowing from abroad, flogging off its asset base and currying favour with wealthy foreigners.

This has been a week in which chickens have started coming home to roost. In addition to intense anger about the threatened closure of the Port Talbot steelworks, official statistics have reiterated the extent to which the British economy lives ‘on tick’. Whilst President Obama’s criticism of Mr Cameron over Libya was unfair, the broader charge – of British freeloading on the American taxpayer over defence – is undoubtedly valid.

More broadly, though, the British economy as a whole is freeloading, on foreign lenders and overseas buyers of British assets. Not only is this unsustainable, but it creates an ever-larger stream of future financial outflows which shows every likelihood of turning into a lethal spiral.

Let’s start with the current account, which is a prime indicator for the state of the economy. This is illustrated in the following chart.

Bop 2000-15

Source of data: Office for National Statistics

Essentially, the current account measures the financial relationship between the British economy and the rest of the world. Back in 2005, this was a small deficit (£17bn). In 2015, however, this deficit stood at £96bn, equivalent to 5.2% of GDP (though in the final quarter it reached a horrific 7%).

This means that more than 5% of Britain’s consumption – which is one definition of GDP – now comes courtesy of foreign creditors.

Of course, these overseas creditors do not subsidise British consumption out of the goodness of their hearts – the difference has to be matched by inflows in the financial account. What this in turn means is that, last year, Britain subsidised its consumption through a combination of overseas borrowing and the sale of assets, to the tune of £97bn.

Over just five years, the total extent to which Britain has inflated its standard of living, through borrowing and selling off assets to fund a current account shortfall, is £350bn.

This, put simply, is the extent to which Britain is living beyond its means.

(If you do think this is in any way sustainable, by the way, there are lots of nice men who would like to play poker with you).

There is, of course, an even nastier sting in the tail of this kind of recklessness. To understand this, take another look at the chart. As you will see, the chart divides the current account into two components – the balance of trade, and a category labelled “income”. The latter, termed by the statisticians “primary and secondary income”, is dominated by the total of interest and profits paid to the foreign owners of British assets and debt, net of equivalent income from abroad.

As the chart shows, the trade deficit, though persistent, has been relatively static – in fact, it was £36bn both in 2005 and in 2015.

The big difference between those years has been a massive deterioration in the “income” component. Back in 2005, Britain earned a net £19.8bn from overseas investments, offsetting a £36.4bn trade deficit to leave the current account a modest £16.6bn in the red.

Between 2005 and 2015, however, the balance of income swung massively, from a surplus of £19.8bn to a deficit of £59.6bn, which means that we are now adding a financial outflow of almost £60bn to a trade deficit of £36bn, resulting in a total current account deficit of £96bn.

If you have any grasp of financial flows, this should worry you – and the reason for it should worry you even more.

Essentially, when you sell an asset or borrow money, you create a future outward flow of profits and interest.

What this in turn means is that, each time Britain fills a current account gap by borrowing or by flogging off assets, it commits to future outflows such that the future current account deficit widens automatically. Thus, the £80bn swing in in the income account – from a surplus of £20bn in 2005 to a deficit of £60bn last year – is a direct consequence of the process of selling assets and borrowing from overseas.

Of course, if you work in Westminster or Whitehall, you don’t let this worry you. You certainly don’t tell the public how dangerous and unsustainable this is. Above all, you don’t admit that Britain is living drastically beyond its means. Instead, you come up with excuses (“the weakness of the Eurozone economy”), and you curry favour with wealthy foreigners, typified most recently by the grovel-fest laid on for Chinese leaders last autumn. The rest of the time, you dream about how to spend even more money that the country doesn’t have on, for example, HS2 and the replacement of Trident.

Even if Britain had the money for either – which, clearly, it doesn’t – both of these schemes come close to a definition of madness. As well as being unaffordable, HS2 is the wrong priority, when Britain needs better rail links across the North (for instance, connecting Manchester and Liverpool with Leeds, Sheffield and Newcastle), and also needs to tackle a huge backlog in the upkeep and repair of its roads.

As for Trident, the current system theoretically enables Britain to obliterate Murmansk or St Petersburg, with the inevitable implication that Manchester, London or Birmingham will be turned into a pile of radioactive rubble by an opponent with vastly larger numbers of warheads. Since I simply don’t believe that any British leader in his right mind would do this, I favour a more affordable, more flexible nuclear capability, such as nuclear-armed cruise missiles fired from submarines or warships. And, rather than spending money that Britain doesn’t have on a system it could never use, I would much rather see greatly increased spending on conventional armed forces.

The publication of the truly horrific current account numbers for the final quarter of 2015 has coincided with the grim news from Port Talbot, where the steelworks clearly stands in grave danger of closure.

The immediate reason for the threat is the dumping of steel by the Chinese, which is something that Britain seems highly unlikely to counter. According to the government, providing state assistance is not possible because of restrictions imposed by the European Union – an ironic comment, coming as it does from ministers who, in the main, believe that Britain should vote to remain in the EU.

One might speculate that British grovelling to China for investment effectively rules out taking a tough line with the Chinese over dumping. It has been reported that Britain has opposed EU-wide action on the issue. If this report is true, then ministers have (a) been telling the public that they cannot act against Chinese dumping because of the EU, whilst (b) trying to dissuade the EU from taking precisely that action.

The Port Talbot works also suffers from two other, “made in Britain” handicaps. The first is a malign form of taxation – Business Rates, a ludicrous tax levied irrespective of profitability or even sales. The second is energy costs which, for industrial users, are far higher than those paid by European competitors.

At this point, a rational government would be doing four main things.

It would be adjusting energy charges to reduce or eliminate the extent to which industrial consumers subsidise household users.

It would be reforming – or preferably scrapping altogether – the absurd system of Business Rates, replacing it with a higher level of Corporation Tax.

It would be taking action over Chinese dumping of steel.

And it would be providing Tata – an excellent company, by the way – with financial support sufficient to keep Port Talbot viable whilst these essential measures are implemented.

In reality, none of these things is likely to be done. At root, the problem is a familiar Whitehall ignorance which believes that manufacturing doesn’t really matter very much.

Whitehall, you see, all too easily believes that a job lost in manufacturing doesn’t matter if, instead, we employ an additional estate agent, “manager” or pizza-delivery driver. This misapprehension – perhaps fostered by the way in which all jobs are aggregated together in statistical publications – reveals gross ignorance, not just of supply-chain considerations but also of the process by which value is added in the economy.

In short, government does not understand the difference between creating value and simply recycling it.

What has been happening has been a hollowing out of the British economy, with asset ownership being traded for short-term consumption, whilst high value-added jobs have been replaced by more peripheral, casual and lower-paid employment.

Of course, I might be accused of venting pointless frustration, because, in practical terms, it may already be too late – not just for Port Talbot, but also for a British economy managed on the assumption that a country can live ‘on tick’ indefinitely.

The point is drawing ever nearer when some very nasty events occur. I will leave you to ponder what these nasty consequences might be, suggesting that you consider the possibility of a sharp fall in Sterling, a sharp rise in Britain’s cost of borrowing, and a simple inability to go on selling assets or borrowing from abroad.

Conceivably, there may be someone reading this who believes that this will never happen, and that the UK can continue indefinitely to live far beyond its means. If so, that person has all the qualities of vision and understanding to qualify for a top job in government.

For everyone else in Britain, the outlook is grim. Living beyond one’s means is not a sustainable policy.

For far too long, Britain has been governed by people whose approach to economics makes the Charge of the Light Brigade look like a sensible military operation.