#65. The Ponzi economy, part 1

STUMBLING ON – FOR HOW MUCH LONGER?

It has become customary, as each New Year begins, for analysts and commentators to rush into print with forecasts of what they think is going to happen in the coming twelve months.

In wishing you all the very best for 2016, I have no intention of conforming to this pattern. Instead, I plan to investigate the structure of a global economy which has become addicted to borrowing.

In any case, where the economy is concerned, I do not claim to know when things are going to happen. After all – to quote Keynes – “markets can remain irrational longer than you can remain solvent”.

But I do think we know what has to happen, even if the timing is uncertain.

At some point, a global economy which has turned into a giant Ponzi scheme has to implode.

The Ponzi economy

That the world has turned its economy into a gigantic Ponzi scheme is surely beyond doubt. There seems no other way to describe a system that, as well as being massively indebted, can only function by adding yet more debt. The big problem isn’t so much the debt mountain itself as the inability to function without an uninterrupted diet of new credit.

During 2000-07, and excluding the purely inter-bank or “financial” sector, the world took on $38 trillion of new “real economy” debt, meaning that $2.20 had been borrowed for each $1 of reported “growth”. Since then, and despite a banking crisis which ought surely to have caused at least a pause for thought, we have borrowed $49 trillion, or $2.90 for each “growth” dollar.

Even these ratios, scary though they are, flatter to deceive, because the “growth” denominator is itself phoney. Such “growth” as has been reported has really amounted, of course, to nothing more than the spending of borrowed money.

What is striking is quite how inefficient and wasteful this is, and the waste is easy to see if you look at the main “borrow-to-grow” culprits.

Not all borrowing is wasteful, and a rational observer might have thought that the world’s biggest borrowers would at least have something to show for their borrowing binge. This new debt might have been invested in productive capacity or infrastructure, for example, or it might have been spent in pursuit of greater equality, or the improvement of social conditions.

In reality, the vast majority of this new debt has, instead, been wasted. The biggest borrower of recent years – China – has lavished borrowed money on capacity that nobody needs, whilst the Americans and the British, amongst many others, have poured money into inflating their property markets, and boosting consumption beyond what they can really afford.

As the old English song reminds us, “the Grand Old Duke of York” marched his 10,000 men up to the top of a hill, only to march them down again. This was a comparatively innocuous piece of futility – so far as we know, none of his men came to any harm, and the physical exercise may even have done them some good.

What the Duke’s modern successors have done, by contrast, has more in common with Humpty Dumpty – they have marched their economic troops up to a precipice from which the only way down is to fall.

The debt addicts’ club – open to all

In order to set the Ponzi economy into some context, let’s put some figures on it. In the United States, total “real economy” debt (which excludes inter-bank borrowing) increased by $19.4 trillion – in real, inflation-adjusted terms – between 2000 and 2014, whilst real GDP expanded by only $3.7 trillion. Britain, meanwhile, added £1.9 trillion of new debt for less than £400bn on “growth” over the same period.

I spent part of the holiday period unearthing quite how much debt countries added for each dollar of “growth” over a period starting at the end of 2000 and ending in mid-2015. Unsurprisingly, the league is topped by Portugal ($5.65 for each $1 of growth), Ireland ($5.42) and Greece ($5.39). Britain’s ratio ($3.46) is somewhat flattering, in that the UK has used asset sales as well as borrowing to sustain its consumption. The average for the Eurozone ($3.54) covers ratios as diverse as Germany (just $1.87) and France ($4.22). China’s $2.56 looks unexceptional until you note that the more recent (post-2007) number is much worse. Economies which seem to have been growing without too much borrowing (such as Brazil and Russia) are now experiencing dramatic worsening in their ratios, generally in the wake of tumbling commodity prices.

In the proverbial nutshell, then, the world has become addicted to borrowing money, spending it, and passing this off as “growth”. This is a copybook example of a pyramid scheme, which in turn means that the world’s most influential economic mentor is neither Keynes nor Hayek, but Charles Ponzi.

The descent into irrational economics

The stages in which this madness has developed are instructive in themselves. In the 1990s, when growth was quite robust, the main formative influences were ultra-cheap energy, technological innovation and the opening up of the former Soviet economies. From 2000 to 2007, a deceleration in underlying growth was masked by escalating indebtedness, with countries like America, Britain, Ireland, Greece and many others blatantly using borrowed money to boost consumption.

By 2008, debt had become so excessive that the world economy ground to a halt. This was when, on any rational analysis, deleveraging was required. However, and far from retrenching, the world adopted cheap money policies instead, most notably by using money created out of the ether to inflate capital markets and thus manipulate yields (the market cost of borrowing) down to artificially low levels.

Clearly, there are two main aspects to this collective madness. The first of these is a deterioration in underlying (that is, non-borrowed) economic expansion, whilst the second is a propensity to try to rig the growth equation by borrowing.

We have pondered the lack-of-growth issue here before, and the main factors in the deterioration seem to have been higher energy and commodity prices, and a growing preference for speculative rather than earned gain.

On the former, expansion in the emerging economies – and Western economic consumption increasingly funded by debt – created big rises in commodity demand, which in turn drove the prices of energy, minerals and food sharply higher.

As for the latter, why bother with the effort and risk of investing and innovating when, with the full encouragement of the government, you could make money effortlessly, and seemingly without risk, just by making leveraged bets on property and other asset markets?

To put it another way, it would be illogical to expect innovation-based growth in a system which instead promotes the speculative.

Where borrowing is concerned, several causal factors can be identified. One of these is globalisation. Let me be clear that there is nothing wrong in principle in transferring production from costly, increasingly-inefficient Western countries to more innovative and cost-effective locations in the emerging world.

What was gravely mistaken, however, was trying to reduce production in the mature economies whilst maintaining, or even increasing, those same countries’ consumption. The big corporates that drove globalisation wanted the inherent contradiction of low-paid workers who are also big-spending consumers, a paradox that Henry Ford, for one, knew to be nonsense.

In an effort to tackle the disconnect between poorly-paid workers and big-spending consumers, a resort to debt became inevitable, at least in the absence of far-sighted restraint exercised by the authorities. This process began with the recycling of emerging economies’ surpluses into the pockets of Western consumers, something which was promoted not only by a profit-hungry banking system but also by policymakers whose creed of “light-touch” regulation blinded them to the implications of basing growing consumption on ever-increasing debt.

By the time of the banking crisis, the practice of borrowing-to-consume – in macroeconomic terms, passing off the spending of borrowed money as “growth” – had become not just habitual but addictive. Such was the scale of global debt in 2008 that cutting the cost of borrowing became the only way of staving off mass default. Of course, making borrowing ever cheaper might be intended to keep already-overstretched debtors afloat, but it also makes further borrowing virtually inevitable.

No way down?

In short, Ponzi economics has taken on a momentum of its own, and today’s economic troops keep marching up the debt hill because, unlike the Grand Old Duke, no-one knows how to march them back down again.

The world’s capital markets mirror a global economy in which debt is enormous and real growth is in very short supply. The market value of capital assets looks inflated on any rational analysis which equates the value of an asset to the stream of income to be expected from that asset over time.

The global economic problem is analogous to the old lady who lives in a big house but has very little money coming in. Like her, the global economy is “asset-rich, income-poor”. The old lady could, of course, sell her large property, but this option is not open to a global economic system whose assets can only be sold to their existing owners.

Property markets are a classic instance of this problem. If you multiply the average price of a nation’s properties by the number of those properties, you can come up with a very impressive asset value for the housing stock as a whole. The snag, of course, is that the only people to whom this housing stock could be sold are the people who already own it.

This makes the supposed aggregate “value” of the housing stock purely notional or, to be more blunt about it, all but non-existent.

Obvious though this is, it has not prevented many countries and many millions of people from believing themselves to be wealthy when this is simply not the case.

Britain is a good – by which, of course, I mean a bad – example of this delusion. Property prices have escalated, which can make a theoretical national balance sheet (and the balance sheets of individual households) look comfortingly impressive. Take away the purely notional and unrealisable value of the housing stock, however, and you arrive at a situation in which most of the asset side of the equation does has no saleable value, whilst the debts and other liabilities are all too real.

I use Britain as an example of this situation because the illusion of prosperity founded on inflated, unrealisable asset values masks a very hazardous reality, in which debts are enormous, reported output numbers flatter to deceive, the structure of the economy is seriously unbalanced, and a dependency on sustaining consumption by selling assets and borrowing from abroad is not sustainable within any realistic definition of that term.

But the UK is simply a microcosm of a much broader economic problem. Periodic wobbles in global capital markets are an inevitable symptom of a situation in which asset values are inflated whilst, at the same time, the global economy’s only real engine of growth – China – has certainly decelerated, even if it has not come off the rails altogether.

A bang, not a whimper

How, in the absence of growth, can inflated capital values be sustained? The answer, of course, is that they can’t. Like all Ponzi schemes, this ends with a bang, not a whimper.

This is why I find forecasts of a ‘big fall’ or ‘sharp correction’ in markets hard to swallow. Ponzi schemes don’t end gradually, any more than someone can fall off a cliff gradually, or be “slightly pregnant”. The Ponzi economy simply continues for as long as irrationality prevails, and then implodes.

Capital markets, though, are the symptom, not the cause. The fundamental problem is an inability to escape from an addictive practice of manufacturing supposed “growth” on the basis of borrowed money.

The authorities – like the much-maligned Duke – might find a way of marching the economy back down the hill.

But such rational retreats are rarely, if ever, how Ponzi schemes end

44 thoughts on “#65. The Ponzi economy, part 1

  1. An insightful and well-written commentary on the state of the global economy. 2016 could be the year when this economic model finally breaks, with equity markets looking decidedly jittery after the fed rate “hike”, commodity and oil prices pushing lower still and gold and silver attempting to break out. All it takes is the first major corporate bankruptcy (Glencore?) and the rest will start to tumble. Once the corporations start to go, then the sovereign crises will begin. How much longer can politicians kick the can?

    • Thank you. If I’m right about the Ponzi nature of the economy, a break-point has to come, and the catalyst may be something that, in itself, isn’t huge.

      The Fed “hike” is so small that it could only disturb markets that are in a very bad way already. The flow of funds out of emerging economies – the reversal of the dollar carry – ought to be getting more attention than it is, as should reports that China spent USD 120bn propping up the RMB in December.

      I agree with you that a big corporate crash may be the trigger.

  2. Thank you once again Tim for speaking so clearly on our collective predicament.I see the Baltic Dry index has also fallen to record lows, seems like the market has lost confidence in the future. I suppose it takes a while for the victims of a Ponzi scheme to face up to the fact they have been scammed, but once they do then action is always quick as first in first served is the rule until implosion. In today’s world that could happen quite quickly,

    • Thank you, and the Baltic Dry is indeed a key indicator.

      As you say, the implosion could happen quickly when it starts – logically, the collapse of any Ponzi scheme should send everyone rushing for the exits pretty much simultaneously.

  3. I read intensely what you say, Tim. A clear thought gives a clear language I think one can say. Thank you!
    The creating of debt coincided with the first oil crisis of 1972 with the oil embargo on oil importing (western) countries. Until then GPD and debt followed a parallel line. After that debt only grew and grew and has as far as I know tripled world GPD. Cheap energy containing huge amounts of net energy as we knew it from the start of oil history up till 1972 is, yes history, and as debt is only ‘hoped for’ net energy we will not be able to repay it in the near future. Quite frightening what is ahead.

    • Thanks. The old Bretton Woods system ceased in 1971, when the US ceased to be gold-backed. The oil crisis began in 1973. The really big increases in debt did not begin until the early 1980s.

      But you are 100% right on the main point. Ending the gold link allowed governments to create money with few restraints. The 1970s oil crises created high inflation, which deterred them from doing so. When oil prices crashed (at the end of 1985), it seemed “safe” to borrow more.

  4. Thanks Tim for these thought provoking ideas. However, last week the Econimist ran an article saying that it did not think UK debt was a problem on the basis that non-mortgage borrowing was not particularly high in historical terms. Also David Smith in the Sunday Times said something similar poo pooing the notion that we were in a period of debt-fuelled growth. So I’m a bit confused!

    • I understand your confusion. The comments you cite are in reply to those who say the economy IS debt-dependent. The Chancellor also said that Britain’s growth did not depend on borrowing – he would not have said this, of course, were others not saying the opposite.

      I will try to unravel this for you if I may.

      “Total debt” includes a big inter-bank or “financial” component. This has diminished a lot since 2007, so the total has fallen on this basis.

      “Real economy” debt – excluding inter-bank – has not decreased, but has risen.

      Within this:
      – Household secured debt has increased – and this is extremely relevant, because it creates huge risk exposure to interest rates – so anyone who ignores secured debt is being disingenuous.
      – Household unsecured debt has been fairly stable, but is now rising markedly – November’s increase was a record at £1.5bn. At the same time, the household savings ratio, which rose after the crash, has now fallen all the way back to less than 5% of household income.
      – Business debt is flat – but this partly reflects continuing very low investment.
      – Government debt continues to increase, albeit at a slowing rate.

      Looking ahead, the OBR expects household debt to rise by a lot more (in £) than it expects the economy to grow. This forecast is a PREDICATE for the growth projected by the OBR. The forecast increases include unsecured as well as secured debt.

      Growth figures, meanwhile, flatter to deceive. Within current GDP, “imputed rents” (which are an accounting item not existing in cash terms) contribute £126bn, and overseas creditors a further £98bn. So about 12% of GDP is “debatable”, to put it mildly, whilst another big chunk still comes from the fiscal deficit.

      So we have debateable GDP, a serious current account deficit, low savings, low investment, official forecasts of rising household debt – and we have both (a) taken on overseas debt, and (b) sold assets, on a big and continuing scale. Borrowing from abroad sets up future outgoing streams of interest, and selling assets creates a future outflow of profits.dividends. This is why the current account deficit has widened from £20bn to £100bn in a short time.

    • Thanks for this – I’ve had another look at the Economist article and they publish a graph of debt in proportion to household income showing quite a decline since 2008 and making the point that this level of borrowing is sustainable.

    • The figures (as % of household income) are as follows:

      2009: Secured 118%, unsecured 39%, total 157%
      2014: Secured 109%, unsecured 36%, total 145%
      2020 (OBR forecast): Secured 117%, unsecured 45%, total 162%

      I think the household income figure is a bit debateable, but that’s another issue…..

  5. The following numbers are from the Statistics Canada website:

    At the end of September, 2015 the total debt outstanding in Canada (bottom line of the credit market summary data table) was $6.70 trillion.

    At the end of September, 2014 the total debt outstanding was $6.17 trillion. In the one year period from the end of September, 2014 to the end of September, 2015 it increased by $530 billion. This is an increase of 8.5%.

    The approximate beginning of the global financial crisis was June, 2007. At the end of June, 2007 the total debt outstanding was $3.99 trillion. In the last 8-1/4 years it has increased by $2.71 trillion. This is an increase of 67.9%.

    Looking at the total debt outstanding in Canada of domestic non-financial sectors (17th line up from the bottom of the credit market summary data table):

    At the end of September, 2015 the total debt outstanding of domestic non-financial sectors was $4.86 trillion.

    At the end of September, 2014 the total debt outstanding of domestic non-financial sectors was $4.54 trillion. In the one year period from the end of September, 2014 to the end of September, 2015 it increased by $323 billion. This is an increase of 7.1%.

    At the end of June, 2007 the total debt outstanding of domestic non-financial sectors was $2.84 trillion. In the last 8-1/4 years it has increased by $2.02 trillion. This is an increase of 70.9%.

    The start date of the Statistics Canada data table can be changed by clicking on the “add/remove data” tab at the top of the page.

    http://www5.statcan.gc.ca/cansim/pick-choisir?lang=eng&p2=33&id=3780122

    • Thank you for this – and I must admit to some neglect of Canada in my research in recent times.

      The USD data that I have for Canada shows total end-year debt of:

      2000: US$1,597bn (218 % of GDP)
      2007: US$3,472bn (also 218%)
      2014: US$4,676bn (267%)

      The latter number (and data for mid-2015) suggests that debt is rising pretty rapidly. How do you see GDP progressing?

    • I am a property developer in Alberta. Unless oil breaks out pretty soon I don’t see any relief any time soon. Energy is by far the biggest national export (going to the US). Canadian Select is trading at sub $20 per barrel.

    • I wish I had a more encouraging answer for you. On a longer term view, current oil prices are drastically below equilibrium. We simply cannot produce oil at these prices, let alone replace the oil produced. The price war between US shales and Saudi and the other Gulf producers is inflicting huge damage on both. US oil output will fall this year, and the Saudi budget is in deep trouble. But the problem is lack of growth in demand – and I can’t see this changing any time soon. So we could be looking at 2 years of these prices.

  6. Thanks Tim – I couldn’t agree more. Its just the thorny question of when.

    My own feeling is that the collapse of the Ponzi global economy would be so dramatic and overwhelming that there will be no limits to the economic tricks that will be deployed to delay the inevitable collapse.

    One of the latest one being touted is the citizen’s wage – a fabulous stunt to ponzi up GDP – funded of course by the central bank. There are all sorts of arguments being put forward as to why this is a good idea and indeed it seems like its about to become a reality in parts of Netherlands and Finland.

    Quite why the citizens of these countries or UK citizens deserve a citizen’s wage when the citizens of say Romania or Zaire don’t, well that confuses me. It seems the argument is that we live in supposedly wealthy countries – where I can only assume wealthy meaning having the capability to create vast amounts of money (via bank lending or QE) without the currency being overly punished.

    My expectations is that these “wealthy” countries will continue to create money at the expense of countries that can’t.The latter will suffer greatly unless they are lucky enough to produce a commodity demanded by the former. My own feeling is that this state of affairs can go on for quite some time – accepting that there is always the possibility of a financial accident (nearly happened in 2008) or more recently it seems increasingly plausible that mass migration might derail things.

    Those risks aside, I think the Ponzi scheme collapses when the titanic financial economy finally hits the iceberg of real world energy i.e. in reality when the wealthy countries start trying to outbid each other for dwindling oil using created money. This will most likely happen at some point on the down slope, post Peak Oil – whenever that might be. The signal will be the oil price, perhaps the only economic indicator left that really matters.

    Until then I think they might be able to keep us marching up that hill.

    • Good points.

      The authorities will indeed try anything and everything to keep the party going. They had no compunction about bashing prudent savers to rescue borrowers, and QE was introduced without any tax clawback on the capital gains that it created.

      Now, “helicopter money” is being touted, and the “citizens’ wage” too, though the latter is surely inferior in all respects to replacing benefits etc with “negative income tax” – ‘above a certain income, you pay the tax-man; below that income, he pays you’.

      What scares me is that, having trashed the normal balance between credit and output, we may now be compounding that by trashing the monetary system.

      Your central point about “wealthier” countries creating money is surely true, as is your point about oil. Depletion continues, the underlying cost structure of new vs old sources continues to worsen, and investment will now be far too low to replace quantities produced.

      If you watch one indicator only, watch forex. If you watch a second, make it credit default swaps. Sovereign bond yields will repay attention too. Compared to these, equity markets are a side-show.

    • Interesting, will watch these – we are due for next cycle of recession and associated equity market crash – and more to follow – its going to be volatile.

      But I think each crash in turn will be met with global monetary responses. It will be 10 green bottles standing on the wall – each time the bottom 10% will fall off the first world cliff (be it bottom 10% citizens or bottom 10% of countries).

      My view is that there is essentially no limit to money creation – at least for the select few countries that can do it. The markets and the governments will always accept it – if not expect it – there is no alternative now except economic armageddon – its far too late for an orderly unwind.. Any inflation it created would be welcomed and justified at length by economists.

      They can’t print oil, they can print money to buy it – but that won’t help when there isn’t enough to keep the game going.

  7. Hello Tim,
    I just wonder when ours and many other developed economies around the world entered into a Ponzi situation as you describe?
    Was it not always thus that say the UK always borrowed to grow ( albeit perhaps in an illusiory manner) or has this disconnect only magnified in recent years?

    • You have anticipated me here – my next piece might well be “the history of the Ponzi economy”!

      On the UK point, two answers. First, there’s a difference between borrowing-to-invest and borrowing-to-consume. Second, the British economy has been in a mess, on and off, for decades.

  8. I remember once while working and studying in London going for an early morning mooch about and choosing the city just for a look/see. I was actually trying to get my head around the complexities of the basal ganglia (neuroscience) and having reached my ‘oh, that’s how it works’ moment I headed back to Holborn, it was just at the start of the rush hour and I found myself walking in the opposite direction to all the earnest city types. Must have been at least 10,000 all marching one way and me, on my own struggling against them in the opposite direction. At the time I thought I was in the wrong, not so sure now!

    Great article Tim.

    • Ha!

      I remember, in my early City days, remarking to my boss about the thousands teeming across London Bridge each morning, likening them to lemmings, and asking whether, if the first one walked off the bridge into the Thames, the rest would follow? He said they probably would, if someone started a rumour….

  9. If we are lucky, we will get two crashes. If we are lucky the first crash will convince the government that it does not have to answer for the 0.1% and it will make the necessary changes. If not the second crash will utterly destroy our “civilization”
    The private sector, non government debt will not be repaid. This bank credit boom is is an asset price inflationary device. Banks don’t directly create money, but credit, which becomes money when deposited in customer accounts. This asset price inflation is what we see as wealth creation
    which is not so. The numbers are bigger is all.
    The federal government creates payments for its debts, and these too become money when finally passed on to their customers’ accounts. So the Fed is not so guilty from this perspective. In fact Government Debt is the total of Treasury securities held in the CB. They are in fact savings accounts which the fed is parking and paying interest on. This is for no good reason, except the government, in its profound ignorance, says the bank must do. The CB has no need for borrowing or for saving, being able at every occasion to pay what it has due perpetually into the future.

    So we have to worry about the private sector debt. Steve Keen among others is pushing for a private debt jubilee.[I lost the link] but he advises that debts be written down to a repayable level.

    In my version I would wipe all debts created by fiat. The banks didn’t put up any assets to create this money, It should face that they cannot literally pretend we use real resources to pay back a loan that will be eliminated on closure. We can let them keep the interest payments portion, but the secondary banking market, also fiat based, will meet the same fate as the fiat principal sums.

    The upshot will be that the bank customers get to keep their property, now unencumbered.
    This will stop much further waste of resources and add some breathing space to the economy. The banks would survive as the depositors money is not touched. In Australia that money is, I am told, quarantined already. Banks have to abide by the Client Money Rules laws whereas they previously did not. We need the banks to distribute government payouts etc. It cannot be done with cash.

    As can be imagined no one in the 0.1% will go along unless we have a stage 1 collapse This might give our politicians the spine required to do the right thing. We can only hope.

    • A lot to answer!

      I agree with you about the creation of money and credit, a topic we have covered here at great length.

      My point here is slightly more specific – QE was about inflating bond markets artificially, in order to depress yields (because slashing policy rates wasn’t enough on its own without slashing market rates as well). This was done because the system could no longer afford to pay realistic rates of interest on the debt mountain we’d created.

      The danger is that of undermining the monetary system as an alternative to facing the fact that vast amounts of debt cannot be serviced, let alone repaid. This choice – monetary manipulation instead of taking defaults on the chin – was either “pragmatic” or “cowardly”, according to taste. As a by-product, inflating capital markets benefited the wealthiest, and no attempt was or has been made to offset this, for example by taxing the capital gains resulting from it.

      I get the point about a debt write-off or jubilee. There seems little point in keeping up the illusion of eventual repayment where we know it cannot happen. My model suggests that about 1/3rd of all global debt can never be repaid.

      This has moral hazard – “I’ve been prudent, so why should my feckless neighbour be bailed out?” – though I don’t see this as a practical obstacle, as the cynic in me is not sure whether governments understand either of the words “moral” or “hazard”.

      However, I’m pretty sure we would need to align the write-downs of assets and debt. To bring down mortgage debt, for instance, we would need to force property prices down to match. Bond markets can be regarded as matched assets and liabilities in themselves, so could be brought down. To do either of these things, though, you would probably have to raise rates sharply. This of itself could cause carnage in the absence of synchronised global co-ordination.

      As I see it, a big chunk of global debt can never be repaid. But we know that the authorities’ invariable preference is for “soft” (inflationary) rather than “hard” or “actual” default. This choice is difficult to exercise in a global economy so depressed that deflation seems likelier than inflation. Meanwhile, debt is itself impairing growth. So it’s “chicken or egg” – do we carry on pretending, fiddling and impairing the monetary system, or admit to the problem and organise orderly default? Human nature being what it is, I would expect continued fiddling and denial right up until the point of implosion.

    • Yes, We are on the same page for sure. [BTW my WordPress account forced me to use a different name and not John Doyle]. There will be several possible Debt Jubilee models possible. I like mine because we have to save banking or the government won’t be able to pay pensions and benefits to the 80%? of the population thrown out of work. The government will need to keep paying the military, police, medical care, transport networks, and coupons for food distribution, etc.
      Inflation will be a non issue as money will not be a market commodity, but fixed.

      It does require planning and that might just happen if we have trial run default crash.

  10. Re. the Duke of York and his men, this is utter fantasy, Dr Tim:

    “so far as we know, none of his men came to any harm, and the physical exercise may even have done them some good.”

    You speak as if it happened, but it never did. You just haven’t done your research. Anyway, Jerry Hall and Rupert Murdoch have just got engaged. Doesn’t that tell you to have faith in the future? After all, that Dickens character rightly said that something always turns up.

  11. “The big corporates that drove globalisation wanted the inherent contradiction of low-paid workers who are also big-spending consumers, a paradox that Henry Ford, for one, knew to be nonsense”.
    Well said.
    This major fault with Capitalism has been identified previously by Marxist scholars who identified this fault in the Capitalist Mode of Production.
    1. For Capitalism to work it must maximise Surplus Value for the Capitalist by paying the Worker lower wages to produce Commodities.(The Value in a Commodity is in the Labour).
    2.For Capitalism to work Consumers must purchase the Commodities produced by the Workers who are also the Consumers.
    3.Therefore Capitalism can’t work.
    4.Introduce Credit and Debt and it does work but for how long?

    The Big Short explains what happened with Sub Prime Mortgages which was a crooked scheme based on Credit and Debt.
    The conclusion was that the Government would step in and rescue the system and that’s what happened.
    The taxpayer rescued the system then so the taxpayer will probably rescue the system again but pay a heavy price for doing so.

    • I think there is a huge difference between capitalism in theory and in practice, especially recent practice (just as there is between socialism in theory or practice, or for that matter Christianity in theory or practice). What we have today isn’t really capitalism at all, but “corporatism”.

      In theory, an economy needs capital as well as labour. This requires the total return to be larger than the return on labour alone, so that the return earned by capital does not come at the expense of labour, but is sourced from an excess created by efficiency.

      Achieving this is possible, which makes both the worker and the owner of capital better off. But this can happen only under optimal conditions which include transparency, free and fair competition, and the equitable treatment of employees, customers and suppliers. Corporatism negates this, which is why true supporters of capitalism – just like true believers in socialism – should both be opposed to corporatism. Likewise, socialism under optimal conditions is one thing, the USSR something quite different.

      A capitalist economy dominated by monopolies and cartels isn’t truly capitalist, just as a socialist economy dominated by apparatchiks isn’t truly socialist.

    • Also Danny, no taxpayers were out of pocket a single cent. Forget that mantra, it’s just plain wrong. The Fed simply sent numbers into the relevant bank accounts, money created at no cost to any account. Taxpayer ire is well warrantied but not because they paid, but because it was venal and even criminal behaviour.

  12. Hi Tim

    Thanks again for a very incisive article.

    You haven’t mentioned derivatives here. I was watching a video interview a few days ago between Nomi Prins and Bernie Sanders. Prins likened the derivatives markets to an inverted pyramid where the base is a tiny bit of “real” stuff (oil, gold) and above is a giant mass of paper speculation. I understand that the “paper” gold market for instance is 300 times the physical market and that therefore the vast majority of seller contracts were in fact false because they could never result in the actual delivery of the metal on maturity; they are simply, and largely, vehicles for speculation rather than the hedging of market risk.

    The derivative markets are absolutely huge and are many times World GDP and must be a major potential flash point and source of instability.

    If markets have become this corrupted then it seems to me that there is no hope of rational reform; that they will simply have to fail and we must hope that something better comes out at the end. However, and I suspect like you, I am not holding my breath.

    • Good points.

      Derivatives began as “legitimate” products – a farmer, for instance, might want the assurance of selling his wheat forward, or a refiner might want the assurance of fixing the cost of buying feedstock – and only later became speculative. In the famous Dutch tulip bubble, all the action took place in derivative form – not a single physical tulip-bulb actually changed hands (and couldn’t – it was out-of-season). So we have known about this problem long enough!

      The sheer scale of the derivatives market, as you say, is huge. Banks are allowed to net off derivatives in their accounts, showing only the net position, which is often the tiny difference between two huge numbers.

      We could easily put limits on this using transaction taxes, but governments don’t want to do this – and I don’t know why.

  13. Tim,
    A stupid question: what would you do if sitting in no 11 or in the Bank of England to get the UK off the debt ropes??
    —–
    For me the one of the big conundrums is how do you put a break on house prices and establish enough “ affordable “ housing for rent or purchase. At the same time as weaning the UK population off regarding a house as a capital asset rather than somewhere to live?

    Hopefully in the longer term this would then release investment funds for the “march of the makers”

    It seems as if this Government doesn’t have a coherent economic strategy

    best Peter

    • Tricky one…

      On affordable housing, the only answer I can see is to go back to building council houses – which would also be a big boost to the economy.

      The property market is central to an economy that remains borrowing-dependent. As you say, though, it drains off investment that could otherwise be put to productive use. It is also far less “safe” than often supposed, because the “value” of housing stock rests entirely on the prices at which properties (in aggregate) can be sold to the people who already own them. This is why housing equity could crash in the event of an economic crisis – for instance, a run on Sterling which required raising interest rates.

      But the policies that would apply a brake would be political anathema. You could impose a mortgage tax, or increase stamp duty, or look at capital gains tax, perhaps imposing CGT on profits from properties held for less than a certain number of years.

      If I were in No 11, my first move would be to state that the government is concerned about high prices, and that future policies will be considered to tame future price increases. The message alone might help, and would at least start a debate.

      On another issue, I would consider raising fuel duties – given how far prices have fallen – with the aim of using the income to exempt SMEs from Business Rates…..

    • I have a solution. It is extremely simple in principle. A targetted Debt Jubilee.
      The target is all the fiat loans taken out by banks. As you will know, banks do not put up a cent when writing loans. The only criteria is that the bank be solvent. The loans are pure credit created and impermanent. They arise and get extinguished all the time. Most loans pass from one bank to another, from the borrower to the seller. from the borrower to the builder etc etc. Not much of it gets into the economy as spending money.

      The government would have to declare all fiat loans, mortgages and the like, void. The banks would have to write them out of existence. The properties mortgaged would remain the property of their owners. Banks cannot make any claims. But the banks would stay solvent as other sources of their income etc would be protected without any bail-ins etc. Depositors funds safe.

      The kind of catastrophe which would mandate such a step would require banks to stay in business.
      Governments would pay a stipend to everyone through the banks and issue coupons etc as in wartime for food rations. If they don’t do this the catastrophe will become chaotic and deadly.
      We are now ordained to crash so we ought to make the best of it and start planning.

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