#145: Fire and ice, part two


Although it was something of a detour from the theme of fire and ice, our previous discussion about “Brexit” does have one point of relevance to that theme. Here’s why.

All things considered, there seems to be an utterly compelling case for intervention in the dysfunctional “Brexit” process by the “adults” in European governments. Yet, even at this very late stage, no such intervention has happened. Governments seem to see no alternative to letting London and Brussels – but mostly Brussels – make a complete hash of the whole process. Indeed, only now do the governments of the countries most affected (Ireland and France) seem even to be implementing contingency plans for an adverse outcome.

Of course, you might jump to the conclusion that irrationality reigns in European capitals, and especially in Dublin and Paris. But it’s surely obvious that this is part of a much wider process, one which we can think of as a form of shock-paralysis.

Essentially, the idea explored here is that governments around the world have been paralysed into inaction, not so much by fear alone as by a simple inability to understand what’s happening around them. Nothing, it seems to them, is happening rationally. They don’t really understand why so many amongst the general public are so angry – and they certainly don’t even begin to understand what’s happening to the economy.

I call this shock-paralysis “the juggernaut effect”.


The word “juggernaut” seems to derive from Sanskrit, and refers to an enormous waggon carrying the image of a Hindu god. The figurative meaning is of an irresistible force, flattening anyone foolish enough to stand in its way.

Rationally, you’d think that anybody standing in the path of a “juggernaut” ought to be making every effort to escape. But it’s quite likely that shock, fear and incomprehension will have a paralysing effect, overwhelming rational faculties, leaving him or her rooted to the spot.

That’s a useful way to describe the effects that current economic (and broader) trends are having. It doesn’t just apply to governments, of course, and it’s prevalent amongst the general public, too.

Just as the person standing in front of the “juggernaut” is all too well aware of its lethality, today’s leaders and opinion-formers surely know at least something about the financial, economic, political and social forces converging on them.

But they seem incapable of doing anything about it.

A big part of this paralysis is incomprehension – any problem becomes infinitely harder to tackle if you don’t understand why it’s happening. And there are reasons enough for policy-makers, and ‘ordinary’ people too, to feel completely baffled.

The irrational economy

You don’t need to be a committed Keynesian – indeed, you need only numeracy – to understand the basic principles of economic stimulus.

If economic performance is sluggish, activity can be stimulated by pushing liquidity into the system, either through fiscal or through monetary policy. If too much stimulus is injected, though, there’s a risk that the economy will overheat, with growth exceeding the sustainable trend. Rising inflation is one of the most obvious symptoms of an over-heating economy.

Here, though, is the conundrum, for anyone trying to understand how the economy is performing.

Since the 2008 global financial crisis (GFC I), the authorities have pushed unprecedentedly enormous amounts of stimulus into the system.

We ought, long before now, to have experienced overheating, with growth rising to levels far above trend.

This simply hasn’t happened.

This should have been accompanied by surging inflation, most obviously in commodities like energy, minerals and food, but across the whole gamut of goods and services, too, with wage rates rising rapidly as prices soar.

Again, this simply hasn’t happened.

To be sure, there’s been dramatic inflation in asset prices, and that’s both important and dangerous. But the broader point is that neither super-heated growth, nor a surge in price and wage inflation, have turned up, as logic, experience and basic mathematics all tell us that they should.

Pending final data for 2018, it’s likely that global GDP last year will have been about 34% higher than it was back in 2008. Allowing for the increase in population numbers, GDP per capita is likely to have been about 20% larger in 2018 than it was ten years previously. This isn’t exactly super-heated growth. According to SEEDS, world inflation stands at about 2.5% which, again, is nowhere near the levels associated with an over-heating economy. Far from soaring, the prices of commodities such as oil are in the doldrums.

Price (and other) data is telling us that the economy has stagnated. But the quantity of stimulus injected for more than a decade says that it should be doing precisely the opposite.

There can be no doubt whatsoever about the scale of stimulus. The usual number attached to sums created through QE by central banks is in the range $26-30 trillion, but that’s very much a narrow definition of stimulus. Ultra-loose monetary policy, combined with not inconsiderable fiscal deficits, have been at the heart of an unprecedented wave of stimulus.

Expressed in PPP-converted dollars at constant values (the convention used throughout this analysis), governments have borrowed about $39tn, and the private sector about $71tn, since 2008. On top of that, we’ve wound down pension provision in an alarming way, as part of the broader effects of pricing money at negative real levels, which destroys returns on invested capital.

Even if we confine ourselves to QE and borrowing, however, stimulus since 2008 can be put pretty conservatively at $140tn.

That’s roughly 140% of where world PPP GDP was back in 2008. You might think of it as the injection of 12-14% of GDP each year for a decade.

That’s an unprecedentedly gigantic exercise in stimulus.

And the result? In contrast to at least $140tn of stimulus, world GDP is perhaps $34tn higher now than it was ten years previously. Price and wage inflation is subdued, and the prices of sensitive commodities have sagged. The prices of assets such as stocks, bonds and property have indeed soared – but one or more crashes will take care of that.

By now – indeed, long before now – anyone in government ought to have been asking his or her expert advisers to explain what on earth is going on. Assuming that Keynes wasn’t mistaken (and simple mathematics proves that he wasn’t), the only frank answer those advisers can give is that they just don’t understand what’s been happening.

Questions without answers?

The utter failure of gigantic stimulus to spur the economy into super-heated growth (and surging inflation) is reason enough for baffled paralysis. But there are plenty of other irrationalities to add to the mix.

If you were in government, or for that matter in business or finance, then as well as asking your advisers about the apparent total breakdown in the stimulus mechanism, you might want to put these questions to them, too:

– Why has a capitalist economic system become dependent on negative real returns on capital?

– Why, since the shock therapy of the 2008 global financial crisis (GFC I), have we accelerated the pace at which we’re adding to the debt mountain?

– Why, seemingly heedless of all past experience, have we felt it necessary to pour vast amounts of cheap money into the system?

– Why have the prices of assets (including stocks, bonds and property) soared to levels impossible to reconcile with the fundamentals of valuation?

– Why has China, reputedly the world’s primary engine of growth, found it necessary to resort to borrowing on a gargantuan scale?

This last question deserves some amplification. Pending final data, we can estimate that Chinese debt has increased to about RMB 220tn now, from less than RMB 53tn (at 2018 values) at the start of 2008. These numbers exclude what are likely to be very large quantities of debt created in what might most politely be called the country’s “informal” credit system.

So, why does an economy supposedly growing at between 6% and 7% annually need to do much borrowing at all?  Put another way, how meaningful is “growth” in GDP of 6-7%, when you have to borrow about 25% of GDP annually, just to keep it going?

And this prompts several more questions. For starters, why are the Chinese authorities, hitherto esteemed for their financial conservatism, presiding over the transformation of their economy into a debt-ponzi? Second, can ‘the mystique of the east’ explain why the world’s markets are seemingly either ignorant, and/or complacent, about the creation of a financial time-bomb in China?

The juggernaut effect

Even these questions don’t exhaust the almost endless list of disconnects in our increasingly surreal economic plight, but they surely give us more than enough explanations for the paralysing “juggernaut effect” in the corridors of power.

Put yourself, if you will, into the shoes of someone trying to formulate policy. Two things are obvious to you, and either one of them would be a grave worry. Together, they’re enough to overwhelm rational calculation.

First, you know that there are some very, very dangerous trends out there. In the purely financial arena, you’re aware that debt has become excessive, whilst the system seems to have become reliant on a never-ending tide of cheap credit.

If your intellectual leanings are towards market economics, you’ll also have realised that pricing money at rates below inflation amounts to an enormous subsidy. Politically, that subsidy is going to the wrong people. If you came into government with business experience, you’ll also know that we’ve witnessed the destruction of returns on capital, which makes no kind of sense from any business or investment point of view.

You might know, too, that the viability of pension provision has collapsed, creating what the World Economic Forum has called “a global pensions timebomb”. If the public ever finds out about that, the reaction could dwarf whatever political travails you might happen to have at the moment.

Lastly – on your short-list of nightmares – is the strong possibility that some event, as yet unknown, will trigger a wave of defaults and a collapse in the prices of property and other assets.

Your second worry, perhaps even bigger than your list of risks, is that you don’t really understand any of this. Your economic advisers can’t explain why stimulus, though carried to (and far beyond) the point of danger, hasn’t worked as the textbooks (and all prior experience) say it should. If there’s anything worse than a string of serious problems and challenges, it’s a complete lack of understanding.

Without understanding, the policy cupboard is bare. You don’t know what to do next, because anything you do might have results that don’t match expectations, making matters worse rather than better.

It might be better to do nothing.

In short, you feel as though you’re making it up as you go along, in the virtual certainty that something horribly unpleasant is going to hit you, with little or no prior warning.

Welcome to “the juggernaut effect”.

#144: “Brexit” and the wait for Godot


It is perhaps appropriate that Samuel Beckett’s play Waiting for Godot was written in French, and premiered in Paris in January 1953, not appearing in English until its London debut in 1955.

As you’ll know, Godot himself never appears, which some might say is the real point of the narrative. Certainly, his non-arrival has no serious consequences.

This is where drama and reality part company. Like Vladimir and Estragon in Beckett’s play, both sides of the “Brexit” impasse have been waiting for more than two years now, and are waiting still, for the political equivalent of Godot to turn up. This time, it’s going to be very serious indeed if the major character (or characters) fail to put in an appearance.

If you’re a regular visitor to this site, you’ll know that I steer well clear of taking sides over the outcome of the “Brexit” referendum. This said, those of us who understand the surplus energy basis of the economy had solid reasons for expecting the vote to turn out as it did.

Though GDP per person was slightly (4%) higher in 2016 than it had been in 2006, personal prosperity in Britain deteriorated by almost 9% over that decade. When the public went to the polls, the average person was £2,150 worse off than he or she had been ten years previously, and was, moreover, significantly deeper in debt.

These are not conditions in which the governing can expect the enthusiastic backing of the governed. There were other factors in play, of course – including widening inequality, and the lack of a national debate over immigration – but the “leave” vote was founded on popular dissatisfaction with an “establishment” seemingly unconcerned about deteriorating prosperity.

The authorities’ fundamental inability to understand the prosperity issue was by no means unique to the United Kingdom, and neither were its consequences confined to the 2016 referendum. Had the deterioration in prosperity been understood in the corridors of power, it’s highly unlikely, for instance, that premier Theresa May would have called the 2017 general election which robbed her of her Parliamentary majority.

Calling an early election – intended to “guarantee security for the years ahead” – was just one of many mistakes made by the British authorities before, during and after the referendum on withdrawal from the European Union. The vote itself  seems to have been called in the confident assumption that the “remain” side would win comfortably. The governing Conservatives then elected as their leader an opponent of the “Brexit” process. Perhaps worst of all, the British side negotiated as supplicants, accepting, seemingly without question, Brussels’ highly dubious assertion that the EU held all the high cards.

But it would be wrong to pin all (or even most) of the blame for the “Brexit” negotiations fiasco on the British side. Whatever mistakes Mrs May and her colleagues might have made, they at least have a democratic mandate for what they have been trying to do. Beset on one side by hard-line “Brexiteers”, and on the other by those opposed to carrying out what the public actually voted for, Mrs May had problems enough, even before her Brussels counterparts set out to play politics with the process.

Under these conditions, it’s hardly surprising that the British parliament seems to have reached an impasse, where the main alternatives to a flawed deal appear to involve either (a) leaving the EU without any agreement at all, or (b) disregarding the wishes of the voters, and perhaps inviting those voters to have another go, presumably in the hope that the electorate will ‘get it right this time’.

Needed – Godot

In considering what ought to happen next, we need to be absolutely clear that the stance adopted by the bureaucrats in Brussels has all along made it impossible for Mrs May to secure an agreement acceptable either to parliament or the voters.

Put bluntly, the point has long since been reached where the adults – meaning the elected governments of EU member nations, led by France and Ireland – should step in, forcing Brussels to offer terms which are both (a) mutually advantageous, and (b) acceptable to the United Kingdom. This really means that Paris and Dublin need to mount an eleventh-hour rescue, not just (or even mainly) of the British economy, but of the EU economy as well.

From the outset, Brussels has made three dangerously false assumptions.

The first is that, in terms of economics, a mishandled “Brexit” will hurt Britain far more than it would hurt other EU member states.

The second, flowing from this but extending well beyond economics, was that the EU side holds all the high cards – essentially, that Mrs May should expect nothing more than scraps from a bounteous continental table.

Third, Brussels assumed the role of punishing British voters in order to deter Italians (and others) from following a similar path out of the EU.

This third point is the easiest to counter. The role of Brussels, which in many other areas is carried out commendably, is to better the circumstances of EU citizens.

It is not to influence how those citizens cast their votes.

The economic point, though critical, is a bit more complicated, but needs to be outlined to explain why Ireland and France, in particular, ought now to be intervening to break the impasse.

Where Ireland is concerned, the assumption in Brussels that a mishandled “Brexit” would more dangerous for the British than for anyone else is gravely mistaken. Although Britain is a major trading partner for Ireland, the main problem for the Republic is a broader one. Essentially, Ireland is in no condition to withstand any major shock to the system – and a bungled “Brexit” would certainly be exactly that.

We’ve examined the Irish predicament before, so a brief summary should suffice here. Following statistical changes (dubbed “leprechaun economics”) introduced in 2015, reported GDP has become an even less meaningful measure of economic conditions. GDP grew by 49% between 2007 and 2017 (including a one-off 25% hike in 2015), adding €97bn (at constant 2018 values) to recorded output – but this occurred courtesy of a near-doubling in debt, such that each €1 of “growth” was bought with €4.85 of net new borrowing. Meanwhile, the all-important energy cost of energy (ECoE) now exceeds 11% in Ireland, at level at which growth is almost bound to go into reverse.

Fundamentally, reported GDP (of an estimated €309bn last year) grossly overstates real activity (adjusted for borrowed spending, €184bn), let alone prosperity (€164bn, or €33,550 per person).

Critically, over-stated GDP gives dangerously false comfort about financial exposure. Aggregate debt, for instance, might be “only” about 320% of GDP, but equates to well over 600% of prosperity.

Worse still, Ireland’s financial sector is grossly over-large in relation even to GDP, let alone prosperity. The most recent available numbers (for the end of 2016) put financial assets at 1750% of GDP, but this equates now to a frightening 3200% or so of prosperity.

Far from deleveraging after the disaster of 2007-08, both debt and financial assets are a lot bigger now than they were on the eve of the global financial crisis (GFC I) – in inflation-adjusted terms, debt has virtually doubled (+95%) since 2007, and financial assets have expanded by about 60%.

Moreover, the markets might know about the “leprechaun” factor in Irish GDP, but seem not – yet – to have applied the logic of that knowledge to the critical measures of national financial risk. On the assumption that the authorities in Dublin do know quite how dangerous Irish financial exposure really is, they have every incentive to strive for a form of “Brexit” which minimises economic and financial damage.

France has different, but equally compelling, reasons for intervening, and would have a lot more negotiating clout to bring to the table. As we’ve seen, there has been widespread unrest in France, unrest whose causes can be traced to deteriorating prosperity. Though personal prosperity as a whole is only about €1,650 (5.8%) lower now than it was ten years ago, the slump in discretionary (‘left-in-your-pocket’) prosperity has been leveraged to 32% by a near-€2,000 increase in the burden of taxation per person.

This has put Mr Macron’s government in an unenviable position. Neither the fiscal carrots offered by the president, nor the law enforcement sticks planned by his government, can address the fundamental issue, which is that a substantial majority of the population supports the grievances (if not necessarily the methods) of the ‘gilets jaunes’.

This seems to mean that Mr Macron can forget about his cherished labour market “reforms”, and further suggests that, unless something pretty dramatic happens, he can probably forget about re-election as well. The last thing his government needs right now is the economic harm likely to be inflicted on France by a bungled “Brexit”. It would be far, far better for the president to act in a conspicuously statesmanlike way to break the impasse.

In this situation, it’s unrealistic to expect Britain to resolve this issue unaided by Europe. If, as most observers believe, Mrs May’s deal is going to be shot down by parliament, neither of the remaining options looks palatable. Both those who support a “no deal” exit, and those who’d like to ignore (or re-run) the “Brexit” vote, are playing with fire. But neither can we expect the Brussels side of the talks to have a last minute conversion either to humility or to pragmatism.

In short, there are compelling reasons for European governments – led by France and Ireland – to enforce a rationality seemingly absent, on this issue, in Brussels.