#99: While time allows – part three

THE “”HOW?”, THE “WHY?” AND THE “WHERE?” OF THE BRITISH ECONOMY

Although the focus here is avowedly global rather than local, it isn’t difficult to justify another examination of the British predicament. The situation is, after all, quite remarkable. Having opted for withdrawal from the European Union (“Brexit”), Britain now finds herself on the brink of critical negotiations without a credible government to do the negotiating.

The horrific fire in Kensington shines a disturbing spotlight on economic and social policy assumptions, as well as on disparities between rich and poor. With the economy deteriorating, there is no consensus on what to do about it. Rather, the “Brexit” affair revealed the rancorous nature of divisions within society.

In order to examine the economic situation in a succinct way, this discussion looks at three issues in sequence. The first is the state of the economy. The second is how it got where it is. The third is what, if anything, might be done to put it on the road to recovery.

An economy in trouble

The economy of the United Kingdom is in a pretty parlous state, which makes it all the more remarkable that economic issues were given little or no attention in the recent election. Labour did propose some changes, but the workability of nationalization, in particular, has to be debatable. The Conservatives essentially offered more of the same, which would have ensured continuity along a path of proven failure.

Growth seems to have fallen sharply, and may now be nearer to zero than to prior forward assumptions of around 2%. Reported growth (of 12%) over the decade to 2016 comes with serious caveats. The expansion in GDP between 2006 and 2016, expressed at constant 2016 values, was £203bn, but this was accompanied by a £1.18 trillion expansion in debt, equivalent to £5.80 of net borrowing for each £1 of reported growth.

Of this borrowing, businesses accounted for just £40bn, or 3% of the total. The vast majority of borrowing was attributable to government (86%) and households (11%). Both are consumption-related forms of borrowing, strongly implying that growth has been flattered by the simple spending of borrowed money.

Adjusting for this, SEEDS estimates underlying GDP in 2016 at £1.51 trillion, 22% below the reported £1.94 trillion. Though large, the £420bn gap between these numbers isn’t hard to find. Underlying trend growth for 2016 is estimated at 0.4% – which is lower than the rate at which the population is expanding (0.7%) – and seems certain to fall still further, given the challenges going forward.

This is bad enough, but the implications for individual prosperity are even worse. The cost of household essentials has been rising at roughly twice the rate of reported inflation, implying that a steady rise in ECoE – the energy cost of energy, emphasised in the Surplus Energy Economics approach – is undermining prosperity. Adjusted also for the increase in population numbers, SEEDS puts average per capita prosperity last year at £20,600, a fall of 13.4% since 2006 (at 2016 values, £23,900). No other major economy has fared this badly.

This SEEDS view is corroborated by a host of “conventional” economic data. Average real wages have been declining since 2009, and no-one seriously expects this to change in the foreseeable future. The current account is heavily (£85bn) in the red, whilst productivity is lamentable. Reported debt (of £4.88 trillion) excludes huge shortfalls in public- and private-sector pension provision, and the tax base seems to have deteriorated to the point where the government cannot fund public services to the standards to which people have become accustomed. There is a very real prospect of “stagflation”.

The reason why – a damaging policy vacuum

In terms of effectiveness as a system of representative democracy, Britain’s political processes have some significant weaknesses. Elections to Parliament are conducted on a first-past-the-post (FPTP) basis which guarantees the dominance of the two established parties. The upper chamber isn’t elected at all, which impairs its ability to advise and restrain. There is no American-style “separation of powers” between the executive and the legislature.

The biggest single weakness with this system is that it relies on confrontation between the two major parties. Tragically, this historic antagonism disappeared in the mid-1990s, when the opposition re-styled itself “new” Labour, and adopted the same economic tenets as the Conservatives. As a result, a politically-influential check on the incumbent economic orthodoxy ceased to exist.

Lacking such a challenge, pro-market economics morphed into a dogma which extended prior policies into dangerous extremes. Even more than the United States, Britain became the poster-child for “liberal” economic ideas taken to their (il)logical conclusions.

The resulting orthodoxy had some glaring weaknesses. It misunderstood risk, deregulating the financial system to the point at which Britain lectured other countries on the supposed virtues of “light-touch” regulation. It assumed that public services could be managed along lines of internal quasi-competition, and welcomed private encroachment into the role of the state. In a climate which emphasized “spin” over substance, government horizons became excessively short-term, which caused particular problems in fields as different as debt and energy. It failed to distinguish between making money and adding value. The virtues both of prudence and of the mixed economy were rejected.

Like any form of extremism, this extended exercise in orthodoxy had serious consequences. The economy became increasingly unbalanced, with value-productive activities like manufacturing displaced by real estate, “out-sourcing”, and simply moving money around. Public services were fragmented, whilst the fiscal system increasingly favoured speculation over innovation. In the mistaken belief that Britain could compete with emerging economies (EMEs) on the basis of price (rather than quality), real wages were allowed to deteriorate, which undermined the tax base whilst encouraging an undue reliance on consumer debt.

An avowed policy of “openness”, together with a lack of concern over debt, resulted in asset sales and overseas borrowing being used to finance trade and income deficits with the rest of the world. This in turn created a self-reinforcing deterioration in the current account, as returns on past capital transactions turned relentlessly into outward flows.

To an unquantifiable (but undoubtedly serious) extent, the logic of economic policy eroded ethics, particularly where the treatment of customers and employees was concerned. This is why banking (but other industries too) became scandal-prone, and neither in the public nor the private sector was much done to enforce accountability. Thus, when a business is discovered to have engaged in dubious practices, it is invariably the shareholders, not the decision-makers, upon whom sanctions are imposed.

The prevailing orthodoxy described here can be identified as the cause, not just of Britain’s economic woes, but of many of its social problems as well. Thus, inequalities between rich and poor, and between young and old, can be traced to the same economic extremism which has undermined prosperity, reduced real wages, prompted excessive borrowing, channelled investment into the “capital sink” of overvalued properties, created asset bubbles, worsened working conditions and security of employment, and eroded the tax base.

The abandonment of confrontation, then, set Britain’s political elite free to embark on an increasingly extreme and dangerous economic path.

Is there an escape route?

Given the scale of the economic and social harm inflicted by a political consensus around a failed orthodoxy, the election of Jeremy Corbyn as leader of the opposition Labour party should have been welcome even to Conservatives – the return of Labour to its social-democratic (or perhaps socialist) roots should help ensure that extreme policies no longer go unchallenged. Changes now seem inevitable, and this has to be positive. What matters, though, is whether the right kind of changes will take place.

Labour has declared itself hostile to the over-domination of important sectors by small numbers of players. The party is surely right to target rail, water and energy, and could usefully add telecoms to the list. Unfortunately, Labour’s preference for nationalizing these sectors seems less than ideal. The public might be better served by breaking them up, such that no single player has a share of 10% or more of any important market.

Similarly, Labour’s preference for imposing higher taxes on “the rich” needs to be nuanced differently. The real problem isn’t income inequality so much as the imbalance between income and assets. Increasing taxes on high incomes is likely to be counter-productive. Instead, and whilst Mr Corbyn might contemplate a wealth tax, the real imperative is to rebalance fiscal and other incentives towards innovation rather than speculation. Logically, taxation of capital gains should be increased, not least because many of these gains have been the direct result of monetary policy – in other words, the authorities are surely entitled to claim a sizeable share of asset gains that they have themselves created.

If higher taxation of capital gains is imposed, there are several glaringly obvious areas in which these proceeds can be used in the interests of economic regeneration. One of these is a much-needed programme of building homes at affordable rents. Another is to reduce the tax burden on small and medium enterprises, most obviously by freeing them from the regressive Business Rates levy. A third would be to reduce the taxation of low wages, which ideally would include merging income tax with NI (national insurance).  Another would be to reintroduce dividend tax exemption for pension funds, a pro-saving policy which had been accepted by all parties prior to Gordon Brown’s notorious 1997 “tax raid”.

Perhaps even more importantly than these “mechanical” measures, Britain needs a renewed emphasis on ethics, and needs to legislate enhanced protection for employees, customers and tenants. This needs to be accompanied by enforcing much more accountability on decision-makers, not just in business, but in the public sector as well.

Will such desirable changes happen? Perhaps ironically, the sheer scale of Britain’s current problems gives some grounds for optimism. The rise of Jeremy Corbyn to unchallenged leadership of the Labour party has effectively smashed one half of the unhealthy consensus around a mistaken economic orthodoxy. The loss of Mrs May’s majority may prove to have been a humbling as well as a crippling blow to the other half of that consensus.

Meanwhile, public opinion is palpably shifting against perceived “unfairness” between rich and poor. The chancellor having stated that “economic” considerations will guide negotiations about “Brexit”, it is to be hoped that he did mean economic factors, not simply ‘profit’.

The final issues have to be those of whether the necessary changes can occur harmoniously, and without a swing to opposite extremes – and whether the economy can respond in the limited time which Britain still has at its disposal.

Even if the right lessons are learned, and quickly, it’s going to be – in the words of the Iron Duke – “a damned near-run thing”.

 

 

#98: While time allows – part two

CAN THE UK ESCAPE A ‘BRITMUDA TRIANGLE’?

If you’ve read the preceding article, you’ll understand how institutionalized thinking – a product of rigid orthodoxy within a closed environment – seems completely to have blinded Britain’s political elite to the very possibility that voters might “defect” en masse to the collectivist alternative offered by Jeremy Corbyn.

This raises at least two important issues. The first is the extent to which the same sort of “institutionalized folly” – the inability to “think the unthinkable” – has been operative elsewhere.

Obvious examples here include the authorities’ blindness to the escalation of risk ahead of 2008 – a blindness which, at least arguably, still persists – the near-unanimity with which the “experts” wrote off Donald Trump as a “joke candidate” with zero chance of success.

The second (and more pressing) question is where Britain goes from here – and the answer to this question must depend, in large part, on whether or not the governing elite is going to remain in the myopia of institutionalized group-think.

Put simply, is this election result going to shock the establishment (in politics, business and finance) into reality? Or will denial go on?

The dangers of denial

When an incumbent regime suffers a shock setback, some of the reactions are predictable, and are far from helpful. There is an almost automatic tendency to try to shift the blame.

So, quite predictably, we’ve been told that the election defeat was wholly the fault of Mrs May and her immediate circle, so is not a reflection of broader failure.

Equally predictably, we’ve heard that the opposition (in this instance, Jeremy Corbyn) didn’t play fair, the implication being that the voters were fooled (which is pretty close to saying that the voters are fools). We saw the same pattern after last June’s referendum on “Brexit”, with defeated Remain supporters arguing that the Leave campaigners cheated, and that those who were duped into voting for “Brexit” were old, poor, poorly-educated and losers (or, in a word, idiots).

This really won’t wash. The failure of an elite to see something coming doesn’t make their opponents dishonest, or the voters foolish. Where expectations and outcomes differ, it’s usually a fair bet that it’s the expectations that were wrong, not the outcome.

We needn’t revisit the causes of popular discontent with the incumbent government. People disliked falling real wages, disliked austerity in the public services, and were angered by a perception that a minority were prospering at the expense of everyone else. They saw no evidence that the Conservatives were going to do anything to address these grievances.

This makes the surge in Labour support wholly rational. Of course, the Conservatives can respond by persisting with the illusion that the voters, duped by unscrupulous opponents, got it wrong.

Doing this would have two consequences. First, it would prevent Conservatives from changing their policies in response to voter demands. Second, and consequently, it would condemn them to protracted irrelevance. Evidence from the past suggests that parties do indeed tend to condemn themselves to marginality in exactly this way.

A ‘Britmuda triangle’?

The practical realities, now, are three in number. First, and despite any deal that Mrs May might put together with the Democratic Unionists (DUP), Britain is condemned for the immediate future to a caretaker administration subject to almost total policy paralysis. No government can undertake any bold policy when a tiny number of its MPs can pull the rug from under it.

Such stasis is bad news at the best of times – and could be desperately bad news now, in what looks a lot more like the worst of times.

Second, and pretty obviously, it is hard to see how a paralysed government, demoralized and frightened of its own shadow, can hope to be an effective negotiator over the post-“Brexit” relationship with the EU.

Third, and despite any claims to the contrary, the British economy is in very big trouble, and now seems virtually certain to deteriorate further.

Last year’s sharp fall in the value of Sterling has now fed through into reported inflation of 2.9%, meaning further declines in real wages. The response of the forex markets since the election result has been comparatively muted, but this does not by any means eliminate the risk of a currency crisis. Indeed, it seems that the comparative stability of recent days may reflect a widening expectation that the Bank of England will have to raise interest rates, primarily to counter inflation, but also to shore-up the pound.

Higher inflation and higher interest rates, plus a waning of confidence and a flight of capital, are the consequences of a currency crisis, but they can also happen without one.

Consumer spending, which has been the engine of the British economy in recent times, is flagging palpably, and can only get worse if confidence wanes, interest rates rise, and property prices fall. The political situation almost guarantees that the fiscal deficit will be larger, for longer.

Even before the election, reported GDP growth had fallen to all-but-zero, and some of us believe that such figures tend to put an over-optimistic gloss on underlying trends anyway. Business confidence at home is said to have crashed since the election result, and there seems no reason why foreign investors shouldn’t take a similar view.

A perfect storm in prospect

In short, the UK now faces a “perfect storm” of stagflation, rising interest rates, weakening confidence and political paralysis – plus, of course, imminent “Brexit” negotiations, and rancorous division within the public.

There are old sayings to the effect that “you bought it, you name it”, and “you broke it, you pay for it”. In this spirit, it is incumbent, both on the Conservatives and on the supporters of the current economic system, to come up with solutions.

Of course, if you believe that the Corbynite programme would rescue the situation, you can afford to be more relaxed about this than if you don’t. If the patched-together minority government falls quite soon, and if the Conservatives persist with denial, then a second election, and a victory for Labour, start to look pretty likely.

Those who doubt the merits of nationalization, an expanded state, higher taxation, higher public spending and bigger fiscal deficits, on the other hand, should be very worried indeed. The economic outlook is more than risky enough to prompt a further swing to the Left by voters in search of solutions.

Can Conservatives respond?

An effective response from the Conservatives needn’t mean an abandonment of the market, because what has passed for pro-market economics in recent years has been far closer to corporatism than capitalism anyway.

Government has done precious little to break-up sectors where over-concentration reduces competition to the detriment of consumers. It has presided over the idiocy of a developed economy trying to compete on the basis of cost rather than on the basis of quality, which is the only viable competitive option for such a country. If anything, the Conservatives need to re-learn the principles of markets that are competitive, free and fair. Policy has exacerbated, rather than tackled, a lamentable bias towards speculation over innovation.

At the same time, Conservatives need to recognize that, in economics, extremes are seldom, if ever, a good idea. There is abundant logical and historical evidence supporting the concept of a “mixed economy”, which blends the best of the private and public sectors, rather than leaning too far in either direction.

There are, then, three things that Conservatives need to do.

First, they need to re-learn the difference between capitalism (in its competitive market sense) and corporatism (which is more “law of the jungle” than Smith).

Second, they also need to re-learn the importance of the mixed economy.

Third, they need to recognize the legitimacy of redistribution, which at the moment is required more in terms of wealth than of income.

 

 

#97: While time allows – part one

BRITAIN AND THE PRICE OF INSTITUTIONALIZED FOLLY

As was explained in the previous article, the outcome of the British general election was eminently predictable. Yet the Prime Minister, her advisors, her colleagues and the “experts” – that is to say, supposedly the “finest minds” in government and politics – did fail to predict it.

They seem genuinely to have been gobsmacked by a result which any intelligent observer should have seen coming.

This debacle cannot be blamed entirely on Theresa May, tempting though that must be to those who share responsibility. To be sure, her plan to stay in office with the help of the DUP (the Ulster Unionists) does make her look detached from the real world. But the decision to call an unnecessary election was not taken by her alone. We can assume that ministers and advisors concurred with her assessment that triggering a vote would deliver a greatly increased majority. Professional analysts and commentators, collectively known as “the experts”, clearly thought so, too.

This, then, was an extreme case of shared folly. An impartial observer might well wonder whether these people are fit to run a whelk-stall.

Unfortunately, international capital markets may now be starting to wonder much the same thing.

We need to understand this collective loss of wits, and not just because the British public deserve better. There is every likelihood that political farce could, within months, turn into economic tragedy.

From crass to crisis?

The dangerous nature of the British predicament needs to be spelled out. The economy runs an entrenched (and worsening) current account deficit, which last year was £85bn, or 4.4% of GDP. This gap must be filled by matching inflows of capital. Debt and equity injections from abroad have ceased to be a choice, or a luxury. In effect, they have become a necessity, a subsidy and a lifeline.

Even before this fiasco, there were plenty of reasons why foreign investors might have considered pulling the plug. Those reasons can only have become more persuasive since Thursday’s vote.

This, it must be stressed, is not a purely academic argument, of interest only to economists. Stasis in the capital or “financial” account is not the norm. So, if the inflow of capital ceases, then in all probability it will turn into an outflow.

Accordingly, the biggest danger now is a “Sterling crisis”, with capital flight taking hold. If you think that a currency, or an investment, might collapse, your natural and logical response is to pull your money out before it happens. We can expect a lot of other adverse economic consequences but, short-term, a currency crisis has become the risk that dwarfs all others.

In this event, a slump in the pound could turn into self-fulfilling panic. If this were to happen, Sterling would tumble, inflation would spike, and interest rates would soar, something that a country with Britain’s amount of debt simply cannot afford. Property prices, which already look wobbly, could be expected to slump if rates rose, putting part, at least, of the banking system into jeopardy. The Sterling value of debt denominated in other currencies would escalate, quite possibly beyond levels of sustainability.

The reality, then, is that an economic crisis could threaten the United Kingdom within a very short time. Averting this requires policies, and it requires a government capable of implementing them.

The barest minimum required now is a demonstration to the markets that somebody competent is in charge. That “somebody”, pretty obviously, isn’t Theresa May. But neither is it the charismatic Boris Johnson, or the cool-headed Phillip Hammond, or anyone else within the collective failure-machine that the government high command has become. And neither, before anyone asks, is it Jeremy Corbyn.

Institutionalized thinking

What, then, is the mind-set that led to this mess? By far the likeliest answer is “institutionalized thinking”. This needs to be explained.

The collapse of the Soviet Union provides a textbook example of institutionalized thinking. To any objective observer, the failure of Soviet-style command economics was very obvious indeed, many years before 1989. Unfortunately, though, the USSR was not being run by objective observers. It was being run by men whose whole political lives had been lived within the confines of a collectivist orthodoxy. That the system might actually fail was not thought about, because it had become – quite literally – unthinkable to those within the institutionalized bubble.

This is not simply a case of people ‘believing what they want to believe’. It is more fundamental than that. It is group-think, within tramlines created by orthodoxy, and imposed by practice.

The same kind of institutionalized thinking which blind-sided the Soviet leadership seems to have taken over the British political elite. To these people, the very idea that millions might vote for Jeremy Corbyn was – again, literally – unthinkable. Within their institutionalized terms of reference, ideas such as nationalization, or imposing heavy taxes on the wealthiest, or reversing privatization, or challenging the tenets of what passes for market economics, were simply mad. Accordingly, therefore, only a lunatic fringe would vote for it.

When millions did precisely that, it must have seemed as though a chasm had opened up where solid ground had once existed. A phrase involving “rabbits” and “headlights” characterizes what seems to have been happening in Whitehall and Westminster since Thursday.

Though a shock, the ”Brexit” vote was not sufficient to shake this mindset because, within the elite, leaving the EU was not unthinkable. The majority of the high command did favour continued membership, but enough of its members supported “Brexit” to make the idea real and credible.

That the voters might also turn their backs on the long-established economic orthodoxy, however, was not something that the high command had ever considered.

Are there solutions?

If there is a historic parallel with what is now happening in Britain, that parallel is 1974. In that year, a second election was called, but it was hardly more conclusive than the first. A Labour government limped on, supported by Liberal votes in Parliament. Nothing much changed, because no-one was in a position to change anything.

By 1976, a lot of influential commentators around the world had reached the conclusion that Britain was probably finished. The ensuing second “Sterling crisis” (the first was 1967) was resolved only with a strings-attached bail-out from the IMF. The institutionalized governing mindset didn’t change, however, and was only rooted out by the new broom wielded by Margaret Thatcher in the aftermath of the 1978-79 “winter of discontent”.

This time around, a rescue by the IMF would be out of the question. Not only are the numbers at stake simply too big, but international capital flows are now vastly larger, and dramatically more rapid, than they were back then. If the markets decide that Britain and the pound are financially toxic, then that – as the saying goes – is that.

This, clearly, is case where prevention is not only better than cure but, is very probably, the only choice on the table. There is no room for complacency – a major economy really can lurch into chaos if things are handled badly enough, especially if serious structural weaknesses already exist.

So somebody needs to get a grip, and soon – but that isn’t going to happen from within the rarefied confines of the political bubble. Mrs Thatcher, and her guru Sir Keith Joseph, were outsiders in the 1970s, people whose ideas differed completely from those of the contemporary political establishment.

Something similar is needed now. Thinking as radical as Sir Keith’s is required, and it will need to be taken up by someone as resolute as Mrs Thatcher.

This is not to say, of course, that a return to Thatcherism is the answer. Very clearly, it isn’t. Neither do Mr Corbyn’s ideas offer a solution. In both instances, turning back the clock won’t work.

Somebody had better come up with something new – and quickly.

A new settlement?

The outlines of a new model aren’t hard to sketch. If Britain is going to stop short of Corbynite collectivism, it is clear that the economy needs to be run along market lines. Equally, though, the current version of the market economy is finished, for two very good reasons – it is failing economically, and it is being repudiated politically.

In all probability, what needs to emerge is a renewed commitment to a “mixed economy” model which takes the best from both the private and the public sectors. Political reality will demand greater redistribution, and an ending (and probably a reversal) of the privatization of public services. Somewhere along the line, fixes need to be found for a system which rewards speculation at the expense of innovation.

For this to happen, many cherished privileges will have to be sacrificed. If there is good news here, it is that the country could hardly become more bitterly divided than it already is – and that “Brexit” can give policymakers greatly enhanced breadth of options.

 

#96: May’s day – or mayday?

THE CASE FOR REFORM – NOT REVOLUTION

If memory serves, bookmakers offered odds of 200-1 against Jeremy Corbyn becoming leader of of Britain’s Labour party, a contest he then won by a very comfortable margin. Though their politics are diametric opposites, Mr Corbyn and Donald Trump do have one thing in common – an uncanny ability to put red faces on the “experts” by pulling rabbits out of electoral hats

As recently as a week ago, some of these experts were suggesting that Labour might struggle to get even 25% of the vote. This was a prediction which always flew in the face of logic. My hunch has long been that pollsters would understate Labour’s support by at least 5%, because many of Mr Corbyn’s most committed supporters are not the kind of people who answer pollsters’ questions. If that rule-of-thumb is right, he could yet confound the pundits again, this time by becoming Prime Minister after Thursday’s vote or, at the very least, by taking away the government’s slender majority.

It isn’t hard to understand why Mr Corbyn might garner a large enough proportion of the vote to pull off a shock. Average wages have been falling adrift of inflation since 2009, and of the cost of household essentials for even longer, and security of employment has been weakening for at least as long. Rightly or wrongly, many people think that a wealthy minority is prospering at the expense of the majority. These are fertile conditions for a popular repudiation of “the establishment”.

Strikingly, this is an election which, as the Prime Minister’s critics allege, quite probably was only called because incumbent Conservatives expected a huge victory. If this is the case, it’s another instance of the same sort of complacency that we have witnessed before, notably over the Scottish independence referendum and the “Brexit” vote on EU membership. As so often in recent times, the establishment – in this instance, the government, its advisors, the “experts” and the mainstream media – just don’t seem to “get it” where the popular mood is concerned.

There really is no excuse for such complacency. Where purely economic issues are concerned, there are two factors guaranteed to make an incumbent government unpopular. One of these is hardship, and the other is a perception of unfairness – and both have been present in abundance in the UK in recent times.

Hardship, at least, is factual. According to a recent report from the Joseph Rowntree Foundation, 19 million people – almost a third of the British population – are now struggling to get by on “inadequate” incomes, up from 15 million (25%) six years previously. Comparing 2016 with 2009, a 12% rise in average wages has been exceeded both by CPI inflation (of 16%) and by the cost of household essentials (22%). By the latter measure, at least, the average wage-earner has now been getting poorer for a decade. This is a longer period of deterioration even than the 1930s, and might be unmatched since the 1840s, or even earlier. Neither does anyone really expect a reversal any time soon, not least because of the increase in inflation following the slump in Sterling after the “Brexit” decision.

Anyone who thinks that this can make an incumbent government popular needs to get out more.

If hardship is electorally bad, perceptions of unfairness are truly toxic, and such perceptions cannot be countered by official statistics. A fair summary is probably that, whilst income differentials haven’t widened over the past decade, inequality of wealth certainly has. Monetary policy, including ultra-low interest rates and “quantitative easing”, has inflated the value of assets – and you can only benefit from this if you had assets in the first place. Back when ZIRP and QE were introduced, those of us who believed there was an imperative political need to accompany asset-inflating policies with higher taxes on the resulting capital gains (and lower taxes on income) were ignored.

The popular narrative, then, and rightly or wrongly, has been that policy has benefited a wealthy minority at the expense of the everyone else. Until quite recently, government ambition in this field was limited to helping the very poorest, which is no answer at all to those who, whilst not in absolute poverty, are hard-pressed to make ends meet.

Beneath the surface issues, a motivating perception is that politicians of all parties have abandoned “the working class”. Under Tony Blair, “new” Labour adopted essentially the same economic policies as the Conservatives, and sought to claim radical credentials on grounds not of redistribution but of “identity politics”. This sense of abandonment by “the establishment” has included not just economic but social issues as well, notably immigration. The estrangement between governing and governed almost certainly proved decisive over “Brexit”, where each and every plea from politicians, business leaders and “the commentariat” for a “Remain” decision probably drove more voters into the “Leave” camp.

One of the more striking features of the “populist” – or simply “popular” – backlash against Western elites has been the failure of politicians of “the left” to capitalise on it. Essentially, social democratic parties are perceived to have sold out – and it’s hard to be a credible campaigner on issues of economic inequality once you’ve bought the second home in Tuscany and packed the children off to expensive fee-paying schools. This is one of two reasons – the other being immigration – why angry voters have veered to “the right” rather than “the left”.

This is where Jeremy Corbyn is different. Because its stilted, “first past the post” voting system effectively reinforces established parties and prevents the rise of a Syriza, a Podemos or an FN in Britain, very limited routes exist for a popular backlash against the elite. The “Brexit” referendum was one such opportunity, and voters took it. But the only other realistic democratic route for challenging the establishment was to seize control of one of the major parties, and this is what Mr Corbyn did.

In the election called by Mrs May, a big part of what is really being put to the test is the extent to which the voters want to kick the establishment in the teeth.

The irony is that Mrs May is not a quintessential establishment candidate in the mould of Tony Blair or David Cameron. She seems to recognize the need for reform, and for narrowing the divisions which have widened alarmingly between the winners and losers from two decades of essentially neoliberal policies in a context of globalization. When she famously told her party to its face that it was widely seen as “the nasty party”, many seem to have failed to recognise that her call for changes to party policy would extend to the economy as well as to social issues.

As the election campaign has unfolded, the sure-footedness of the Corbyn camp has contrasted strikingly with the stumbling of the Conservatives. Voting choices are as often about perceptions of competence as they are about policy. Apparent attempts to frighten voters away from Mr Corbyn seem to have misfired, whilst he has been as determined to distance himself from his own party’s recent past as from his opponents.

The view taken here, which will not surprise readers, is that the Western elites have failed, and nowhere has their failure been more conspicuous than in America and Britain. Allowing market capitalism to mutate into corporatism has been damaging, both socially and economically. A large part of Donald Trump’s appeal was simply that he wasn’t an establishment figure in the mould of Hillary Clinton. In Britain, Jeremy Corbyn has been winning over voters simply by distancing himself from the elite. He has set out to prove, were proof necessary, that he isn’t another Tony Blair or David Cameron.

In reality, Mrs May isn’t another Blair or Cameron either, but this differentiation has proved difficult to establish.

Mr Corbyn is right, then, about many of the ills that he identifies. The economy has indeed been mishandled, which is one reason why Britain is now – in the words of Bank of England chief Mark Carney – dependent on “the kindness of strangers”. The economy has become progressively less balanced, with a continuing decline in manufacturing output contrasting with growth in the real estate and financial services sectors. The majority have indeed suffered, not just through deteriorating real wages but also through the increasing casualization of employment as well. The authorities – though ironically Labour, not the Conservatives – did bail out bankers as well as banks.  Not enough has been done to break up the domination of critical sectors by small numbers of companies, or to ensure that those at the top – not just in business, but in the public services as well – are held to account for their mistakes. There has been a failure to recognize that secure, well-paid employment is a necessary basis for robust demand.

Where Mr Corbyn goes wrong is in his solutions. In this respect, by far the most dangerous of his proposals is nationalization. He seems not to realize that a current account deficit of 4.4% of GDP, or £85bn, means that Britain must – stress, must – attract matching capital inflows. In a very real sense, the UK depends to a truly frightening extent on foreigners – those overseas investors who buy British businesses, invest in Britain, retain their profits in Britain, and lend Britain money.

There are plenty of reasons why foreign investors might already be getting nervous. “Brexit” may not be a bad thing, but the uncertainty around it is undeniable. One of the more persuasive bear arguments lies in the deterioration in wages, because low-and-falling real wages are bad news for any business trying to grow its sales. The current account and fiscal deficits combine to suggest that neither the economy nor the government appreciates the need to live within its means.

The danger of a Sterling crisis is quite palpable, as is the failure of politicians and planners to recognize its implications. If the threat of nationalization turned the inflow of capital into an outflow, there is a very real danger that Sterling could crash. If this happened, not only would inflation spike – to the detriment of wage-earners – but interest rates could soar as well, the latter causing the property market to crater.

Britain does need to wean itself off a diet of cheap credit by moving rates up – not least to counter the alarming deficits in pension provision – and would benefit, over time, from letting property prices drift lower.

But nothing would be gained, and a huge amount could be lost, if these things happened suddenly, in an atmosphere of panic. Britain survived “Sterling crises” in 1967 and 1976 – but the risk of “third time unlucky” is perilous.

From an avowedly pro-capitalist – but anti-corporatist – perspective, Britain needs to break up (but not nationalize) over-concentrated sectors, do much more to help small and medium-sized enterprises (SMEs), empower consumers, tilt the balance towards innovation and away from speculation, and re-commit itself to the mixed economy. But swinging from failing corporatism back to already-failed collectivism isn’t the solution.

The best outcome – the one likeliest to pluck the flower of safety from the nettle of danger – would be a Conservative government with a workable majority, led by someone committed to popular capitalism rather than to corporatism, and robustly opposed by a Labour party that has gone back to its roots.

The worst outcome could be a government committed to nationalization, barely opposed at all by a Conservative party tearing itself apart in a welter of recriminations.

 

Manchester

The next article to appear here is written and ready to go. But I feel we all need to pause because of the tragedy in Manchester.

I cannot have been more than about five years old when I was caught up in a bombing. A warning had been given, and we all filed out to safety before the bomb went off.

At that age, you just don’t understand what’s going on.

Decades on, I still don’t understand. Human beings have our differences, and we argue for our opinions. That’s natural.

But I cannot peer into the darkness of soul that can inflict murder and mayhem on innocent people, so many of them children.

My sympathies are with the bereaved and the maimed, the frightened and the bewildered.

Compared with this, nothing else matters.

#95: Exponentials unravelled

STRIKING CONCLUSIONS ON THE BEHAVIOUR OF DEBT AND GDP

Just occasionally, when conducting research for a project, one can stumble – almost accidentally, as it were – upon something which is really important.

During preparatory research for a discussion of “chaos theory” – my shorthand term for the various doomsday scenarios which purport to predict the collapse of Western civilization – I happened to notice that the trajectories of world debt and GDP seem to be following an internal mathematical logic of their own.  More specifically, each seems to be subject to exponential progression at remarkably consistent rates.

If this is indeed the case, its implications could be far-reaching, which is the reason for sharing this with you here.

I assume that readers are conversant with exponential progression but, just in case, here’s the gist. Essentially, a numerical series can adopt a “j-curve” or “hockey-stick” shape even though the annual rate of change remains the same. Imagine a $1,000 investment, increasing by 5% per year. In the first year, the extra 5% increases the total by $50, to $1,050. By year 17, however, the total has reached over $2,000, so that year’s increase is more than $100, even though the rate of change is still 5%. Each year, then, the quantity added becomes bigger despite the rate of growth being constant.

The first chart applies a constant rate of progression to total world debt. Let’s be clear about the conventions used in this and subsequent charts. All numbers are expressed in international dollars, converted using the PPP (purchasing power parity) method. In all cases, values are stated in constant 2016 dollars. The blue columns on the chart are historic numbers since 1999, with the 2016 data-point being the end of September, since year-end debt figures are not yet available. The red columns are SEEDS projections out to 2022, and the superimposed black line is an exponential progression at a constant rate of change.

95 1 debtjpg_Page1

Where debt is concerned, the exponential rate which produces a remarkably close fit is 5.2%. In fact, annual variations from this rate have been strikingly small – and, for each of these charts, a close-up version at the end of this article shows quite how exact the correlation has been.

In 2009, and for wholly understandable reasons, total debt did exceed the 5.2% trend-line, but the very modest deleveraging which occurred in the following year restored the relationship.

Let’s be clear about the implications of this. What this chart is telling us is that global debt is growing by a constant 5.2% annually, and has been doing so for more than fifteen years. Come hell or high water – or their economic equivalents of boom and bust – this progression hardly varies at all. Neither, of course, does inflation enter into this, because these are constant-value numbers.

The suggestion, then, is that global credit expansion is subject to some internal mathematical logic of its own. This, in  turn, would help to explain why there has been no retreat from borrowing despite the shock effect of the GFC (global financial crisis) of 2008.

The next chart applies the same methods to GDP (gross domestic product), again in constant (2016) PPP-converted dollars.

95 2 GDPjpg_Page1

Once again, the correlation is very close – had the constant rate curve been followed exactly, GDP would have been $92 trillion (rather than the actual $94tn) in 2010, and $107tn (rather than $111tn) in 2015, but these are very minor divergences.

The big difference this time, though, is that the annual rate of compound expansion is 3.2%, rather than the 5.2% revealed by the progression of debt. (Please note that the first three charts used here have proportionate vertical axes, enabling an undistorted visual appreciation of comparisons).

Strikingly, GDP is growing at a trend rate (3.2%) which is significantly lower than the rate (5.2%) at which debt is increasing. And, since the debt number has been bigger than the GDP number from the outset, the quantity of debt being added each year is bigger than the annual amount of growth.

Moreover, the gap between the annual increments of debt and growth is widening – as, of course, mathematically it must.

This largely explains why the ratio of global debt to global GDP has increased from 163% in 1999 to 221% at the end of September last year. It further suggests that, if the incremental rates of change identified here remain in place – and there seems no reason why they shouldn’t – then the debt ratio will reach 246% by 2020 and 272% by 2025. Neither ratio is impossible – after all, debt to GDP is already higher than 272% in countries such as Japan and the United Kingdom.

Again, a fascinating implication of this finding is that GDP, like debt, rises at a constant rate seemingly dictated by internal mathematical logic. To be sure, GDP got ahead of this rate in the years immediately preceding 2008, but then fell back to trend. Once again, the close-up charts at the end of this discussion show how the trend was first exceeded, and then restored, by the boom-and-bust cycle around the GFC.

This, of course, refers to GDP as the authorities measure it, and regular readers will know my view that recorded GDP has been inflated by the spending of borrowed money. The logic here is that, just as investment relinquishes current in favour of future consumption, the spending of borrowed money, since it does the opposite, is a form of negative investment. In fact, debt is simply one component of futurity, which also embraces, most obviously, pension provision. Just as debt has expanded, pension provision has weakened, because both are components of our financial relationship with futurity.

Therefore, the SEEDS system produces estimates of how much borrowed money is used to inflate current consumption at the expense of the future. This creates estimates of underlying GDP, and this series is the subject of the next chart.

95 3 UL GDPjpg_Page1

As you can see, there is, once again, a remarkably close fit between actual numbers and a compounding rate of change, which in this instance is 1.8%. Because it excludes the estimated impact of spending borrowed money – of mortgaging futurity, that is – the trend rate of expansion is a lot lower than the rate applicable to GDP as recorded officially.

It is, of course, up to you whether you agree, or not, with my view that, by ramping up debt and using a lot of it to fund consumption, we are boosting today’s consumption at the expense of tomorrow’s. This interpretation seems to me to be reinforced by the opening up of enormous shortfalls in provision for futurity, most visibly in pension deficits.

In short, if pension funding is deficient, the amount available to all of us as pensioners in the future will be smaller than it would otherwise have been. This in turn suggests that we are “pillaging the future” to increase current consumption. Of course, the reason why pension deficits are ballooning, ultimately, is that returns on invested assets have collapsed – and this is a direct consequence of cheap money policies, essentially imposed on central banks by the sheer impossibility of servicing today’s debt mountain at historic (higher) rates of interest.

Wherever you stand on this “mortgaging the future” question, the key point to emerge here is surely that both debt and GDP seem to be subject to rates of change which correlate so closely as to suggest that an internal mathematical dynamic is operating.

The immediate conclusions seem to be that:

  • World debt is growing at a compound annual rate of 5.2%.
  • GDP is growing at a compounding rate of 3.2%.
  • Adjusted for the effects of passing off the spending of borrowed money as “growth”, underlying economic output is growing at a trend rate of 1.8% annually.

All of these numbers exclude two factors which are further undermining prosperity at the individual level. The first of these is population growth, which dilutes per capita shares of economic output. The second is the rising trend in the Energy Cost of Energy (ECoE) – by driving up the cost of household essentials, rising ECoEs act as an expanding “economic rent”, undermining prosperity as this is experienced as “discretionary” (ex-essentials) spending capability.

The findings presented here, of course, are global aggregates, and individual countries’ experiences and prospects vary very significantly around these central trends. India, for instance, could go on growing at current underlying rates for several more decades, whilst the British economy could fall apart within five years.

The general conclusion, however, has to be that, because internal rates of growth are pushing up debt much more rapidly than GDP, there will in due course have to be a reset, most probably through the “soft default” process where the real value of accumulated debt is destroyed by a sharply higher inflation.

What this will not do, however, is reset broader futurity as typified by pension deficits – so we will still need to readdress how we allocate resources between the present and the future.

95 5 detailjpg_Page1

#94: Spring has sprung……a leak

THE TRIUMPH OF HOPE OVER REALITY

I’m a cheerful person – really, I am – and with the sun shining on a shimmering sea outside my window, who wouldn’t be? But there’s a big difference between reasonable optimism and outright delusion, and the latter, it seems, has been taking a big hold over many of those whose job it is to forecast our economic weather.

This week, we’ve seen a pretty upbeat set of forecasts from the IMF (the International Monetary Fund), which has predicted that growth in world GDP (measured in international dollars at PPP rates of conversion) will improve this year, from 3.1% to 3.46%, rising steadily thereafter, to 3.7% by 2019, and nearer 3.8% by 2022. This seems to have reinforced an optimism percolating through the forecasting community, with some even opining that we may be approaching a nirvana known as “take-off velocity”.

In fact, and if the IMF is right, global economic output will be 24% bigger in 2022 than it was in 2016. To find a six-year growth record as good as this, you have to go back to the period from 2002 to 2008, when world GDP grew by 29%, and that ended well, didn’t it?

Oh.

The trouble with “take-off velocity”, you see, is that, if the aeroplane is carrying too much weight, it can fly straight into a brick wall. “Weight”, in this context, means debt. The SEEDS database shows that the 29% growth achieved between 2002 and 2008, whilst adding $21.5 trillion to GDP, was accompanied by $44.7tn in net new borrowing. In other words, world debt grew by twice as much as GDP (if you’re a stickler for detail, the ratio was 2.09:1).

This couldn’t happen again, could it? Surely we’ve learned from the shock effect of the 2008 global financial crisis (GFC), haven’t we?

Well, no.

In 2016, global GDP grew by 3.4%, adding $3.9tn to GDP. Where debt is concerned, we do not yet have comprehensive data for the whole of the year, but we do know that world debt increased by over $11.4tn in the first three quarters of 2016.

In that nine-month period, governments borrowed more than $5.5tn, households $2.3tn, and non-financial businesses $3.5tn. That stacks up to $3.90 of borrowing for each $1 of reported growth, even if we assume that prudence reigned supreme, such that nobody borrowed at all in the three months running up to Christmas.

To be sure, we cannot make a one-for-one comparison between borrowing and growth. But we do know that a lot of this credit expansion went into consumption expenditures, not least because that’s what governments spend most of their money on. The calculations made by SEEDS suggest that, stripped of the spending of borrowed money, reported growth of 3.4% falls to an underlying level of just 1.2% – and even that probably makes some pretty generous judgments on the validity of a very big pile of borrowing.

Nor is that all – because debt is not the only hostage that current practices are handing to posterity. Debt, though it adds to the burdens of futurity, can at least be managed, if we let inflation accelerate, essentially bilking lenders by paying them back in devalued money.

This cannot work with other forms of futurity, most obviously pensions, where the same inflation that devalues debt simultaneously increases the burden of future payments, not just of pension commitments but also of welfare. It should come as no surprise whatsoever that pension deficits are continuing to widen alarmingly.

In short, claims that we are nearing “take off velocity” should be taken with a huge pinch of salt.

Indeed, we’d do better to steer very well clear of any kind of take-off – until the pilots on the flight-deck of the world economic aeroplane have sobered up.