#150: The management of hardship

GOVERNMENT AND POLITICS IN AN AGE OF DETERIORATING PROSPERITY

Though just over a month has passed since the previous article (for which apologies), work here hasn’t slackened. Rather, I’ve been concentrating on three issues, all of them important, and all of them topics where a recognition of the energy basis of the economy can supply unique insights.

The first of these is the insanity which says that no amount of financial recklessness is ever going to drive us over a cliff, because creating new money out of thin air is our “get out of gaol free card” in all circumstances.

This isn’t the place for the lengthy explanation of why this won’t work, but the short version is that we’re now trying to do for money what we so nearly did to the banks in 2008.

The second subject is the very real threat posed by environmental degradation, where politicians are busy assuring the public that the problem can be fixed without subjecting voters to any meaningful inconvenience – and, after all, anyone who can persuade the public that electric vehicles are “zero emissions” could probably sell sand to the Saudis.

And this takes us to the third issue, the tragicomedy that it is contemporary politics – indeed, it might reasonably be said that, between them, the Élysée and Westminster, in particular, offer combinations of tragedy, comedy and farce that even the most daring of theatre directors would blush to present.

From a surplus energy perspective, the political situation is simply stated.

SEEDS analysis of prosperity reveals that the average person in almost every Western country has been getting poorer for at least a decade.

Governments, which continue to adhere to outdated paradigms based on a purely financial interpretation of the economy, remain blind to the voters’ plight – and, all too often, this blindness looks a lot like indifference. Much of the tragedy of politics, and much of its comedy, too, can be traced to this fundamental contradiction between what policymakers think is happening, and what the public knows actually is.

Nowhere is the gap in comprehension, and the consequent gulf between governing and governed, more extreme than in France – so that’s as good a place as any to begin our analysis.

The French dis-connection

Let’s start with the numbers, all of which are stated in euros at constant 2018 values, with the most important figures set out in the table below.

Between 2008 and 2018, French GDP increased by 9.4%, equivalent to an improvement of 5.0% at the per capita level, after adjustment for a 4.2% rise in population numbers. This probably leads the authorities to believe that the average person has been getting at least gradually better off so, on material grounds at least, he or she hasn’t got too much to grumble about.

Here’s how different these numbers look when examined using SEEDS. For starters, growth of 9.4% since 2008 has increased recorded GDP by €201bn, but this has been accompanied by a huge €2 trillion (40%) rise in debt over the same decade. Put another way, each €1 of “growth” has come at a cost of €9.90 in net new debt, which is a ruinously unsustainable ratio. SEEDS analysis indicates that most of that “growth” – in fact, more than 90% of it – has been nothing more substantial than the simple spending of borrowed money.

This is important, for at least three main reasons.

First, and most obviously, a reported increase of €1,720 in GDP per capita has been accompanied by a rise of almost €27,500 in each person’s share of aggregate household, business and government debt.

Second, if France ever stopped adding to its stock of debt, underlying growth would fall, SEEDS calculates, to barely 0.2%, a rate which is lower than the pace at which population numbers are growing (about 0.5% annually).

Third, much of the “growth” recorded in recent years would unwind if France ever tried to deleverage its balance sheet.

Then there’s the trend energy cost of energy (ECoE), a critical component of economic performance, and which, in France, has risen from 5.9% in 2008 to 8.0% last year. Adjustment for ECoE reduces prosperity per person in 2018 to €27,200, a far cry from reported per capita GDP of €36,290. Moreover, personal prosperity is lower now than it was back in 2008 (€28,710 per capita).

Thus far, these numbers are not markedly out of line with the rate at which prosperity has been falling in comparable economies over the same period. The particular twist, where France is concerned, is that taxation per person has increased, by €2,140 (12%) since 2008. This has had the effect of leveraging a 5.3% (€1,510) decline in overall personal prosperity into a slump of 32% (€3,650) at the level of discretionary, ‘left in your pocket’ prosperity.

At this level of measurement, the average French person’s discretionary prosperity is now only €7,760, compared with €11,410 ten years ago.

And that hurts.

Justified anger

Knowing this, one can hardly be surprised that French voters rejected all established parties at the last presidential election, flirting with the nationalist right and the far left before opting for Mr Macron. Neither can it be any surprise at all that between 72% and 80% of French citizens support he aims of the gilets jaunes (yellow waistcoat) protestors. “Robust” law enforcement, whilst it might just temper the manifestation of this discontent, will have the almost inevitable side-effect of exacerbating the mistrust of the incumbent government.

Because energy-based analysis gives us insights not available to the authorities, we’re in a position to understand the sheer folly of some French government policies, both before and since the start of the protests.

From the outset, there were reasons to suspect that the gloss of Mr Macron’s campaign hid a deep commitment to failed economic nostrums. These nostrums include the bizarre belief that an economy can be energized by undermining the rights and rewards of working people – the snag being, of course, that the circumstances of these same workers determine demand in the economy.

After all, if low wages were a recipe for prosperity, Ghana would be richer than Germany, and Swaziland more prosperous than Switzerland.

Handing out huge tax cuts to a tiny minority of the already very wealthiest, though always likely to be at the forefront of Mr Macron’s agenda, looks idiotically provocative when seen in the context of deteriorating average prosperity. Creating a national dialogue over the protestors’ grievances might have made sense, but choosing a political insider to preside over it, at a reported monthly salary of €14,666, reinforced a widespread suspicion that the Grand Debat is no more than an exercise in distraction undertaken by an administration wholly out of touch with voters’ circumstances.

Whilst Mr Macron has appeared flexible over some fiscal demands, he has ruled out increasing the tax levied on the wealthiest. This intransigence is likely to prove the single biggest blunder of his presidency.

Even the tragic fire at Notre Dame has been mishandled by the government, in ways seemingly calculated to intensify suspicion. Rather than insisting that the restoration of the state-owned Cathedral would be funded by the government, the authorities made the gaffe of welcoming offers of financial support from some of the most conspicuously wealthy people in France.

This prompted some to wonder when corporate logos would start to appear on the famous towers, and others to ask why, if the wealthiest wanted to make a contribution, they couldn’t have been asked to do so by paying more tax. It didn’t help that the authorities rushed to declare the fire an accident, long before the experts could possibly have had evidence sufficient to rule out more malign explanations. After all, in an atmosphere of mistrust, conspiracy theories thrive.

The broader picture

The reason for looking at the French predicament in some detail is that the problems facing the authorities in Paris are different only in degree, and not in direction or nature, from those confronting other Western governments.

The British political impasse over “Brexit”, for instance, can be traced to the same lack of awareness of what is really happening to the prosperity of the voters – whilst “Brexit” itself divides the electorate, there is something far closer to unanimity over a narrative that politicians are as ineffectual as they are self-serving, and are out of touch with real public concerns. Similar factors inform popular discontent in many other European countries, even when this discontent is articulated over issues other than the deterioration in prosperity.

At the most fundamental level, the problem has two components.

The first is that the average person is getting poorer, and is also getting less secure, and deeper into debt.

The second is that governments don’t understand this issue, an incomprehension which, to increasing numbers of voters, looks like indifference.

It has to be said that governments have no excuses for this lack of understanding. The prosperity of the average person in most Western countries began to fall more than a decade ago, and any politician even reasonably conversant with the circumstances and opinions of the typical voter ought to be aware of it, even if he or she lacks the interpretation or the information required to explain it.

Governments whose economic advisers and macroeconomic models are still failing to identify the slump in prosperity need new advisers, and new models.

A disastrous consensus

Though incomprehension (and adherence to failed economic interpretations) is the kernel of the problem, it has been compounded by the mix of philosophies adopted since the 1990s. Following the collapse of the Soviet Union, an informal consensus was created in which the Left accepted the market economics paradigm, and the centre-Right tried to be ‘progressive’ on social issues.

Both moves robbed voters of choices.

Though the social policy dimension lies outside our focus on the economy, the creation of a pro-market ‘centre-Left’ has turned out to have been nothing less than a disaster. Specifically, it has had two, woefully adverse consequences.

The first was that the Left’s adoption of its opponents’ economic orthodoxy destroyed the balance of opposing philosophies which, hitherto, had kept in place the ‘mixed economy’, a model which aims to combine the best of the private and the public sector provision. The emergence of Britain’s “New Labour”, and its overseas equivalents, eliminated the checks and balances which, historically, had acted to rein in extremes.

Put another way, the traditional ‘Left versus Right’ debate created constructive tensions which forced both sides to hone their messages, as well as preventing a lurch into extremism which, whilst it might sometimes be good politics, is invariably very bad economics.

The second, of course, was that the new centre-ground – variously dubbed the “Washington consensus”, the “Anglo-American model” and “neoliberalism” – has proved to be an utterly disastrous exercise in economic extremism. One after another, its tenets have failed, creating massive indebtedness, huge financial risk and widening inequality before finally presiding over the wholesale replacement of market principles with the “caveat emptor” free-for-all of what I’ve labelled “junglenomics”.

As well as undermining economic efficiency, these developments have created extremely harmful divisions in society. Whilst Thomas Piketty’s thesis about the divergence of returns on capital and labour is not persuasive, the reality since 2008 has been that asset prices have soared, whilst incomes have stagnated. This process, which has been the direct result of monetary policy, has rewarded those who already owned assets in 2008, and has done nothing for the less fortunate majority.

There is a valid argument, of course, which states that the authorities’ adoption of ultra-cheap money during and after the 2008 global financial crisis (GFC I) was the only course of action available.

But the role of policymakers is to pursue the overall good within whatever the economic and financial context happens to be. So, when central bankers launched programmes clearly destined to create massive inflation in asset prices, governments should have responded with fiscal measures tailored to capture at least some of these gains for the unfavoured majority.

Simply put, the unleashing of ZIRP and QE made a compelling case for the simultaneous introduction of higher taxes on capital gains, complemented by wealth taxes in those countries where these did not already exist.

Failure to do this has hardened incompatible positions. Those whose property values have soared insist, often with absolute sincerity, that their paper enrichment is the product entirely of their own diligence and effort, owes nothing to the luck of being in the right place at the right time, has had nothing whatever to do with the price inflation injected into property markets (in particular) by ultra-cheap monetary policies, and hasn’t happened at the expense of others.

For any younger person, often unable to afford or even find somewhere to live, it is necessarily infuriating to be lectured by fortunate elders on the virtues of saving and hard work.

It’s a bit like a lottery winner criticizing you for buying the wrong ticket.

A workable future

The silver lining to these various clouds is that future policy directions have been simplified, with the paramount objectives being (a) the healing of divisions, and (b) managing the deterioration in prosperity in ways that maximise efficiency and minimise division.

Any government which understands what prosperity is and where it is going will also reach some obvious but important conclusions.

The first is that prosperity issues have risen higher on the political agenda, and will go on doing so, pushing other issues down the scale of importance.

The second conclusion, which carries with it what is probably the single most obvious policy implication, is that redistribution is becoming an ever more important issue. There are two very good reasons for this hardening in sentiment.

For starters, popular tolerance of inequality is linked to trends in prosperity – resentment at “the rich” is muted when most people are themselves getting better off, but this tolerance very soon evaporates when subjected to the solvent of generalised hardship.

Additionally, the popular narrative of the years since 2008 portrays “austerity” as the price paid by the many for the rescue of the few. The main reason why this narrative is so compelling is that, fundamentally, it is true.

The need for redistribution is reinforced by realistic appraisal of the fiscal outlook. Anyone who is aware of deteriorating prosperity has to be aware that this has adverse implications for forward revenues. By definition, only prosperity can be taxed, because taxing incomes below the level of prosperity simply drives people into hardships whose alleviation increases public expenditures.

In France, for example, aggregate national prosperity is no higher now (at €1.76tn) than it was in 2008, but taxation has increased by 17% over that decade. Looking ahead, the continuing erosion of prosperity implies that rates of taxation on the average person will need to fall, unless the authorities wish further to tighten the pressure on the typical taxpayer.

Even the inescapable increase in the taxation of the very wealthiest isn’t going to change a scenario that dictates lower taxes, and correspondingly lower public expenditures, as prosperity erodes.

A new centre of gravity?

The adverse outlook for government revenues is one reason why the political Left cannot expect power to fall into its hands simply as a natural consequence of the crumbling of failed centre-Right incumbencies. Those on the Left keen to refresh their appeal by cleansing their parties of the residues of past compromises have logic on their side, but will depart from logic if they offer agendas based on ever higher levels of public expenditures.

With prosperity – and, with it, the tax base – shrinking, promising anything that looks like “tax and spend” has become a recipe for policy failure and voter disillusionment. This said, so profound has been the failure of the centre-Right ascendancy that opportunities necessarily exist for anyone on the Left who is able to recast his or her agenda on the basis of economic reality.

Tactically, the best way forward for the Left is to shift the debate on equality back to the material, restoring the primacy of the Left’s traditional concentration on the differences and inequities between rich and poor.

On economic as well as fiscal and social issues, we ought to see the start of a “research arms race”, as parties compete to be the first to absorb, and profit from, the recognition of economic realities that are no longer (if they ever truly were) identified by outdated methods of economic interpretation.

Historically, the promotion of ideological extremes has always been a costly luxury, so is likely to fall victim to processes that are making luxuries progressively less affordable. Voters can be expected to turn away from the extremes of pro- public- or private-sector promotion, seeing neither as a solution to their problems.

This, it is to be hoped, can lead to a renaissance in the idea of the mixed economy, which seeks to get the best out of private and public provision, without pandering to the excesses of either. Restoration of this balance, from the position where we are now, means rolling back much of the privatization and outsourcing undertaken, often recklessly, over the last three decades.

Both the private and the public sectors will need to undergo extensive reforms if governments are to craft effective agendas for using the mixed economy to mitigate the worst effects of deteriorating prosperity.

In the private sector, governments could do a lot worse than study Adam Smith, paying particular attention to the explicit priority placed by him on promoting competition and tackling excessive market concentration, and recognizing, too, the importance both of ethics and of effective regulation, both of which are implicit in his recognition that markets will not stay free or fair if left to their own devices.

For the public sector, both generally and at the level of detail, there will need to be a renewed emphasis on the setting of priorities. With resource limitations set not just to continue but to intensify, health systems, for example, will need to become a lot clearer on which services they can, and cannot, afford to fund.

Starting from here

Though this discussion can be no more than a primer for discussion, there are two points on which we can usefully conclude.

First, a useful opening step in the crafting of new politics would be the introduction of “clean hands” principles, designed to prove that government isn’t, as it can so often appear, something conducted “by the rich, for the rich”.

Second, it would be helpful if governments rolled back their inclinations towards macho posturing and intimidation.

A “clean hands” initiative wouldn’t mean that elected representatives would be paid less than currently they are. There is an essential public interest in attracting able and ambitious people into government service, so there’s nothing to be said for hair-shirt commitments to penury. In most European countries, politicians are not overpaid, and it’s arguable that their salaries ought, in some cases at least, to be higher.

There is, though, a real problem, albeit one that is easily remedied. This problem lies in the perception that politics has become a “road to riches”, with policymakers retiring into the wealth bestowed on them by the corporate sponsors of ‘consultancies’ and “the lecture circuit”. This necessarily creates suspicion that rewards are being conferred for services rendered, a suspicion that is corrosive of public trust, even where it isn’t actually true.

The easy fix for this is to cap the earnings of former ministers and administrators at levels which are generous, but are well short of riches. The formula suggested here in a previous discussion would impose an annual income limit at 10x GDP per capita, which is about £315,000 in Britain, with not-dissimilar figures applying in other countries. It seems reasonable to conclude that anyone who thinks that £300,000, or its equivalent, “isn’t enough” is likely to have gone into politics for the wrong reasons.

Where treatment of the “ordinary” person is concerned, there ought, in the future, be no room for the intimidatory practices which have become ever more popular with governments whose real authority has been weakened by failure.

One illustrative example is the system by which council tax (local taxation) arrears are collected in Britain. At present, the typical homeowner pays £1,671 annually, in ten monthly instalments. If someone misses a payment, however, he or she is then required to pay the entire annual amount almost immediately, compounded by court costs of £84 and bailiff fees of £310. Quite apart from the inappropriateness of involving the courts or employing bailiffs, it’s hard to see how somebody struggling to pay £167 is supposed to find £2,067.

This same kind of intimidation occurs when people are penalized for staying a few minutes over a parking permit, or for exceeding a speed limit by a fractional extent. Here, part of the problem arises from providing financial incentives to those enforcing regulations, a practice that should be abandoned by any government aware of the need to start narrowing the chasm between governing and governed.

We cannot escape the conclusion that the task of government, always a thankless one even when confined to sharing out the benefits of growth, is going to become very difficult indeed as prosperity continues to deteriorate.

There might, though, be positives to be found in a process which ditches ideological extremes, uses the mixed economy as the basis for the equitable mitigation of decline, and seeks to rebuild relationships between discredited governments and frustrated citizens.

#133: An American hypothesis

IS DONALD TRUMP THE FIRST ‘ECONOMIC REALIST’?

When the historians of the future get around to writing up our current era, one of the things likeliest to strike them will be the difference between what is actually happening and what most decision-makers think is happening. Historically, it is fascinating to speculate on how many of the worst decisions of governments have sprung from false interpretation and incorrect information.

From a contemporary perspective, what is evident now is an ever-widening chasm between conventional economic evaluation and the actual trend of events. Where conventional interpretation sees growing prosperity and contained financial risk, you don’t have to step very far outside the box to see a process of economic deterioration, elevated risk and, most seriously of all, a growing threat to the stability of currencies.

For regular readers, of course, this is familiar fare. We know that an economy hampered by a rising trend in the energy cost of energy (ECoE) is being subjected to an ultimately-futile process of denial based on credit and monetary adventurism.

Rather than revisiting this strategic theme, the aim here is to pose a theoretical question, and see where it leads.

Here is the question – what would a government do if it did recognise these realities, and came to understand that prosperity is already declining in the West, and may, before long, turn downwards in the emerging market (EM) economies, too?

It is beyond doubt that such a recognition would bring about drastic changes, both in assumptions and in policy. What follows is an examination of what those changes might be. It’s also safe to assume that these changes would be resented by those still wedded to the conventional, and that their mystification would lead rapidly to anger, suspicion and hostility.

It is suggested here that, if any government anywhere in the world is behaving in ways which are consistent with this pattern, it is the Trump administration. To what extent can Mr Trump be credited with – or, by some, accused of – acting on the basis of ‘new reality’?

What if understanding dawned somewhere?

If a government did discover the processes that are at work in the economy, the first conclusion that such a government would reach is that prosperity has become, at best, a zero-sum game. This would mean that, instead of the world becoming more prosperous in shared progression, the prosperity of one country can only be enhanced at the expense of others.

This, of course, is anathema to conventional economics, which pins its faith in David Ricardo’s “comparative advantage” theory. Essentially, Ricardo argues that we all get richer if we all concentrate on what we’re, so to speak’, ‘most best at’. From this, it follows that maximising trade between nations is to the benefit of all. This has long been an article of faith for economists.

What Ricardo did not have to consider, though, was the concept of a world with finite characteristics. It’s a reasonable hypothesis that constraints on the maximum availability of resources (such as land, water and, above all, energy) might render the law of comparative advantage inoperable. In short, once you postulate limits to potential prosperity, ‘all in it together’ quickly becomes ‘every man for himself’.

Trade, currencies and national advantage

If a government did arrive at the ‘zero-sum prosperity’ conclusion, it would concentrate on pursuing national advantage in trade. Governments already do this, of course, but they are in general influenced sufficiently by the Ricardian calculus to pursue national advantage in a mutual context. Whilst they want to skew trade agreements in their own favour, they do so from an assumption that there are mutual benefits to be accrued from such agreements.

The various trade deals pursued by the Obama administration illustrate this. Though these deals undoubtedly had a pro-American bias, they were nevertheless framed in an ‘internationalist’ way, based on assumptions of potential mutual benefit.

Our imaginary zero-sum prosperity government would differ radically, because its disbelief in mutual advantage would result in an instinctive preference, if not for outright protectionism, then at least for blatantly one-sided arrangements. The result would be a more aggressive stance on trade, characterised by an undisguised pursuit of national benefit, almost heedless of what the consequences for other countries might be.

This government would also want to leverage whatever benefits it might get from the relative strength of its currency. Under normal circumstances, a strong currency is bad for trade, making home-produced goods costlier than foreign alternatives. That matters a lot less, though, if you use tariffs to decide what you do and do not want to buy from overseas. For example, you might decide that a strong currency helps you purchase resources from abroad, but the strength of the currency needn’t suck in more manufactured goods because, if this starts to happen, you simply stick tariffs on them.

It need hardly be stated that the politics and the rhetoric accompanying this stance would be nationalist in tone. Moreover, this nationalist approach towards trade would be certain to show up, too, in other, non-trade aspects of foreign policy, including areas such as diplomacy and the management of alliances. Neither is it at all fanciful to assume that this nationalism would be replicated in domestic policies. Politicians often ‘wave the flag’ in pursuit of votes – the only difference about a government founded on a zero-sum prosperity assumption would be that the nationalism invoked would be the real thing.

The emphasis on nationalism described here need not, though, result in bellicosity. Indeed, it is likelier to take the form of isolationism or, at least, of a reluctance to expend “blood and treasure” in ways that do not benefit the country’s prosperity.

Thus far, we have envisaged a government determined to use trade to pursue national prosperity – and, implicitly, broader national advantage as well – on the basis of zero-sum world potential. As well as being implicitly inimical to free trade in goods and services, this argues for an equally restrictive attitude towards the movement of capital and labour.

For a start, the government we are envisaging would not want foreign investors acquiring domestic assets. At the same time, it would not want to see its businesses investing overseas rather than at home, something which they might well be inclined to do if costs elsewhere were lower, a differential that would be exaggerated by a strong currency.

Likewise, such a government would be inimical to the free movement of labour. If its preference was for businesses to invest at home – rather than moving their operations to lowest-cost locations – then it would be equally opposed to that cheap labour being imported through immigration. It would see large-scale immigration as the domestic face of a globalist calculus that it wished to disrupt.

Battle lines

What we are envisaging here is a government which – by interfering with the flow of trade, capital and labour – is challenging the most treasured objectives of the ‘globalists’.

In critical ways, some demarcations are being drawn here between our theoretical government and those who, either in principle or in pursuit of profit, work from diametrically opposite assumptions. A nationalist stance, reinforced by opposition to immigration, plays to a domestic audience often branded “populist” by its increasingly unpopulist opponents.

Essentially, then, any government operating on the premise of nationalism founded on a zero-sum prosperity calculus would face fervent opposition, both at home and abroad. Opponents would fall into two main categories – those who benefit from the globalist model, and those who are internationalist out of conviction. Those persuaded by internationalism out of conviction overlap extensively with those whose policies are self-defined as ‘liberal’.

What emerges from this is that the opponents of our theoretical government might be defined as ‘liberal globalists’. Since this essentially defines the long-established political and economic consensus of the Western world’s ruling elites, the government that we are envisaging would, of necessity, be ‘anti-establishment’, challenging both the vested interests and the conventional assumptions which favour globalism.

Donald Trump – theory into practice?

Just to recap, then, a government which became persuaded about zero-sum global prosperity could be expected to ditch huge swathes of what has been the economic consensus for more than three decades.

It would pursue policies of national advantage which would be hostile to free trade, and opposed to the free movement of capital and labour. It would abandon the substance (and, very probably, the rhetoric, too) of mutuality. It would face very stiff, often visceral opposition both from internationalist and from globalist persuasions.

So much for theory – what about practice?

The government which comes closest to our theoretical outline is the Trump administration. Mr Trump’s political platform can be described as ‘populist-nationalist’, and his opposition to globalisation is palpable. If Mr Trump has an identifiable enemy, that enemy resides, not in Beijing or in Moscow, but in Davos.

This interpretation has been influenced by a two-part essay by analyst Thierry Meyssan. His argument is that Mr Trump’s political stance, developed over the fifteen years before he entered the White House, is based on opposition to American ‘imperial’ behaviour and a renewed focus on domestic prosperity alone. As Mr Meyssan puts it, Mr Trump is “a politician who refuse[s] to engage his country in the service of transnational elites”.

It is certainly striking that, unlike his predecessors, Mr Trump shows no appetite for military interventions, in the Middle East or anywhere else. He certainly does not want America to be ‘the world’s policeman’, especially if what is being policed benefits globalist corporates a lot more than it benefits Americans

Ideologically, some of this puts Mr Trump in some positions which, at first sight, can look pretty bizarre. For example, it seems unlikely in the extreme that Lenin was ever one of the President’s favourite authors, but Thierry Meyssan is surely on to something when he cites this passage by the Soviet leader at the start of his second essay:

 

“Imperialism is capitalism which has arrived at a stage of its development where domination by monopolies and financial capital has been confirmed, where the export of capital has acquired major importance, where the sharing of the world between international trusts has begun, and where the sharing of all the territories of the globe between the greatest capitalist countries has been achieved”

 

Brought forward into the circumstances of today, references to monopolies, the dominant role of international capital and the free flow of capital between countries are indeed redolent of what Davos likes, and Mr Trump, instinctively and perhaps calculatedly, does not.

According to Mr Meyssan, the President’s election was based on a “promise to return to the earlier state of Capitalism, that of the ‘American dream’, by free market competition”. Thus interpreted, Mr Trump opposes the small number of “multinational companies [which] gave birth to a global ruling class which gathers every year to congratulate itself, as we watch, in Davos, Switzerland. These people do not serve the interests of the US population, and in fact are not necessarily United States citizens themselves, but use the means of the US Federal State to maximise their profits”.

Synthesis

Thus far, we have been examining two distinct issues.

The first is an interpretation of what a government might do, if it became persuaded that the scope for growth in global prosperity has been exhausted.

The second is Thierry Meyssan’s acute interpretation of Donald Trump as a nationalist opponent of globalisation and its attendant ideologies and policies.

What is surely very striking is how these two strands intersect. It’s doubtful if Mr Trump and his advisors are familiar with the energy-based interpretation of economics, certainly as discussed here, and modelled by SEEDS. But it’s by no means improbable that he has arrived at similar conclusions by different routes.

It certainly seems apparent that the consensus symbolised by Davos is vehemently opposed to Mr Trump’s apparent agenda. Moreover, if he has indeed picked a fight with “Davos man”, he could hardly have chosen a more formidable opponent. What we do know is that he has already thrown some big spokes into the wheel of a model which favours the global flow of goods, capital and labour on a basis geared towards the maximisation of the share of GDP which goes into corporate profits rather than labour.

If this interpretation is correct, we should anticipate efforts to break up some of the most powerful global corporations with large shares in their respective markets. Mr Trump might not have read Lenin, but he certainly seems to understand Adam Smith’s emphasis on the primary importance of competition, free, fair, and unfettered by excessive concentration. Once that is understood, trust-busting becomes logical.

Outcomes

Fascinating though the politics of all this undoubtedly are, the decisive issue is likely to be economic. Essentially, can nationalism deliver more for American voters than globalisation has achieved?

The reality is that, in pure economic terms, globalisation isn’t a hard act to follow. The essential premise of globalisation is that profits can be increased by locating production in the cheapest places, whilst continuing to sell goods and services in the (relatively) wealthy West.

There was always a huge contradiction at the heart of this philosophy – essentially, if well-paid jobs are shipped out of Western markets, how are Western wage-earners supposed to carry on with high levels of consumption? Thus far, the answer has been to make credit cheaper, and more readily accessible, than it has ever been before. This strategy has landed us with extraordinary levels of debt, unprecedentedly cheap money, and all of the risks associated with financial adventurism.

According to SEEDS, the United States has not bucked the trend towards lower prosperity in the West. Whilst not as badly affected as, say, Britain or Italy, SEEDS indicates that the average American is 7.7% ($3,380) poorer than he or she was back in 2005.

Though GDP data appears to contradict this calculation, two factors can be cited to support it. First, an overwhelming majority (93%) of all growth in American GDP in recent years has come from internally-consumed services (ICS) – such as finance, real estate and government – whilst the aggregate contribution to growth of hard-priced, globally marketable output (GMO), such as manufacturing, construction, agriculture and the extractive industries, has been zero. (The other 7% came from increased exports of services).

Second, growth in GDP has been far exceeded by an ongoing escalation in debt. Comparing 2017 with 2005, GDP has grown by $3.25tn, but debt has expanded by $14tn, a ratio of $4.30 of new debt for each $1 of reported growth. By definition – and, latterly, based on experience as well – pouring cheap credit into the system to sustain consumption in the face of deteriorating wages is not a sustainable way of running the economy.

In short, there is a compelling case to be made that Americans are significantly poorer now than they were twelve years ago – and, were this not the case, there has to be a strong possibility that Mr Trump would not have become President.

The first conclusion we can reach seems to be that, in linking prosperity with nationalism, Mr Trump has been pushing at an open door. We cannot know whether his policies can deliver more for Americans than globalisation, but it won’t be all that long before we find out. Obviously, nobody should underestimate the opposition that Mr Trump will go on encountering from those whose economic interests he threatens.

 

#131: Not about “Brexit”

PROSPERITY AND RISK IN THE UNITED KINGDOM

What follows is an analysis of the British economy, from the perspectives of performance and risk.

It is not a discussion of “Brexit”.

Readers are, of course, welcome to discuss any pertinent issue, “Brexit” included. But a non-“Brexit” focus has to be stated clearly, because one of the most regrettable effects of the whole “Brexit” process has been to divert attention away from the economic fundamentals. Distractions don’t come much bigger than “Brexit”.

Perhaps the most striking characteristic of the British economic situation is the stark divergence between two different views. One of these is an official and consensus interpretation, founded on conventional economics, which portrays performance as no worse than lacklustre. There is, however, a raft of other indicators which paints a much less satisfactory picture.

Analysis undertaken using SEEDS – the Surplus Energy Economics Data System – indicates that prosperity peaked as long ago as 2003, and that the consequent strains are now becoming ever more apparent. Declining prosperity, of course, characterises most advanced Western economies. The United Kingdom stands out, though, for the rate at which prosperity is deteriorating, and for the elevated level of risk associated with this trend.

The great dichotomy

According to conventional metrics, the economy of the United Kingdom continues to grow, albeit at a less than sparkling pace. GDP is expected to increase by about 1.4% this year which, though hardly impressive, at least outpaces the 0.6% trend rate at which population numbers are expanding. People are, then, getting gradually better off, whilst unemployment remains low.

The problem with this interpretation is that it is hard – arguably, impossible – to square with a host of other indicators. First, wage growth is very subdued, barely keeping up with CPI inflation, and falling steadily further adrift of the cost of household essentials.

Second, productivity growth has fallen to virtually zero, having averaged just 0.2% since the 2008 global financial crisis (“GFC I”).

The labour market is characterised by increasing casualization and insecurity of employment, factors which contribute to depressed wage levels despite officially-low unemployment.

There is every reason to suppose that consumers’ ability to spend is in rapid retreat. Customer-facing businesses (including shops, restaurants and pubs) are going through a fire-storm of closures, failures and job losses. Consumer credit has climbed to potentially dangerous levels, with anecdotal evidence that this credit is being used, not for discretionary purchases, but simply to meet living expenses. There is also reason to suppose that big-ticket purchases are in decline. Surveys indicate that large and increasing numbers of households are struggling to make ends meet.

Government, too, seems strapped for cash, not really knowing how to provide necessary increases in funding for areas such as health, defence and care for the elderly. Local as well as central government looks resource-constrained.

Broader indicators of economic stress include homelessness, with young people, in particular, finding accommodation to be costly, often of poor quality, and hard to obtain. Seemingly-rapid rises in violent crime – including a dramatic surge in moped offences, of which there were 23,000 in London alone last year, compared with just 827 five years earlier – do not seem consistent with a prospering society.

In short, there is an abundance of evidence that, far from getting better off, the average British person is getting poorer. At first glance, this is impossible to square with any level of reported “growth” in economic output.

The SEEDS interpretation

An answer to this conundrum is supplied by SEEDS, which indicates that prosperity per person in the United Kingdom has been declining relentlessly since as long ago as 2003.

Over the period since then, reported GDP has risen by £386bn (23%), to £2.04 trillion last year from £1.65tn (at 2017 values) in 2003. Against this, however, aggregate debt increased by £2tn (62%).

This means that each £1 of reported growth has been accompanied by £5.20 in new borrowing. It also means that, against current growth expectations of about 1.4%, the UK typically borrows 5.7% of GDP each year.

The stark implication is that, like many other Western countries, Britain has been pouring cheap credit into the economy to shore up consumption. In short, most of the supposed “growth” of recent times has been nothing more substantial than the simple spending of borrowed money.

Stripped of this borrowing effect, SEEDS calculates that, within recorded growth of £386bn since 2003, only £77bn can be considered organic and sustainable. This puts ‘clean’ (borrowing-adjusted) GDP for 2017 at £1.59tn, barely ahead of the 2003 number of £1.53tn. On this basis, underlying growth has not kept up with increases in the population, so that ‘clean’ GDP per capita has decreased by 5.1% since 2003.

The compounding headwind has been a sharp rise in the energy cost of energy (ECoE). This, of course, is a worldwide problem, but has been particularly acute in the United Kingdom. Back in 2003, Britain’s ECoE (3.4%) was lower than the global average (4.5%). Today, though, ECoE is markedly higher in the UK (9.2%) than in the world as a whole (8.0%).

On a post-ECoE basis, prosperity per capita in Britain has fallen by 10.3% (£2,540), to £22,020 last year from a peak of £24,550 in 2003. Prosperity has declined in other Western countries over the same period, but Italy is the only major economy where the fall has been as rapid as in the UK.

SEEDS shows no sign of this downwards trend slackening, and projects that British prosperity will be a further 4.2% lower in 2022, at £21,090, than it was in 2017. In short, the average person is getting poorer at rates of between 0.5% and 1.0% each year.

Meanwhile, of course, his or her share of aggregate debt continues to increase.

Elevated risk

Deteriorating prosperity necessarily increases risk, because the ability to carry any given level of financial burden is a function of prosperity. Falling prosperity also impairs the ability to fund public services.

Trends in debt ratios reflect deteriorating prosperity. Aggregate debt at the end of 2017 (£5.25tn) equates to 258% of GDP but 361% of prosperity, the latter number having risen markedly since 2007 (283%).

More worryingly, the rise in debt exposure has been matched by sharp increases in proportionate financial assets, a measure of the size of the banking system. The most recent figure, for the end of 2016, puts Britain’s financial assets at 1124% of GDP, but this rises to 1547% when prosperity, rather than GDP, is used as the denominator. The SEEDS estimate of financial assets in relation to prosperity at the end of last year is 1577%, again sharply higher than the level on the eve of the financial crisis in 2007 (1285%).

Measuring debt and financial assets in relation to prosperity are two of the four risk yardsticks used by SEEDS. The UK looks high-risk on the debt measure, and extreme-risk in terms of the scale of its banking exposure.

On the third risk criterion, which is dependency on the continuing availability of credit, the British score is no worse than that of most comparable economies. The United Kingdom does, though, also depend on a continuing ability to borrow from abroad, to sell assets to overseas investors, and to attract inward flows of capital. This dependency looks risky, because the severe travails of customer-facing businesses, and the implied hardship of consumers, necessarily impair the attractiveness of Britain as a place in which to invest.

Finally, Britain has a high score on what SEEDS calls “acquiescence risk”. Put simply, the less prosperous people become, the less likely they are to back painful recovery plans should these be required in a future financial crisis. Worsening prosperity has already had a marked effect on political outcomes in America, France, Italy and elsewhere, and the same factor is likely to have tilted the balance decisively in the referendum on “Brexit”. Should it become necessary for Britain to repeat the 2008 rescue of the banks, popular acquiescence in such a measure should be no means be taken for granted.

 

SEEDS 2.15 United Kingdom 21072018

 

#128: GFC II

THE ANATOMY OF THE NEXT CRASH

Surprising though it might seem, barely two weeks have elapsed since those of us who anticipate GFC II – the sequel to the 2008 global financial crisis (GFC I) – were in a very, very small minority.

Consensus opinion, backed to the hilt by conventional economics, said that no such event was going to happen. Rather, we had entered the sunny uplands of “synchronised growth”, and debt had ceased to be anything much to worry about.

Of course, events, in Italy and elsewhere, haven’t yet proved us right, or the consensus wrong. We remain in a minority, though one that seems to be becoming larger. But events should embolden us, and on two fronts, not one.

First, recent developments strengthen the case for GFC II, not because of their seriousness alone, but because – as will be explained here – they conform to a logical pattern that points towards a coming crisis.

Second, we’re being reminded of quite how far conventional economics is out of touch with reality. This, of course, will be proved decisively if – or when – GFC II does happen.

This, when you consider its implications, is really quite remarkable. Government, business and finance all place heavy reliance on a school of thought which decrees that the workings of the economy are entirely financial – so, if events prove this approach to have been wrong, the ramifications will be enormous.

Those of us who understand that, far from being a matter of money, the economy is an energy system, have a lot of work in front of us.

This seems like a good point at which to publish the promised brief summary of why GFC II is likely.

ECoE starts to bite

Here is one big difference which makes the two contesting views of the economy incompatible. For anyone who believes in money-based interpretation, there are few (if any) logical barriers to perpetual growth in prosperity.

From an energy perspective, however, there is every reason to doubt the feasibility of indefinite expansion on a finite planet.

To be quite clear about this, what is contended here is not that we will “run out of” either petroleum or of energy more broadly. Rather, the argument is that we are running out of cheap energy.

“Cheap”, in this context, does not refer to sums of money invested in the supply of energy. Rather, it refers to the quantity of energy consumed whenever energy is accessed.

The definition used here is the energy cost of energy, or ECoE. Throughout much of our industrial history, the trend in ECoE has been downwards. This trend, beneficial for growing prosperity, was driven by geographical reach, economies of scale and technology.

In recent times, however, both reach and scale have plateaued, and technology has become a mitigator of ECoE increase rather than an accelerator of ECoE decrease. The driver now is depletion.

According to SEEDS, the global trend ECoE was 1.7% in 1980, and 2.6% in 1990. The difference between the two numbers was modest, and neither was a material (or, to most observers, even a noticeable) head-wind to growth.

Because the operative trend is exponential, however, ECoE was close to 4% by 2000, and had now become large enough to start driving a wedge between economic expectation and economic outcome.

The dynamic of sequential crises, part one – GFC I

By about 2000, then, underlying growth in prosperity was weakening, something not helped by the form of globalisation being promoted. Fading growth wasn’t something that conventional economics could explain, let alone accept.

What was apparent, however, was that the ability of Westerners to go on increasing their consumption was flagging, not least because of the outsourcing of skilled, well-paid jobs to the emerging market economies (EMs).

The solution to this seemed simple – give consumers easier and cheaper access to credit.

Two expedients combined to further this aim. The first was to drive down the real (ex-inflation) cost of borrowing. The second was to increase the availability of debt through “deregulation” of the financial sector. Both accorded with the prevailing ideology of laissez-faire economics, with its emphasis on diminishing the role (including the regulatory role) of the state.

Obviously enough, this strategy drove global debt upwards. Expressed in PPP dollars at constant 2017 values, world debt increased by 43%, from $121 trillion in 2000 to $174tn in 2007. Nobody in any position of influence seemed unduly concerned about this, because GDP had increased by a seemingly-impressive 53% over the same period.

Hardly anyone seemed to notice that each $1 of this growth had been accompanied by $2.08 of net new debt. Accordingly, the clear inference – that a big chunk of this “growth” was nothing more substantial than the simple spending of borrowed money – passed largely unnoticed.

The second, less obvious consequence of deregulation was the diffusion of risk, and the separation of risk from return. Various innovative practices enabled the creation of high-return, high-risk instruments which could be sliced in such a way that high risk was divested and high return retained. Surprisingly few observers noticed quite how dangerous this practice was likely to prove.

Risk-aversion revisited

The first – and, with hindsight, unmistakeable – portent of GFC I happened during the “credit crunch” of 2007. Banks, suddenly aware of elevated risk, couldn’t know which counterparties were safe, and which were not.

This was an instance of risk-aversion. What resulted was an interruption in the continuity of credit supply. This took down the small number of banks which had been reckless enough to finance their lending using short-term credit from wholesale markets. These aside, the system seemingly recovered from risk-aversion, though astute observers must by now have realised that the “credit crunch” might well be a precursor to something more systemic.

This 2007 chapter is highly relevant now, because we have entered a new phase of risk-aversion. Even before recent events in Italy, some of us had discerned the rise of risk-aversion, most obviously in the travails of a string of EM currencies. The probability is that this isn’t simply a function of a strengthening dollar, but reflects the withdrawal of capital from countries now seen as risky.

This time – and with a significance that will become obvious shortly – it is the creditworthiness of countries and their currencies which are being questioned, not just that of banks

This is why, here, we had started discussing GFC II, and commenting on its imminence, well before anything kicked off in the Euro Area (EA).

These events have not, then, changed our expectations. Rather, they have conformed to a pattern in which an outbreak of risk-aversion precedes a full-blown crisis.

The dynamic of sequential crises, part two – GFC II

So far, the dynamic of GFC II is conforming to the pattern of GFC I, with an episode of risk-aversion happening first. If the pattern continues, we will get through this chapter and breathe a collective sigh of relief – just in time for GFC II to catch us unawares.

This time, though, the fundamental dynamic is different, which means that the shape of GFC II will be different as well.

The explanation for this lies in how we responded to GFC I.

Put simply, during GFC I the authorities woke up to the obvious fact that the world had too much debt. Whenever debt becomes excessive – for a household, a business or a whole economy – the primary problem isn’t whether the debt can be repaid. At the macroeconomic level, at least, repayment can usually be deferred.

The big and immediate problem is servicing the debt – and this, by 2008, had become something that the world’s borrowers simply couldn’t afford to do. The logical solution seemed to be to slash interest rates.

This involved two processes, not one. The first, which was to take policy rates down to somewhere near zero, would never have been enough on its own. This was why massive QE programmes were launched, buying bond prices upwards in order to force yields sharply lower.

Defenders of QE argued that this didn’t amount to “printing” or otherwise creating new money, that it wasn’t monetisation of debt, and that it wouldn’t spark a sharp rise in inflation.

None of these assurances was, or is, cast-iron. QE isn’t the creation of money so long as it is reversed in good time. QE may not in principle be debt monetisation, but it certainly has become that in Japan, where QE money has been used by the BoJ to buy up nearly half of all JGBs in issue. It would be no huge surprise if the ECB, too, adopted monetisation as the least-bad way out of the looming debt crisis. And QE need not spark inflation, if by that term is meant rises in retail prices – but QE most assuredly has created huge inflation in the prices of assets.

A new adventurism

Be that as it may, what we have seen since GFC I has been “monetary adventurism”, which is distinct from the “credit adventurism” practised before 2008. The credit variety hasn’t gone away – indeed, it has worsened, with each dollar of “growth” since 2008 coming at a cost of $3.39 in new debt, compared with a ratio of 2.08:1 before GFC I – but monetary adventurism has leveraged its consequences.

The numbers are that, between 2008 and 2017, GDP increased by $28.8tn, but debt expanded by $98tn. Nor is this all. The destruction of returns on capital has created what the WEF has called “a global pension timebomb”, blowing a hole estimated by SEEDS at close to $100tn in worldwide pension provision adequacy. QE has poured something of the order of $28tn into the system. In the background, meanwhile, ECoE has continued to tighten its grip, rising from 5.3% in 2007 to 8.0% now.

To cut to the chase, most of the recorded “growth” in world GDP since 2008 has been cosmetic, amounting to nothing more substantial than the simple spending of borrowed money. As we have seen, this is corroborated by the concentration of “growth” towards the lower end of the value-added spectrum.

Bring the increase in ECoE into the equation as well and what we are looking at is a 10% ($7.6tn) increase in world prosperity trying to support a 54% ($98tn) expansion in total debt. Moreover, the 10% increase in aggregate prosperity has barely matched the rate of growth in population numbers. People have not been getting more prosperous, then, but they have been getting ever further into debt.

What on earth could go wrong with that?

Not like GFC I – the nature of GFC II risk

Thus far, with an episode of risk-aversion in the EM economies compounded by debt worries in Europe, events are following the pattern of GFC I.

But there are at least three reasons why we should not assume that GFC II will continue to look a lot like GFC I.

First, prosperity per person has been declining across almost all of the Western economies. The worst affected countries include France (a fall of 5.4% since 2007), Australia (-6.0%), the United States (-6.3%), Britain (-7.9%) and – of course – Italy, where prosperity has declined by 8.4%.

It is no coincidence at all that major political reverses for the establishment have happened in four of these five countries. Deterioration in prosperity seems certain to have informed the “Brexit” vote, the election of Mr Trump, the defeat of all established parties in the first round of presidential voting in France, and the triumph of Lega and M5S in Italy.

The relevance of this going forward, though, is something termed here “acquiescence risk”. This broadly means that populations undergoing hardship are likely to oppose any kind of rescue plan, especially if it is assumed by voters to involve rescues for an elite, and “austerity” for everyone else.

The second big difference between conditions now and those prevailing in 2008 is that recklessness has no longer been confined almost entirely to the developed economies of the West. This broader compass is hinted at by risk-aversion in the EMs. On the SEEDS risk matrix, China is now rated as riskier than any economy other than Ireland.

Third, and most important of all, a phase of “credit adventurism” which put banks at risk in 2008 has become a wave of “monetary adventurism” which puts fiat currencies themselves at risk.

What we should anticipate, then, is that GFC II will be truly global, not exempting EMs, and that, this time, currencies, and therefore national economies, will share a wave of risk previously (in 2008) borne largely by banks alone.

Precedent can help us anticipate why GFC II will happen – but will prove a poor guide to its shape and extent.

= = = = =

Since brevity was promised here, it is to be hoped that the foregoing provides a succinct summary of why GFC II is likely.

There seem certain to be plenty of opportunities for going into this in greater detail.

 

= = = = =

#125: Quantum of risk, part two

IRAN, OIL & THE CURRENCY DIMENSION

At first sight, it might appear a reasonable inference that the greatest significance of Mr Trump’s decision about the deal with Iran will be felt in oil markets. The reality, though, may be rather different. Oil may not be hugely affected, and the Iran decision might not do all that much to hasten the next supply squeeze.

The line explored here is that the greatest ramifications of President’s decision may show up in two other areas.

One of these is a widening in the nascent schism between Europe and America over what “capitalism” really means. This is a topic that we’ve explored here before, and needn’t revisit now. This said, the Iran situation could prompt Europe (and others) to accelerate their retreat from the “Anglo-American economic model”.

The other consequence, of far greater immediate practical importance, is what this development might mean for fiat currencies.

Three critical issues, #1 – the petro-prop

To put this in context, we need to remind ourselves of three critical points.

The first is that the US dollar relies massively on the “petro-prop”. Because oil (and other commodities, too) are traded in USD, anyone wanting to buy these commodities needs first to purchase dollars. This guarantees buyer support for the USD, and this in turn gives the dollar a big valuation premium.

If you convert other currencies into dollars on the basis of the prices of comparable goods and services, what results is a PPP (purchasing power parity) rate of exchange. If you then compare this with market averages, you can only conclude that the markets price the dollar at a premium to the fundamentals.

And that premium is massive. Through 2017 as a whole, for example, the market priced the dollar at a premium calculated by SEEDS at 78% above its purely economic (PPP) value. This isn’t new, of course, and premia have certainly been the norm since America ended gold convertibility way back in 1971.

But it’s the dollar’s “petro-prop” premium which alone enables the United States to issue massive amounts of debt – and seldom this can have been more significant than it is now, given America’s bizarre budgetary outlook.

It’s also at least arguable that only the “petro-prop” has allowed the Fed to run huge QE programmes, without either (a) risking severe currency depreciation, or (b) having to maintain interest rates at appreciably higher levels.

So, if you think that QE and ZIRP have underpinned the global financial system in a beneficial way since GFC I, then you have the “petro-prop” to thank for this outcome.

If, conversely, you share the view that “monetary adventurism” has been a new exercise in recklessness, then the “petro-prop” should carry much of the blame.

Either way, the “petro-prop” is a critical feature of the monetary landscape.

Any weakening of it could usher in hugely disruptive change. The one thing, above all, that the United States really doesn’t need right now is for countries buying and selling oil to start doing so in currencies other than USD.

Three critical issues, #2 – fiats in the firing-line

The second point we need to note is that, whereas GFC I, as a consequence of “credit adventurism”, put the banking system at risk, GFC II could extend the risk to the world’s fiat currencies, because the folly-of-choice since GFC I has been “monetary adventurism”.

Fissures in the monetary system are already showing up, initially in the plunging values of a string of EM (emerging market) currencies.

The consensus assumption seems to be that this is happening because of a strengthening USD.

This interpretation, however, is probably far, far too simplistic. The reality might be that investors are becoming more risk-averse, prompting a flight of capital out of EM economies.

This sort of risk aversion, albeit concentrated then on banks rather than national economies, happened in 2007, with the “credit crunch”.

If we call that the “banking credit crunch”, and regard it as the precursor to GFC I, then it’s reasonable to view current trends in EM currencies as a “currency credit crunch”, setting the scene for GFC II.

Three critical issues, #3 – an ignorance of risk

The third in our triumvirate of foundation factors is that fiat currencies, and the financial system more generally, already stand at unparalleled levels of risk – but anyone who assesses these issues along conventional lines is not in a position to appreciate this risk.

Essentially, stock numbers (such as debt), and flow data (typified by reported GDP), are insufficiently connected by conventional interpretation. Imagine that a given economy’s debt rises but, at the same time, its GDP increases, too, restraining the expansion in the ratio. This would be a mathematically valid equation if changes in stock don’t impact measured flow – but they do.

The GDPs of advanced economies (in particular) are dominated by household consumption, which typically accounts for between 60% and 70% of activity measured as GDP. But pushing credit into the system boosts this consumption, thereby invalidating much of the apparent debt ratio comfort derived from apparent increases in GDP. In short, a cessation of credit expansion can expose masked debt risk by undercutting debt-financed expenditures.

That such an event looks increasingly likely is underscored by Nomi Prins’ recent observation that the next threat to the system may be bottom-up, not top-down.

Authorities and observers are accustomed to appraising top-down risk, assessing – for example – the scale to which banks’ assets might be vulnerable.

What happens next, though, could very well be bottom-up. What this means is that hard-pressed borrowers might stumble off a treadmill in which debt servicing has become an increasingly onerous burden within the context of flat-lining incomes and rising household expenses.

What are the risks?

The SEEDS answer to the risk issue is to use calibration based, not on credit-inflated GDP, but on prosperity. The aim is to strip out the component of growth which derives from the simple spending of incremental borrowed money. At the same time, SEEDS factors in trends in the energy cost of energy (ECoE).

An ongoing SEEDS study of the Big Four fiat currencies suggests that risk exposures may be very, very much greater than conventional (GDP-based) calibration indicates. Debt, for example, equates to ‘only’ about 250% of GDP in the United States, but rises to 340% when measured against prosperity.

Other Big Four debt ratios, translated to prosperity calibration, rise to 349% (compared with 250% of GDP) for the UK, 305% (rather than about 240%) for the Euro Area, and 456% (versus 360%) for Japan.

The corresponding impacts on financial assets exposure are even more pronounced. Britain’s financial assets rise from about 1140% of GDP to 1578% of prosperity. For the others (with the GDP-based equivalent in brackets), the levels now stand at 768% (rather than 595%) for the Euro Area, 927% (733%) for Japan, and 660% (490%) for the United States.

All of these ratios – both for debt and for financial assets, measured against prosperity – are far higher now than they were ten years ago, on the eve of GFC I – which isn’t what you’d conclude if you settled for measuring both against credit-inflated GDP.

This leads us to two immediate and very sobering conclusions, neither of which should really come as any great surprise. Indeed, both are pretty obvious, properly considered.

First, if a country spends a decade gaming its currency, it masks the attendant risks, just as it is increasing those risks.

Second, any course of action tending towards a weakening of the dollar’s “petro-prop” could have unexpected consequences. Of course, we don’t yet know what Mr Trump’s Iran move really means, and we don’t know how Russia, China and – critically – European countries are going to respond.

One thing, though, seems certain. Whilst it proved impossible for Saddam Hussein’s Iraq to shift oil trade away from dollars,  there is no reason why really big players shouldn’t do exactly this. If major oil importers such as China, India and even the Euro Area develop new bilateral terms of petroleum trade with Iran, there is no reason whatsoever why these deals should be conducted in dollars.

In the proverbial nutshell, when your need for debt capital is being pushed up by budgetary irresponsibility, it makes no sense at all to undermine demand for your currency.

 

#102: The great divide

THE EMERGING SCHISM IN CAPITALISM

In comparison with most articles here, this discussion is unusually lengthy. It has also taken longer than usual to put together, and covers some complex issues. It does, however, highlight an emerging split within the “capitalist” world – a split that we cannot afford to ignore.

In essence, it describes how a fanatical extreme has controlled “free-market” or “capitalist” economics for far too long. This fanaticism is described here as “laissez-faire”, to distinguish it from the more moderate, “popular” form of capitalist thinking which recognizes both the value of the private-public “mixed economy”, and the importance of regulation and of a strong ethical code.

If you want a shorthand term for “laissez-faire”, ‘junglenomics’ is suggested. It describes a form of near-anarchic, “survival of the fittest” thinking which is close to “law of the jungle”.

It puts its faith in “caveat emptor” rather than regulation.

It argues that private ownership (rather than free and fair competition) is the essence of the market economy.

And it scorns government (except when it needs to be rescued by the taxpayer, of course).

This thinking, manifested through deregulation, created the debt explosion and the escalation in risk which caused the global financial crisis (GFC) of 2008. We are still paying for that crisis, and should anticipate a sequel, especially if the supporters of laissez-faire succeed in repeating the recklessness of deregulation.

Given President Trump’s deregulatory agenda, such a repetition seems increasingly likely.

This time, however, some perfectly decent “capitalists” are likely to pursue a very different course, with Europe providing the lead. In the European Union (EU), the emphasis increasingly is on macroprudential regulation, enforcement of competition, and the protection of consumers and workers.

As this schism widens, the previously-consensus “Anglo-American economic model” could become exactly that – a model supported only by America and Britain (and, conceivably, by the United States alone, if British voters oust the economic “liberals”).

In memoriam

Perhaps because so many of my forebears went off to fight in the First World War – though fewer returned – I’ve been more than usually interested in the commemorations that have been taking place since 2014. Last year we had the Somme and Jutland, and this year, Passchendaele.

But another anniversary looms a couple of years ahead, and it’s to be hoped that this one is celebrated to the full, not least because of its huge contemporary significance. That anniversary is the bicentenary of the first Factory Act, which became part of British law in 1819.

The scope of that law was extremely limited, and its enforcement left a great deal to be desired. It’s important, though, because it is established the principle that the state has a duty to protect working people from the worst excesses of unscrupulous employers.

Over the intervening years, in Britain and around the world, this principle has been extended, to the point where workers in most advanced economies enjoy substantial protection from exploitation and unfair treatment, as well as from hazards in the workplace. In parallel with this, we have enacted a great deal of legislation to protect customers from unscrupulous practices.

The result is that, today, both workers and consumers benefit from extensive protection. Safety at work is part of this, as are entitlements such as sick-pay and paid holidays, and provisions guarding against unfair dismissal. On the consumer side, protection is equally extensive. For example, the roadworthiness of taxis is generally tested to levels more demanding than those which apply to private cars, and the licensing of drivers includes criminal records checks. Hotels, too, are extensively inspected, over vital issues such as food hygiene and fire precautions.

All of this adds costs, which taxi firms, hoteliers, and employers in general, must pass on to their customers. We pay a little more, but what we get in return is worth it. We can step into a taxi knowing that its brakes work properly, and the driver isn’t a convicted rapist. The hotel that we choose for our holiday or city break mightn’t be perfect, but we can be pretty sure it isn’t a twin of Grenfell Tower.

For the proprietor, this regulation can be irksome – but is made less so by the knowledge that all his competitors, too, are regulated in exactly the same way. If some players could evade the regulations, of course, they could cash in, offering lower prices to attract unwary customers, and putting the law-abiding supplier at an unfair competitive disadvantage.

A further stage in the protection of the consumer has become topical in recent years, and that is the regulation of financial services. When we buy a fridge or a car, we have the assurance that the product is safe, but, beyond that, most of us also have a pretty good idea of what the product does, and how it does it. Even the most informed lay person has much less knowledge of financial products, though, so additional protection is required. This extends into macroprudential regulation, because a dishonest or reckless financial firm can endanger, not just the customer, but the broader economy as well.

So customary are these protections that we take them for granted. They’re not perfect, of course – nothing can be. But, when something does go wrong, the focus immediately falls on regulation, and three questions tend to be asked.

Did someone break the law?

Was enforcement faulty?

Or do we need to tighten the rules?

The fact that the focus automatically turns to regulation shows quite how ingrained our assumptions about the benevolent role of oversight have become.

Turning back the clock

There are, however, some who don’t share the widespread acceptance that regulation is a good thing. Bizarre though this may seem, it doesn’t seem to matter to these people whether your hotel is safe, your taxi is driven by a convicted criminal, your employer tramples all over you, or a bank or insurer exploits your comparative ignorance of financial products. Neither, it seems, are they much concerned about practices which create a systemic threat to the system.

This viewpoint, which we can label “laissez-faire”, is the fanatical end of the capitalist spectrum. It states, mistakenly, that private ownership (rather than free and fair competition) is the core principle of market economics, and that government is, in effect, a necessary evil, to be minimized wherever possible. This makes advocacy of privatization a matter of principle, coupled with a sometimes visceral dislike of the public sector.

With private enterprise, always and everywhere, labelled “good” – and the public sector labelled “bad” – this is a very black-and white worldview. In fact, if capitalism can be likened to a faith (which, for extremists, it can), the “laissez-faire” persuasion is a hard-line sect within that faith. Though philosophically a sect, laissez-faire puritanism has long since ceased to be a fringe group. Indeed, it has dominated capitalist thinking for far too long.

To extend the faith analogy a little further, the laissez-faire domination of capitalism is equivalent to the Inquisition taking over the sixteenth-century Vatican. That never happened, of course. But, if it had, Protestants would not have been the only victims of Torquemada’s wrath – equal venom would have been directed at “compromisers”, meaning anyone having the temerity to suggest that the Lutherans might not be wholly bad, and that an accommodation could be reached with the followers of Calvin.

Where this is particularly relevant right now is in the field of regulation. For the zealots of laissez-faire, minimizing government also means minimizing regulation.

In particular, they argue that no good can ever come of government interference in contractual arrangements between employers and employees. Customers, meanwhile, don’t need the sort of protection they have today, because self-interest, in the form of caveat emptor (“let the buyer beware”), is a better defence than regulation.

Over an extended period, the hard-line laissez-faire persuasion has taken over the commanding heights of capitalism. Sometimes known as “the Washington consensus” and “the Anglo-American economic model”, it has long been established as orthodoxy, not just in America and Britain, but in many other countries, and in important transnational organizations as well.

Trump and the zealots

The United States has long been the home of laissez-faire extremism, and never has this been the case more emphatically than under Donald Trump. The wave of deregulation which rolled on under Bill Clinton and George W. Bush was stemmed by the Obama administration, which favoured a more proactive role for government. To the zealots, this was tantamount to betrayal, and many of them regard “Obamacare” as something not far short of treason.

With Mr Trump in the Oval Office, economic zealotry is back – with a vengeance. Most significantly, the emphasis is on weakening regulatory oversight, including rolling back the 2009 Dodd-Frank Act, and the related “Volcker rule”. Instead of doing something really useful – like, for example, “trust-busting” market-dominating players in the tech space – the focus is firmly back on “deregulation”.

In anyone who understands how economics and finance really work, hearing gleaming-eyed fanatics talking about “deregulation” provokes a frisson of fear – because it means that the lunatics, far from being chastened by past experience, are on the loose again.

Because, of course, we’ve been down this road before.

We’ve heard all the gibberish about “light-touch” regulation.

We’ve heard how banks can be trusted to be the wisest custodians of their shareholders’ best interests.

We’ve heard the rabid advocacy of “animal spirits”.

Worst of all, we’ve heard the rants about how all things government are bad – rants which didn’t stop until the laissez-faire zealots found themselves on their knees, begging for rescue from the very same state which they had spent a decade and more denigrating.

The peril of extremes

If there is a single lesson that we should all have learned by now, it is that all forms of economic extremism lead to disaster.

After collectivism crippled the Soviet Union and its eastern bloc satellites, most sensible people thought we’d learned a decisive lesson about the dangers of fanaticism. It turned out, however, that the laissez-faire extremists were plotting catastrophe on a scale dwarfing the localised disaster of Soviet communism.

This really got under way in the second half of the late 1990s, and the tragedy is that so many were taken in by the fanatics.

We accepted the nonsense that low wages could make an economy prosperous, an imbecility addressed in the previous discussion.

We believed the gibberish which said that there was no danger in using cheap and easy credit to fill the gap between high consumption and low wages.

We listened open-mouthed, in the midst of the biggest credit-fuelled bubble in history, to declarations that “boom and bust” had finally been buried.

And we watched as the fanatical pursuit of debt-financed “growth” brought the world financial system to the brink of catastrophe.

No-one should be in any doubt that “deregulation”, and related excesses, caused the global financial crisis of 2008. Deregulation undermined the monitoring of what banks were up. A more robustly-regulated system simply wouldn’t have tolerated sub-prime mortgages, the packaging of toxic debt products, and other techniques for driving a wedge between risk and return. “Cash-back” mortgages, and excessive loan-to-value and debt-to-income ratios, would not have been acceptable in an earlier era of more robust oversight.

As we now know, taxpayers around the world had to step in to rescue the laissez-faire fanatics from the consequences of their own hubris. This showed up their self-serving hypocrisy for what it was, because, if they had really put their faith in market forces alone, they would have accepted the wipe-out of banks and bankers as the logical consequence of “animal spirits”.

Instead, of course, they ran for whatever cover the much-derided state could provide.

The continuing high price of folly

Moreover, the billions spent by governments rescuing banks was just the tip of an iceberg of consequences created by deregulatory madness. Worst of all, the sheer scale of the debt burden created by these fanatics has forced us into an era of unprecedented low interest rates, with no prospect whatsoever of restoring normality any time soon.

By ‘normality’ is meant interest rates that are at least two percentage points higher than inflation, giving investors a real return on their capital. Anything less than that is both abnormal and destructive – and an unacceptable price to pay for allowing the lunatics to take over the asylum.

Of course, policies of ultra-cheap money have pushed debt to levels far higher than they were in 2008 – but the damage has extended very much further than that. For a start, cheap money has stymied ‘creative destruction’, keeping alive businesses which really ought to have disappeared to free up both capital and market space for new, more dynamic players.

The effect on saving, and on the broader issue of futurity, has been devastating. Just as debt has escalated, pension provision has collapsed. According to a recent report, the aggregate pensions shortfall in eight economies – Australia, Canada, China, India, Japan, the Netherlands, the United Kingdom and the United States – stood at $67 trillion in 2015, and is set to reach a mind-boggling $428 trillion (at 2015 prices) by 2050.

The eight-country pension shortfall is growing by $28bn per day, and, in the United States alone, is expanding at the rate of $3 trillion per year, roughly five times what America spends on defence.

Essentially, what this means is that the recklessness of the past fifteen years has made it impossible for people to save sufficiently for retirement.

Calculations for this paper indicate that the collapse in returns on investment has multiplied savings requirements by about 2.7x. So, to get the same return that he or she would have earned by putting aside 10% of income before the crash, someone now has to save 27% – and that’s simply impossibly unaffordable.

The shortfalls in provision which have arisen so far represent just the slump in returns on investment made previously, during the pre-crash era. The dramatic rate at which shortfalls are escalating, on the other hand, reflects the sheer impossibility of saving enough in an environment in which returns have been crushed.

Economic distortion

Another dire consequence of the policies forced on the authorities by previous madness is the distortion of the relationship between assets and income. Because asset values have soared – into, and arguably beyond, bubble territory – whilst returns have crashed, the balance of incentives has tilted dramatically, in favour of speculation rather than innovation and investment.

Given the sheer inability of many governments to understand this concept, it needs to be spelled out.

Imagine you have, say, $500,000 to invest. If you put this into a business, you’ll struggle to earn a decent return in a depressed economy in which demand is dependent on ever-expanding credit.

In certain pivotal sectors, the struggle is made even harder, for two reasons. First, cheap money is keeping afloat competitors who really ought to have gone under.

Second, some governments are unwilling to break up either cartels or market-controlling giants, which – amongst other negatives – have enormous predatory pricing power. To cap it all, if you do make a success of your investment, you’ll be taxed pretty heavily on the income that it generates.

Given this, wouldn’t it be better – and easier – just to put your capital into property or other assets? Their values are unlikely to fall – because governments shamelessly back-stop them – and the capital gains that you accumulate will be taxed at rates lower than income.

Many governments are incapable of understanding this process – let alone of doing anything about it – so are baffled by the resulting symptoms. As the centre of gravity of activity swings from the innovative to the speculative, sectors like real estate and financial services expand, whilst activities like manufacturing shrink. Because of the growth in sectors which generate money but don’t add much value, both real wages and productivity trend downwards. Debt escalates as both households and governments struggle to make ends meet. In the worst cases, the current account deteriorates as outward flows of income to overseas investors escalate.

The country’s exchange rate slumps as investors start to question the validity of a national business model based on the speculative use of cheap capital. This in turn sparks inflation – and will in due course force up interest rates, finally killing the cheap-money economic fallacy.

This is now happditening to Britain. If the dollar were not supported by the “commodity prop” of dollar-denominated commodity markets – which means you have to buy dollars before you can purchase commodities – it would probably be happening already to the United States as well.

Wisdom fights back

The good news is that some countries are beginning to recognize the folly of laissez-faire and the finance-based economy. Chief amongst these realists are the Europeans. The EU has shown itself prepared to support what really matters in free-market economics, which isn’t private ownership, or a small state, but free and fair competition. That’s why Europe’s regulators are toughening their stance over market distortion – and the investigation of alleged cartel activity between German car manufacturers underlines that this policy isn’t specifically anti-American.

The next thing that Europe is likely to do is to clamp down hard on the “gig” economy.

Its supporters like us to call it the “sharing” economy, but then the laissez-faire camp need no lessons from George Orwell on the usefulness of euphemism.

When the aim is to drive down wages and undermine working conditions, this is called “reform” of the labour market. “Liberalization” is the laissez-faire term for undermining consumer regulation, and going soft on market concentration. “Light-touch regulation” means turning a blind eye to dangerous practices in the financial sector. “Freedom”, as the laissez-faire camp uses the word, means allowing the powerful to trample roughshod over everyone else.

We should be in no doubt about what the “sharing” concept really amounts to. On the labour side, it means taking away both job security and the protections which, over two centuries, have become synonymous with working conditions in a civilized economy.

For the customer, it means circumventing regulations designed to protect the public, simultaneously under-cutting traditional businesses operating under established rules.

Though some European leaders – such as M. Macron in France – might hold out for laissez-faire, they’re unlikely to succeed.

As far as Europe is concerned, laissez-faire – or economic “liberalism” – has been rumbled.

The politics of sanity

This, of course, also highlights political choices. Voters – who are also both consumers and, usually, workers as well – have three main choices.

The first is to defy recent experience and enlightened self-interest by letting the laissez-faire camp swing the wrecking ball again.

The second is to ignore precedent and elect collectivist politicians.

The third, rational choice is surely to choose a “popular capitalist” form of free-enterprise politics which dismisses both laissez-faire and collectivism, and puts the emphasis on tight regulation, robust ethics, the mixed economy, and a fearless defence of free and fair competition.

Unfortunately, because the label “capitalist” is applied without discrimination to both the laissez-faire and the popular strands of market-favouring thought, the probabilities are likely to swing increasingly towards collectivism.

In America, it was Wall Street excess which took Bernie Sanders remarkably close to the Democratic nomination and, in Britain, it is laissez-faire fanaticism which could put Jeremy Corbyn in power.

Faced with an incumbency which wants to give the green light to undercutting wages, taking away employment rights, undermining consumer protection and scaling back public services, a vote for Labour can seem highly rational. Mr Corbyn must be cheered every time he reads an article praising the “gig economy”, or advocating yet more privatization.

Finally, in this context, the negotiation of post-“Brexit” trade deals gives the British authorities a temptingly easy way to make matters even worse than they already are. A trade deal with the United States, if slanted towards laissez-faire, could make it impossible to reach a constructive agreement with Europe.

If, for example, the British decide to admit chlorinated chicken, genetically-modified produce and hormone-treated meat – even after a transitional period – their farmers would find themselves barred from European markets.

Much more seriously, the British (and the Americans) already completely fail to understand European intentions on financial services, where the aim is not to rival London and New York in third-party markets.

Rather, the erection of compliance barriers to Anglo-American finance would create more than enough scope for Frankfurt, Paris and other European financial centres to expand to the point where they supply the entire internal needs of European commerce.

World-changing

What we are witnessing, then, is an emerging schism within the “capitalist” world.

Whilst America (and perhaps Britain) persist with laissez-faire “junglenomics”, Europe is opting for a “popular capitalist” version, with the emphasis on regulation, ethics, free and fair competition, and the mixed economy.

Ironically, the result is likely to be that “the Anglo-American economic model” becomes exactly what it says on the tin – a model supported by Britain, America, and hardly anybody else.