The King Canute Economy: Governments' Futile Attempt to Stem the Tide 31 comments
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I have had a good day in browsing through the economic news, as I found three very interesting articles which together represent a consistent theme (although I say lucky, I mean only in the finding but not the implications of the content). The first of these comes from Ambrose Evans-Pritchard, the second Peter Schiff, and the last Liam Halligan. For the former, Ambrose Evans-Pritchard, I often disagree with his analysis, but can not dispute that he often identifies some fascinating stories on the economy. Today, I came across an article which is of particular interest, and some highlights are given below:
In a report entitled "Worst-case debt scenario", the bank's [Societe Generale] asset team said state rescue packages over the last year have merely transferred private liabilities onto sagging sovereign shoulders, creating a fresh set of problems. [this was exactly my argument at the time the first bailouts were being undertaken]
[and]
Governments have already shot their fiscal bolts. Even without fresh spending, public debt would explode within two years to 105pc of GDP in the UK, 125pc in the US and the eurozone, and 270pc in Japan. Worldwide state debt would reach $45 trillion, up two-and-a-half times in a decade.
[and]Inflating debt away might be seen by some governments as a lesser of evils.
If so, gold would go "up, and up, and up" as the only safe haven from fiat paper money. Private debt is also crippling. Even if the US savings rate stabilises at 7pc, and all of it is used to pay down debt, it will still take nine years for households to reduce debt/income ratios to the safe levels of the 1980s.
I strongly recommend reading the article in full. All in all, this is not far from the kind of scenario that has long been painted on my blog. Shifting debt from the private sector onto the public sector, at exactly the time that the public sector would be starved for revenues, was always going to be a disaster.
In another article Peter Schiff, a long term bear, touches on another theme of my blog - the role of China in the world economy, and the artificial low level of the RMB in relation to the $US. The SocGen report and Schiff's report are actually just looking at two sides of the same equation. If we put the two reports side by side, it is apparent that both of the reports are actually discussing exactly the same problem - which is that governments have sought to replace private debt with government debt, and that the only route out of the debt is eventual currency devaluation. In replacing private debt with public debt, the imbalances in the world economy will be maintained. This is an extract from Schiff's article:
While the peg certainly is responsible for much of the world's problems, its abandonment would cause severe hardship in the United States. In fact, for the U.S., de-pegging would cause the economic equivalent of cardiac arrest. Our economy is currently on life support provided by an endless flow of debt financing from China. These purchases are the means by which China maintains the relative value of its currency against the dollar. As the dollar comes under even more downward pressure, China's purchases must increase to keep the renminbi from rising. By maintaining the peg, China enables our politicians and citizens to continue spending more than they have and avoiding the hard choices necessary to restore our long-term economic health.
[and]
As demand falls for both dollars and Treasuries, prices and interest rates in the United States will rise. Rising rates will restrict the flow of credit that is currently financing government and consumer spending. This change will finally force a long overdue decline in borrowing. So, not only will Americans lose access to the consumer credit that funds their current spending, but the things they buy will also get more expensive.
Our short-term loss will be in sharp contrast to the gain felt by foreigners, who will be rewarded with falling consumer prices and a more abundant supply of investment capital. In other words, the American standard of living will fall while that of our trading partners will rise.
As for Liam Halligan's article, he reports on a report from the OECD as follows:
Less prominent was the admission that: "The upturn in the major non-OECD countries, especially in Asia and particularly in China, is now a well-established source of strength for the more feeble OECD recovery". So the Western world is relying on the emerging markets – the far-flung economies of the East – to pull them out of this slump.
The West's debt-soaked consumers, firms and governments badly need to "de-leverage" – which channels resources into interest and repayment costs, rather than expansion. The likes of Brazil, China, India and the others, meanwhile, have far, far lower debts than their Western rivals, so can spend the next few years "levering-up" – taking on more credit, in turn fuelling growth even more.
All of these articles relate to an article I wrote a long time ago explaining the underlying change in the world economy, and which explained the economic crisis as the shift in wealth generation from West to East. In particular, the opening of the East saw a sudden massive expansion of the labour force (labour meaning with access to capital, markets and technology).
My argument was that the massive credit and housing bubbles were simply masking the underlying change in the world economy that flowed from the supply shock of new labour into the world economy. I have written several versions of the article, but my version on Huliq is a short version and can be found here (note: there is an error - zero sum 'gain' should be 'game'), or a fuller discussion can be found here.
What we are seeing in the reports and the analysis of the three articles cited here, is the process of governments seeking to hold back and resist the fundamental change that has taken place. The change that I am referring to is that there is a massive redistribution of wealth, and that there is now a situation of hyper competition throughout the world. In an article for Trade and Forfaiting Review magazine, I explain this in simple terms by making a comparison between the fortunes of SUV car manufacturers and the Tata (TTM) Nano car:
While the US and, to a lesser extent, Europe are seeing catastrophic contractions in their car markets, the Tata Nano has a massive waiting list among Indian car buyers, keen to upgrade from two wheels to four. The contrast between the old industry, perhaps best exemplified by General Motors, and this innovative upstart illustrates the new shape of the real-world economy.
The important point about the Tata Nano is that it is meeting a new demand from a rising middle class in emerging economies. In the interim, the credit-fuelled demand for SUVs, the mainstay of US car industry profits (until recently), is collapsing. On the one side there is a car that rests upon an unsustainable credit-fuelled consumption boom, a car that flattered the aspirations of the indebted and, on the other, there is a car that meets the rising aspirations of the world’s new wealth generators.
The point is that SUVs represent a concentration of car-owning wealth in the hands of the few, and the Nano is the shift of that car-owning wealth into the hands of the many. It is representative of the underlying shift in real wealth, which is redistributing towards the East, and levelling down the West in the process.
It is a crude characterisation of the change in the world economy, but many large companies such as GE are already changing their product lines to meet these changes. The middle of the market has shifted down whilst broadening. The problem is that these changes are real, and are taking place now. Governments are seeking to withstand the reality of the changed circumstances of the world. The trouble is that, as much as any government might resist the change, it is unstoppable. Nobody is going to put the 100s of millions of new workers back in a box - and there are still large reserves of labour ready to enter the market.
It is only when the economy is seen in this light that we can truly see the madness of government policies - whether the policy of China, the US or the UK. Each country is seeking to maintain an equlibrium that never actually existed. The credit and housing bubbles in the West flattered the underlying condition of economies such as the UK and US, and the world economy was misdirected to feed the illusion of wealth in the West. The overall structure of the underlying economy is the Tata Nano economy, but all governments are seeking to maintain the SUV economy. In doing so, the imbalances are becoming ever larger, as ever more is owed by the current account deficit countries to the surplus countries. The growth in the imbalances is simply going to make the final adjustment ever harder.
I call this the 'King Canute Economy'.
In the legend of King Canute on the sea shore, it is popularly represented that King Canute was so arrogant that he actually sought to hold back the tides. However, King Canute was actually demonstrating that, for all his power, there were some forces which he could not overcome. As we contemplate the actions of governments around the world, it is possible to wonder whether they have ever heard King Canute's story.
In the case of King Canute, he ended up with wet feet. In the case of the world economy, the consequences might not be so mild.
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can the masters of the universe hold back the tides indeed.
of coruse as negative as all this is, if the OECD countries can generate enrgey using clean technology and take away flows of USD to the oil countries. Then we could see a re-emergence of wealth back to the west. Also if the west shuts off imports into their markets, more domestic manufacturing could fuel added value in the western economies.
The point here is that the USA has more faith in making money in the Chinese market and by doing so become closer to China. Then to block off chinese exports and make them in their own country.
I agree that the asset bubbles created a veil of untruth and hid the underlying weaknesses of the west economies but be clear these asset bubbles were financed by the east as well. So in effect the east paid a great deal towards this fake wealth. Also the IT and technology revolution did add a great deal of real value to the western economies.
Innovation and technological advancement adds so much to an economy. More than economists can ever believe. This is why R+D pays off. The USA strategy of getting low value added goods madeinthe East while spending its time/money on R+D may pay off.
From where the US is standing I belive they know they have to create real value added to their economy. So I do not think their arrogance is blinding them. They better hurry up and they better hope they can generate 2-3 trillion/year from clean energy. If they create enough money through QE and hyperinflate the money supply by 100-150%. Then in 2020 they may be able to wipe out all their debt.
I couldn't disagree more. Anyone who blames a manipulated Chinese currency for the flaws of the US (and UK) economies needs to study basic economics.
The US recession was built on greed, borrowing and inadequate financial regulation. The US recession did not occur because of Chinese export strength.
It is Asia and China in particular that has helped the global economy come out of recession. Australia and Japan are the most obvious beneficiaries but there are others.
I hope our SUV governments become more like the Tata, only then do we have a chance to regenerate in the new era. So far, ours are intent on becoming 12-wheeler semi sized.
As freedom shifts, gradually, fitfully but inexorably, so shift trade, capital flows, innovation, entrepreneurship, wealth creation and the very capacity to create wealth, and the growth in the Middle Class.
As the Middle class rises in the Global South and compresses in the West and Russia so the institutions and values of the Middle class will, eventually, bloom in the Global South and atrophy in the West.
As the Middle class ascends in the Global South so will, in time free markets, free elections, free worship, free speech and human rights and decencies.
As the Middle class is hunted and culled in the West and Russia, totalitarianism, elitism, state sanctioned cruelty and brigandage and the rule of vicious men and women over the rule of law will ascend in the West and Russia.
The US, EU, Russia, China are all, in their own particular various malign and corrupt ways trying to resist this tectonic shift. Each in their own way is likely to fail. The West and Russia will not be able to prevent the flight of liberty, prosperity, security and sanity from their rapidly darkening domains and the Chinese will not be able to prevent the arrival of liberty in their still dark inland empire.
The Red star is surely setting in the East and rising in the West.
In the geography known as the US, the ideal known as "America" is dying but in the geography of the Global South, especially, Asia , the ideal of "America" may yet be, is likely to be, born again.
"America" is greater than a geography and greater by far than the current US Regime.
The best investment advice, now and for the foreseeable future, would be "Go east, young man, and prosper where the many virtues of freedom are being newly discovered and cherished."
Let's say that the mercantilist's currencies had been allowed to rise against the dollar such that we had balanced trade. We would now have far fewer and smaller problems. Yes, we would have had fewer imports, more inflation, more expensive oil and a lower standard of living over the last decade or so; but we would also have much higher employment and much smaller, if any, debt problems. Govt. debt would have been smaller because there wouldn't have been the huge capital account surplus to pay for it without offering very high interest rates. Consumer debt would have been smaller for similar reasons and because higher interest rates would have discouraged consumption and choked off any nascent housing boom.
On Nov 22 08:03 AM TradingHelpDesk wrote:
> "While the peg certainly is responsible for much of the world's problems"
>
>
> I couldn't disagree more. Anyone who blames a manipulated Chinese
> currency for the flaws of the US (and UK) economies needs to study
> basic economics.
>
> The US recession was built on greed, borrowing and inadequate financial
> regulation. The US recession did not occur because of Chinese export
> strength.
>
> It is Asia and China in particular that has helped the global economy
> come out of recession. Australia and Japan are the most obvious beneficiaries
> but there are others.
On Nov 22 10:55 AM americanincanada wrote:
> Was it Yogi who said "It is difficult to predict things correctly.
> Especially the future."? China is increasing its military spending
> and has potential internal problems. The US population sees what
> is happening with the present economic leadership and will put different
> people in government in 2010 and 2012 (although trying to find individuals
> who have good economic ideas but are more free thinking on social
> issues and do not have aggressive foreign policy goals is going to
> be difficult). Growth in US GDP can make debt less of a problem.
> "Transfer of wealth" is not the correct concept, "transfer of economic
> growth" is.
In addition to the SUVs, millions of Americans bought houses that were way bigger and more luxurious than they could afford. Housing wealth was overconcentrated in these too-big-to-afford houses. Now the buyers are defaulting and the houses are empty. If instead of building 2400 square foot luxury houses America had built 1200 square foot affordable housing, there wouldn't have been such a catastrophic wave of defaults as we are seeing now. America built SUV houses. Americans, really, can only afford Nano houses.
When you buy something you are "commanding the resources of the economy". If some banker gives you a $600k mortgage then you can command the economy to build you a 2400 square foot luxury house. But most people lack the means to command that much of the economy. They cannot personally generate $600k of surplus value (i.e. income beyond what it costs them to eat and live) in order to repay the economy for that house. By making those unpayable mortgages available to too many people who lack the personal resources to repay, the US financial system allowed the gross overconcentration of housing wealth to be built and purchased.
This is a very serious misallocation of economic resources. There are now millions of big expensive houses in the US that nobody can afford to own. After the 1930s Depression many mansions were converted to apartments and other multifamily uses because there weren't enough rich people left who could afford that much house. If 2 families shared a 2400 square foot house they could probably afford to own it. If the problem is overconcentration of house, the obvious solution is dilution of house ownership by making duplexes or apartments out of houses that are too big for one family to afford.
I think cynicus economicus is right that world wealth is in a process of levelling. Asians can now afford a Nano house where previously they could only afford a shack. Americans can now afford a Nano house where previously they thought they could afford a McMansion. There are millions of US McMansions just waiting to be converted to affordable Nanos. King Canute should not expect to stand in the way of this evolution by maintaining the illusion that these are viable "single family" homes.
The U. S. then spends the money....;and then has to tax citizens to pay back the money and compounding interest to the central bank in gratitude for the money the central bank created out of thin air.
How much wiser for the government to have just spent the money in form of digital credits deposited to vendors, contractors and retirees. and have no debt to pay off or interest tread mill to begin running on.
If inflation started to heat up from the distribution of government money it simply had to adjust tax revenue rates to soak up money that was exceeding productivity.
A simple system but too simple for the evil minds that need complexity for the evil spells they cast on politicians and publics.
For instance, Amborse supports quantative easing, whereas Liam thinks this the spawn of the devil.
This opposition is to such an extent that it si sometimes difficult to reconcile their working for the same paper.
Kudos to the Telegraph for allowing such diversity of opinion.
The more mature of the Telegraph's audience, of which I am proud to call myself one, encourage open debate between the two on their very different prescriptions, crying:
'Fight!' 'Fight!' Fight!'
So far they have resisted such blandishments.
The link included in the article draws attention to the relative shortfall of materials, and in particular oil, to the increasing number of people who are part of the international work force, producing traded goods.
I'd like to emphasise this point, which I think will become even more pronounced in the next 20 years.
Here is the Uppsala Univeristy's analysis of expected oil availability out to 2030:
www.tsl.uu.se/uhdsg/Pu...
An absolute decrease from 85mb/d to 75mb/d up to 2030 is not good news in the context of increasing population and rapidly increasing BRIC demand.
In that context we may be talking about electric scooters taking over the world rather than Tata Nanos.
BTW - a really fine article - I totally concur with the thrust of it.
One huge objection however. Your use of the word redistribution and the meaning it has in command economics. It would be less confusing if you used revaluation in the context of production in relation to consumption and asset values.
Another point that is grossly underestimated is the part played by phony stats and accounting fraud.
The Law of Paradoxical Counter-Productivity applies here. This means that conversion to the Tata Nano will accellerate the depletion of scarce resources instead of saving them. It is a mathamatical certainty resulting from a world economy based on scarcity as opposed to a world economy based on abundance! It's too bad that this fact was not even touched on in the article for Trade and Forfaiting Review magazine.
Rather than trying to preserve the car culture which the world is now done with whether we like it or not, policy should be re-directed to public infractructure rather than private infrastructure. We NEED walkable communities and fossile fuel free cities. It's quite apparent that you're caught in the same web of self-deceipt that GM was caught in.