Australia’s previous Liberal Party Prime Minister John Howard “came out swinging” last night in support of the policy agenda his government shared with the preceding Labor Party government of Bob Hawke and Paul Keating: ”neoliberalism” (for non-Australian readers, the Australian Liberal Party is closer to the US Republican Party or the UK’s Tories than the US vision of the word “Liberal”, while the Australian Labor Party is akin to the US Democratic Party or the UK’s Labour Party).
In Five great reforms are an essential legacy, Howard defends “neoliberalism”, and argues that the financial crisis was actually the result of distortions to the financial system by well-meaning but ill-advised government tampering with the financial system:
The world, including Australia, will not respond effectively to the global financial meltdown unless we properly understand its origins.
The subprime debacle originated in the United States, where the regulations about the making of loans were far too lax. It was a laudable social goal to spread home ownership as widely as possible, but the method involved the distortion of the financial system. Failures of regulation have contributed to the severe economic circumstances we now face. I do not seek to defend the excesses on Wall Street and elsewhere. However, these failures and the challenges we face do not represent a systemic failure of capitalism or indeed of the market system…
There is no doubt that government enthusiasm for promoting home ownership added to the current crisis, and much of this emanated from governments keen to reap the political benefits of extending home ownership to its electorate. A proud new home owner is likely to vote for the incumbent government whose “reforms” enabled him or her to gain the title deeds to a house, rather than merely handing over rent to a landlord–or so politicians appear to believe.
In the USA, this took the form of successive Republican and Democratic administrations promoting home ownership via the (to non-Americans!) laughably named institutions Fannie Mae and Freddie Mac. In Australia, we had a panoply of enticements into home ownership that went beyond even the American bias, including encouragements not only to own one’s own home, but to be a landlord as well (I wonder how many politicians truly grasped the irony–and ultimate futility–of that combination?):
- A “First Home Buyer’s Grant” that gave those who had not previously owned a home a cash grant of, at various times, A$7,000, and $A14,000 to help them purchase that house. In an attempt to revive the now flagging Australian housing market, this grant has yet again been increased from $7,000 to $14,000 for the purchase of an existing house, and $21,000 for the purchase of a new dwelling. This boost is supposed to be temporary…;
- State top-ups of this scheme that increase it to $24,000;
- At various times the scheme has been temporarily boosted. Howard’s Government introduced the scheme as an allegedly temporary offset to the impact of introducing a Goods and Services Tax [GST] in 2000. He then doubled it in an attempt stimulate the economy during 2001. Now Rudd’s Government has done the same–and topped it by tripling it for the purchase of a new dwelling.
- No capital gains tax on sales of an owner-occupied house–so that the entire capital gain from selling your home on a rising market is tax-free;
- Tax deductibility of interest payments on purchases of additional houses, with the expectation that this will encourage the construction of accommodation for renters. Known as “negative gearing”, it allows a landlord to deduct interest payments from his/her rental receipts, and get a tax deduction if the rental income is less than the interest bill; and
- The rate of capital gains tax is half the rate of income tax–which encourages people to speculate on capital assets rather than work.
This perverse combination of incentives encourages both home buyers and speculators to compete against each other with leveraged funds on the Australian housing market.
Howard himself contributed to this farce by introducing the First Home Buyers Grant in the first place, never removing this “temporary” scheme after the GST adjustment phase was over, doubling its rate as an economic incentive during the 2001 downturn, and by setting the capital gains tax rate at half the income tax rate. His attribution of blame for the financial crisis to government intervention would have been somewhat more believable if his speech had included a “mea culpa” for his own contributions.
But even so, he presented a half-baked theory of what caused the crisis, and a view of economic reform that, in future years, will be derided as naive. He proposed that “five great reforms” were the core of the neoliberal agenda:
In 1980 our nation needed five great reforms. We needed to deregulate our financial system, fundamentally change our taxation system, make our labour markets freer, reduce excessively high tariffs and rid the government of ownership of commercial enterprises that would be better run privately. By 2007 these five great reforms had been achieved.
Those five reforms were an essential Australian contribution to what one might properly describe as the neo-liberal experiment of the past 30 years…
The merits of Howard’s final four “reforms” are still open to debate, but how anyone could champion the first reform–the deregulation of the financial system–as a “great” reform in today’s climate beggars belief.
As I argued in the Roving Cavaliers of Credit, financial deregulation was based on a misguided belief that the financial system operated like an ordinary market for goods, where the market itself would work out a sensible volume of and price for credit. A proper analysis of how money is created shows instead that a deregulated financial system will pump out as much credit as borrowers can be enticed to take on. In a world in which leveraged speculation on asset prices is possible, that will lead to the economy taking on so much debt that it will ultimately fall into a debt-induced crisis–which is where we are now.
Once in this situation, deregulated finance then amplifies the problem by going from supplying too much credit to cutting off the credit tap in a manner that reduces overall economic activity.
So the financial deregulation that Howard championed last night, and that successive Labor and Liberal governments introduced, led not to a better functioning economic system, but to a financial catastrophe that is still in its infancy.
To argue that the entire crisis was due just to the subprime scam, and lax financial regulation, is to ignore the obvious signs in the data that too much credit was being generated relative to income. These signs go back to mid-1964 in Australia, and to Armistice Day in the USA.
USA and Australian Debt to GDP Ratios
Right from day one of the post-WWII period, the US financial system grew debt faster than than the USA economy grew its GDP. As a result, the ratio of debt to GDP rose from a manageable 45% of GDP in 1945, to 290% now (without factoring in the impact of derivatives, etc., which will surely require drastic upward revisions of the recorded level of debt). In Australia, we practiced 20 years of prudent finance–from 1945 till 1964, all under a Liberal Government–before the days of profligate finance began–also under the same Liberal government.
Financial deregulation simply assisted the finance sector’s own innate tendency to pump out as much debt as it would manage, and each “rescue” of the financial system by regulators like the Fed in the USA and the RBA in Australia simply encouraged the centre of financial speculation to move from one asset class to another. The Subprime Scam was simply the last gasp of the system, which was pushed so far by the naive belief that conventional (“neoclassical”) economists have in free markets for everything that they stood by while the finance sector pretended to make money by lending money to people with a history of not honouring their debts.
Even though the Subprime Scam was extreme, it was simply the current system pushed to its extremes: it was not an aberration due to lax regulation, but the final gasp of a system that was always pumping out too much debt, and had already many times overextended itself into what should have caused a corrective crisis.
Now we are being held in a permanent financial crisis by governments attempting to revive the system while continuing to honour debts that should never have been issued in the first place.
The one aspect of Howard’s defence of his economic agenda that is plausible is his argument that Rudd “cherry-picked” history to describe everything the Liberal Party did as neoliberal, while portraying the Labor Party (ALP) as non-neoliberal. In reality, both parties supported a neoliberal agenda–the Liberals merely went further in following that “logic” to its inevitable denouement.:
However, it is not plausible for the Rudd Government to argue on the one hand that Australia has entered the financial crisis in better shape than just about any other nation, and yet declare my government guilty of the extreme neo-liberalism which has allegedly brought about the crisis. The strength of the Australian banking system is a direct result of a sensible balance between market forces and prudential regulation adopted by my government not long after it came to office…
The construct of Rudd’s essay in The Monthly is clear. The wicked neo-liberal governments of Margaret Thatcher, Ronald Reagan and John Howard pursued policies of total deregulation that let the market rip, yet the more benign social democratic administrations such as the Hawke government, the British Labour governments of Tony Blair and Gordon Brown and the American Democrats under Bill Clinton followed a different path and got the balance right. It now falls, according to Rudd, to the social democrats to unite to save capitalism.
I expect that the belief that the Australian banking system is immune from the problems that have beset the rest of the world will be sorely tested in the next year or two, as the macroeconomic crisis caused by financial deregulation strikes at the heart of Australian homeownership. The level of household debt in Australia is as high as in America (when measured in terms of each country’s GDP), and though all the focus has been on the USA’s irresponsible lending to the Subprimes, in fact household debt in Australia grew three times as fast as it did in America in the last twenty years.
The Australian financial system is thus dependent on all Australian mortgage holders being able to service their debts, when the only source most of them now have to do that is their jobs. As jobs go as the crisis deepens, the solvency of the Australian financial system will be sorely tested.
No-one will then claim that financial deregulation was a “great reform”.
Perhaps Dr Keen can explain what is happening with Iceland and why?
It seems there are already reports that the US recession is coming to an end soon. http://au.biz.yahoo.com/090224/2/24tkd.html.
This was the same thing during the dot com bust. Atleast 2 years went by and the market economist advisers were talking that the markets were recovering until they officially acknowledged a recession.
After that it took around 2 years for it to recover.
Er, folks, when a country undergoes a currency crash, it’s called from the outside a deflationary crisis, but domestically it involves massive price inflation, due to higher import prices, as the large imbalance of imports over exports and/or of foreign liabilities over domestic assets is at the root of the crash. And Iceland imports everything except cod, cows, and geo-thermal,- (NB Alcoa built an aluminum smelter there). The overall result of such a crisis is that the entire output of the country is devalued compared to RoW and standards of living are sharply curtailed, until the country can export its way out of the crisis. Care for some cod?
Somehow a small clique of insiders got control of the tiny country of Iceland and effectively turned it into an international hedge fund. The American pro-labor economist Dean Baker, a good egg, recently caught out former Fed governor Prince Mishkin in a quote from a couple of years ago, praising Iceland as the very model of a modern neo-liberal major general. But I wouldn’t worry my head, were I an Aussie, over the example of Iceland, as a relevant precedent. Yes, you’re bound to be f**ked, but so is the RoW. And misery loves company.
On the question of Iceland and Australia. Australia has 50 times the population of Iceland perhaps the difference comes from the old adage.
“if you owe the bank $300,000 and you can’t pay, you have a problem, if you owe the bank 1 billion dollars and you can’t pay, the bank has a problem”
We, Australia as a whole, (not just the dumb government) owes going on for $1 trillion and we will never be able to pay. With Iceland their problems have occurred, with Australia the international bankers’ problems have yet to occur, perhaps because,it is unthinkable.
Australia is considered one of the better debtors but we haven’t paid our way for 33 years! What does that say about the other debtors?
Just like the general store keeper that extends credit to many customers in a failing community hoping for a “recovery” long after this becomes futile the governments of the world are trying to patch up a “Titanic” economy without a dry dock.
I hope that with the communists comming on to the scene, we won’t be replacing the stupid extremist neoclassical dogma with some stupid extremist dogma such as communism.
Intellectual effort must be mustered and applied. This to soften the inevitable landing and then plan for a stable future. The actions being taken seem to be pushing us to an episode of very rapid collapse a “stall”.
Thanks for posting the graph Contrarian,
Granted Iceland’s inflation rate shot for the moon. They were on a debt binge of massive proportions.
I’m wondering about what’s happening to Iceland now and going forward. When no one has a job, no one has savings and no one can sell a single thing. Everyone has no money. If no one has money, no one can buy things. If no one can buy things the shops must drop price further and further. This is monetary deflation and price deflation. More businesses fail ans unemployment continues to rise. Where does the future inflation come from?
The price inflation was history. I think the inflation graph as very telling, it is very old now though. Iceland’s growth and inflation boom is over!
I’m trying to find info on what is happening now in Iceland.
Hi BTB!
The price inflation figure for Iceland is 18% in January 2009.
Hi Contrarian,
Can you please explain how prices will hold up going forward in Iceland?
Where will the money come from to buy things?
What do you propose will happen to the prices of prime real estate in Iceland?
To make it worse, Iceland have exchange rate controls, with a black market. The official exchange rate that have collapsed, is not what you get on the black market. The discount is around 40 % to an exchange rate that is already around 50 % off. I know, because there is a flood of used cars hitting Norway, from Iceland, and the dealers typically exchange their Norwegian currency, to Iceland’s currency through the black market. The cars are dirt cheap.
This Argentina, Iceland scenario is definitively a worry I have for countries like the UK. THe US seems to be a little more conservative, so this far, I’m a bit in doubt as to what will happen there. Even if the text book might say deflation, I think when you get a bankrupt country like the US, UK or Iceland, or countries like in Eastern Europe, at some time I think that is inflationary, as the exchange rate collapse because of deflationary forces.
One thing about Iceland is that they have all this 2,5 % inflation target’s as everyone else. All that bull about financial stability, looks just like any other central banks homepage. They even had what initially looked like very low inflation, tracking the inflation rate in most other countries until their currency blew. I think it’s scary, and I really think the Iceland scenario is the black swan event for the US and other countries.
There is also a lot of people from Iceland coming to norway looking for job as their economy have collapsed. Another thing is the push in Iceland to get a membership or a currency like the euro introduced, well let’s hope the Euro is around when that time comes. However, I suspect, that the market’s are around a level, that might turn out to have been the ultimate low, the weakening YEN is a sign of a low in the markets. Unless this fiat money thing still have further to go. the CDS on most countries are just going up making it more and more expensive to insure against default, I think that is a hyperinflationary trend, like deflationary first, until it just suddenly pops. However that must be the black swan scenario, we probably will avoid.
In Latvia, they are taking around 20 % wage cuts in the government, and pensions does not get paid out. It have stopped, as I know all this from someone living in the country. They are desperate to keep their exchange rate stable against the euro because of all the euro loans. They are effectively forcing deflation to keep the rate stable, after years of 30-50 % year on year money growth. I think it will crack badly. UK hedge fund speculators are pushing down the Swedish currency very badly. It’s at an all time low against the Norwegian currency. The reason is that Swedish banks have expanded heavily into Latvia and the other baltic countries. The hedgefunds see it as a one way bet. They look for the big profit in the swedish krone, when latvia pops, and it will. I just don’t know when. It’s a desperate situation in eastern europe. Ukraine is practically already bankrupt, with the market pricing a 40 % default risk, in Russia however it’s just a 10 % risk.
Hi BTB!
Firstly, I’m not making any predictions on the price levels for Iceland going forward. All I’m doing is to provide for the facts on hand on what is currently happening in Iceland.
Currently, given the data on hand, Iceland is suffering price inflation. The best reason for this is the plunging Icelandic currency.
But the question is, how can countries like Iceland have debt deflation and price inflation simultaneously?
Well, under the conventional demand-supply equilibrium model, prices should come down. But in this case, as Steve Keen mentioned about the idea of equilibrium, the system is out of equilibrium and cannot return to equilibrium.
If there’s no money to buy imported things, that does not mean the prices of things must come down. What will happen is (1) demand destruction and/or (2) the seller goes out of business (and contribute to higher unemployment). The remaining few sellers that survive will most likely sell to the richer Icelanders who can cough out the higher prices.
I do not know enough about Iceland. So, what I’m offering here is just my guess. I guess in this case, we can have simultaneous asset price deflation and price inflation.
In fact, the price inflation can even contribute to asset price deflation. Why? Let’s say the price inelastic things go up in prices (e.g. food), this will impose further pressure on the budgets of Icelandic families. Those who are in mortgage stress will be in greater stress. As a result, some mortgage holders will fold and forced to liquidate their house.
That’s just my theory.
A guy I feel sorry for is timothy geithner. I think he knows that his reputation can get destroyed on having his job, no matter what happens, outside of his control. I think he looks sick on pictures, like if he wants to be somewhere else. Like he really knows he is rearranging the decks on the Titanic. If it’s the titanic, then I think insolvency, followed by the Iceland/Argentina style hyperinflation is the most likely scenario.
Prudentsaver,
Sorry for Geithner? I am surprised.
Giethner is a gatekeeper for the Banksters, ensuring that they have access to the public trough of US taxpayer bailout money.He is a protege of Rubin and Summers(of Glass-Steagal repeal fame which was instrumental in setting up the GFC, back in 1999) who along with the many other NY banker elite need the ponzi US economy to suck in yet more debt , in order that they may prosper.
Geithner could care less about the average US citizen. The reason why he looks so haunted is that he probably knows that the US banking system as he knows it is about to die and with it the power, influence and riches that it provides to him and his superiors.
I don’t see him that way. He was a guy that was of the earliest to warn of derivatives and taking initiative to regulate them. He studied and lived in Asia, speaks chinese, and is not as the other guys in Wall Street. He probably have the outsider perspective, that means he knows, that he don’t what he is doing. That’s what makes him look so scared. The trouble for the US vs Japan, is that the US breaks into hyperinflation at some point if they go down the japan path due to insolvency.
From Wiki;
“After completing his studies, Geithner worked for Kissinger and Associates in Washington, D.C., for three years and then joined the International Affairs division of the U.S. Treasury Department in 1988. He went on to serve as an attache at the US Embassy in Tokyo. He was deputy assistant secretary for international monetary and financial policy (1995–1996), senior deputy assistant secretary for international affairs (1996-1997), assistant secretary for international affairs (1997–1998).[8]
He was Under Secretary of the Treasury for International Affairs (1998–2001) under Treasury Secretaries Robert Rubin and Lawrence Summers.[8] Summers was his mentor,[10][11] but other sources call him a Rubin protégé.
In 2002 he left the Treasury to join the Council on Foreign Relations as a Senior Fellow in the International Economics department.[14] He was director of the Policy Development and Review Department (2001-2003) at the International Monetary Fund.[8]
In October 2003, he was named president of the Federal Reserve Bank of New York.[15] His salary in 2007 was $398,200.[16] Once at the New York Fed, he became Vice Chairman of the Federal Open Market Committee component. His somewhat caustic and arbitrary management style was often evidenced during his tenure with the Federal Reserve. In 2006, he also became a member of the Washington-based financial advisory body, the Group of Thirty.[17]”
That doesnt read like an outsider’s CV to me (Or a person qualified for SecTreas for that matter), and I havent noted his father’s priveliged position in US politics and finance. Tim Geithner was groomed for his current position.Kissinger and Associates along with CFR are well known Neo Con and Bankster type “New World Order” development establishments. Obama was told to put him where he is now. By whom? Well, you can guess……….
He have lived in Zimbabwe, that needs to count for something, maybe that’s why he looks like he is extremely scared. I’m worried that this crisis potentially, worst case could evolve into something that will cause Ron Paul to be elected in 2012. That will mark the end of the federal reserve and a return to the gold standard. I think Paul might be capturing an anti-semitism that will probably devenlop if the system really goes down hard.
I have a question for Steve, it’s really a yes/no question.
“If the American people ever allow private banks to control the issue of their money, first by inflation and then by deflation, the banks and corporations that will grow up around them (around the banks), will deprive the people of their property until their children will wake up homeless on the continent their fathers conquered.” -Thomas Jefferson
Do you feel that this is what have happened now?
Well, only in the sense that private banks necessarily control the creation of credit, so this is in effect inevitable rather than something for which there is an alternative–like State-controlled money or commodity money. As soon as loans of any sort are allowed, the genie is out of the bottle.
The alternative I prefer is to accept reality–that money will always be credit-dominated–and then remove the temptation the non-bank public has to borrow too much money by redefining the secondary markets for assets so that leveraged speculative profits are much less likely to occur.
One trend that have been developing for the last two weeks is that US oil consumption is beating forecasts, or a trend reversal. I’m not sure of what to make of it yet, but it’s the only indicator that are currently bullish for the US.
Timothy Geithner has known the score for a long time – i don’t feel for him at all.
That Bozo like all in the Team Obama should sit down and be honest with themselves and the US people and say ‘lets just announce the fact that we are stone motherless broke!’
Stuff it!
The quicker we go bankrupt the quicker we can start the process of rebuilding…..lets stop pretending….the phony US Empire has to collapse…..we stuffed it up and its all over.
quote
yet the more benign social democratic administrations such as the Hawke government, the British Labour governments of Tony Blair and Gordon Brown
unquote
I don’t agree with you and here< I am a UK citizen and left the UK three years ago, whilst hating Blair and Brown for creating grosss inflation of house prices and debying it year after year.
When the crisis hit I finally started to research myself and created my own website at
http://www.peoplecount2.org
I think what the governments have done is stupid for us (not for them and the banks – keep the party rolling what?)
I amust say it took a child to see what was going on if they just decided to look at house price graphs and eranings of people).
Sad really
Message to ChristopherBrooks.
I maybe asking a stupid question here but can I contact you? You seem to be along the same lines as me.
I am an engineer and to me the whole idea of a virtual money system in the hands of human beings seemed absurd when we live on a physical resource of limited resource.
I love physics now and have come to know the laws of the conservation of energy and stuff like that as well as solar radiation levels and the power of the sun. I believe that this economic ‘smokescreen’ impedes from behaving in a reasonable manner and the desire to be the owner of ‘paper’ seems absurd.
I am not a crank, I just decided to sit down a piece everyhting together that I could and realised that we ignore simple solutions that are there but people do not care because ‘paper’ is the god.
Sirius Blade of http://www.peoplecount2.org