Two prominent economics textbook writers have recently written that the Global Financial Crisis (GFC) shows that the world needs more economics rather than less.
Writing in the New York Times, Gregory Mankiw could see some need to modify economics courses a bit in response to the GFC, but overall he felt that:
“Despite the enormity of recent events, the principles of economics are largely unchanged. Students still need to learn about the gains from trade, supply and demand, the efficiency properties of market outcomes, and so on. These topics will remain the bread-and-butter of introductory courses.” (That Freshman Course Won’t Be Quite the Same, New York Times May 23 2009)
Writing on a blog The East Asia Forum, authors Doug McTaggart, Christopher Findlay and Michael Parkin wrote that:
“The crisis has also brought calls for the heads of economists for failing to anticipate and avoid it. That idea, too, is wrong: much economic research pointed to the emerging problem.
More economic research (and teaching), not less, is the best hope of both emerging from the current crisis and of avoiding future ones.” (The state of economics, East Asia Forum, May 21 2009)
What a load of bollocks.
The “principles of economics” that Mankiw champions, and the ”More economic research (and teaching)” that McTaggart et al are calling for, are the major reason why economists in general were oblivious to this crisis until well after it had broken out.
If they meant “Principles of Hyman Minsky’s Financial Instability Hypothesis”, or “More Post Keynesian and Evolutionary economic research”, there might be some validity to their claims. But what they really mean is “principles of neoclassical economics” and ”More neoclassical economic research (and teaching)”–precisely the stuff that led to this crisis in the first place.
Neoclassical economic theory supported the deregulation of the financial system that helped set this crisis in train. See for example this New York Times report on the abolition of the Glass-Steagall Act in 1999 “CONGRESS PASSES WIDE-RANGING BILL EASING BANK LAWS” (New York Times November 5th 1999). The reporter Stephem Labaton noted that:
The opponents of the measure gloomily predicted that by unshackling banks and enabling them to move more freely into new kinds of financial activities, the new law could lead to an economic crisis down the road when the marketplace is no longer growing briskly…
Then he observed that
Supporters of the legislation rejected those arguments. They responded that historians and economists have concluded that the Glass-Steagall Act was not the correct response to the banking crisis because it was the failure of the Federal Reserve in carrying out monetary policy, not speculation in the stock market, that caused the collapse of 11,000 banks. If anything, the supporters said, the new law will give financial companies the ability to diversify and therefore reduce their risks. The new law, they said, will also give regulators new tools to supervise shaky institutions.
This is a very apt description of the role of neoclassical economists over the last 40 years: every step of the way, they have argued for deregulation of the financial system. Now we have McTaggart and colleagues making the self-serving claim that:
The current crisis is a failure of regulation that calls for not more regulation, but the right regulation.
So the same economic theory that supported the abolition of Glass-Steagall, amongst many other Depression-inspired controls, is suddenly going to be able to do a volte-face and tell us what “the right regulation” might be? Garbage.
What is really needed is a thorough revolution in economic thought. First and foremost this has to be based on empirical reality, and from this perspective almost everything that current textbooks treat as gospel truth will end up in the dustbin.
Coincidentally, many non-neoclassical economists whose writings have been put into the dustbin by today’s economics orthodoxy will be back on the shelves once more. Minsky, Schumpeter, Keynes, Veblen and Marx don’t rate a mention in in most current economic textbooks; they had better feature in future texts, or by 2060 or so we’ll be back here again.
Though I’m clearly annoyed at Mankiw’s and McTaggart’s drivel, I’m not surprised by it–in fact I predicted it (I doubt that they can point to anything they wrote prior to the GFC that predicted it!). I said the following in an article “Mad, bad, and dangerous to know” published on March 12 2009 in issue 49 of the Real World Economics Review:
Despite the severity of the crisis in the real world, academic neoclassical economists will continue to teach from the same textbooks in 2009 and 2010 that they used in 2008 and earlier…
they will interpret the crisis as due to poor regulation,…
They will seriously believe that the crisis calls not for the abolition of neoclassical economics, but for its teachings to be more widely known. The very thought that this financial crisis should require any change in what they do, let alone necessitate the rejection of neoclassical theory completely, will strike them as incredible.
Sometimes, I would like to be wrong…
Finally, what lesson did neoclassical economists take from the Great Depression? That the Federal Reserve caused it via poor economic policy. Who do current neoclassical economists blame for this crisis? The Federal Reserve of course, for poor economic policy:
By 2007, fuelled by the Federal Reserve’s egregious policy errors, markets were moving into unsustainable bubble territory. The Fed by this time had realized the problem was getting out of hand and had moved interest rates up sharply—too sharply—and burst the house price bubble. (McTaggart et al).
But who staffs the Federal Reserve? Neoclassical economists of course…
Please, let’s not fall for this nonsense a second time. Keynes tried to free us from neoclassical economic thinking back in the 1930s, only to have neoclassical economists like John Hicks and Paul Samuelson eviscerate Keynes’s thought and re-establish a revitalised neoclassical economics after the Depression was over. This time, let’s do it right and get rid of neoclassical economics once and for all.
May 25th, 2009 at 2:56 pm
While its too much to expect economists to have a sense of collective culpability about the GFC, its amazing that there is so little sense amongst economists that the discipline is ripe for a major paradigm shift.
One thing that I wonder about is who stands within your definition of a “neo classical economist”?
Would the definition encompass both a Keynesian and an Austrian?
May 25th, 2009 at 3:32 pm
Depends on how little they know of Keynes. I’ll be posting on Austrian economics and its Say’s Law hangup in the next Debtwatch. Many economists who call themselves Keynesian are basing their interpretation on Samuelson and the like. If someone calls themselves a Post Keynesian on the other hand, they have surely at least read Keynes.
May 25th, 2009 at 9:56 pm
Steve,
I may seem a little un academic in suggesting this, just put it down to a non-economal background.
In the early seventies I was active (polictically) as a follower of Ayn Rand.
The idealistic Philosophy appealed to me.
Objectivism, wow what an approach. It took me some time to realise that she was more a philosopher than an economist, none the less a part of that has stayed with me.
At the time we, as a group, could see that the politics of me tooism, of inflation, erosion of private ownership, the watering down of individualism etc etc. was rampid.
We formed a political party (Workers Party) wrong name wrong conitation, right attitude. (the real worker, productivity etc) There was some joy in the journey, the publicity gave attention to our the extremist views, it made people think – private roads-school and education vouchers- flat rate taxation (sorry about that)and a host of user pay principles.
We had meetings oganised speakers at little B.Y.O. restaurants on Tuesday nights, such as Max Newton – Financial Review, and later The Australian, Editor and economist, Prof Lachlan University of Wollongong, Greg Lindsay, founder of the Centre of Independent Studies was a member. His idea to create the Centre was first put to us all.
Greg has made a great and most respected success of it, I am sure you will agree. These people and ideas may be yesterday, but the methodology of “spreading the word” is not.
Surely, we have enough people that contribute to your blog to “invite” to to a number of different venues (restuarants) throughout all of Sydney’s metro area, say one Tuesday evening per Month.
Invite a journalist,(many diffrenet ones over a period of time) a neo classical economist a business person from banking or manufacturing, distribution or retail, to tell it like it is -”at the moment” Invite a student leader of economic movement from, say, Sydney University.
I am sure you get what I mean, everyone invite somebody. There are so many people that really like to be a part of this sort of information in a relaxed and inclusive way.
What are your thoughts on this type of “Minsky Economics and the Future in Economic Stabilty?” approach to what is suggested?
May 25th, 2009 at 10:36 pm
Hi gaday,
I quite like the idea, and I was thinking of suggesting kicking something like this off at around Xmas time this year–since I’ll be too caught up with other work until about then anyway–with a Debtwatch Xmas dinner. Obviously I’d want to hold one in Sydney, but it would also be possible to hold ones in other capital cities in Australia if there was a sufficient number of people interested in attending.
Of course, this would be about 50% social as well as 50% intellectual. I have thoroughly enjoyed the community that has come together through the blog, and I’d like to meet the people behind the posts–as I’m sure others here would too.
If that then led to a regular dinner meeting like those you used to have in the WP (say once every two months? Let’s not be too ambitious to begin with, nor take up too much of our lives), then I’d be delighted too. I wouldn’t be in a position to organise this though–someone or sometwo or more would need to take that on.
May 25th, 2009 at 11:09 pm
The Reserve Banks aim is essentially control engineering. What any control engineer will tell them is that given an increasingly unstable system, eventually it is going to go out of control. So eventually the Reserve Bank will get it wrong, unless it does something more fundamental to stabilise the system, like constraining debt.
May 25th, 2009 at 11:57 pm
Perhaps a very simple question that I should be able to research myself.
My understanding, which may be wrong, is that the US following the great depression, its market ie wall street did not reach the same level until the 1950’s. That is more than 20 years.
Where as, according the ASX downloads the Australia market recovered in about five years.
Is this correct or can I not read the entrails.
regards
Basso
May 26th, 2009 at 12:08 am
Steve, I’m from Perth and I’d be happy to coordinate a Perth group/meeting. Perhaps if you could organise a legitimate time to get across we’d all be keen to hear from you (pun intended). If your thinking of doing this, maybe worth thinking big for a whole-of-australia strategy. Cheers, Mark
May 26th, 2009 at 12:20 am
I clicked on business cycle monitor and got exactly that.
The usual clap trap of reading pigs intestines and the corresponding cycles. The dead give away, with these web sites, is not giving of an office address that you can front up to and ask see the actual pig and its entrails.
I also live in Perth and do not have a financial barrow to push. I will help, if I can, if you head west.
May 26th, 2009 at 12:23 am
Steve, I for one am looking forward to your critique of Austrian economics. Having read your book plus a few Austrian works (Rothbard, Woods, works from mises.org) it does sound awfully compelling. The core beliefs in the entrepreneur, heterogeneous capital, false price signals via money printing/artificial interest rates, recession as liquidation of malinvestment, and belief that all macro is just micro sure make more sense than Keynesism. And heck I just fly planes for a living! It was on the basis of Austrian insights that I moved the super to cash and rented to avoid buying a house (I hadn’t found your stuff at that stage) in Aug 07. That plan sure worked out okay. Their belief that interest rate control combined with money printing is actually the source of the business-cycle (via systematic error in entrepreneur forecasting leading to liquidations) allowed me to study the business cycle in terms of real ‘cycle’, not the random walk rubbish promoted by financial ‘invest for the long term’ planners.
Are any tenets of Austrian economics consistent with your post-Keynes views? Where is the best place to go for a self-education in your view of econ?
Cheers, M
May 26th, 2009 at 12:31 am
The pigs entrails speaks above. (business cycle)
If this figment of the imaginations has any credibility he now will post his name and the airline that he flys for.
I could go on but will not.
May 26th, 2009 at 12:52 am
Steve,
To what extend Mainland Chinese economists are infected with the neo-classical economics?
I started looking at
http://iaps.cass.cn/english/articles/content.asp?class=1
This is an old article but it gave me an interesting summary:
http://iaps.cass.cn/english/articles/showcontent.asp?id=1127
It looks that they may use some elements of mainstream economics as a tool but simultaneously they look at alternative western theories and build their own ideas. They are vary pragmatic and have no problem in re-using useful components coming from conflicting western schools and systems.
Is this correct?
May 26th, 2009 at 1:58 am
I can’t help thinking that the current system strongly favours a privileged minority; and that they have both the means and the mechanisms for perpetuating it (including the system for making new economists).
If so, your ideas will catch on when some group figures out how to use them to take control.
May 26th, 2009 at 4:35 am
[...] 25, 2009 by admin Cassander, writing at Steve Keen’s Debtwatch,* puts the hammer to those arguing that the death of the patient had nothing to do with the doctor: What a load of [...]
May 26th, 2009 at 9:02 am
I am coming to a conclusion that the LOB-otomy (LOB = Load Of Bollocks) problem affects mainly the Anglo-Saxon culture and satellite cultures (like Polish) drawing from it. It has more to do with the European dogmatism rather than logical errors made by some scientists a century ago.
The dogmatic European and American culture integrates Christianity, Roman property law and Greek-Roman tradition of binge consumption.
I would argue that this is our local problem only.
We are not aware of what’s going on in other cultures because we think that our culture is The Ultimate Most Successful Global Culture and because we don’t have an easy access to other cultures due to the language barrier. English is The Ultimate Language. (I am at least aware that other languages exist.)
If you check how economics is treated in China this is a different story to what’s going on in Australia. If you remove all the dogmatism and liberal ideological elements even the neoclassical brand of economics offers useful models. They simply don’t care about all that garbage.
If you read Russian analytic articles it is obvious for them that the American empire is dying. This is not based on wishful thinking only this is more an observation drawing on analogies with the self-destruction of the USSR.
Most of us are even not aware of that. Maybe we don’t want to know?
We are primed to be dogmatic. One God, one Marx, one truth. Absolute freedom, absolute property rights. The Chinese are primed to be pragmatic as this is their cultural axis. They dabbled with Christianity (twice) and with Marxism.
Didn’t work well for them so no further experiments are encouraged. You can be a Christian there but you are not allowed to disrupt the social order by insisting that artificial contraception is morally wrong and that a three-child policy is better that the one-child policy. What is important is the stability and the wealth of the nation. And the well-being of individuals in this context as well.
Can you imagine a discussion about abortion in China? The discussion gripping the US and some European countries? Even president Obama was recently drawn into this controversy. The topic simply doesn’t exist in China not because of the censorship but because it is irrelevant. This discussion in the US is like playing music on sinking Titanic. The same applies to the great idea of creationism and other similar issues splitting the Ultimate Nation.
I am not an economist and I can only make observations based on checking the Wikipedia, popular books and popular websites.
That’s why I would like Steve to comment on what I am writing about from a more enlightened position.
What’s wrong with indifference curves if you treat them as a useful simplification showing how humans (agents) behave in certain circumstances? Of course real humans do not behave like that. It is like using Newtonian physics. When certain conditions are met it is OK to use that model. When certain conditions are not met the model has to be replaced with the relativity theory. The same applies to the concept of equilibrium. This might be a useful auxiliary concept to show that under certain circumstances forces of supply and demand meet at a certain level of prices. If the conditions are not met a more complex dynamic model applies. The problem is not only with the LOB-otomy itself but with the way the scholastic model is force-fed to students in western countries. You have to be familiar with it in order to pass an exam.
I have a suspicion that the Chinese know about the limitations and how to utilise the theories rather than get overwhelmed by them. They even use elements taken from the Austrian school of economics.
It would be interesting how economics is taught in Argentina and Brasil. Does anyone on the forum speak Spanish/Portuguese? I will check the websites of Russian universities when I have time.
I don’t agree that Steve has to work hard on convincing relevant people that the neoclassical LOB-otomy is wrong. The reality will convince the sceptics in a few years time – maybe even much sooner. What is more important is to get ready for the next phase. We in Australia should be partners of China and Brasil in the technological development and education.
We should not reduce ourselves to a country only known for coal mines and holiday destinations.
And we should get rid of negative gearing / reduced capital gains tax rate right now, dear Lu Kewen. “Ceterum censeo Carthaginem esse delendam”
May 26th, 2009 at 11:29 am
Dear Basso,
Welcome aboard. I approved your comments because they were substantive about the topic of this site, but I’d ask you in future to be rather less colourful in your description of a fellow blog member. I didn’t plan it this way–it has truly evolved–but the discussion on this site has been passionate and yet free of the “flame wars” that have broken out on other sites.
Now on your question about the time period for market indices to recover, your best sites are finance.yahoo.com, which will give you daily close prices for the DJIA back to 1928, and Robert Shiller’s site where he maintains the 10 year trailing price to earnings ratio, which is a better guide to market valuation levels than price alone.
May 26th, 2009 at 11:32 am
Some aspects of Austrian thought are worthwhile, but I think their theory of value is false.
The best place to find my views on econ–apart from the critical stuff you’ve already read in Debunking Economics–is to go to my lectures, which I have now added to this site (see the Lectures tab in the menu bar).
Start with the History of Economic Thought lectures, then check out Managerial Economics (you could go straight to the latter if you wish). You’ll find lots of Schumpeter there, who originated in the Austrian School but went well beyond it.
Then if you’re a glutton for punishment -:), try my lectures on Financial Economics where I go into some of the technical detail behind my approach to Minsky.
May 26th, 2009 at 11:44 am
There are many problems with indifference curves as a metaphor for human behaviour, but the key problem is that they don’t work. There was a very careful experiment by a German economist (Sippel) published in 1997 where he set out to illustrate the theory behind indifference curves (known as “Revealed Preference”) and ended up contradicting it.
He concluded:
“We find a considerable number of violations of the revealed preference axioms, which contradicts the neoclassical theory of the consumer maximising utility subject to a given budget constraint. We should therefore pay closer attention to the limits of this theory as a description of how people actually behave, i.e. as a positive theory of consumer behaviour. Recognising these limits, we economists should perhaps be a little more modest in our ‘imperialist ambitions’ of explaining non-market behaviour by economic principles.” (Sippel 1997: 1443)
The best explanation as to why it doesn’t work is “the curse of dimensionality”: the model works as a toy with 2 goods only on a sheet of paper. But if you walk into a supermarket with say 1000 commodities in it, and simply try to decide whether you will or will not buy one item of each, then you face 2^1000 choices–there are that many different “shopping bundles” with which you could leave the store.
Trying to work out which of these “maximises your utility” would take you several millions of times more years than it took for the universe to get from the Big Bang till now.
In reality, what is “rational behaviour” in this case is not to attempt to consider every option, but to find a way to not consider the vast majority of options so that you can make a reasonable decision in finite time.
May 26th, 2009 at 12:14 pm
Hello All,
Hoping someone might be able to direct me to the Australian equivalent of Steve’s DebtWatch No.31 data on USA Ratios of Debt and Money to Base Money. I’ve started compiling my report for TAFE and need some marrow to avoid being speculative.
May 26th, 2009 at 12:38 pm
Steve,
It was just an example , probably a bad one – I didn’t mean that I believed in indifference curves and I said that: “Of course real humans do not behave like that.”
My point is that if we consider a centrally-planned economy where the central planning authority determines which products in what quantities should be made available to the people and a market economy where agents independently chose products – such an oversimplified model could be good enough to spot the difference in the behaviour of customers when they get more money to spend.
(Sorry your point is valid I worked very hard to invent an example when we can employ such an oversimplified model).
May 26th, 2009 at 12:44 pm
Just download the RBA Bulletin Statistical Tables dobther. You’ll have some spreadsheet work ahead of you but you’ll find all the data there.
May 26th, 2009 at 12:55 pm
Yes sorry ak, I missed your subsequent qualification.
Overall I agree that what we need is to take the best from a range of theories to construct something empirically realistic. That harvesting will take drastically more from some schools of thought than others though. Myself and another blog member are currently caught up in a debate on an Austrian site, and lots of that approach belongs in the dustbin. Parts of it though–Shackle and the like–offer a lot.
I am not sure that the Chinese are dispositionally less likely to succumb to religious attitudes towards economic thought than we are though–Mao’s period had a lot of demi-religion to it!
May 26th, 2009 at 1:30 pm
Steve,
Surely the best line of attack when discussing the flaws of neoclassical and monetarist thinking is to point to some hard,fact-based discrepancies first? Arguing that markets aren’t efficient or at equilibrium is bit like trying to argue that the world isn’t a disc with a flat-earther. Both sides ‘know’ they’re right, and you won’t get any further than that at a dinner party.
I think two big killer blows are:
1. Kydland & Prescott, nobel prize winning economists, tell us that credit money is created before base money (as noted in the Cavaliers of Credit). Doesn’t this take a wrecking ball to the model of reserve banking, even forgetting the ridiculous money-multiplier for a second?
(Incidentally Steve, why didn’t their research shake the banking world?)
2. Everyone knows excessive government debt is bad, or at least concerning right? (Dinner party guests nod in unison). Well what about private debt? Both as a proportion of income and in gross terms? Then pull out the debt to GDP graphs, making sure to include the depression years.
With a beer in hand I’ve tried to introduce the role of money, credit creation, asset bubbles to some of the smartest people I know who work at the productivity commission and that big Telco. I tried to point them in the way of Minsky and Steve, and highlighted the shaky record of commercial economists and Ben Bernanke and Glenne Stevens. None of it worked. Mispricing of credit they say- pure and simple. BUT, when I prompted them with the questions above they momentarily had that scared, confused look.
May 26th, 2009 at 1:46 pm
Agree entirely alex78,
Which is why I base my presentations on that graph and that monetary data. But I also have to explain why I reject large slabs of accepted economics as I and others try to build a realistic alternative, so the theoretical stuff has to be aired too.
As to why Kydland and Prescott didn’t shake up the banking or economics world, some of the former are aware of this but it’s convenient to stick with the money multiplier myth, and most don’t think that deeply about what they do to begin with; economists on the other hand are very good at ignoring anything that conflicts with a priori beliefs.
May 26th, 2009 at 1:47 pm
Steve,
“I am not sure that the Chinese are dispositionally less likely to succumb to religious attitudes towards economic thought than we are though–Mao’s period had a lot of demi-religion to it!”
This is exactly the point I want to make:
Because they had terrible experience with the Cultural Revolution they ditched the old communist ideology.
Therefore I think that they are highly immune to all the new strains of ideological viruses including the liberal one.
The Party wants control, stability and growth. The rest is irrelevant.
Exactly the same learning process happened in Europe – they learned after WW1 and WW2 that nationalism and uncontrolled competiton between states weren’t good. So we have EU as the product of the change.
May 26th, 2009 at 2:22 pm
RBA director Warwick McKibbin says stimulus spending political http://www.news.com.au/business/story/0,27753,25539360-462,00.html
“Professor McKibbin said the biggest threat to the world recovery was the possibility that the US would allow inflation to rise.”
Actually, the biggest threat to the world recovery is to allow neoclassicals to further dictate policy.
May 26th, 2009 at 2:29 pm
ak and Steve,
Firstly, the idea of a dinner etc. is to be strongly commended.
Secondly, wrt Chinese economics I tend to support ak’s views. I say this from the perspective of having owned businesses in China since 1990, including in recent years private for profit higher education colleges and having personally taught modern (behavioral) micro-economics to undergraduate and post-graduate students.
My observation of the Chinese academics that I hire (to moonlight) from the Chinese public universities to lecture and tutor is that they are mainly interested in knowing what works in reality. They are generally speaking living exemplars of the famous Deng Xiao Ping saying “No matter if it is a white cat or a black cat; as long as it can catch mice, it is a good cat”. To be frank, in general, in my view they are also smarter than most Australian academics, reflecting a much larger pool of gifted individuals.
In this context, the biggest ptroblem that I have had in organising the teaching of economics has been wrt macro-economics and finance.
The neoclassical orthodoxy, as modified by modern behavioral economics and a Schumpeterian approach to dynamics, tends to describe reasonably well what goes on in China at the micro level and the correct policy approaches. Despite one’s criticisms of neo-classical theory, it remains, for instance, true that say wrt water policy, people will use more of it if it is underpriced, than if it is correctly priced to take account of various externalities. Chinese academics have few problems in adopting, using and teaching these tools. For instance, adapting Josh Learner of HBS’s theories and materials re- the economics of venture capital, essentially a Schumpeterian view, is very applicable and works well in China.
The problems occur when one tries to have a Chinese academic teach an Australian or USA conventional macro-economic or finance course. Firstly, it does not relate well to the Chinese insititional reality. This reality is one of an economy which at the macro-economic level is still largely influenced by quantitative controls on finance, not price signals. Secondly, it does not compute to the average Chinese academic who looks out their window and sees asset bubbles in certain sectors, including wrt University land sales, wants to understand the causes and finds little comfort in Western macro-economic thought as set out in the mainstream text books.
Consequently, despite my own lack of expertise in macro-economics and finance, I have have been encouraging some to adapt Steve’s materials to the Chinese institutional context. We are at a very early stage.
May 26th, 2009 at 3:17 pm
Australia has only just entered its period of depression. We are in the middle of our unemployment increase, which will cause the house price bubble to finally pop in a most dramatic fashion.
Our income as a nation is being savaged (see http://business.smh.com.au/business/rio-agrees-to-huge-cut-in-iron-ore-price-20090526-bli5.html). Lower prices for dramatically lower volumes of our exported dirt. At the same time costs are rising, thanks to Rudd et al.
The US derivatives meltdown is still unfurling – the government can only print so much money before it has some serious consequences.
So we shouldn’t jump to any conclusions too early. I believe that we should wait a few (very harrowing) years before seeing what economic dogma arises after the depression.
May 26th, 2009 at 4:41 pm
Thanks for the update Suitably. I’m with you.
Have you all noticed how many stories have centred on the $A lately? $A has had its largest 3 month rally ever (since it was floated). Also the speculation that the $US will crash (QE, China, etc) is in the media every day.
This sends me some very bearish signals for the $A. I don’t know when. There may be a final spike up or a bob along sideways for a few weeks or months. But I believe the $A is getting ready to resume its bearish trend that started last year. The retracement appears just about exhausted.
Depending on the severity of the fall (I believe well under 60c) the policy and economic implications will be drastic. A falling $A will help with our foreign income but it will crush many import/retail businesses that have been limping along. This will not be good for employment.
May 26th, 2009 at 5:46 pm
http://www.theaustralian.news.com.au/story/0,25197,25531333-7583,00.html
Hopefully the public are waking up to the burdens of debt, like McKibbin.
BTB and SuitablyIronicMoniker, couldn’t agree more on all points. When we have to fund our debts by competing on world debt markets, the mountain of US debt that is being issued shortly will then show us how much our real borrowing costs will be. I suspect that it will in actuality be a lot more than the Budget allows for (Statswatcher?)
This caught my eye;
http://www.news.com.au/adelaidenow/money/story/0,26907,25517239-5015839,00.html
“Property asking prices falling fast”.
I know in the area I am in (Gold Coast) this is true and not only in the ritzy areas this article suggests. It’s happening across the board.
More interesting though is that this was predicted in January by a licensed property valuer I chatted with. He said then that settlement prices were often well below asking, making valueing (then) quite difficult. Volume then was very thin thus values difficult to predict (all lower though, just by how much). He predicted that more volume would only come when asking prices “got real”. He said also that would be the point from which he thought residential property values would post some “serious” declines.
May 26th, 2009 at 5:46 pm
In February Credit-Suisse’s debt strategists said that the chart commonly used to highlight the US’s indebtedness is wrong and grossly over estimates the ratio. They also say the chart is“ ..analytically meaningless – and arguably the most dangerous piece of propaganda to come out of the current crisis.”
I can’t get hold of the original document but here is an article with excerpts from Credit Suisse (without charts)
http://www.businessinsider.com/2009/2/us-debt-levels-are-fine-debt-to-gdp-chart-is-wrong-and-meaningless
And here’s a piece with their charts:
http://www.dailymarkets.com/economy/2009/02/08/debt-to-gdp-chart-analytically-meaningless/
Also google ‘credit suisse debt to GDP’. There’s a bit of discussion about this, and the best seems to be at this message board.
http://boards.fool.com/message.asp?mid=27432358&sort=whole
May 26th, 2009 at 6:01 pm
And on the perils of running big deficits, this is a good article by Mauldin.
http://www.safehaven.com/article-13407.htm
“The Paradox of Deficits”
“Europe, Japan, and the US cannot try to borrow $5 trillion in the next two years without a serious distortion of the bond market, not to mention the entire economic landscape.
I have long thought that “crunch time,” the end game, would show up around 2013-14. But I never in my wildest imaginings thought we could run an almost $2 trillion deficit. That crazy guy on the corner telling us “The end is nigh”? He may be right.
Long before we get to 2015, let alone 2019, I think the bond markets will have called a halt to $1 trillion deficits. There will be a real crisis. The deficits will not be funded at anywhere close to an interest rate that will not break the budget.”
May 26th, 2009 at 8:03 pm
alex78,
I am paranoid about data.
I run a google search (but for a slightly modified phrase). What I got is the response to the original article.
http://www.businessinsider.com/yes-we-are-drowning-in-debt-2009-2
“The chart, the CS analysts said, combined two different statistics and suffered from double-counting. Specifically, the analysts said, the “financial debt” segment counted whole loans and asset-backed securities as different types of debt when in reality asset-backed securities just repackage whole loans. ($1 billion of mortgage-backed securities and $1 billion of mortgages don’t make $2 billion of debt).
Ned Davis of Ned Davis Research was one of those who produced the original Debt To GDP chart, and he now defends it. He doesn’t dispute the double-counting charge. He simply notes that, even if you exclude financial-sector debt, US debt levels are very high.”
“current record debt levels are well above
the mean for the past 60 years. It is not
technically wrong and anyone is free to
derive their own meaning.”
The revised debt ratio is 228% of GDP instead of 350%
May 26th, 2009 at 9:10 pm
Credit Suisse is trying to talk their book.
If debt levels are so manageable in America, why are foreclosures skyrocketing? How do they explain the boom and asset bubble that showed up all around the world a few years ago?
Also if debt servicing levels are so good why is the demand and supply of finance crashing. If liquidity was only the problem, demand would still be growing, with supply constrained. Certainly not the case in Oz. Demand for finance has fallen across the board.
World trade and retail sales are down across most of the western world too. If it was as simply as CS were suggesting we would expect to see demand for goods rising, due to consumers having increased spending power (lower debt servicing because of lower interest rates).
Some double counting makes sense as well. In many cases fresh debt was used to leverage against old debt. The value of the old debt crashed, leaving the fresh debt to be repaid as well as the old.
I wonder if CS has released their simplistic explanation because they may have a problem with lots of “simply mis-priced toxic assets”? Keep talking the book guys, maybe you will believe it yourself some day.
May 26th, 2009 at 9:14 pm
Can you believe this? Wow. Dr Debelle – “In the current circumstance, these models have not been useful because they generally do not handle credit well, if at all”
May 26th, 2009 at 9:21 pm
and there is more … “When the input of models would perhaps have been most beneficial, we have been trying to apply linear frameworks to a world which in the current circumstances is at its most non-linear.” see http://www.rba.gov.au/Speeches/2009/sp_ag_150509.html
May 26th, 2009 at 9:34 pm
Steve,
As you are going to comment on Austrian economics in the near future, you might like to know a fellow Aussie in John Quiggin has already done so recently:
http://johnquiggin.com/index.php/archives/2009/05/03/austrian-business-cycle-theory/
He might have read your posts and stolen your thunder. But the following is the rebuttal from the von Mises Institute:
http://mises.org/story/3466
This might provide more material and new issues that you might want to include in your future critique.
May 26th, 2009 at 9:51 pm
Thanks for pointing out that RBA speech, Dave. Gee-zuz!! Where to begin? Rarely have I ever read something so trapped within dogma, so self-referential to an absolute, irrefutable, self-evident truth.
I loved the first line of the conclusion:
“Inflation targeting in Australia has coincided with a period of low and stable inflation, and a prolonged economic cycle with a high average rate of growth, which has only recently come to an end.”
It reminds me of bank profits since the 87 crash. The bank losses resulting from the GFC are larger than the sum of the last 20 years of profits (or something stupid like that, assuming assets are marked to market and pre-2000 generally accepted accounting principles aren’t raped and pillaged). So the last 20 years of “high average rate of growth” is all well and good so long as you don’t count the 21st year.
The guy who wrote that speech is defending a system which created the GFC without taking into account the GFC itself. Scary, though very convenient for his absolute truth.
I wish someone would pay me to take a trip to Rio to deliver crap speeches.
May 26th, 2009 at 10:25 pm
ak
Henry Bloget, Harvard (or Yale) graduate and even Ned Davis have no clue about debt. There is no double counting. If I lend one dollar to you and you on lend it to somebody else, who in turn lend it to somebody else and so on. Let say ten times. The one dollar has created 10 dollars of debt. The reason that it is not one dollar of debt is there is ten times the use and ten times the risk of default. The mortgages were initially provided by bankers, the initial lenders. The loans were repackaged through securitization vehicles on sold to investors as debt securities. The investors were/are the next lenders of the same mortgage. The banks have not completely “passed the parcel” as the bank insolvency in the global financial crisis has clearly proved. The concept of “clean sale” of mortgages is a chimera. Hence securitization and on sale of mortgages increases debt obligations and therefore financial debt should be added onto other debt. There is no double counting, at least not materially.
May 26th, 2009 at 10:47 pm
Debt equates to a risk (or looking at it from the other side, credit equates to a promise). To be in debt is to take on the risk that you will not be able to pay, and will suffer some consequence.
So the question boils down to who should be in a position to take risk and how much risk should they take? Let’s look at the options:
When government takes on risk they effectively bind ALL citizens to commit to repayments on that government debt. The decision makers in government are inevitably long gone by the time any consequences of their actions come to light. For government to go broke is a disaster for the nation and for everyone concerned, even the people who thought it was a really bad idea end up paying the price.
When a private individual takes on risk they (hopefully) do so of their own free will and ultimately they are the one to succeed or fail by their own decisions. They reap the consequence of their own actions. If a private individual goes broke then it is unpleasant for the individual, but not a complete disaster, and this is a way to unwind mistakes in an orderly and safe manner. The nation as a whole will not suffer if some percentage of private individuals are successful while some other percentage fail (although equity might be a concern to some, at least they all had the opportunity to succeed).
If a private individual might be risk-adverse (i.e. not want to go into debt) then it seems reasonable that they should not be under any external pressure to do so. They will not succeed as well as some, but they will not fail as badly as others either. Opting out should be allowed as a basic moral premise.
For this reason, private debt is a lot less dangerous to the nation as a whole than government debt. Also private debt has only a weak guarantee (private individuals go broke much more easily than governments do). There are some problems with private debt… the most important being when lots of private individuals all go broke at the same time. Then it becomes a much bigger problem (still not as bad as government going broke). The other problem is that certain particularly powerful companies have the ability to manipulate government and protect themselves at the taxpayer’s expense (e.g. various US banks) this is nothing other than theft, and should be treated as such.
The saying goes, “When the tide goes out, you know who has been swimming naked.”
May 26th, 2009 at 11:18 pm
Lyonwiss,
You have made a very good point.
Debt securities are bonds and when I buy one (well I’ve never tried…) I effectively loan money to the issuer.
http://financial-dictionary.thefreedictionary.com/Debt+security
However they have also been branded as assets as they are securities.
http://www.investorwords.com/273/asset.html
From that point of view the process of securitisation leads to selling assets by a bank to a buyer.
“Now you see it now you don’t…”
May 27th, 2009 at 12:16 am
There’s a method of gambling where if you win, you win, and if you lose you cover the loss by betting bigger next time. In theory you will always eventually win, thus restoring all previous losses in that run (no doubt there is a formal name for this method). In practice it rapidly hits dangerously high bets. Try at home with matchsticks first.
May 27th, 2009 at 12:33 am
Tel,
The gambling method goes by several names, most commonly the Martingale Method:
http://en.wikipedia.org/wiki/Martingale_(betting_system)
Long-term, a gambler using this method does no better than break even, assuming that the bets are fair (ie. the payout exactly reflects the odds). You win small most of the time and crash big occasionally. If you only look at the time period between the big losses, it looks like a great system
May 27th, 2009 at 1:01 am
Tel,
It would be really interesting to see a direct exchange of arguments between you and prof Mitchell on his blog.
It is not the first time I am facilitating such an exchange indirectly by comparing your arguments with his arguments.
You wrote that:
“Debt equates to a risk (or looking at it from the other side, credit equates to a promise). To be in debt is to take on the risk that you will not be able to pay, and will suffer some consequence.
(…)
When government takes on risk they effectively bind ALL citizens to commit to repayments on that government debt. The decision makers in government are inevitably long gone by the time any consequences of their actions come to light. For government to go broke is a disaster for the nation and for everyone concerned, even the people who thought it was a really bad idea end up paying the price.”
His opinion expressed on
http://bilbo.economicoutlook.net/blog/?p=2531
is exactly the opposite:
“Well the way the system actually operates in real world land is as follows. The Government sells a bond to the non-government investor and debits the bank account you hold and credits some account within the government reflecting your bond holdings. Numbers just go into ledgers. You get a letter outlining the parameters of the bonds you just bought which includes the maturity date and the interest to be paid on the face value.
On maturity, some operator in the Government reverses these transactions – credits you bank account with the bond repayment plus interest and debits the account recording your bond holdings.
The national government can always do this.”
and
“The only way the US Government or the Australian Government would ever default on payments in their own currencies would be because they chose to for political reasons. There is no financial constraint on meeting all obligations in their own currencies irrespective of how large these obligations are. Even if the private markets “stop buying the debt” the government will still be able to spend. The debt after all does not finance the net spending!”
So who is correct?
May 27th, 2009 at 1:45 am
Steve,
I think the effect that causes the cyclical part is consumer spending, particularly credit fueled consumer spending.
As I understand it, Mises said to understand what went wrong, you must first imagine how it can go right. Imagine a world with no credit, where you saved 100% first for all purchases. Here purchases would be distributed according to peoples age and incomes in an orderly manner. No young 20-somethings buying a house, car, flat screen here. A 2nd hand car at 21, new car at 25, first house at 30 and so on. Aggregate spending in this model is driven largely by demographics.
Now consider a world where in good times you can borrow up to 5 years of income for purchases based on the ‘business cycle’. In the first up year of the cycle say 20% borrow 5 times income, plus the current years income and spend 6 times annual income on ’stuff’. In the second year another 25% borrow up. All this spending creates additional demand and employment leading businesses to invest (spend) to expand capacity. In the third year another 30% borrow and spend leaving only the last and weakest 25% to spend in the fourth year. Now when you borrow up big to spend, it is a once-off event. No-one can repeat the trick the following year….
So what happens in the fifth year? Nothing, no more consumer borrowing and aggregate spending drops back to income only. This however is a reduction in the growth rates in spending which is measurable and soon enough firms slow down production and employment growth. Once no-one is left to borrow up, firms have to scale back to meet say 90% of baseline income only spending as indebted consumers have debts to repay. Now we fall into the cycle of slowing production, employment and spending….the business-cycle. This effect is compounded by the availability of credit against assets (mortgage equity withdrawal) which rise and fall in value. If you look at a chart of credit and GDP growth (RBA or US Fed) the synchronisation is nearly perfect! Personally I track private employment growth as it is less volatile than spending or production (inventory change) and reflects the mood of businesses (i.e. expansionary or contractionary).
Am I wrong in seeing the problem as high LVR credit availability? This seems to me to drive the cycle and I don’t see that changing anytime soon. If fact Obama/Rudd are practically begging the banks to lend, and that is the explicit goal of dropping lending rates. But if consumers are maxed out already…and as Steve says, around ~20% of 2007 GDP was credit financed. What does that portend for no-credit 2009?
BASSO, am happy that you don’t enjoy my work, or the internet only business model. Feel free to ignore it. I aim to aggregate macro-economic content from all over the world and try to distill it into a simple framework. It is aimed at those with a less developed economic knowledge, as I try to distill the cycle into an 8-stage model. It really worked out for my mum and relos who are riding this cycle pretty well. Others find it useful also. Pretty low key though if you’re a hedge fund manager or economist. The better part of my work is free, current (within days of official release) and widely published for general consumption. What is your contribution to society?
May 27th, 2009 at 3:24 am
Tel
“Private” debt can and now is putting the banks at risk. This particularly as it has been rising exponentially, and being used for ponzi style “investement”. The governments having been trying to keep debt “private” are now finding it necessary to take on this debt in an attempt to keep the banks solvent and everything going.
I conclude that any net national debt or credit, private of government, external (cross border) or internal is bad. This because the cumulative effect is to weaken and eventually destroy trade. All national accounts should balance over a reasonable period of time.
Control Systems Engineering principles always predict an eventual collapse if debt/credit is permitted to rise continually. Just as we are seeing now and have seen in history in 1892 and 1932. Control systems engineering takes both time and the effects of feedback into account and until mainstream economics adopts these principles the economics discipline is simply bollocks.
Also the cross border debt is far more of a problem as it must be paid (or the creditor must hope to be paid) in the foreign currency. More risk more negative pressure and eventual collapse.
The proposition; private debt good, government debt bad, is bollocks it is just part of the neo-classical dogma which most resembles witchcraft.
May 27th, 2009 at 3:58 am
BrightSpark1,
I agree with your statement on economic witchcraft. For too long has government and academia been enthralled by neoclassical dogma. Engineering would make a very positive difference to economic theory and practice.
I would think that most people would agree with the idea that government shouldn’t get into debt just for the sake of doing so; there should always be an important reason for doing so.
If it wasn’t for the failure of markets in developing an immense private debt bubble, which is now deleveraging, Labor wouldn’t have to intervene by going into debt.
The Coalition made themselves look like good economic managers by an economic debt substitution process: they essentially substituted public debt for private debt. While the Coalition was paying down the public debt, private debt was building into ever stronger toxic proportions. This way, the economy was kept strong for many years while public debt was reduced to a net position.
Labor won and took power just before the private debt bubble peaked, and is now deleveraging. Due to the drop-off in consumption and investment, the usual economic woes have followed: rise in unemployment, reduced tax revenues, etc. To combat this, Labor embarked upon a program of government spending. Due to this, Labor is made to look like bad economic managers when, in fact, Labor inherited a bubble economy: property, stockmarket, private debt, (derivatives?), etc, which is now deflating.
When it comes to blaming Labor for deficit spending of a projected $AUD300 billion, the Coalition proved worse by allowing a far greater increase of private debt to occur under their watch.
However, the Coalition shouldn’t be blamed for this. After all, whether it is the Coalition or Labor in power, they follow the advice of neoclassical economists. This is where the problem lies, regardless of political ideology, whether left or right.
Those who claim that public debt will cause more harm than good should read Steve’s PhD thesis, especially towards the end. It helps the reader to see outside the cocoon that conventional economics has enthralled society with.
With debt-deflation, property bubble deflation, falling prices, mass unemployment, bankruptcy cascades, etc, should government heed the advice of neoclassicals and do nothing?
For all the flak that Labor has copped for debt spending, Steve has pointed out that whatever the government does, it will not be able to pump-prime $AUD100 billion per year for a decade or more to replace the private debt that is deleveraging.
On other matters, Dean Baker has a good article about the Fed: “Waterboard the Fed?”
http://www.cepr.net/index.php/op-eds-&-columns/op-eds-&-columns/waterboard-the-fed/
May 27th, 2009 at 7:50 am
ak
For every borrower there is at least a lender. The debt to the borrower is an asset to the lender. The debt from a mortgage also creates an asset in the house. Building up to the global financial crisis, the RBA said that growing household debt did not matter because there was also growing assets. True, but it was an irrelevant comment, because the risk of default of larger amounts of debt has increased. Further nonsense about “debt doesn’t matter” that has been said include: “we owe it to ourselves”, “one person’s loss is another person’s gain” etc..
The great myth which led to the global credit crisis was that securitization allowed unlimited lending because it spreads the risk to investors who bought mortgage-backed securities, created by the banks. The main problem with this is that the banks could not completely sell all mortgages to investors. They were mostly selling mortgage-backed commercial papers, which are 90 and 180 days securities to investors to fund increased lending. When investors lost money and stopped buying those short-term securities, the banks were still stuck with the long-term mortgages, which are collateralized assets, normally with regular income from mortgage repayments. The trouble is the mortgage assets lost value as house prices fell and no income was coming in when the mortgages defaulted. Many banks became insolvent, many could not lend and few want to borrow: a credit crisis.
Anyone can play around with numbers and data, including Henry Blodget, Ned Davis and the folks at the RBA. But do they really understand what they are doing or saying? Debt is debt, however it is packaged or securitizied as assets. Financial sector is debt, like another debt, and should be added to total debt. $1 billion of mortgage-backed securities and $1 billion of mortgages DO make $2 billion of debt. More people are involved in more borrowing and more lending. The total credit market debt to GDP is 350% and not 228%. The mind boggles when you realized there are some $50 trillion of credit default swaps, not included in the calculation.
May 27th, 2009 at 9:19 am
Re: Martingale system – that is why casino have limits on tables….because anyone with deep enough pockets can use this system….but you end up in a situation where you need to place an enormous amount just win back your intial bet…..and then when you lose that one – you double it again…etc…..
May 27th, 2009 at 10:24 am
Interesting discussion on the Martingale System.
This system is theoretical. In practice, emotions distort outcomes.
When a gambler is winning he takes more risk. (after all he is just risking profit). When a gambler knows the feeling of winning (from past experience) and is losing, he will take more risk because he hopes to regain the winning feeling.
Gambling, speculating or investing. The definitions may get blurry, but the emotional responses are all the same.
In theory the winning gambler stops and takes profit. In practice he is always trying to make a “little more”.
May 27th, 2009 at 10:31 am
Philip,
Read that article by Dean Baker, hilarious isn’t it. Researching my report i came across that knowledge that the Fed actually isn’t run by the US government but is a private consortium run by 12 banks.
I’d hazard that there is now ability to over come and ameliorate economic cycles and especially this present cyclic crisis of unprecedented magnitude until that institution is nationalised.
To have the power to print money without oversight is extremely foolish, unless of course you’re running the show (to a point).
Incidentally I wondered why Obama didn’t chose someone else for the Head of the Fed until I found this out. He can’t, he doesn’t get the privilege of choice.
Australia established the RBA in 1959 and the English Labor Party nationalise their National Bank, the Bank of England in 1946. The US needs to follow suite to at least get some form of accountability happening. While the ability to control monetary policy is in the hands of the actual people who profit from money creation then there is no chance that this economic crisis will be resolved.
If ever there is a conflict of interest, this is it.
By the way, I found this publication while trawling the net:
Money facts; 169 questions and answers on money- a supplement to A Primer on Money, with index, Subcommittee on Domestic Finance … 1964.
Is this a legitimate document?