Economic debate in Australia today reminds me of one of the great lines in The Rocky Horror Show. As he invites Brad and Janet to meet Rocky, Frank-N-Furter taunts Janet with the lines:
I would like--if I may--to take you on a strange journey...
“I see you shiver with anticipation!
But maybe the rain is really to blame
So I’ll remove the cause,…
But not the symptom!”
It seems that in Australia, the reverse can apply: the symptom can be removed without eliminating the cause. We can avoid a serious recession while doing nothing to reduce private debt.
Excessive private debt caused the Global Financial Crisis. The expansion of private debt caused a false bubble prosperity for the last one and a half decades. Now that the growth in private debt has ceased, economies worldwide are going into a severe downturn driven by deleveraging: consumers in particular are spending far less as they try to reduce their debt levels; output is plummeting, and unemployment is rising.
Australia was as caught up in this process as anywhere else in the OECD. And yet somehow, we aren’t going to suffer much in the way of ill consequences? It seems heroic to assume so, and yet this was the basis of the recent Budget. Discussion and criticism of it by the Opposition and many economic commentators likewise focussed far less on the causes and expected severity of the downturn, and far more on the government’s projections of how rapidly it would return the federal budget to surplus.
Treasury Secretary Ken Henry’s speech to Australian Business Economists (Contemporary challenges in Fiscal Policy, Sydney, 19 May 2009) provided the most detailed defence of the Budget estimates that the recession would be over by 2010-11 and be followed by a boom, do no worse than reduce annual GDP by half a per cent in 2009-10, and see net government debt peak at 14 per cent of GDP in 2013-14 (Budget Paper No. 1, p. 3-9). In this Debtwatch I want to take a more critical look at this document than our economic journalists have done to date, and contrast the assumptions behind it, and its modelling, with my approach.
For God's sake keep a grip on yourself Janet. I'm here - there's nothing to worry about.
The Treasury’s Approach
I’ll quote the key economic argument in Henry’s speech in its entirety first, and interpret it later:
So let me tell you what we actually did. It’ s a bit complicated. But not too complicated, I’ m sure, for this audience.
I’ ve already outlined some of the context for this work. But a quick re-cap: We developed the medium-term scenario to provide parameters for the medium-term projections of the budget balance. The latter are required to span the gap between the four-year forward estimates period and the 40 year projections contained in the intergenerational reports.
In spanning the gap we also wanted to reconcile the short and medium-term GDP trajectory with the long-term projections contained in our IGR ["Inter-Generational Report"] modelling. Call us fastidious if you like, but we don’ t like discontinuities in our economic projections. We wanted to be sure that we were describing a medium-term scenario that is consistent not only with the short-term forecasts, but also with the long-term IGR projections.
The approach is predicated on a gradual recovery in aggregate demand in the final forecast year (2010-11), after which the supply-side drivers of the economy take over.
This is how we went about it. First, recall that we can describe GDP growth using a number of different decompositions. Usually, we employ the components of aggregate demand to tell the story. But increasingly we have used the supply-side decomposition that isolates changes in the following key variables:
(1) the population aged 15-plus;
(2) the participation rate;
(3) the employment rate;
(4) average hours worked; and
(5) labour productivity.
All of these things are cyclically sensitive, including the first because of the cyclical sensitivity of immigration.
We can obtain an index of real GDP simply by multiplying together these five things.
The weak GDP growth rate forecast for 2010-11 can be explained as follows. Despite relatively strong productivity growth of 2½ per cent, and the population aged 15-plus growing by 1¾ per cent, GDP growth is only 2¼ per cent. Weak demand sees both a fall in the participation rate (which subtracts about 1 percentage point), and an increase in the unemployment rate from 7½ per cent to 8½ per cent (which subtracts another percentage point).
As we move into 2011-12, however, growth strengthens sharply: productivity growth is weaker, but still a healthy 2 per cent; the growth in population aged 15-plus is also weaker, but still a healthy 1½ per cent; the participation rate is unchanged; and the unemployment rate falls by one percentage point. You might be interested to know that in coming out of the recessions of the early 1980s and 1990s the unemployment rate fell by about a percentage point a year for the first two years. Taken together, these factors produce a GDP growth rate of 4½ per cent.
That pattern is repeated in the following year, 2012-13. Then in each of the following four years the unemployment rate falls by only one-half of a percentage point a year; productivity growth slows to only 1½ per cent; and the participation rate adds half a percentage point a year. These factors produce annual growth of 4 per cent.
The productivity growth rate of 1½ per cent is less than that used in the two IGRs published to date. It is the actual backward-looking 30-year average. The profiles of the unemployment and participation rates over the period 2013-14 to 2016-17 weren’ t plucked out of the air either. They ensure that by the end of that period, potential GDP is back on the long-term trajectory contained in our IGR [Inter-Generational Report] modelling, having spent nine years from 2008-09 below that trajectory. By 2016-17 the output gap has closed, with an unemployment rate of 5 per cent and a participation rate consistent with the labour force models used in the IGR projections. (Henry 2009, pp 14-16)
Deconstructing Treasury I: The context
Three contextual points stand out in this statement.
Firstly, there is no discussion of what actually caused the GFC, here or anywhere else in Henry’s speech. The fact that it originated in the financial system is noted, but why it originated there, and what caused it, is not considered.
Secondly, “the long run” in the Budget papers is determined by assumptions the Treasury made about the economy’s future in its Intergenerational Report, which was published in 2007. Since those assumptions were made prior to the Global Financial Crisis, that means that the Treasury is assuming that the GFC will have no long term effect on the economy: it will suppress output and employment for a couple of years, but after that everything will return to how it was before the GFC came along.
Thirdly, the Treasury produced its Budget estimates for GDP growth by decomposing growth into 5 factors, making assumptions about those factors over time, and adding them up to produce estimates for 2010-2017. Four of the five numbers used–and the Treasury’s expectations for inflation as well–are shown below (the Treasury didn’t provide its estimates of average hours worked, so that factor is presumably collapsed into the employment rate; and their table [Table One on page 15] says “Unemployment Rate” where I believe they meant “Employment Rate”).
Note that Henry describes this decomposition as a “supply side decomposition”. There’s no argument that population is a “supply side” issue–not withstanding Peter Costello’s “Baby Bonus”, it’s fair to assume that the households decisions about whether to have children are not determined by economic conditions. Ditto productivity to some degree: higher economic growth should lead to higher productivity, but there will be productivity growth even when the economy is stagnant, so at a first pass one can treat productivity growth as independent of aggregate demand.
But are the participation rate and the employment rate “supply side” factors–set by household decisions alone rather than influenced by the demand that currently exists for workers? Henry also notes that all these factors “are cyclically sensitive”, which implies they are affected by demand conditions. So why call them “supply side” factors?
Because if you follow neoclassical economic theory, the rate of growth “in the long run” is determined by the labour supply decisions of households and the rate of productivity growth. While “in the short run”, neoclassical economists will concede that there can be insufficient aggregate demand to employ all workers who wish to work, in the long run they assume that everyone who wants a job can get one, so that “in the long run” the unemployment rate is determined by households, based on their preferences for income and leisure.
Credit issues–even ones as severe as the GFC–don’t factor into the Treasury’s modelling because, following neoclassical economics, they assume that money and credit don’t have any long term impact. Monetary factors like credit and debt are not included in Treasury’s macroeconomic model (TRYM) in any way. Ultimately, their model assumes that the economy will settle down to a long run equilibrium rate of growth determined solely by household labour supply decisions and the rate of technological progress.
Deconstructing Treasury II: Alternative Long Run Assumptions
Now let’s consider the Treasury’s approach in detail, starting with the the framing of the Budget’s assumptions so that they were consistent with the outcomes of the IGR. Henry’s defence that “Call us fastidious if you like, but we don’ t like discontinuities in our economic projections” doesn’t mean that the approach it took here was the only one available. It could also have revised the IGR projections in the light of the GFC, and then made the Budget assumptions consistent with these lowered assumptions about the future.
And there are severalways it could have done that. It could have:
- stuck with the IGR’s assumptions about long run rates of growth, but treated the GFC as a “one-off” event that took a permanent chunk out of economic performance for a few years; or
- treated the GFC as something that permanently altered the economy’s long term growth rate so that the economy was on a permanently different path; or
- some combination of the two.
Because it did none of the above, the Treasury was forced to assume that the medium term impact of the GFC would be to accelerate Australia’s economic growth: since their long run scenario assumed that the GFC altered neither the level of output in 2040 nor the rate of growth then, and yet in the short run (the next two years) it would reduce growth, then in the medium term growth had to accelerate to catch up with the IGR forecasts.
Therefore the Budget’s projections come down to hope. IF the GFC has no impact on the economy in the long run, AND the economy necessarily settles down to an equilibrium rate of growth independent of financial factors, THEN the Budget’s forecasts will be correct.
If on the other hand the GFC does have a long term impact–either by taking pushing the economy down but not affecting the long run rate of growth, or by taking a chunk out of the economy now and altering the rate of growth–and the economy’s equilibrium isn’t independent of financial factors, then the Budget’s forecasts will be wildly wrong.
Deconstructing Treasury III: Alternative Short Run Assumptions
Equally the short run assumptions–that the GFC will cause output to fall by 0.5 percent this financial year and grow by just 2.25 percent next year–can be challenged. The Treasury’s Budget Papers abound with statements like “The 2009-10 Budget has been framed against the backdrop of the deepest global recession since the Great Depression” (Statement 1, p. 1-1). And yet this recession is expected to be shallower than those of 90-92 and 82-84, when GDP fell by 1.25 percent and 2.5 percent respectively?
What if “the deepest global recession since the Great Depression” has an outcome like its predecessor, when output fell by as much as 10 percent a year?
This might sound extreme, but it’s in the ballpark of what’s happening in the rest of the OECD, where US output is falling at 6 percent and Japanese at over 10 percent. Certainly it would have been more realistic to assume that “the deepest global recession since the Great Depression” would have a greater impact than any post-WWII recession, especially since the figures coming out of the rest of the OECD imply that, in the words of Rocky Horror’s Narrator, this recession will be “no picnic”.
What if Treasury had assumed that something half that bad–something like the current downturn in the USA of a 5 percent fall in real GDP in a year–as the immediate impact of the GFC, rather than a mere 0.5 percent?
Though Treasury had to use a single forecast to frame the Budget, it could also have considered a range of scenarios, rather than the single incredibly upbeat scenario it presented and now defends.
On its record with picking the GFC to date, the Treasury is in no position to rest on its forecasting laurels. The comparison of its expectations in 2008 for the most recent financial year with reality makes for interesting reading:
Deconstructing Treasury IV: Doing the Time Warp Again
The real problem with the Budget is that it is based on the same approach to economic forecasting that Keynes lampooned in his often cited but rarely appreciated statement on the long run. It was not a quip about mortality, but a justified criticism of the manner in which the economists of his day assumed that the economy would always return to equilibrium after any disturbance:
“ But this long run is a misleading guide to current affairs. In the long run we are all dead. Economists set themselves too easy, too useless a task if in tempestuous seasons they can only tell us that when the storm is long past the ocean is flat again.” (Keynes, A Tract on Monetary Reform, 1923)
Though one might hope that economics had learnt from the past and improved since Keynes’s day, the reality is that it has instead reconstructed the same manner of thought that existed before Keynes and the Great Depression. The vast majority of models used by economists to predict the future course of the economy today are subject to Keynes’s criticism of 1923. The Treasury’s TRYM model has these same characteristics–though now expressed in mathematical models rather than impenetrable prose:
There are those who say life is an illusion - And reality as we know it, is merely a figment of our imaginations.
- A short term that into which “shocks” can be fed like a change in the growth rate, which then affects all related variables;
- A long run which is in equilibrium with assumptions made about productivity, labour supply, and population growth that generate growth projections which match recent experience, altered only by anticipated changes in demographics; and
- Assumptions about how quickly the equilibrium will reassert itself that generate a cyclical convergence from any short term disturbance.
So if an enormous financial shock–whose causes are not understood–has only a minor impact on the Australian economy, after which we will return to an equilibrium path that reflects recent history, then the Budget will be accurate. And if not?…
It’s just a jump to the Left…
There is a minority of economists who completely reject this approach to economics. But when the economy itself appeared to be booming, that minority was ignored by the majority of “neoclassical” economists, and regarded as “left wing critics of capitalism” by the public.
Now that the GFC is afoot, it is finally possible to get across the fact that the criticism was directed not so much at capitalism itself, as at woolly and delusional thinking about capitalism masquerading as economic logic.
Much of this minority’s time was taken up with pointing out why neoclassical economics was delusional (see my Debunking Economics for a collation of those critiques). Only part of it was devoted to developing alternative theories of how the economy operated, with the outstanding contribution there being Hyman Minsky’s Financial Instability Hypothesis. The core aspects of this approach to the economy are that:
And then a step to the right...
- The economy is inherently cyclical and will never be in equilibrium, either now or in the future;
- Credit and money are critical and impact on real economic activity in “the long run” as well as in the short, and must be included in any macroeconomic model; and
- Asset markets matter because debt-financed speculation on them can both drive economic activity and lead to financial crises.
These insights lead non-neoclassical economists to focus on issues that neoclassical economists ignore–such as the level and rate of growth of private debt–and require a different, truly dynamic approach to modelling the economy, as opposed to the equilibrium-obsessed approach that dominates neoclassical economics.
I’ve recently published two academic papers based on this credit-driven, non-equilibrium approach to economics (one is already available in Economic Analysis and Policy, the other will be published in the Australian Economic Review in September). They’ll be combined into one approach in the book I’m writing on the financial crisis for Edward Elgar Publishers (Finance and Economic Breakdown, estimated date of publication December 2011). Here I’ll show how both of them predict a rather different outcome from the GFC to the “return to business as usual” hopes of the Treasury.
These models are still very basic and incomplete–in particular, I have not attempted to fit them to the Australian data. But they indicate the essential differences between the modelling approach the Treasury takes and true dynamic modelling.
What is a Credit Crunch?
The phrase “credit crunch” has entered the vernacular, but what in fact is it? The easiest way to describe it is as a sudden reduction in people’s willingness to take on debt, and banks’ willingness to extend credit. This phenomenon can be captured by the model I outlined in the Roving Cavaliers of Credit by changing three key parameters:
It's something we ourselves have been working on. But it seems our friend here has found a way of perfecting it.
- The average time horizon over which borrowers aim to repay their loans drops;
- The rate of recirculation of existing bank reserves falls; and
- The rate of creation of new credit money drops.
The changes to financial parameters are shown in the table below. The impact of these three variables on economic activity in this model of a credit-driven economy are dramatic.
The model itself is quite simple, but it differs from TRYM and its neoclassical cousins in one vital way: it is fundamentally dynamic. As noted above, TRYM’s “dynamics” simply result from the model’s key variables converging to some assumed “long run” values that are arbitrarily imposed on the model. For example, the graph below from TRYM’s documentation shows what TRYM assumes will happen to unemployment “in the long run”: it will converge to a steady state level that in 1995 they assumed was 7%.
The fact that unemployment behaved very differently between 1996–when this document was written–forced the Treasury to change the 7% figure to 5.25%. But it it still imposed on the model–it is not something that results from the interaction of unemployment with other variables in the model.
This is why the Treasury can assert that the GFC will have no long term impact on the unemployment rate: because its model simply assumes so.
Things are rather different in the real world, and a truly dynamic model goes at least part of the way to capturing that. Below are four simulations of the impact of a permanent credit crunch–a permanent shift in financial parameters–in the Roving Cavaliers model. Not only does the size of the shock have a dramatic impact on unemployment in the short term–causing everything from a short recession with a mild shock to a long Depression with a large one–but the equilibrium rate of unemployment changes permanently as well.
The model generates an acceleration of growth after a credit-crunch-induced recession, rather like the one that Treasury is assuming will happen–but again, in contrast to the Treasury’s model, this acceleration is not merely an assumption, but a product of the model’s many feedbacks.
Deleveraging and Economic Breakdown
The Roving Cavaliers model above simulates a crisis of liquidity, something which can easily be overcome if firms’ willingness to take on debt, and banks’ willingness to lend, can be restored. If this were the nature of the crisis we are experiencing, then it could be reversed simply by increasing confidence–which is the one thing that can be said in favour of an official forecast that the recession will only last a year and result in unemployment no worse than 8.5 per cent.
But it's the pelvic thrust That really drives you insane...
But what if the crisis is one of solvency instead? What if the real cause of the crisis is not merely a sudden drop in confidence resulting in lower rates of creation and circulation of credit, but too much debt altogether?
That possibility is captured in my Minsky model, in which a series of booms and busts leads to one final bust where the accumulated debt is so great that the economy can no longer service it. Output and employment collapse, and the only way out is to deliberately reduce the debt.
This model’s dynamics are generated by four interacting factors:
- Wage demands by workers based on the rate of employment
- Investment decisions by firms based on the rate of profit
- Speculative borrowing by firms based on the rate of economic growth; and
- Lending by banks
Its equations can be summarised as saying that:
- Workers share of output will rise if wage demands exceed the growth in productivity
- The employment rate will rise if economic growth exceeds the sum of productivity and population growth
- Banks lend to finance investment and speculation and charge interest on the outstanding debt; and
- Speculation rises as the rate of economic growth increases.
Those four factual statements result in a model that generates a series of trade cycles, each apparently like the previous one, but with the level of debt altering over time.
A crucial factor is the distribution of debt between productive and unproductive purposes–between genuine investment and mere speculation. The former builds additional productive capacity that can be used to meet financial commitments in the future, even if today excessive increases in the debt burden leads to a recession. But borrowing that merely finances speculation on the stock exchange or the housing market about the prices of shares and houses adds to debt now without increasing our capacity to service it in the future.
The “No Speculation” simulation shown in the following graphs has only productive borrowing; the “Ponzi Finance” simulation has borrowing to speculate on asset prices as well as productive borrowing.
It is possible to generate a crisis in the “No Speculation” case by choosing a set of initial conditions that result in more extreme cycles–it is a “chaotic” model that has “sensitive dependence on initial conditions” in the technical vernacular–but generally speaking it is a stable system that won’t lead to a debt crisis (in fact in the simulation here, debt to GDP ratios are negative, which means that firms accumulate positive bank balances).
The Ponzi Finance system however is inherently unstable: the growth of unproductive debt during a boom–when people borrow money to speculate on rising asset prices–adds so much to debt that the amount accumulated in the previous boom is never completely repaid before the next boom takes off. The debt to GDP ratio therefore ratchets up over time, until ultimately, so much debt is taken on that the economy experiences not merely a recession but a Depression.
These models are far from “the ant’s pants” in terms of what truly dynamic economic modelling could be. But they are far in advance of models like Treasury’s TRYM that predict the future simply by assuming that it will be pleasant.
END OF COMMENTARY
Comments on the Data
The latest credit figures indicate that, were it not for the First Home Vendors Boost (let’s call it what is really is), private debt in Australia would now be falling. The increase in debt for the month of April was a mere A$776 million, with a A$6.5 billion increase in mortgage debt almost offset by a A$4.8 billion fall in business debt and a A$1 billion fall in personal debt. The change in private debt is therefore on the cusp of reducing aggregate demand, whereas for the past 17 years, it has been adding to it.
Table One
Table Two
Even though I expect that the government’s “Keynesian pump priming” will not prevent a Depression, it is still instructive to compare the Government debt levels, which are the focus of Canberra’s current hysterical debate over the Budget, with private debt levels.
It is an indictment of economic and political thinking that our last forty years of economic debate have been dominated by a song and dance about the Government’s debt levels when out of control private debt levels have been virtually ignored.
The run up in private debt since the recession of 1990 has been so great that changes in government spending are simply too small to neutralise the impact of de-leveraging by the private sector. The next graph shows the contribution that change in debt makes to aggregate demand–defined as the sum of GDP plus the change in debt. Deleveraging has only just begun in Australia, and yet already the reduction in the rate of growth of private debt has sliced about 8 percent off aggregate demand. The government’s attempts to counter this, though huge by historical standards, are trivial compared to the scale of private sector de-leveraging.
This is another very interesting chart;
http://www.comstockfunds.com/files/NLPP00000/026a.pdf
Do we think stocks are too expensive?
Otto C and BTB,
As you will probably know there is an alternative view on gold from an Elliottwave-influenced perspective due to Alf Field – http://www.freebuck.com/articles/afield/081126afield.htm – who has a different analysis of the gold wave pattern to date and seems to have some credibility. He thinks the $700 low won’t be re-tested.
(Sorry to gold-bug the discussion everyone else – though perhaps this is relevant to Keenist versus Farberite positions on the $US).
Bill.
Hi Otto,
I still believe that gold is headed lower. I cannot predict an ultimate downside yet. But my min downside is $650.
Looking at the long term charts for precious metals. I reckon they will make a major low sometime in the next 2 to 4 years.
After that I expect a new bull market to commence. A new bull market does not mean $10,000 for gold. What it means is that the trend will be predominantly up (with intermittent retracements) for many years after that low.
a link to some “bond market” information, entitled “The Ascent of Money”
http://www.abc.net.au/tv/guide/netw/200906/programs/ZX0064A002D4062009T203000.htm
Hi all,
As a mere mortal in the world of economics I have been struggling to understand the role of bonds and the bond market and consequently much of these fine discussions go straight over my head, preventing me from making any personal analysis of the arguments. Then I stumbled onto this link – showing on ABC tv in Australia tonight.
If anyone does watch, can you report back on whether the info is accurate/useful?
bye for now.
contrarian, thanks for the answers above – I’m finding this discussion useful, so let’s continue…
Also macca, a question for you – your hypothesis makes much sense, however it will be strengthened if you can extend it to cover whey japan failed to experience hyperinflation – ‘the exception that proves the rule’.
Regarding the weimar problems, why was it that if the hyperinflation was due in part to vital good scarcity driving inflation in the post war years, that the nazi reichsmark managed to revive the economy – presumably during continued difficult economic conditions persisting throughout the 30′s (being in the middle of the GD and all)?
Next a general theory of hyperinflation should address zimbabwe – which on the face of it seems to be a straightforward case of government madness and outright money printing.
So to conclude it would be useful to draw zimbabwe, japan, weimar and the nazi economy together to look at common and un-common factors in the fundamentals of all these situations.
Once I satrted digging, I quickly found an article suggesting Japan is first for hyperinflation.
http://www.marketoracle.co.uk/Article10738.html
“May 18, 2009 – 07:40 PM
By: DailyWealth
Economics
Best Financial Markets Analysis ArticleTom Dyson writes: Mrs. Watanabe is dumping the yen. According to a story from Bloomberg this week, Japanese businessmen, housewives, and pensioners are dumping the yen against foreign currencies, especially the Australian dollar, the New Zealand dollar, and the euro. Women control the family finances in the typical Japanese household, so the international media has nicknamed the Japanese individual investor “Mrs. Watanabe.”
Bloomberg says Mrs. Watanabe is now short 153,326 contracts against the yen. That’s 35 times the short interest on March 4, the day the dumping began. There’s so much excess saving in Japan, the country’s interest rates are miniscule. Right now, the interest rate on a one-year CD is Japan is 0.25%. Compare Japanese rates to foreign rates: The Aussie dollar yields 3%. The Brazilian real yields 10.25%.
…
Here’s the thing: The Japanese government is broke and can’t pay back its debts. I think the gargantuan fall in the yen comes when Mrs. Watanabe figures out Japan’s government will never pay back the $7 trillion she loaned it.”
Also another article in a similar vein:
http://www.meltingpotproject.com/mpp/how-hyperinflation-will-hit-america.html
scepticus,
“Regarding the weimar problems, why was it that if the hyperinflation was due in part to vital good scarcity driving inflation in the post war years, that the nazi reichsmark managed to revive the economy – presumably during continued difficult economic conditions persisting throughout the 30’s (being in the middle of the GD and all)?”
The hyperinflation occured in 1919-1923 not only in Germany but also in Poland and Hungary.
They introduced hard currency in Germany in 1923. The Nazis come to power in 1933 as a consequence of the crisis and deflation.
“The stock market crash of 1929 on Wall Street marked the beginning of the Great Depression. The effects of the ensuing world economic crisis were also felt in Germany, where the economic situation rapidly deteriorated. In July 1931, the Darmstätter und Nationalbank – one of the biggest German banks – failed, and, in early 1932, the number of unemployed rose to more than 6,000,000.”
http://en.wikipedia.org/wiki/History_of_Germany
I don’t have time for a more thorough analysis but I strongly advice to become more familiar with the official interpretation of history before considering conspiracy theories.
In 1919 situation was completely different than in 1933.
correction – hyperinflation in Germany started in 1921.
It started in Poland earlier due to the war with Soviet Russia 1919-1920 and the budget deficit (which reached 155% in 1921 after winning the war).
http://en.wikipedia.org/wiki/Inflation_in_the_Weimar_Republic
http://en.wikipedia.org/wiki/Hyperinflation
http://www.huffingtonpost.com/michael-j-panzner/holes-in-the-china-recove_b_211054.html
China’s economic performance may not be all it’s cracked up to be.
MACCA,
There is an even more interesting story unfolding right now. The collapse of Ukraine – 23% GDP drop, the Russians playing hard ball. The govt of Ukraine banned publishing statistics there.
(And this is probably the best solution to GFC anyway)
You won’t read about it in Englisg speaking media. I can translate the news in the evening.
MACCA and others.
Does GDP meen very much anyway. The OZ GDP rose is the last quarter! We have a “not technical recession”. LOL
This was put down to the fact that we had a rare trade surplus. But the current account was stil in deficit leaving the 34 year loosing streak unbroken. It appears that this Metric called GDP can be borrowed and still counted as a nett asset! LOL
If the fuel guage on my car was behaving like this I would get a new one.
GDP and GDP “growth” or should that be something called “groath” is a joke and we need to find a new, valid metric. The neo classicals do not seem worried about this demonstating their collective stupidity.
“Brightspark” you are too generous!! “neo classicals do not seem…” Me thinks it is becoming ridiculous the way the ‘mass media’ is now behaving!! 1984! has arrived!(or maybe the ‘movie: “V for victory” Scary Stuff!! now!!
Next headline will be: R
“Recession Over!!” Let us all rejoice!!
BrightSpark1,
Outside of a RIO or BHP boardroom , Australian’s are in a recession.That is all that can be said of the 1Q2009 GDP figure.
Moreover, those ore shipments that got the GDP figure over line included substantial speculative orders by brokers and middlemen rather than demand from mills. The Govt is trying to clamp down on speculation but is having problems. In any case , a recovery it is not.
http://www.theaustralian.news.com.au/business/story/0,28124,25588476-5005200,00.html
“The government-controlled China Iron and Steel Association has completed a detailed investigation into the stockpile, which triggered alarm bells with China’s leaders earlier this year as volumes started to quickly mount but demand for steel stayed flat.”
http://www.chinamining.org/News/2009-05-15/1242347700d24689.html
“Customs data showed that six of the top 10 iron ore importers in the first quarter were traders, compared with an average of two or three.”
ak,
I found the “meltingpotproject” article posted by scepticus above an interesting read. It speculates that after a dollar rally (BTB?)there ensues a fiat currency meltdown with origins beginning in Eastern Europe , leading to global competitive currency devaluations and then commodity hyperinflation.
It articulates much further along the lines of what I was thinking when I wrote this;
“At best I think the US can achieve a wide trading range for the USD primarily because Europe and Japan are basket cases too. It is negative selection at work- of all the turds, the USD just happens to be the turd that floats-for now.”
Meaning the main thing helping the USD presently (besides reserve status) is the poor state of Europe and Japan.
If *negative selection* of paper currencies in general reaches the extremes of meltingpotprojects scenario, this then will truly be a global inflation flame out of epic proportions.
The Miseans will be proved right as gold prices (in fiat currency) will go ballistic?
The problem’s actually more complex. If I had time I’d whack up a post, but I’m trying to steal some time to work on my book.
Briefly, the “textbook” definition of GDP is:
GDP = C+I+G+X-M
“GDP equals consumption plus investment plus government spending plus exports minus imports”
M fell by 9 billion, X (more on this in a sec) fell by 3 billion, so there was a +6 billion turnaround in the “net exports contribution to GDP” (as it’s known).
Now for a healthily growing economy, all 5 factors would be increasing–including imports, since lots of the C+I+G are spent purchasing them. But suddenly spending on imports has dropped $9 billion in a quarter–that’s over 2% of GDP. That implies that spending has dropped, not risen. This is not what I call a sustainable “growth” pattern.
Secondly, the “increase” in exports that was spruiked when the GDP figures came out. The GDP figure is a “real” measure: the ABS has survey info on nominal output, and then produces the real by deflating it (which produces what is known as the chain-weighted GDP figure). So they take actual dollar amounts and divide them by a range of price indices to generate the real GDP figure, which attempts to quantify the actual level in output.
Since we are a large exporter, the export price index is obviously important. This is normally revised by the ABS every June, to reflect changes in annual contract prices that are normally settled in April.
For some reason, they used the revised price index in this quarter’s figures–one quarter earlier than normal. These revised contracts have much lower prices–up to 40% falls for some commodities–so the resulting price index was much lower. (Thanks to Gerard Minack of Morgan Stanley for the detective work on this).
Divide a known dollar figure for coal exports by a smaller estimated price index and what do you get? A dramatic increase in the volume of coal exports… In fact, the exported tonnage probably fell significantly (this could be calculated by adding up all the reported tonnages, but since the ABS GDP survey works at the higher level of aggregation of dollars produced [and disaggregation would mean recording dollars of brown coal, dollars of coking coal, blah blah... and deflating each separately] this isn’t an option for them.
This explains the “huh” factor of the very next day’s announcement that we had gone from a substantial trade surplus to a deficit. How does that tally with the “increase” in exports in the GDP figures? The trade deficit is the dollar value of exports minus the dollar value of imports–there is no “price deflating” going on.
So putting this all together, the probable outcome for real output in the last quarter was a fall of over 2% (looking just at C+I+G+X).
MACCA,
I think that the size of these Eastern European economies which are really sick is too small to start a meltdown. Sick are Lativia, Ukraine, to some extent Hungary and Slovakia. Not Poland though. Poland is doing quite well.
The political background of the conflict in Ukraine is coralling Ukrainians back to the Russian political backyard.
More on this:
http://www.smh.com.au/world/help-ukraine-pay-for-gas-or-its-cut-off-again-putin-warns-west-20090604-bx9z.html
and more:
http://www.boston.com/business/articles/2009/06/04/ukraine_economy_down_21_percent_in_q1/
I will need to spend several hours on reading so I may post another update on this tonight or tomorrow.
Thanks very much for the clarification Steve.
The ABS is simply an adjunct of the modern version of Orwell’s Ministry of Truth (MoT).
It is neutered by political spin and coersion. Much like Treasury. Desperate measures for desperate times.
The Outback Oracle,
“Don’t underestimate the degree to which Asians think ahead. They are quite prepared to sacrifice personal consumption for benefits arising in 20 years time.”
You make some valid points.
Although, the relevance and nuinsece of my point has more to do with a critique of the development model that Governments of the Asian ecomonic region have implemented post WWII. Please let me explain.
The Asian economic development model has, and is still, focused on running current account surpluses.
For this region to maintain current account surpluses, they *must* be, by definition, producing more goods & services in excess of what they are willing to consume. This is an indisputable truism.
Governments of this region have adhered to policy stances that have suppressed, or at least, not provided the necessary conditions to enable their domestic market consumption to flourish. Whilst in equal time, the Asian development model has focused on the development of the regions export industries.
This policy stance has resulted in the successful expansion of the regions industrial productive capacity, for the sole purpose of increasing the supply of tradable goods and services to its trading partners.
This stance, amongst many other less dominant factors, has manifested enormous trade and competitive imbalances between the various trading nations. These trading and competitive imbalances are particularly prevalent between the US and PRC, although the US and PRC are not on their own here.
Moreover, it is the automatic consequence of the PRC’s need for the US to absorb its vast manufacturing overcapacity. Nothing scares the mandarins of Beijing more than the idea that the US might undergo, or even force, a sharp reduction in its trade deficit with the PRC which, of course, would have the automatic impact of forcing the PRC lending to the US to collapse, as well as, collapsing their own export industry at the same time. The two are inextricably linked.
Whilst, China continues with such policies that maintain current account surpluses by supressing the RMB’s appreciation, they must continue to purchase USD denominated assets, if they do not wish to have the RMB appreciate significantly against the USD. This is an indisputable truism.
The PRC can of course purchase all manner of foreign assets that foreign governments will allow. There are, of course restrictions on what, and how much of what, foreign agents are able to invest in. This is nothing new nor ominus.
The PRC, are taking advantage of price declines, by divesting their USD reserves, through stock piling raw commodities. Although this activity is ephemeral in nature. Further, they appear to be purchasing non-USD denominated assets around the world, some of which are in our back yard. Please see:
”
SAFE’s Foray on Aussie Bank Assets Puzzles Market
By CSC staff, Published: January 08,2008
Related articles
A 200 million USD investment of China’s foreign reserves by the State Administration of Foreign Exchange has come as a surprise to international financial markets. How China will deal with its 1.5 trillion USD foreign reserve has been a mystery lately and small part of that mystery has just been answered. And it wasn’t as most people expected.
SAFE, through its Hong Kong-based subsidiary ‘SAFE Investment Company,’ purchased a minority stakes in three of Australia’s biggest banks — a 1% stake of both Australia & New Zealand Bank (AZZB) and Commonwealth Bank of Australia (CBA), and nearly 0.33% of the total stake of National Australia Bank — altogether at a cost of 200 million Australia dollars (USD 176 million)….”
http://www.chinastakes.com/article.aspx?id=138
A point to note, here, regarding central bank reserves is that they are *intended* to act as a buffer to counter currency shocks. This is, definitely, not the intended purpose of the PBoC $USD 2T reserve portfolio. When the PBoC goes off purchasing assets that can not be readily liqudated, and as such, go against the raison d’etre for accumulating currency reserves, then this accumulation of “reserves” has been garnered under impropriety.
This policy stance of reserves accumulation by PBoC, can not, and will not continue forever. At some point, the PRC will willingly, or through coercive uni-lateral measures taken by the US, alter its policy.
The PRC is still, at this very moment, running a current account surplus with the US, although significantly diminished to that of the recent past. The US consumer has taken the first step in this readjustment. Although, it is to early to say, whether the consumer retrenchment, on its own, is sufficient to cause the PRC to alter its long-term policy stance or merely continue its attempt to “get blood out of a stone”, through further currency depreciation. Time will tell.
It will be clearly evident, when the PRC has altered its policy stance to allow the RMB to appreciate with respect to the USD. This adjustment will likely not be sudden, rather a gradual readjustment that will be agreed upon between the PRC and USG. For both the fait of the US and that of PRC are intimately tied together.
The only other alternative is for the US to attempt to compete with PRC and offer PRC tradable goods & services that the the PRC desires over and above those that PRC can offer the US. This will not be an easy course to steer.
The dominant financial risk that the PRC may face, isn’t the risk that the USG won’t honor its Treasuries. Rather, it is the risk that the USD will eventually depreciate against the RMB, reducing the RMB value of PBoC’s Reserve portfolio.
The current rhetoric from the PRC mandarins suggests that there is a lack of commitment to any policy change. Take for example:
“China to Take Steps to Boost Exports; Will Keep Currency Stable
By Bloomberg News
May 27 (Bloomberg) — China’s State Council, or Cabinet, said the government will take steps to boost exports while keeping the country’s currency “basically stable,” the state television reported today.
Falling exports are the biggest challenge for the world’s third-largest economy, the council said.
China introduced a 4 trillion-yuan ($586 billion) stimulus package last year as exports slumped and economic growth slowed. Maintaining external demand can create favorable conditions for employment, businesses and domestic consumption, China Central Television said today, citing a council meeting headed by Premier Wen Jiabao.
The nation will keep its currency “basically stable at a reasonable and balanced level,” the council said, without elaborating.
China will take all measures to stabilize overseas demand as shrinking exports are the nation’s biggest challenge, “currently and for some period of time in the future,” the council said.
The government will focus on exports involving intensive labor and advanced technology, according to the report.
The government will arrange $84 billion in short-term export credit insurance for 2009, the council said. The coverage of export credit insurance will also be expanded, it said.
China will allocate additional funds to support exporter guarantees, according to the report. About $10 billion will be set aside as credit for the export industry in 2009, the state television said, without elaborating.”
http://www.bloomberg.com/apps/news?pid=newsarchive&sid=a_eNXWnQtdcg
iconoclast,
I agree with your observations however I don’t understand what’s wrong with what they are doing.
“Governments of this region have adhered to policy stances that have suppressed, or at least, not provided the necessary conditions to enable their domestic market consumption to flourish.”
Why should they enable that consumption? I would argue that Asian culture is about moderation in consumption. It is also about accumulation. “To be rich is glorious.”
I think that they are right. We are wrong.
Obviously there might be some problems caused by the trade imbalance but I think they are well aware that maybe 20 or 30 years of cheap commodities are left and then the party is over. They want to build as much infrastructure and real wealth as they can over the next 20 years and start worrying about the consumption later.
American consumers will be tossed away as an empty eggshell at some point in the future. So what?
Ak,
I agree, in part, with you’re conclusions as well.
My analysis is more of an attempt to reach conclusions on how these dynamics will play-out using organons of logic, rather than an attempt to make a moral judgment call.
Although, in some instances when the rules of “fair” trade, are not bent, but broken, then we have an outcome that is for all concerned a race to the bottom.
On the one hand, the leading proponent countries of laissez-faire free-market ideology, who chose the rules, have had it shoved right back down their throats.
Having said the above, the Asian development model did produce more goods & services than what the region had been prepared to consume.
So the question is why did they produce more than what they were prepared to consume?
This point on its own, suggest that it has nothing to do with their culture of saving, but their choice of over producing above their own desire to consume and to export the balance to their trading partners.
Now given the raison d’etre of the existing economic system is based on the culture of consumption they were able to find ready markets prepared to consume their tradable goods. If that were not the case, there would be no reason to attempt this policy.
I conclude the economic model based on consumption, and in some countries, over consumption, is at the heart of the problem.
Many of you might be interested int this,
http://www.newscientist.com/special/can-science-reinvent-economy
Hi scepticus!
Actually, the Nazis did not issue the Reichmark. What happened was that the Germans replaced the hyperinflated Papiermark with the Rentenmark in Nov 1923, which was backed by mortgaged land and industrial goods. That Rentenmark was just an intermediate currency and wasn’t legal tender. The Reichsmark become the new legal tender in August 1924.
So, the hyperinflation ended long before the Nazis came into power. Here comes the interesting facts of what happened,
The stabilisation of the German currency happened in spite of monetary inflation. There’s no conclusive explanation in the book though.
iconoclast
The US military is also dependent on foreign held US dollars being repatriated via purchasing treasuries. The very weird thing is that the US could not fund its military without trade deficits. I think china is going to tire funding its rival’s military soon.
I don’t think it was just the Asians holding down consumption. The US knew they could take advantage of the dollar reserve status by spending like crazy overseas, military bases and trade deficits, and the money would come back to them to spend again. It was a massive free ride and the US took it. The top 10% got extremely rich and the rest are up shit creek without social security and health care.
ak,
Just noticed your comment. Yes what you say is correct. I have just put in a submission on funding the National Broadband Network which you can see here.
http://stableproductivemoney.wordpress.com/2009/06/12/submission-to-national-broadband-network-greenfields/
I am trying to find better ways to explain what is proposed. Another way is that we stop banks issuing loans that are backed by other loans as the way to increase the money supply. We use amassets (or something similar) that guarantees that when we increase the money supply there is something tangible backing it.