“The recession has brought forward the time when the non-Western economies produce more than half of world GDP, for the first time since the middle of the 19th century. We had expected this to happen, but not quite so soon. The West will have to start to get to grips with the fact that we are no longer dominant and cannot expect to have things our own way,” said Douglas McWilliams, CEBR’s chief executive.

The think-tank predicts the West will account for just 45pc of the world economy by 2012, and expects global GDP to fall by 1.4pc this year, the first decline since 1946.

Further Evidence of the Influence of Energy on the U.S. Economy

“Hamilton acknowledges early on in his report that the proportion of income spent on energy is an important determinant of consumer spending patterns. The theory is fairly simple: if energy expenditures rise faster than income, then the share of income for other things besides purchasing energy must decline, such as spending on mortgage payments for a second home in Las Vegas. In other words, rapid, large increases in energy prices may curtail consumption enough to trigger larger financial problems – like the bursting of a housing bubble – that when aggregated across an economy may cause or contribute significantly to a recession.”

It reminds one of a famous fable about Albert Einstein’s last exam. Upon being told that his final pre-retirement term paper in physics contained the same questions as those posited on the previous year exam, Einstein remarked: “Ah, yes, the questions are the same. The answers, however, have changed”. Link to article

By: Clive Maund @Gold Seek

Posted Sunday, 8 March 2009urce:

Something truly remarkable happened last week that has major implications for the global economic crisis – despite all the doom and gloom and the broad stockmarket continuing to make new lows, copper broke out upside from a 3-month long base pattern. Why is this so important? – because copper has a history of being one of the earliest if not THE earliest lead indicators for the world economy, so much so that it is sometimes called Dr Copper. So what happened? – let’s take a look on a 6-month chart. Link to charts

by Dr Constantin Gurdgiev

Here is a new insight into recessions dynamics. This time from the IMF (see link here)…

What Happens During Recessions, Crunches and Busts? by Stijn Claessens, M. Ayhan Kose, and Marco E. Terrones (IMF WP/08/274) looks at “the linkages between key macroeconomic and financial variables around business and financial cycles for 21 OECD countries over the period 1960–2007.”

Data set covers 122 recessions, 112 (28) credit contractions (crunches), 114 (28) episodes of house price declines (busts), 234 (58) episodes of equity price declines (busts).

The authors “find evidence that recessions associated with credit crunches and house price busts tend to be deeper and longer than other recessions... Episodes of credit crunches, house price and equity price busts last much longer than recessions do [4 quarters on average]. For example, a credit crunch episode typically lasts two-and-a-half years and is associated with nearly a 20% decline in credit. A housing bust tends to persist even longer—four-and-a-half years with a 30% fall in real house prices. And an equity price bust lasts some 10 quarters and when it is over, the real value of equities drops by half.“  Link to article with tables

By Simon Dixon

Today, as I write, the new merged UK banking giant Lloyds has underestimated the loss that is about to be incurred as a result of the merger with HBOS. The banking giant has received a huge bailout selling more shares to the government and is on its way to being yet another private bank doomed to nationalisation.

On the television I hear no mention of why this might be apart from propaganda trying to make the public angry about the CEO’s who have taken too much bonus and ’caused’ all this mess. It is very easy to divert attention away from our unsustainable system by blaming the crisis on greed when you have every newspaper and television show focusing on greed as the cause.

We are in this mess because as mentioned in prior posts we are running our economy on economic theory that does not work. Orthodox economic theory refuses to recognise that almost all of the money in our economy is created as a debt through loans. This is what a banking licence permits you to do. We are in a global financial crisis as our economy thinks that the cause is greed and lack of regulation and the cure is to take on huge fiscal burdens, leading to the nationalisation of banks so we can implement further regulation.

Nobody discusses that our economy is built upon an unsustainable foundation that will inevitably lead to a financial crisis. We do NOT need to nationalise our banks we do need to nationalise our money supply. We are here not because of some conspiracy theory about the banks or excessive greed, we are here because of our philosophy of how we should run our economy and our theory of how we should control the amount of money in our economy.

There is a huge problem with orthodox economic theories – they don’t work in the real world and the global financial crisis is evidence of this. Economists must recognise the significance of the fact that almost all money in our economy has been created through debt, debt that can never be repaid without a complete depression, if we are to get anywhere near a solution and to reach sustainable economics. Economics must question the foundation of theories such as the multiplier and the quantity theory of money and start to look at the facts. This article discusses some of the problems with orthodox economics and how it has contributed to the current global financial crisis and our philosophy of more debt, more bailouts and more bubbles to turn around our economy.

To set the foundation on current thought, as we speak the government is in the midst of decreasing interest rates until we inevitably reach zero (Monetarism in order to stimulate consumer and corporate debt), bailouts and huge stimulus packages (Keynesian fiscal policy in order to increase the national debt) and the new one is quantitative easing (The Bank of England creating money out of thin air to buy government debt). All these policies are aimed at creating more debt, because the reality is – our economy needs more debt to sustain growth and prevent a depression under our current debt based economy – take away the debt and there is nothing because almost all of our money supply is created through debt – no debt, no money. As you all know I am not against debt, I am against mixing up debt with supplying money to our economy – a task that must be nationalised. Money is far too important not to be supplied through the public sector. This system is only justified through orthodox economic theories and our misunderstanding about how to supply money to our economy as discussed below.

Traditional Money Theory

Orthodox economics does not recognise the importance of almost all of the money in our economy being created as a debt to a bank. Under the current system if our economy wants more money, we need to create more debt. More debt means more interest to be repaid. More interest to be repaid means less purchasing power. Less purchasing power means more debt to survive and so on and the cycle continues. These facts need to be incorporated into economic theories of money.

The first thing to recognise in such a debt based system is that money borrowed is not money lent; it is money created. Economists know this, but fail to apply it throughout their discipline. At the heart of the economy is money, and at the heart of modern economies is a misunderstanding about money. This misunderstanding comes from some of the theories outlined below.

The Multiplier

The suggestion that banks create money was once regarded as pure fantasy by both bankers and economists, who insisted that banks merely lend money. However, modern economics textbooks are quite open about the process. The ability of banks to multiply the quantity of money beyond the amount originally deposited with them is given an accepted title – ‘the multiplier effect’.

In conventional theory, the multiplication of money is not seen as being open-ended. Money creation by banks and building societies is not seen as an expanding process in which money created by past loans is perpetually recycled, re-loaned, providing an endless supply of new money, building up into a vast infinitely ballooning total f money and debt. The entire system is supposed to be self-limiting, with controls and restrictions built into it. According to theory, it ought not be possible for an economy to operate on 97% bank-created credit as it is today. According to theory, the money supply ought not to have been able to inflate with no more than 3% contribution from the government. According to theory, such vast multiplication should not have been possible, but the theory does not meet the facts.

Rather than an infinitely expanding balloon, the system of money creation by banks and building societies is supposed to resemble a pyramid. It is sometimes referred to as the ‘pyramid of credit’. At the base of the pyramid is a firm foundation of true money, the coins and notes created by government. Above this is the narrowing pyramid of bank created credit, which, because of the legal restrictions on banking can only reach a certain height.

Chief among these legal restrictions is that known as the ‘liquidity ratio’. This is supposed to set a strict limit to the amount of money that banks can create via loans. For some years, the liquidity ratio was set at 10%. This meant that a bank could only issue loans equivalent to 90% of the money deposited with it at any one time, since it had to retain 10% of its deposits in liquid form, such as cash. The pyramid of credit is built up by stages, at each stage a smaller round of loans leading to a smaller number of new deposits.

At the first stage, only 90% of the original, true money could be loaned, and thus return to the banks as new deposits. Of this new, smaller set of deposits, again only 90% could be loaned, and thus return to the banks as a further set of new deposits. Each round of loans is built on 90% of the previous round, and in the end, after a series of even smaller loans, the final loan is a minute amount, and the pyramid of credit is complete. Once the pyramid of credit is complete, no more money can be created by lending, unless what the books refer to as ‘brand new, true money’ is introduced at the base. In other words, only when the government creates and supplies more coins and notes as debt-free cash can the system start again, building up a further pyramid of loans on the new money.

There is only one trouble with this theory. It doesn’t apply. The liquidity ratio was abandoned in 1981 as part of the deregulation of domestic and international finance. Banks are now legally allowed to lend and re-lend without the restriction of a liquidity ratio. In fact, for years, the banking system had found ways round the liquidity ratio by investing in short-term government securities, (Which are re-deposited in banks once spent and are actively a part of the money creation process) and it had long been functionally meaningless.

The other restriction traditionally supposed to act upon banking is that known as the asset / reserve ratio. It was a requirement on banks to have sufficient sums of their own money as a standby. The purpose was to make sure that the amount of money they possessed as a company – their own capital reserves – was adequate to cover any loans that might default and not be repaid. A reserve / asset ratio of 10% meant that if banks had made loans of £10,000,000, they must have £1,000,000 in their own company reserve. In the UK, a reserve of about 10% has generally been regarded as adequate, and was for many years a legal requirement. However, like the liquidity ratio, the reserve / asset requirement has been abandoned. Today, at the time of this writing, the only legal reserve / asset requirement on banks is that 0.5% of all their assets be logged with the Bank of England in the form of notes and coins. Financially, this is a total irrelevance. As a limitation on banking it is also meaningless, since the Treasury supplies notes and coins to commercial banks to meet the general demand, and this 0.5% simply becomes part of the overall demand for coins and notes!

The reserve / asset ratio has been replaced by the ‘capital adequacy’ ratio. Again, this is a requirement on banks to have sufficient capital of their own, and is set at 10% on international agreement. But there is no requirement that this 10% reserve be held in cash; indeed the bulk of the banks capital is held in the form of investments, especially government bonds. But whenever a bank purchases government bonds or any other investment using money from its capital reserves, the money enters the economy, and then registers as a new deposit. Instead of being a restriction on banking and money creation, the money supply process is actually sustained by such bank purchases from reserves.

Despite the fact that both the liquidity ratio and capital reserve have either been abandoned, or become totally meaningless or counterproductive restrictions, economics textbooks and banking theory still present money creation in the context of these supposed restrictions.

The last thing that is being suggested here is that a restoration of these controls is what is needed. As we speak the government is discussing more regulation as the solution for the global financial crisis. History has shown, there has hardly been a moment in history when the banking system has actually been under control, and this will never work, except to the disadvantage of the majority of the population, the banks themselves and the functioning of the economy. The point about the multiplier theory is that it has allowed economists to believe in and present the current system as one that operates under control, when it empirically does not.

Under this understanding most believe that bank credit only lasts for the duration of the loan, and upon repayment will be cancelled out of existence. This is not what actually happens at all! As any bank manager will confirm, when money is repaid into an overdrawn account, the bank cancels the debt, but the money is not cancelled or destroyed. The money is regarded as being every bit as real as a deposit; it is regarded by the bank as the repayment of money that they have lent. That money is held and accounted as an asset of that bank.

The fact that upon repayment, money that they have created is not destroyed, but is accounted as an asset of the bank, proves beyond dispute that when banks create money and issue it as a debt, they ultimately account that money as their own. The only factor which disguises their indisputable ownership of the money they create is the fact this returning money is usually rapidly re-loaned.

Borrowing in the modern economy almost always outpaces repayments, which is why the money supply escalates. This means that money returning as repayments usually does not accumulate in the banks own account, but is quickly re-loaned, along with more debt.

When borrowing is sluggish, during a recession as we are in today, some banks can be awash with money from past repayments in their own account. This surplus money can be used to boost the banks balance sheet as is badly needed today or can be used by the banks and building societies to make investments, purchasing stocks and bonds available on the world money markets, boosting their company reserves hugely, and placing beyond doubt whose money this is.

The point about repayments is that money is not destroyed, but is withdrawn from circulation. Thus the total of deposits held by the population is decreased. In this sense, a deposit has been destroyed, but not the money. Upon repayment of a loan, money returns to the bank or building society that created it. This money then only re-enters the wider economy if someone else takes out a loan, or if the bank spends the money on an investment. Either way, this money is accounted and treated as the banks own property. Therefore it is true to say that loans are temporary, but the money created by banks is permanent. Once created, it belongs to the banks, constantly returning to their ownership and control, with the repayment of each debt. This is how 97% of all money in our economy is created today and economic theories must recognise this if we are to reach the conclusion that we need to nationalise our money supply not our banks.

Monetarism

As the government does not directly control our money supply and the multiplier effect has ballooned out of control, the Bank of England uses monetary controls indirectly by controlling interest rates and the cost of borrowing. Another element in economic theory relating to banking and the money supply is the use of interest rates. Fluctuating interest rates are used both to influence the rate of bank lending, and as a policy intended to cover almost the entire realm of economic management. As we cannot control our money supply directly we must influence the money supply indirectly through interest rates. The school of thought from which this economic policy derives is the Chicago School, initiated by irving Fisher, and later championed by Milton Friedman. It is the ideology which completely dominates modern economic thought.

The philosophy is to give full rein to the free market, whilst attempting to guide the overall activity of the economy by managing the money supply. This a government does by lowering or raising interest rates through the monetary policy of the central bank. This alternatively encourages and discourages borrowing, thereby speeding up or slowing down the creation of money and the growth of the economy. Low interest rates encourage both industrial investment and consumer borrowing, leading to a growth in the money supply. High interest rates mean that new borrowers are deterred and the growth in the money supply is slowed. The fact that, by this method, people and businesses with outstanding debts can be suddenly hit with huge extra charges on their debts, simply as a management device to deter other borrowers, is an injustice quite lost in the almost religious conviction surrounding this ideology.

Just when the economy is getting going, investment is healthy, jobs are being created and production and prosperity are increasing, the economy is deemed to be overheating , and the great bogey, inflation, appears. And the only way that modern economics can think of to cope with a financial phenomenon over which all economists disagree – inflation – is to stamp on the entire money supply, throwing the entire economy into recession, bringing bankruptcy to millions.

This method of controlling banks, inflation and the money supply certainly works; it works in the way that a sledgehammer works at carving up a roast chicken. An economy dependent upon borrowing to supply money, strapped to a financial system in which both debt and the money supply are logically bound to escalate, is punished for the borrowing it has been forced to undertake. Many past borrowers are rendered bankrupt; homes are repossessed, businesses are ruined and millions are thrown out of work as the company sinks into recession. Until inflation and overheating are no longer deemed to be a danger, borrowing is discouraged and the economy becomes a stagnating sea of human misery. Of course, no sooner has this been done, than the problem is lack of demand, so we must reduce interest rates and wait for the consumer confidence and the positive investment climate to return. The business cycle begins all over again.

There could be no greater admission of the total and utter inadequacy of modern economics to understand and regulate the financial system than through the wholesale entrapment and subsequent crippling of the entire economy. If we think that this is better than controlling the money supply directly by nationalising our money supply then it is no wonder we are in a global financial crisis.

Inflation

Orthodox economics explains inflation as ‘too much money chasing too few goods’. Michael Rowbotham believes Inflation is not caused by too much money; it is caused by too much debt-money. He believes Inflation is entirely due to a lack of permanent stable money stock and our reliance upon bank credit to supply the majority of our money. The backlog of debt constantly feeds through into industrial costs, raising prices and depressing consumer spending power. It is this lack of purchasing power – the gap between prices and income -which Michael believes is the driving force behind inflation. His theory seems to be the most consistent with the real world facts too.

Inflation is nothing but the upwards drift of prices and wages in an economy where industry is desperately trying to recoup outlay and cover all the financial costs of production, whilst the consumer is desperately trying to bridge the gap between their income and the price of goods. Inflation is the result of the two sides of the economy – consumers and producers, wages and prices – being set at odds by the perpetual lack of purchasing power, and it is quite endemic under a debt based system

In economics inflation is attributed to the very opposite! Inflation is declared by most economists to be ‘too much money chasing too few goods’. In an economy based 97% upon money that has had to be borrowed into existence, when the total of debt is in excess of the entire money stock, when everyone is competing for what money exists to avoid further debt, when the money in circulation is required both as a medium of exchange and also required to repay the debt that created it, when a booming economy has been financed on the back of consumer borrowing and industrial borrowing for investment, when our everyday experience is that there is never enough money and when there is a superabundance of goods and services of all descriptions – quite honestly, does ‘ too much money chasing too few goods’ sound realistic? Quite honestly, which is the more likely? That inflation is due to excess money or the backlog of debt? Turning their back on debt and completely ignoring one half of the spiralling money supply process, economists deem inflation to be caused by ‘too much money’.

The idea that inflation is due to debt and excessive banking is not a novel suggestion, indeed it is contained in the very word ‘inflation’ which was originally applied to the expansion of money by banks beyond its true amount through the creation of additional credit. However, the suggestion that the action of banks in ‘inflating’ the currency could lead to price inflation has in recent years been completely swamped by a single theory of inflation – the Quantity Theory. This argues that if the quantity of money, or its speed of circulation, rises to the point where more money is available than is necessary for the purchase of goods currently available, then the prices of those goods will rise to absorb this ‘excess’. Inflation is thus seen as an automatic and inevitable result of any increase in the money supply above that needed for the purchase of goods. The quantity theory of inflation, which disregards completely the nature of money and the impact of debt on prices and incomes, is contradicted by almost every piece of evidence we have, whilst the role of debt in causing inflation is confirmed.

Over the centuries, there has been a constant complaint by ordinary people of poverty amidst plenty – not ‘too few goods’ but ‘not enough money’. There has also been a parallel complaint by industry of the difficulty of finding a market for their goods at prices that allowed them to stay in business. A difficulty in producing goods is never industry’s complaint. The difficulty is in selling goods, which strongly argues a lack of money, and in meeting costs, which strongly argues excessive debt. Inflation as ‘too much money chasing too few goods’ seems historically completely different to reality. But it does show a striking parallel with the increasing reliance upon bank debt-money.

If inflation were anything to do with ‘too few goods’ it ought to have died out decades ago with the choice of goods growing exponentially, not increased over the years.

As for ‘too much money’, how can this be said to apply? As we have seen, the average family and the average business is up to its eyeballs in debt of one kind or another mortgage, overdraft, credit cards and hire purchase. What is more, the level of personal and business debt has increased over the last fifty years, at precisely the time that inflation has become an annual feature. Add this to the fact the governments constantly complain of not enough money to spend on pensioners, hospitals, education or whatever.

The economist’s explanation of inflation is riddled with such contradictions and inconsistencies. None of it makes sense, and none of it explains why inflation is so persistent, despite all efforts to control it. In particular, there is a complete failure to account for the fierce price inflation that occurs during a period of economic boom when there is no question of ‘too few goods’. Why do prices soar during a boom? Why is competition deemed suddenly inoperative as a factor holding down prices, just when competitive growth is at its most intense?

The reason the prices rise once recovery is underway is that firms have been investing, and must repay the costs associated with this investment. The debt may be in the form of a bank loan, or it may be in the form of an obligation to pay dividends on a new share issue, but either way, new overheads have been incurred and these must be reflected in prices. The rapid price inflation during a boom is caused by firms charging the true financial cost of goods. Prices begin to reflect what firms actually have to charge in order to meet their costs. As prices rise, incomes get left behind and the lack of purchasing power in a debt economy starts to become apparent. This price rise and lack of purchasing power continues until no more debt can be sustained and we enter a financial crisis as people default on their debts.

Such an analysis also helps to explain the behaviour of prices during a prolonged recession. During a recession, the gap between prices and incomes that would be evident if firms charged the full price of goods is masked. Firms try to hold back costs and so keep prices low. But they cannot do this indefinitely. If a recession continues for a number of years, more and more firms are unable to defer costs, and slowly prices start to creep up to meet costs. The fact that such price increases are due to pasts costs incurred, and not current wage rises, is obvious, yet economists are totally stumped by the phenomenon of inflation during a prolonged recession, or ’stagflation’ as it is termed.

Almost all the instances of hyper-inflation have taken place in economies crippled by their debts. The South American and African countries where inflation has at times ranged between 100% and 500% per year were all, without exception, suffering at the times from huge debts to the IMF and World Bank 0 debts upon which they had to make substancial annual repayments. The inflation in Germany during the 1920’s, which is often attributed to the German government running up an excessive government deficit, was equally associated with an explosion of debt.

The global financial crisis

As a result of this debt based system growth can only be sustained if we continuously take on more debt to supply the economy with the money it needs. However, the money the economy needs can never be achieved, as there is more debt than money, so we must continually re-finance in an endless spiral of debt. This debt incurs ever increasing interest charges and leads to price inflation as the only way to service past industrial debts.

In a situation where prices are rising relative to income, consumers have three options; either accept that their income buys less, press for higher wages, or borrow to buy. Of these, seeking higher wages was once seen as the ‘least-worst option’; however this simply produced the spiral of wage / price inflation of the 1970’s. A rise in wages can never close the gap between prices and incomes, since the gap is not due to the level of wages, but the effect of debt. All that a rise in wages achieves is to push up prices yet higher, the debt component of prices and the erosion of incomes by mortgages both remain.

Leading up to the financial crisis, people tended to regard ‘borrowing to buy’ as the least-worst option. Of course, all this borrowing meant lower disposable income in the future, whilst all industrial borrowing for investment will be represented in higher prices in the future. We are told that consumers have spent beyond their means and bankers have been greedy. The reality is consumers have re-financed to survive as banks have propped up the unsustainable system for as long as possible by increasing debt levels until the only borrower was those sub-prime borrowers who eventually defaulted. To blame this on consumers overspending and banks over lending is just an inevitable consequence of unsustainable economics and all they did was maintain debt to prop up the system for as long as possible. Now the government steps in and takes on the debt the economy needs to sustain the unsustainable.

This cycle is now over, we must nationalise our money supply not our banks and we need to move towards sustainable economics. Our current policies are all geared towards sustaining the unsustainable through increasing consumer and industrial borrowing (Lowering interest rates), increasing government borrowing (Fiscal stimulus and bailouts) and quantitative easing (Creating money out of thin air and loaning it to the government).

The mathematics of debt is uncompromising and the gap between prices and incomes in a debt economy cannot be concealed indefinitely by ever more debt-buying.

What we are experiencing now is a true deflation, involving falling prices and wages. The result is massive bankruptcies across the economy. This is hardly surprising since, with a general fall in both prices and incomes, the debt component of the price of goods is increased.

Concluding thoughts

To refer to bank credit creation as ‘the money supply’, as both government and economists do is completely misleading. The whole point is that, apart from the government’s trivial 3% contribution of coins and notes, there is no money supply. To call mortgages and loans ‘borrowing’ is also misleading. They are charter for the private creation of credit, charged at interest, and advanced against a person’s future income, allowing the purchase of goods already in existence, but for whose purchase insufficient money exists.

Also, the intermediate squabble between left and right on taxation and spending priorities does not represent the full range of choices. The real political option is embraced by the creation and supply of money by government instead of private banks when we nationalise our money supply. This completely opens up the economic options of extra funding, increases the political choice of expenditure and offers the prospect of true welfare. How dare a government claim it cannot find the money to pay for this or that when they do not bother to create any money?

A full understanding of the financial system provides a solution for so many micro and macroeconomic conundrums and financial contradictions that it can only be described as a revelation. The analysis and proposals for monetary reform offer a leap forward in economic understanding of quite breathtaking dimensions, and promises a revolution in the entire discipline. Academically, as well as in practical terms, to say this is exciting is an understatement.

From EndTheRecession.org

February 20th, 2009

The following may seem to be a brain teaser, but if it clicks in your mind, you will suddenly have a very different perspective on the world, and in particular, the current crisis. Enjoy.

There is one need in society that will always exist. No matter how much certain individuals believed that they couldn’t live without their Porsche, they will find that there is only one thing that really matters. That one thing is food.

Society is held together on the basis of one commonly held assumption – that when you walk into a certain designated buildings and hand over a piece of delicately printed paper, you will be given food in exchange.

This might seem a little like stating the obvious, but this highlights the absurdity of our current position.

When all is said and done, we know that the computers, cars, designer clothes, foreign holidays and other trappings of luxury mean very little in a near survival situation. Anyone who has spent any time in a near-death scenario will understand what little value you really place on such physical things. What really matters to us, in moments of clarity, is that our loved ones and ourselves are fed and safe from harm.

Now, we’ve come a long way over the last few hundred years. We know that we can, without a doubt, organise ourselves in such a way that everyone in our society is provided for, with at least a shelter and adequate food to stay alive.

In fact, we can do much better than that – we can provide everyone with food, clothing, heating, internet, telecommunications, mobile phones, public transport – the list goes on. We have made enough progress in technology and in the art of organising ourselves that we can ensure that everyone is provided for.

Except, that is, in a recession.

Take money out of the equation

Forget about money for a short while. Doing so will help you see the absurdity of the situation we are in.

A few hundred years ago, you would most likely spend your time working on the farm, producing the very food that you eat.

In modern times, you work away from the fields, producing various things that people want. In return, you are given tokens – gold coins, printed paper sheets, or more commonly now, numbers in a database. You take this coin, paper or numbers and exchange them for food.

You work, you contribute to society, and in return you are given tokens that you can redeem anywhere in society.

We can see that there is a voucher system in place. In the UK, the vouchers are called pounds. In the US, they are called dollars.

Now imagine, one day, somebody realises that we have all been using more vouchers than we have been earning. You get your vouchers in return for contributing to society (the genuine value you contribute is an issue for another debate, but let’s just look at the monetary value). If you are using more vouchers than you have been earning, then you are taking more than you give. Naturally, someone else, somewhere, must be giving more than they take. The real, physical economy can only be a zero-sum game.

Would it be possible that everyone was taking more than they give? Everyone was simultaneously eating more food than they produce?

Of course not – the food would run out within days.

The absurdity of the current situation…

So when we find ourselves in a situation where the vast majority of people are in debt, and the total of their debt far exceeds the value of everyone else’s savings, who exactly is under-consuming?

How is it possible that we are all taking more than we are giving?

It isn’t, neither mathematically nor logically.

If you understand this, the complete absurdity – and the complete illegitimacy – of the current monetary system should become apparent.

After all, how can we all simultaneously be ‘borrowing from the future’ when everything that we have borrowed to buy exists NOW, in the present?

What would happen if we were to cancel all our debts right now? Literally wipe the slate clean, forget about money completely. (This is not necessarily a proposal – just a mental riddle).

What are we left with?

If we removed money from the equation, what would we be left with?

We would be left with everything that we currently have.

We would be left with an ample supply of housing, machinery, office space, computers, food, and people with time on their hands.

In other words, we have everything we need to continue living the way we have been living for the last few years.

Everything we consumed in that period was created in that period – not in the future – so why do we need to ‘pay for it’ in the future? The idea of ‘living beyond our means’ works applies to some individuals, but can not apply to everyone collectively. It’s true that a 20 year old may have spent more on credit than they have earned in their lifetime, but how is it possible that we have all spent more than we have earned?

It’s all about the numbers

This current recession is all about a defective monetary system and a currency that is nothing more than numbers floating around in a computer system. It has no basis in reality.

Big decisions

It’s time for us to make some big decision about how we organise ourselves as a society. If we were starting from scratch, would we really design a system like this? Would we design a system whereby our decisions about what we produce and how much we work is determined by the numbers created in a computer system? Would we design a system which inevitably results in a shortage of those very numbers every 7-10 years? When we are sat here, looking for work; when businesses are sat there, looking for consumers; when banks are sat there, looking for customers; and no-one can make the first move simply for the lack of electronic numbers?

This is a crazy system. A recession is an absurd idea, and can only happen in a society that has become too wrapped up in the numbers and statistics to see the reality and common sense behind the situation.  It’s time we started again.

But the beauty of the solution is that we don’t even require a revolution – it’s very simple to get out of this depression. Find out just how simple it is by reading The Solution.

13 February 2009

http://www.voxeu.org/index.php?q=node/3065

This is not an ordinary recession that differs from other recent episodes simply by being somewhat more severe. It differs in kind.

The end of the Cold War brought a decline in military spending and a recession which impinged most heavily on the states, like California, where the military-industrial complex was an important part of the local economy. The nationwide unemployment rate rose from 5.25% in 1989 to 7.5% in 1992. It then fell every year reaching just under 4% in 2000. The “free market” took care of the recession of the early 1990’s. Resources moved from the defence industries, trickling into other uses through innumerable channels. The federal government did not need to take a hand. Beginning in 1993, the federal deficit in fact shrank every year turning into a modest surplus in 1998. That was a very ordinary recession.

If the current situation were at all similar we would expect a recession in residential construction with unemployment among construction workers and mortgage brokers. Naturally, recent boom areas would be hard hit but we would expect resources gradually to trickle into alternative employment. Instead, we are threatened by a veritable disaster.

Balance sheet recessions

What is the difference? It resides in the state of balance sheets. The financial crisis has put much of the banking system on the edge – or beyond — of insolvency. Large segments of the business sector are saddled with much short-term debt that is difficult or impossible to roll over in the current market. After years of near zero saving, American households are heavily indebted.

The holes that have opened up in the balance sheets of the private sector are very large and still growing. A recent estimate by Jan Hatzius and Andrew Tilton of Goldman Sachs totes up capital losses of $2.1 trillion; Nouriel Roubini thinks the total is likely to be $3 trillion. About half of these losses belong to financial institutions which means that more banks are insolvent – or nearly so – than has been publicly recognised so far.

So the private sector as a whole is bent on reducing debt. Businesses will use depreciation charges and sell off inventories to do so. Households are trying once more to save. Less investment and more saving spell declining incomes. The cash flows supporting the servicing of debts are dwindling. This is a destabilising process but one that works relatively slowly. The efforts by financial firms to deleverage are the more dangerous because they can trigger a rapid avalanche of defaults (Leijonhufvud 2009).

Three examples

Richard Koo (2003) coined the term “balance sheet recession” to characterise the endless travail of Japan following the collapse of its real estate and stock market bubbles in 1990. The Japanese government did not act to repair the balance sheets of the private sector following the crash. Instead, it chose a policy of keeping bank rate near zero so as to reduce deposit rates and let the banks earn their way back into solvency. At the same time it supported the real sector by repeated large doses of Keynesian deficit spending. It took a decade and a half for these policies to bring the Japanese economy back to reasonable health.

The US Great Depression saw no consistent policy of deficit spending on adequate scale in the 1930’s. War spending not only brought the economy back to full resource utilisation but also crowded out private consumption to a degree (Barro 2009).¹ The deficits run during the war meant that:

1. At war’s end, the federal government’s balance sheet showed a debt of a size never before seen, but also
2. The balance sheets of the private sector were finally back in good shape.

At the time, a majority of forecasts predicted that the economy would slip back into depression once defence expenditures were terminated and the armed forces demobilised. The forecasts were wrong. This famous postwar “forecasting debacle” demonstrated how simple income-expenditure reasoning, ignoring the state of balance sheets, can lead one completely astray.

The lesson to be drawn from these two cases is that deficit spending will be absorbed into the financial sinkholes in private sector balance sheets and will not become effective until those holes have been filled. During the years that national income fails to respond, tax receipts will be lower so that the national debt is likely to end up larger than if the banking sector’s losses had been “nationalised” at the outset.

The Swedish policy following the 1992 crisis has been often referred to in recent months. Sweden acted quickly and decisively to close insolvent banks, and to quarantine their bad assets into a special fund.² Eventually, all the assets, good and bad, ended up in the private banking sector again. The stockholders in the failed banks lost all their equity while the loss to taxpayers of the bad assets was minimal in the end. The operation was necessary to the recovery but what actually got the economy out of a very sharp and deep recession was the 25-30% devaluation of the krona which produced a long period of strong export-led growth. Needless to say, the US is in no position to emulate this aspect of the Swedish success story.

US predicaments

Strong contractionary forces are at work in the US emanating both from the capital and the income accounts. Stabilisation requires major policy actions on both fronts.

• First, the financial system must be recapitalised so as to remove the relentless pressure to deleverage from the banks.
• Second, a spending stimulus sufficient to reverse the rapidly worsening decline in incomes must be administered.

When the entire private sector is bent on shortening its balance sheet and paying down debt, the public sector’s balance sheet must move in the opposite, offsetting direction. When the entire private sector is striving to save, the government must dis-save. The political obstacles to doing these things on a sufficient scale are formidable.

If banking system losses are of the magnitude estimated by Goldman Sachs or Roubini, the banks need capital injections of at least another $200-300 billion. Even if injections equal to all their losses could be effected, the banks might still want to contract, now that they know how dangerous their leverage of yesteryear was.

The American public understands clearly that the present disaster was fashioned on Wall Street (albeit with some stimulus from Fed policy). Outright bail-outs are a “hard sell” therefore. But the American ideological taboo against “nationalisation” also stands in the way of dealing with the matter in the straightforward way that Sweden did. The present administration, like the last, would like to recapitalise the banks at least partly by attracting private capital. That can hardly be accomplished as long as the value of large chunks of the banks’ assets remains anybody’s guess. Government guarantees against (some part of) losses that may be incurred might solve this problem. But it would be a strangely contrived way out of a political impasse.

Fiscal stimulus will not have much effect as long as the financial system is deleveraging. Even if that problem were to be more or less solved, the government deficit would have to offset both the decline in industry investment and the rise in household saving – a gap that is rising as the recession deepens. Here, too, the public is sceptical and prone to conclude that a program that only slows or stops the decline but fails to “jump start” the economy must have been a waste of tax payers’ money. The most effective composition of such a program is also a problem.

Almost all American states now suffer under self-imposed constitutional balanced budget requirements and are consequently acting as powerful amplifiers of recession with respect to both income and employment. The states will spend everything they get, as will a great many local governments. The point of the stimulus package is to increase spending. Income maintenance for unemployed and other low income households will also be effective.³ Tax cuts will produce considerably less spending per dollar than these other programmes. However, the political prospects seem to portend a less than ideal program mix.

Perils, present and future

If government programs end up not being large enough to turn the recession around, we have to look forward to a deflationary period of indeterminate length. If they do succeed, however, severe inflationary pressures may surface quite quickly.

The US ratio of federal debt to GNP is not particularly high at this time. But it does not take into account the very large off-balance liabilities of entitlement programs. Since the present crisis began, moreover, the Federal Reserve System and other federal agencies have made bail-out, loan and credit guarantee commitments totalling many trillions of dollars with uncertain eventual implications for the consolidated federal balance sheet.

Much will depend on the willingness of the nation’s foreign creditors to continue to accumulate or at least to hold dollars at low rates of interest. Should this willingness falter, inflation will be hard to contain.

There is much to fear beyond fear itself.

Editors’ note: This column is a Lead Commentary on Vox’s Global Crisis Debate where you can find further discussion, and where professional economists are welcome to contribute their own Commentaries on this and other crisis-linked topics.

References

Robert Barro, 2009, “Government Spending is no Free Lunch” (Wall Street Journal, January 22).

Leijonhufvud, 2009 “Two Systemic Problems,” CEPR Policy Insight No. 29, January

Richard C. Koo, 2003, Balance Sheet Recession: Japan’s Struggle with Unchartered Economics and its Global Implications, Singapore: Wiley

Footnotes

1 The crowding out at full employment, Barro thinks, “most macroeconomists would regard … as a fair [test case] for seeing whether a large multiplier ever exists” (italics added). Most macroeconomists will presumably agree that World War II was not a free lunch but are not likely to agree to Barro’s test case inference.

2 There were plenty of bad loans but at that time they did not have the non-transparent “toxicity” that “sliced and diced” CDO’s were to generate in the present crisis.

3 Milton Friedman’s negative income tax proposal seems to have become anathema to conservatives by now. It would work in our present situation.
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