Category Archives: Economic theory and policy

“There is something strange about fighting debt by incentivizing more debt”

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We have had no recovery from 2008-09. Instead of recovery which a business cycle should bring following a downturn, we are on a precipice of even worse. This is from an interview with the head of the Bank for International Settlements:

The world economy is just as vulnerable to a financial crisis as it was in 2007, with the added danger that debt ratios are now far higher and emerging markets have been drawn into the fire as well, the Bank for International Settlements has warned.

Jaime Caruana, head of the Swiss-based financial watchdog, said investors were ignoring the risk of monetary tightening in their voracious hunt for yield.

“Markets seem to be considering only a very narrow spectrum of potential outcomes. They have become convinced that monetary conditions will remain easy for a very long time, and may be taking more assurance than central banks wish to give,” he told The Telegraph.

Mr Caruana said the international system is in many ways more fragile than it was in the build-up to the Lehman crisis.

Nothing like the path to recovery that has been pursued over the past five years. Everything not only unimproved but a massive potential fall now before us. And might I say, with this economic disaster there has been not a thing apparently learned from the policy errors made in 2009. What would be done if another recession comes to pass? This is the world now unlike how it was then.

Credit spreads have fallen to to wafer-thin levels. Companies are borrowing heavily to buy back their own shares. The BIS said 40pc of syndicated loans are to sub-investment grade borrowers, a higher ratio than in 2007, with ever fewer protection covenants for creditors.

The disturbing twist in this cycle is that China, Brazil, Turkey and other emerging economies have succumbed to private credit booms of their own, partly as a spill-over from quantitative easing in the West.

Private credit booms, as in a flood of credit with no real return.

HETSA symposium on the future of the history of economic thought

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We’ve just had a symposium on my book, Defending the History of Economic Thought, at the History of Economic Thought Society of Australia meeting here in Auckland. I’m no fan of economics in the form of running a line through a set of dots, although I’m not an enemy either. But the astonishing transformation of economic theory from a philosophical study to social physics may be all right for the academic world – may be – but it’s not so all right for those who need to understand what’s going on if they’re trying to make policy.

Economics has a vast store house of approaches that are different from the mainstream, some bundled into different schools, such as Austrian economics, and some just part of an array of models that had been part of the mainstream in the past but have been sidelined for one reason or another. No natural science, for example, has ever had some concept from the past return in the way that Malthus’s early nineteenth century theory of over-saving and demand deficiency was resurrected as Keynesian economics and remains embedded in Y=C+I+G. The challenge to today’s mainstream provided by discarded theories and different schools has seen an effort made to push HET out of the economics classification and, as was attempted in Australia in 2007, to blend it into a category that was to be called, History, Archaeology, Religion and Philosophy, as far as possible from economics itself. My book is about that attempt, and a similar one in Europe in 2011. And the interesting part for me, during this symposium, was to find how many even here in Australia, want to make that transformation.

Why that is, I still cannot fully understand. There’s plenty of sociology in HET even as it stands, but there is also a good deal of rethinking old ideas as well. In the present structure you can do both. If HET became history and philosophy of science, the traditional form of HET would disappear, even as it is already shrinking in North America.

The contrast between our meeting in Auckland and the American HET meeting in Montreal at the end of last month was incredible. You would think that with economic theory at such a low ebb, that there would be many papers looking at the pre-Keynesian theory of the cycle, as just one example. As it happens, there was not a single paper in Montreal on either Keynes (or Marx for that matter), and very few that dealt with economic theory as in what did economist A say about issue B. There instead remains a systematic effort to reward sociology of knowledge. Here in Auckland, however, there have been just the kinds of papers that interest me, on both sides of these debates, and there are knowledgable people who can offer truly in-depth analyses and critiques.

It is, in fact, my wish that HET become in part what it never quite has been able to be, become a proving ground for older ideas that are tested in a pit of criticisms by people who are interested in these issues and know an immense amount about these ancient theories. It now happens in a haphazard way, but I think it should become institutionalised. There is, in fact, a new on-line journal that has opened called “History of Economics and Policy” which in my view is the direction things should go.

At the symposium, there were many things said from the floor that I found very useful and interesting, but amongst them was that MIT is about to make a history of economic thought course compulsory for its PhD candidates. If that is actually true, HET will be back within a decade.

Low interest rates are a killer

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Part of the Keynesian disease, a big part, is the fetish for low rates of interest. Not everyone now necessarily thinks so. This is from the Bank for International Settlements:

The international body representing central banks is warning its members that record low interest rates are generating conditions for another global financial crisis that may be worse than the first.

In its annual report, the Swiss-based Bank for International Settlements (BIS) expressed serious concern that global share markets had reached new highs and the interest rate premium for many risky loans had fallen.

“Overall, it is hard to avoid the sense of a puzzling disconnect between the markets’ buoyancy and underlying economic developments globally,” the bank wrote.

The BIS says the disconnect is largely due to continued monetary stimulus in the form of money printing and record low interest rates by many developed economy central banks.

Why interest rates too low are a problem is hardly obvious and is hardly taught. Very clear from reading the pre-Keynesian literature but who reads any of that now. But the BIS is sending out the clearest possible warning but is it even possible that anyone at the heights of our political establishment would either understand or act on this advice.

With thanks to Julie for sending the link along.

US GDP contracts at a rate of 2.9%

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Not exactly news but quite incredible all the same:

The Commerce Department said on Wednesday gross domestic product fell at a 2.9 percent annual rate, the economy’s worst performance in five years, instead of the 1.0 percent pace it had reported last month.

I especially like the bit about the worst in five years. It has now contracted during a supposed recovery at the same rate as it did at the height of the GFC. And for those few remaining fans of a demand stimulus, let me just add this:

Consumer spending, which accounts for more than two-thirds of U.S. economic activity, increased at a 1.0 percent rate.

Usual Keynesian ignorance about the two-thirds of economic activity. But however much it contributes, the economy went backwards even though consumption grew.

Getting Say’s Law exactly right

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It is so rare for anyone to get Say’s Law exactly right that you must forgive me if I quote at length, specially since he quotes me. This is from an article by Steve H. Hanke, Professor of Applied Economics at the Johns Hopkins University in Baltimore, and titled, “GO: J.M. Keynes versus J.-B. Say”. It is found in the publication, Global Asia:

The French economist J.-B. Say (1767-1832) was a highly regarded member of the Classical School. To this day, he is best known for Say’s Law of markets. In the popular lexicon – courtesy of John Maynard Keynes – this law simply states that “supply creates its own demand.” But, according to Steven Kates, one of the world’s leading experts on Say, Keynes’ rendition of Say’s Law distorts its true meaning and leaves its main message on the cutting room floor.

Say’s message was clear: a demand failure could not cause an economic slump. This message was accepted by virtually every major economist, prior to the publication of Keynes’ General Theory in 1936. So, before the General Theory, even though most economists thought business cycles were in the cards, demand failure was not listed as one of the causes of an economic downturn.

All this was overturned by Keynes. Kates argues convincingly that Keynes had to set Say up as a sort of straw man so that he could remove Say’s ideas from the economists’ discourse and the public’s thinking. Keynes had to do this because his entire theory was based on the analysis of demand failure, and his prescription for putting life back into aggregate demand – namely, a fiscal stimulus (read: lower taxes and/or higher government spending).

The rest of the article deals with the new statistic that has just been released by the Bureau of Economic Analysis in the United States which has largely been undertaken because at the instigation of the great Austrian economist, Mark Skousen. The notion that consumption drives an economy is so nonsensical since consumer demand is the end of all forms of production, from mining coal to generating electricity and so to focus on consumer demand is focusing on nothing at all other than the end of the production process. But if we are looking at value added, as we ought to be, only about 5% of economic activity is directed at selling directly to consumers. The new supply side statistic that has been developed, which at long last gets this balance right, will make a great difference in how the economy is perceived, which should also make a difference in how it is managed, or at least it is to be hoped. Let me finish with one further quote from Professor Hanke:

Even though the always clever Keynes temporarily buried J.-B. Say, the great Say is back. With that, the relative importance of consumption and government expenditures withers away. And, yes, the alleged importance of fiscal policy withers away, too.

Contrary to what the standard textbooks have taught us and what that pundits repeat ad nauseam, consumption is not the big elephant in the room. The elephant is business expenditures.

If you really want to stimulate the economy, it is business at every stage of production you have to go through and not the consumer. How different that kind of economic policy would need to be, but at least it will have the merit of actually producing positive results.

HET Montreal 2014

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The History of Economic Thought conference in Montreal has just ended and, as always, it was wall-to-wall interesting. I have already given a background report on the paper I gave before it was given and I can now report how nicely it went. Even in HET where historical change is our line of work, there is that dreamworld notion that everything stays as it is without effort so my warning that the history of economics has enemies who would drive it as far as they can from economic theory seems remote and incomprehensible. But the people who would move it are still in executive positions, but now it’s for a new generation to deal with.

The most remarkable aspect of the conference was that there was not a single paper on Keynes. Two, three, four years ago, such conferences were crawling with “Keynes, return of the master” sorts of things. Now, not a one. It’s not that the Keynesians have gone anywhere since it is still impossible to think about macro without aggregate demand. Instead, there is confusion and uncertainty about how to go forward, but try to find a textbook that talks about the national economy without mention of C+I+G. It can’t go away unless economists begin to understand Say’s Law and that’s not happening soon. So it is a sullen quiet resentment that hovers over economics with the vultures ready to pick at the bones of economies that fail to recover due to perceived failures of the various austerity programs. I think the Chinese are more likely to try a market-based solution before the Americans but that really means no one is likely to try one any time soon.

And as a bonus, Montreal is lovely, more similar to Melbourne, as I’d been previously told, than it is to Sydney. But the many “a louer” signs everywhere shows a city down on its luck. But aside from six months of winter with ten foot snow drifts, this seems a very liveable place to be.

Disproving Keynesian economics once and for all

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I don’t allow comments on this blog mainly because I am not up to policing what other people say. But I read them and this today, from Rob, was stunning. Referring to my little rant on the uselessness of economic theory today, he wrote:

But at least it has advanced enough to tell us that for more growth, we need …. more broken windows:

The Lack of Major Wars May Be Hurting Economic Growth

Tyler Cowen is a professor of economics at George Mason University

I mean, what would a dead white male like Frederic Bastiat know anyway?

Tyler Cowen is, of course, a live white male, but given there are such things as negative knowledge – things that if you believe them make you dumber than if you knew nothing at all – it is possible for him to know less than Frederic Bastiat, dead though he may be. Let me quote from the opening of that column:

The continuing slowness of economic growth in high-income economies has prompted soul-searching among economists. They have looked to weak demand, rising inequality, Chinese competition, over-regulation, inadequate infrastructure and an exhaustion of new technological ideas as possible culprits.

An additional explanation of slow growth is now receiving attention, however. It is the persistence and expectation of peace.

Let me put it this way. There is bad economics, there is unbelievably stupid economics, and there is the belief that growth has slowed because there are no wars.

It is neither here nor there that there’s not all that much peace around anyway. But let me remind you of the greatest disproof of Keynesian economic policy in history. Everyone always points out that one Keynesian data point which is the so-called boom that came at the start of World War II. Not a boom at all since what most people remember about the home front was rationing and controls of every kind, and if you are thinking about the labour shortages, merely recall that around half the labour force under thirty was drafted into the army. But that’s not that point either, although it should put quite a dent into such Keynesian thought.

It is the coming of peace in 1945 that is the grand refutation of Keynesian economics. At the end of the war, within a year millions who had been overseas fighting, or had been part of the war effort at home, were suddenly in the labour market looking for work. Many women who had taken jobs while the men were overseas also remained in the workforce. The Keynesians were continually badgering Truman to maintain war-time deficits since, they said, if he did not the US would go straight back into the depression. Truman, however, having had a business background, hated deficits and the US virtually balanced its budget in a single year. No deficits, no stimulus, no nothing. The US slashed its expenditures and in so doing set off the greatest economic boom in world history, a boom that lasted straight through until ground into the dust by the war on poverty, and dare I say it, the unfunded, deficit-financed war in Vietnam.

Thinking about economic issues from the demand side is the single biggest mistake anyone can make in economics. In fact, if you do think that way, you aren’t even an economist since Say’s Law was once considered the best test of a sound economist. Not many of them around any more, I fear.

Here is the message. An economy is driven only by real value adding supply. Nothing else. This is the message of Say’s Law, supposedly discredited by Keynes but as accurate a statement of economic principle as there has ever been.

A bit of a rant and tirade of my own

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From the most recent of Captain Capitalism’s rantings and tirades of a frustrated economist:

As I’ve aged and become more experienced, I start to realize just how much of a fraudulent study economics is. Not because economics isn’t important. Not because there isn’t some serious important issues that economics addresses. It’s not even that the secret to riches for all does lay within economics (it does and it is what ultimately drives my eternal passion for economics). But rather how the field’s self-proclaimed experts have turned it into nothing more than self-serving political bunk. It is no longer simply about the “efficient allocation of resources” or “maximizing the wealth of people” but rather idiotic concepts like the Phillips Curve, running advanced (and ultimately flawed) economic models, fretting about things like the liquidity trap, drawing idiotic foursquare games for “prisoner theory,” and the hundreds of other temporary and fleeting relationships that have been observed in the past 60 years that the economist academians trump out and treat it as if it were a real science when in reality it is a constantly changing art as it is human psychology that underpins it all.

The unfortunate fact is that economics has gone from amongst the social sciences to join the non-science of socialist religious observance. So if I may continue to quote:

If you truly want to understand (or disprove some things about) economics, I argue going backwards. I argue going outside the study. I argue applying some basic, simple logic and factual testing to see if this increasingly complex “field” even makes sense anymore or is merely a circle jerk for wanna-be mathematicians just like religion is for most clergymen.

For example, a simple question I have, is WWII the only data point the Keynesianism can point to in history where it worked? And if so, why the hell did we base the entire western world’s governance and economic policies on something so ill-tested?

Another, precisely whose brilliant idea was it that government should intervene period? Who precisely died and made you economic king giving you authority to “provide incentives” or “boost demand curves?” Since when was it the government’s and politician’s responsibility to MANAGE people? (I’ll tell you who. One sick, power-hungry, totalitarian, that’s who).

And though I am certainly very political, shouldn’t we be concerned when the likes of Krugman call Republicans racist or we start claiming that 100% purely politically moves such as “diversity” have some kind of inherent value? i.e. – why is politics allowed to enter, let alone corrupt economists and their views?

I could go on, but these simple questions are identical to the basic, logical questions we need to ask (but aren’t allowed to) of religion.

Economics once really was useful and enlightening but you’d have to go back to its golden age, from Adam Smith to John Stuart Mill. Since the mathematicians took over sometimes around the 1870s, and economics became social-physics, it has been generally downhill. I read journals now as part of my penance, but it is mostly non-answers to unimportant questions. Meanwhile, not only do politicians invent whatever economic theory they need to suit their wishes, so too do their economic advisors. Economics was once a discipline. You obeyed its rules or your economy would unravel. There is only just that last small bit of Adam Smith-John Stuart Mill left to keep our economies from completely crashing, but even that small bit is eroding fast. Economics has for the most part gone back to being Mercantilist trash.

US – five years into its 20 year lost decade

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The Japanese have had a twenty year lost decade following their own Keynesian stimulus. This is America reported at Drudge today:

92,009,000 Americans Not Working…
Labor Force at 36-Year Low…
7 Million Have Left Under Obama…
Lethargic economy…

And we could end up with the same kind of outcome if we don’t get on top of our debt and reduce unproductive spending. Decline is slow, and not everyone becomes poor, but in the end as a nation, we are less well off and the way out becomes more difficult every year. If the Labor Party is merely ignorant about what’s in store if we don’t fix the deficit, then it’s par for the course. But if they do understand but are still standing in the way of change, then they are despicable.

Negative interest rates in Europe specifically designed to lower saving and raise inflation!

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Just what Europe’s economies need, lower saving and higher inflation:

Mario Draghi: “Together, the measures will contribute to a return of inflation rates to levels closer to 2%”

The European Central Bank has introduced a raft of measures aimed at stimulating the eurozone economy, including negative interest rates and cheap long-term loans to banks.

It cut its deposit rate for banks from zero to -0.1%, to encourage banks to lend to businesses rather than hold on to money.

The ECB also cut its benchmark interest rate to 0.15% from 0.25%.

The ECB is the first major central bank to introduce negative interest rates.

If one set of Keynesian policies don’t seem to work there are then others they have that will fail just as well. And if -0.1% doesn’t work they can lower the number even more. And the thing is, they are clueless about why none of this will work.