Tag: economics

Irrelevant equilibriums

While I agree with Ari Andricopoulos’s observation of the danger of the Taylor rule as well as the utter ineptitude and irrelevance of the whole orthodox macroeconomic profession, this post somehow tends to remind me of Princess Leia pointing out how the tighter the Empire grasped, the more star systems would slip through its hands.

Equilibrium: γ*ES  = (1-αd)*d + (1-αi)*i + (1-αw)*w + (1-αC)*C  (3)

This means that the spending of existing savings exactly matches the amount being saved without any new debt being taken out. This is the true equilibrium in an economy that we need to aim for.

In any case, you can see how the dividends, interest and wages from GDP at time t, as well as the external sources of money (from existing savings, new loans and new central bank money) make up the next period nominal GDP.

What has gone wrong:

I would say that during the 1945 to 1975 period, a period of excellent growth across the developed world, we were broadly in equilibrium. The savings broadly matched the spending of exisiting savings. Governments, using Keynesian policy tools would increase their spending (the government component of L) when savings were too high and reduce when more savings were being spent than new savings made. It all worked pretty well.

What changed in the 1970s was the rise of credit. Looking at the Equilibrium equation (3) above, the share of GDP going to interest and dividends went up relative to the share going to wages. The coefficients of consumption (α) for the interest and dividends is lower than that for wages so we had the following inequality:

γ*ES  < (1-αd)*d + (1-αi)*i + (1-αw)*w + (1-αC)*C

This means that the economy is out of equilibrium. The GDP shown in figure 1, will now go down because of the excess savings.

Previously fiscal policy would have been used to stimulate growth and return the system to equilibrium.

Increased government debt is far more efficient at stimulating the economy than increased private sector debt. I show here that a 10% net increase in private sector debt stimulates the economy and adds approximately 1.1% to GDP growth in the year that the debt is taken out. So the multiplier of private sector debt to GDP here is 11%. However, the cost in future years due to the increase of interest repayments at the expense of wages is 0.15% of GDP for every year going forwards.

The same amount of increased government debt costs only 0.9% of GDP going forwards, but crucially the multiplier on this spending is much higher. Therefore much less government debt is needed to create the same amount of economic stimulus as private sector debt. In fact, I estimate that government debt is an order of magnitude more efficient.

 One problem with the Taylor rule is that it uses a linear trend extrapolation. But the increase in debt means that the growth potential of the economy is lower each year so trying to keep it at the previous trend means more and more debt.

Another point which I disagree on, is that the inflation targeting does not separate inflation with a domestic source compared to that with a foreign source. I discuss the error that I believe that they are making here.

But the main problem is that, as with the whole orthodox macroeconomic profession it seems, is that IT IGNORES PRIVATE SECTOR DEBT.

I can not stress how obvious this is. It assumes that debt can grow indefinitely. It assumes that previous debt has no impact on growth. It creates a positively reinforcing feedback mechanism that ends in stagnation.

This is the real danger of the Taylor rule, Dr Bernanke.

Far from the mainstream notion that private sector debt is irrelevant, I would argue that it makes more sense to measure the macroeconomy – to the extent that we bother pretending it even exists, which is the subject for another day – in credit money. This method would have its flaws, of course, because credit money can evaporate in a heartbeat, but it would have the benefit of providing a much more accurate snapshot of any given moment in macroeconomic activity than the woefully irrelevant Samuelsonian GDP model.

This observation on the negative correlation between private sector debt and GDP growth by Dr. Andricopoulos should be particularly educational for empiricists:

A few weeks ago I wrote this post which showed the results of my empirical study on the effect of private sector debt on the economy. It found that a 10% increase in the level of private sector debt corresponded to a 0.15% decrease in GDP growth every year going forwards. Considering that the levels of private sector debt in many advanced economies is around the 200% level, this is a pretty big drag and on its own would explain the current secular stagnation.

Now, according to the Keynesians and Neo-Keynesians, this shouldn’t be any more possible than the stagflation of the 1970s. Once more, even by its own supposedly empirical standards, Keynesianism, or more properly, Samuelsoniansim, is seen to be a failure.

It’s also worth noting that even Dr. Andricopoulus’s history is an inaccurate summary, at least as far as the USA goes. Below is a chart showing the annual growth of total public and private sector debt, aka “credit money”, in the US economy from 1948 through 2014. Where is this sudden “rise of credit” that is supposed to have taken place in the 1970s? Is it the increase from 8.58 percent in 1969 to a peak of 16.03 percent in 1985?

Debt and particle acceleration

This is an interesting and intriguingly simple way of explaining the debt-deflation cycle:

The scientists at CERN can create matter from nothing only if they also create its offsetting opposite anti-matter. Similarly banks are only able to create money from thin air provided they create, at the same time, the offsetting opposite amount of anti-money, otherwise known as debt.

In short our modern banks are the particle accelerators of the financial system. They conjure money and anti-money, fortunes and debts, from nothing.

It is informative to extend this analogy a little further. When particles and anti-particles are created from nothing energy is ‘consumed’ and when they later recombine to annihilate one another this energy is then re-released. There is an analogous, though opposite, process of energy capture and release associated with the creation and destruction of money and debt.

When a bank makes a loan it splits zero into a fortune (money) and its equivalent debt. This process releases new spending power into the economy producing a burst of economic energy. Conversely when, at a later date, the money is recombined to annihilate the debt, both money and debt vanish and an equivalent amount of spending power, economic energy, is withdrawn from the economy.

At any given time, if the amount of credit being created roughly balances with the amount being destroyed the spending power within the economy will remain roughly constant and the economy will be stable. On the other hand, if there is an imbalance between credit creation and credit destruction the economy will be unstable. An excess of credit creation – new money and new debt – will amplify economic activity. Conversely an excess of credit destruction – repaying old debts – will attenuate economic activity.

From the remorseless logic of Brahmagupta’s mathematics it follows, any economic boom generated by high levels of debt creation will have the seeds of its own destruction within it. These credit-creation fuelled booms will inevitably lead to their partner, a credit-destruction driven bust – otherwise known as a debt deflation cycle.

This simple way of thinking about how our monetary and banking system works helps explain what has gone wrong with monetary policy over recent years… Our own voting patterns have trained our political leaders, like Pavlov’s dog, to seek a relentless but ultimately unsustainable credit expansion. However, when policy makers seek to engineer an economic boost through credit expansion they are also, due to the mathematics of Brahmagupta, engineering a future economic slump. This helps us understand where the deflationary forces currently taking hold in the Eurozone have come from. These are, in large part, the inevitable consequence of previous monetary policy designed to engineer credit expansion.

The next time you see the term ‘Money Supply Growth’ it may be worth pausing for a moment to reflect on the ideas of an obscure 7th century Indian mathematician and think instead of the term ‘Debt Supply Growth’.

This should help explain why you simply cannot borrow or spend your way out of debt. It’s like trying to dry yourself off by jumping in the pool. It’s a logical contradiction, no matter how convincingly economists like Ben Bernanke and Paul Krugman manage to dance in circles, draw epicycles, and dazzle you into thinking they are speaking anything but utter nonsense.

I think I can explain it even more simply, however. Money is a measure. And no matter how you may redefine the “inch” by making it increasingly smaller on the ruler, you do not make the object measured any longer.

Best Novel 2016

Ben Bernanke isn’t talking to us in the title of his new account of the 2008 financial crisisnovel, he’s talking to the gentlemen paying his speaker’s fees.

“When the economic well-being of their nation demanded a strong and creative response, my colleagues at the Federal Reserve, policymakers and staff alike, mustered the moral courage to do what was necessary, often in the face of bitter criticism and condemnation. I am grateful to all of them.”

As with all Fedspeak, you have to translate it into English. What he so bravely did was bail out the owners of the large banks at the cost of the US economy. The USA will now never exit the debt-prison into which Helicopter Ben locked it without a catastrophic meltdown.

I think we’re going to need to get a ruling from MidAmeriCon if The Courage to Act will be eligible for Best Novel next year. It certainly contains more fiction than the average fantasy novel.

Closing the work gap

Be careful what you wish for. The top ten countries with the lowest male-female labor force participation gaps:

  1. Togo
  2. Rwanda
  3. Burundi
  4. Tanzania
  5. Congo
  6. Laos
  7. Myanmar
  8. Sierra Leone
  9. Malawi
  10. Uganda

This suggests advocates might like to do well to reconsider whether closing the wage gap is truly an objective worth pursuing.

“Gee, Jane, isn’t it swell that we both make exactly the same wages now?”

“Well, Bob, as you know, it’s tough to make it on five cents per day.”

“But we have this lovely mud hut! And each other!”

“Yeah, about that, Bob. Human Resources told me that all monoracial heterosex is rape. So I’m going to need you to move out. Shaneeqwa from Marketing is moving in, and, by the way, Payroll is going to send three cents of your daily wages to me starting tomorrow.

No income growth in two decades

Despite two stock market booms, there has been no real income growth since 1994:

Real Median Household Income Has Been Flat for 20 YearsDespite ultra-loose monetary policies over the past several years,
incomes adjusted for inflation have fallen for the median U.S. family.
With the benefits of monetary expansion going to a small share of the
population and wage growth stagnating, incomes have been essentially
flat over the past 20 years. In the long run, however, classical economics would tell us that the
pricing distortions created by the current global regimes of QE will
lead to a suboptimal allocation of capital and investment, which will
result in lower output and lower standards of living over time. In fact,
although U.S. equity prices are setting record highs, real median
household incomes are 9 percent lower than 1999 highs. The report from
Bank of America Merrill Lynch plainly supports the conclusion that QE
and the associated currency depreciation is not leading to higher global
output. The cost of QE is greater than the income lost to savers and
investors. The long-term consequence of the new monetary orthodoxy is
likely to permanently impair living standards for generations to come
while creating a false illusion of reviving prosperity.

Karl Denninger was among the first to point out that even if it worked, Quantitative Easing could not possibly do what was claimed of it. Thus demonstrating what I pointed out, which is that it was merely about buying more time for the bankers to make hay before the eventual crash of the global economy. We’re already seeing signs of the wars that conventionally accompany depressions, and depending upon your definition of depression, we’re only six years into this thing.

The inequality of austerity

For all the talk about the “idle poor” and lazy Greeks, let’s not forget that corporate welfare to the “idle rich” and politically connected Greeks is often rather substantial. That’s not just a left-wing talking point, in this age of banking bailouts, the subsidies to the very rich may actually exceed those to the overtly government dependent. It’s clear that the burden imposed by the IMF is not falling, like the rain, on the rich and poor alike.

Greece’s unbalanced austerity and drastic increase of poverty. The poorest households in the debt-ridden country lost nearly 86% of their income, while the richest lost only 17-20%.  The tax burden on the poor increased by 337% while the burden on upper-income classes increased by only 9% !!! This is the result of a study that has analyzed 260.000 tax and income data from the years 2008 – 2012.

According to the study commissioned by the German Institute for Macroeconomic Research (IMK) affiliated with the Hans Böckler Foundation:

– The nominal gross income of Greek households decreased by almost a quarter in only four years.

– The wages cuts caused nearly half of the decline.

– The net income fell further by almost 9 percent, because the tax burden was significantly increased

When you see statistics like that, you sort of assume that there will be some sort of revolution taking place, and frankly, it would be hard to blame them. Crony “capitalism” of the sort we’ve seen dominate the Western economies since 2008 is not something that any genuine capitalist should support.

Taleb corrects Pinker

He observes that Pinker has been fooled by randomness and The “Long Peace” is a Statistical Illusion:

When I finished writing The Black Swan, in 2006, I was confronted with ideas of “great moderation”, by people who did not realize that the process was getting fatter and fatter tails (from operational and financial, leverage, complexity, interdependence, etc.), meaning fewer but deeper departures from the mean. The fact that nuclear bombs explode less often that regular shells does not make them safer. Needless to say that with the arrival of the events of 2008, I did not have to explain myself too much. Nevertheless people in economics are still using the methods that led to the “great moderation” narrative, and Bernanke, the protagonist of the theory, had his mandate renewed.

Now to my horror I saw an identical theory of great moderation produced by Steven Pinker with the same naive statistically derived discussions (>700 pages of them!).

  1. I agree that diabetes is a bigger risk than murder –we are victims of sensationalism. But our suckerdom for overblown narratives of violence does not imply that the risks of large scale violent shocks have declined. (The same as in economics, people’s mapping of risks are out of sync and they underestimate large deviations). We are just bad at evaluating risks. 
  2. Pinker conflates nonscalable Mediocristan (death from encounters with simple weapons) with scalable Extremistan (death from heavy shells and nuclear weapons). The two have markedly distinct statistical properties. Yet he uses statistics of one to make inferences about the other. And the book does not realize the core difference between scalable/nonscalable (although he tried to define powerlaws). He claims that crime has dropped, which does not mean anything concerning casualties from violent conflict.
  3. Another way to see the conflation, Pinker works with a times series process without dealing with the notion of temporal homogeneity. Ancestral man had no nuclear weapons, so it is downright foolish to assume the statistics of conflicts in the 14th century can apply to the 21st. A mean person with a stick is categorically different from a mean person with a nuclear weapon, so the emphasis should be on the weapon and not exclusively on the psychological makup of the person.
  4. The statistical discussions are disturbingly amateurish, which would not be a problem except that the point of his book is statistical. Pinker misdefines fat tails by talking about probability not contribution of rare events to the higher moments; he somehow himself accepts powerlaws, with low exponents, but he does not connect the dots that, if true, statistics can allow no claim about the mean of the process. Further, he assumes that data reveals its properties without inferential errors. He talks about the process switching from 80/20 to 80/02, when the first has a tail exponent of 1.16, and the other 1.06, meaning they are statistically indistinguishable. (Errors in computation of tail exponents are at least .6, so this discussion is noise, and as shown in [1], [2], it is lower than 1. (It is an error to talk 80/20 and derive the statistics of cumulative contributions from samples rather than fit exponents; an 80/20 style statement is interpolative from the existing sample, hence biased to clip the tail, while exponents extrapolate.)
  5. He completely misses the survivorship biases (which I called the Casanova effect) that make an observation by an observer whose survival depends on the observation invalid probabilistically, or to the least, biased favorably. Had a nuclear event taken place Signor Pinker would not have been able to write the book.
  6. He calls John Gray’s critique “anecdotal”, yet it is more powerful statistically (argument of via negativa) than his >700 pages of pseudostats.
  7. Psychologically, he complains about the lurid leading people to make inferences about the state of the system, yet he uses lurid arguments to make his point.
  8. You can look at the data he presents and actually see a rise in war effects, comparing pre-1914 to post 1914.
  9. Recursing a Bit (Point added Nov 8): Had a book proclaiming The Long Peace been published in 1913-1934 it would carry similar arguments to those in Pinker’s book.

Taleb is using a different means to reach much the same conclusions I have. Again. Pinker is essentially applying the same “This Time It’s Different” argument to violence that the mainstream economists applied to the dot com bubble, the housing boom, and the post-2008 “recovery”.

Simplistic thinkers inevitably think in linear terms. They assume tomorrow will be like today because today was pretty much like yesterday. Both those who know history and those who understand probability understand that at some point in time, this will no longer be the case.

History is rife with long periods of peace and tranquility. Those are quite often the sections missing from the history books, because there was nothing much that was noteworthy to record. But human nature being what it is, sooner or later events always becoming more exciting, which usually means more bloody.

It’s not hard to understand why there are fewer wars these days. Nuclear weapons have put an end to the post-French Revolutionary progress towards Ludendorffian total war. But that doesn’t mean they will never be used or that Man will not find other means to fight cataclysmic wars. It’s rather remarkable that anyone would make such abysmally stupid claims about the prospects for the continuation of the “Long Peace” when the USA is moving rapidly towards ethnic civil war, Europe is preparing for extreme ethnic cleansing, and the Dar al-Islam is in the process of uniting under a new and aggressive Caliphate even as the USA attempts to instigate war with Russia.

Assuring mutual destruction

The “bad bank” concept only appears to have delayed the inevitable default, not prevented it:

It was the failure of Creditanstalt, a Viennese bank founded in 1855 by Anselm von Rothschild, that arguably sparked the Great Depression, setting off an unstoppable chain reaction of bankruptcies throughout Europe and America.

No-one would think that what happened last week at Austria’s failed Hypo Alpe-Adria Bank International falls into quite the same category; we are meant to be in the recovery phase of the latest global banking crisis, so this is more about re-setting the system than again bringing it to its knees, right?

Well, make up your own mind. I suspect neither financial markets nor policymakers have yet caught onto the full significance of the latest turn of events.

In a nutshell, the Austrian government has had enough of funding the bank’s losses, and announced plans to “bail-in” external creditors to the tune of €7.6bn instead. As such, this marks a test case of new European rules to make creditors pay for failing banks. About time too, you might say. What took them so long?

Only in this case, the bonds are notionally guaranteed by the Austrian state of Carinthia, which now theoretically becomes liable for the bail-in. It’s an echo of the mess Ireland got itself into at the height of the banking crisis, when it foolishly attempted to stem the panic by underwriting all Irish banking liabilities; the move very nearly ended up bankrupting the entire country. Hypo will bankrupt Carinthia.

What the central bankers and politicians are doing is trading risk for time. I, and other economic realists, have been repeatedly wrong about the timing of events; I thought both Greece and Ireland would go bankrupt by 2013. But the fact that the defaults have not begun yet does not mean that the crisis is over, in fact, it does not even mean that the crisis is less serious than before. Quite the opposite, actually.

While I understand if those who don’t pay much attention to international economics might simply assume at this point that I don’t know what I’m talking about because things don’t seem to necessarily be all that bad, it might be helpful to keep in mind that the current situation is unprecedented.

For example, in most previous historical situations, Austria’s Hypo Bank would have gone bankrupt back in 2009. Instead, it was nationalized and put Austrian taxpayers on the hook for up to $25 billion.  The assets were divided and a “bad bank” created, but now that bad bank is in such dire straits that the Austrian government isn’t willing to continue funding its ongoing operational losses. But instead of simply declaring it bankrupt, they have put the assets of the equivalent of a U.S. state behind it.

This may buy them as much as another five years. But it also assures the financial destruction of an entire region of the country. What the banks have successfully done is create a system of mutually-assured destruction, gambling that electorates would rather let them off the hook than risk their governments defaulting, with all the turmoil that would subsequently ensue.

Therein lies the problem

Zerohedge reports on a world engulfed in debt:

If anyone has stopped to ask just why global central banks are in such a rush to create inflation (but only controlled inflation, not runaway hyperinflation… of course when they fail with the “controlled” part the money paradrop is only a matter of time) over the past 5 years, and have printed over $12 trillion in credit-money since Lehman, the bulk of which has ended up in the stock market, and which for the first time ever are about to monetize all global sovereign debt issuance in 2015, the answer is simple, and can be seen on the chart below.

It also shows the biggest problem facing the world today, namely that at least 9 countries have debt/GDP above 300%, and that a whopping 39% countries have debt-to-GDP of over 100%!

The problem with this can be seen in one of the famous Reinhart-Rogoff papers, Growth in a Time of Debt:

Our main findings are: First, the relationship between government debt and real GDP growth is weak for debt/GDP ratios below a threshold of 90 percent of GDP. Above 90 percent, median growth rates fall by one percent, and average growth falls considerably more. 

And before you cite the well-known Excel error, that changes nothing substantive. The core cause of the global depression is becoming increasingly obvious to everyone. The root of the problem, as I have been pointing out since about 2002, is that in a credit money system, the central banks cannot print borrowers.

This means their obvious next step will be the usual attempt to move the problem up a level by centralizing internationally and pushing for a global currency that will automatically devalue the currencies being replaced by a factor that will reduce debt/GDP below 90 percent.

This time it’s different again

No matter how many times they are wrong, stock market watchers are just going to keep throwing out the same old line out, looking to catch the little fishies.

The Nasdaq is rapidly approaching the 5,000 level and is less than 4% away from all-time highs that were set 15 years ago. These landmark levels are bringing back bad memories of the late 1990s, when people went crazy over money-losing tech stocks (and bad pop songs). The good times ended when the bubble popped in March 2000, causing huge losses for investors and making many tech companies to disappear.

All of this begs the question: Does the fact that Nasdaq has joined peers like the Dow in record territory signal another bubble is brewing in tech stocks?

No, this tech party doesn’t appear destined to end in tears. That’s because today’s tech stocks look all grown up. They’re more fundamentally sound than their 1999 peers, and their valuations are based on something the dotcom stocks of the past never had: real earnings.

“There’s no bubble when it comes to technology stocks,” said Scott Kessler, head of technology equity research at S&P Capital IQ.

Counterpoint: Twitter is valued at $31 billion. Facebook is valued at $223 billion. And the world is rapidly plunging into war from the Middle East to Eastern Europe.