How do we get out of this mess?
24/10/08 14:17 Filed in: Economic Crisis
I find all the numbers about the economy that are being banded around now to be mind-boggling. There are two big numbers that stick in my mind and that is the size of the bank bailouts in the UK and the USA. In the UK, the cost of the bailout plan is estimated to be around $1 trillion and in the USA, $700 billion.
The USA is the largest economy in the world with an annual Gross Domestic Product of $13.8 trillion, that represents about 25% of the world’s total economic output. The UK is the fifth largest economy with a GDP of $2.8 trillion. Ranking at positions of 2, 3, and 4 are Japan, Germany and China. China’s economic importance is growing fast but the size of its economic output is a little over 25% of that of the USA.
These are a lot of numbers I know. I wanted to write them down so I got some perspective on what it is we are talking about.
The size of the UK bank-bail out if it was looked at on the scale of national economies would rank at 13th in the international GDP table. The amount of money that the UK is making available to its banks is greater than the GDP of some 166 other countries.
With the cost of the bailout, the size of the national debt of USA and UK has soared during 2008. Under the Bush administration, the size of the national debt as a proportion of GDP has risen from 60% to around 115%. In the UK, the national debt may reach 100% of GDP or more this year.
Another alarming statistic (Source: BBC Business news 24 October 24, 2008) is that the UK aggregate of national debt, corporate and personal borrowing is three times that of the country’s annual economic output.
So what’s happening now? We’ve had runs on banks and international markets. Now there’s a new game on the streets. We’re having runs on national economies. Banks, hedge funds and mutual funds are demanding repayment from economies that they perceive to be at risk, either because of their reliance on foreign borrowings or because they are net importers of goods and services or both.
The UK pound has fallen 20% against the dollar in the past three months. South Korea’s currency, the won, has fallen by 29%. There are some obvious candidates like Hungary, Ukraine and Iceland lining up in the financial emergency room too.
The South Korean problem is complex and again, whilst the issues are in the banking systems, they have nothing to do with mortgages, housing or sub-prime loans but wholesale capital withdrawals resulting from imprudent deals struck by banks in currency hedges (Currency hedges are intended to offset risk through the simultaneous sale and purchase of forward currency contracts).
South Korea is a strong exporter. Its trading performance and its balance of trade is healthier than UK’s and probably the USA’s too albeit on a smaller scale. It ranks thirteenth in the world in terms of economic output.
Other countries suffering substantial capital withdrawals are South Africa and Argentina.
It’s expected that the UK will announce economic contraction today or “negative economic growth” as the city boys like to call it. It will get worse, possibly much worse as the UK has moved out of manufacturing industries to an economy where its mainstay is the fast contracting financial services sector. The financial services sector in the UK while it only accounts for 4% of total employment represents 30% of the UK’s GDP.
As Mr. Bush Sr. said, “It looks like we’re in deep doo doo now.”
It’s not only about the sub-prime issue anymore. When markets start dealing in national economies, it affects us all. Historically, national instability on a wide scale has tended to result in conflict and wars. Let’s hope we’ve learned some lessons from the past.
I’ve heard lots of arguments about reducing taxation and the bailout bringing benefits from the “trickle down” effect. Trick or treat more like! The treat is that the wealthy benefit, and the trick is that the poor suffer. Trickle down has been argued since Hoover in the twenties. It didn’t work then, it doesn’t work now. There is nothing to support the argument that it has ever worked.
In principle, I am strongly opposed to the bail out now. I have changed my mind about it. I am opposed to it since it is fundamentally undemocratic. To use, Chomsky’s words, “private corporations are tyrannies who account to no one other than themselves.” They are run for their own profit, not the benefit of the world or the public. In short, they are in it for themselves and no one else. If banks want to play Russian roulette with national economies, they’ll do it if they see profit for themselves.
I don’t believe either that the rot in the banking systems is solely to blame for our current economic difficulties. I have never believed that particular story. The turmoil in our financial systems is, I believe, a symptom of underlying economic instability rather than its cause. Banks may play a big part in that system and be central to its functioning but they do not exercise any overall control of the economy itself, but supply a service to it. The service is debt, more normally called credit. The realisation or appreciation of assets, or the prospect of future earnings offsets the credit risk. Credit is at risk, when economies contract, assets depreciate and earnings do not grow or diminish. When credit goes bad, banks make losses.
The so-called sub-prime crisis may not have happened unless the value of homes, of mortgage collateral, was called into question. The asset value of homes fell which meant that banks were unable to realise the security they had taken in return for the credit that they had extended.
My real concern is for the average person on the street. I don’t know a massive number of people, but I have talked to so many who are suffering or have suffered major economic hardship now. They have lost their jobs, their homes and in one case, I know someone who will be facing bankruptcy in the next couple of weeks. He was formerly a capable and successful businessman. I don’t need government to say, “We’re in recession. It’s official!” I know that to be the case as financial difficulties are multiplying around me all the time. I can see them with my own eyes. Everyone I know, every single person knows someone who is suffering real hardship now.
So what’s the answer? There are possibly two answers, but both amount to the same thing. It’s not that difficult. The answer is about democracy. In the dictionary definition, democracy "is government by the people in which the supreme power is vested in the people and exercised directly by them or by their elected agents under a free electoral system." In the phrase of Abraham Lincoln, democracy is a government "of the people, by the people, and for the people."
We need to decide whether democracy is what we want and be prepared to do something about it. We have to decide what we want in this world, if it’s public welfare or not. The wellbeing of banks does not and will not necessarily bring about public welfare or alleviate personal financial hardship. They will willingly take taxpayers’ money then spend it in achieving their own ends whether that’s mergers, acquisitions or anything else, so long as it feeds their own self-interest.
The free market ideology was upheld until big businesses started to flounder. Now everyone is talking about increased regulation and control of big business by government. I might ask, in order to achieve what end and for whose benefit?
The political process has become divorced from the people both in the UK and the USA. I do not know anyone who believes they have any real influence over the democratic process. Government is, therefore, no longer democratic or to use Chomsky’s words “there is a democratic deficit”. Whether it’s Republican or Democrat, New Labour or Conservative, nothing will change until we recover the essence of Lincoln’s dictum and we assume and take responsibility for public well-being.
Obama will not make a difference unless he works within some overall social organisation that restores democratically representative government. The real power structures within our society have little to do with government, but are capable of being transformed by government if it has the political will to do so. These power structures that are founded on economic self-interest will resist change by using every means at their disposal. It’s no small challenge.
I believe in democracy. I also believe in freedom, personal and social responsibility and self-determination. That’s about all.
I mentioned two options: First. we can pull out of free market economics to an extent and endeavour to restore economic equilibrium through increased government control and regulation. I am not sure it will work. Democratic government represents the will of the people. Business corporations represent their own interests. They are neither the same nor are they necessarily compatible. Our economic systems are failing. It may be that government intervention keeps the market, which is fundamentally unstable and inherently inefficient, on “life support”, but I wonder if the patient will ever recover. This is the first option. It’s about big government and government control. Nevertheless, it requires a fundamental re-alignment of the conduct of government with overall public interest and wider democratic participation.
I’ve had a number of personal crises in my life. They have all been about change and the need to change. I’ve never had a benevolent philanthropist throw money at me so I could carry on living as before. I have had to change. There is a lot of nonsense talked about the Chinese etymology of the word crisis saying that it signifies two words, “danger” and “opportunity”. This is incorrect. In fact the Chinese word crisis is derived from the something closer in meaning to “an incipient moment”, a moment in which something is in the process of becoming. I believe that a crisis is closely connected, not with catastrophe but, with the process of change itself.
My second option is also my preferred one and it involves turning the bailout on its head. It goes like this: We leave the markets and businesses alone to find their own solutions. They may or may not. It matters little. Government provides a safety net to the people and directs its resources entirely for the benefit of the people affected by any systemic economic failure. $700 billion should do it easily, and it would not be a bottomless pit either. In practical terms, this means that it would need to guarantee not the wellbeing of banks, but the safety of people’s money in those banks. It means that it would not legislate massive state initiatives to create jobs like the “new deal”, but support economic initiatives by the people themselves for the benefit and wellbeing of themselves and their own communities. It might even go further and promote work in environmental, health, education and ‘care for the elderly’ initiatives.
The key difference would be one of focus and of catering for people directing their efforts and resources for their own wellbeing, rather than for the benefit of the small minority who control large corporations. Large corporations may or may not survive in such a world. Their survival would be influenced by different factors, not by how much profit they made, but by how well they served a social need or purpose. I would vote for such a world.
It may be that the right solution is a hybrid of these two options. I would not rule out the direct intervention by government in a bank's administration or in facilitating a take-over in order to act in the public interest. My problem is in government using taxpayer's money to buy banks out of a problem that achieves little by way of improving corporate responsibility, and offers no obvious social benefit.
Sadly, I doubt if the answer will come with Barrack Obama, but he does offer the best chance of change. I hope he's not just different icing on the same old cake. There isn’t a hope in hell of getting out of this mess with McCain and Palin.
In conclusion, here’s today’s economic update from Europe. Shares in Europe’s main markets are down between 7% and 8% this morning.
The Bank of England deputy governor, Charles Bean said, "This is a once in a lifetime crisis, and possibly the largest financial crisis of its kind in human history."
The price of gold, typically, the place people put money in times of crisis has fallen by five per cent.
The USA is the largest economy in the world with an annual Gross Domestic Product of $13.8 trillion, that represents about 25% of the world’s total economic output. The UK is the fifth largest economy with a GDP of $2.8 trillion. Ranking at positions of 2, 3, and 4 are Japan, Germany and China. China’s economic importance is growing fast but the size of its economic output is a little over 25% of that of the USA.
These are a lot of numbers I know. I wanted to write them down so I got some perspective on what it is we are talking about.
The size of the UK bank-bail out if it was looked at on the scale of national economies would rank at 13th in the international GDP table. The amount of money that the UK is making available to its banks is greater than the GDP of some 166 other countries.
With the cost of the bailout, the size of the national debt of USA and UK has soared during 2008. Under the Bush administration, the size of the national debt as a proportion of GDP has risen from 60% to around 115%. In the UK, the national debt may reach 100% of GDP or more this year.
Another alarming statistic (Source: BBC Business news 24 October 24, 2008) is that the UK aggregate of national debt, corporate and personal borrowing is three times that of the country’s annual economic output.
So what’s happening now? We’ve had runs on banks and international markets. Now there’s a new game on the streets. We’re having runs on national economies. Banks, hedge funds and mutual funds are demanding repayment from economies that they perceive to be at risk, either because of their reliance on foreign borrowings or because they are net importers of goods and services or both.
The UK pound has fallen 20% against the dollar in the past three months. South Korea’s currency, the won, has fallen by 29%. There are some obvious candidates like Hungary, Ukraine and Iceland lining up in the financial emergency room too.
The South Korean problem is complex and again, whilst the issues are in the banking systems, they have nothing to do with mortgages, housing or sub-prime loans but wholesale capital withdrawals resulting from imprudent deals struck by banks in currency hedges (Currency hedges are intended to offset risk through the simultaneous sale and purchase of forward currency contracts).
South Korea is a strong exporter. Its trading performance and its balance of trade is healthier than UK’s and probably the USA’s too albeit on a smaller scale. It ranks thirteenth in the world in terms of economic output.
Other countries suffering substantial capital withdrawals are South Africa and Argentina.
It’s expected that the UK will announce economic contraction today or “negative economic growth” as the city boys like to call it. It will get worse, possibly much worse as the UK has moved out of manufacturing industries to an economy where its mainstay is the fast contracting financial services sector. The financial services sector in the UK while it only accounts for 4% of total employment represents 30% of the UK’s GDP.
As Mr. Bush Sr. said, “It looks like we’re in deep doo doo now.”
It’s not only about the sub-prime issue anymore. When markets start dealing in national economies, it affects us all. Historically, national instability on a wide scale has tended to result in conflict and wars. Let’s hope we’ve learned some lessons from the past.
I’ve heard lots of arguments about reducing taxation and the bailout bringing benefits from the “trickle down” effect. Trick or treat more like! The treat is that the wealthy benefit, and the trick is that the poor suffer. Trickle down has been argued since Hoover in the twenties. It didn’t work then, it doesn’t work now. There is nothing to support the argument that it has ever worked.
In principle, I am strongly opposed to the bail out now. I have changed my mind about it. I am opposed to it since it is fundamentally undemocratic. To use, Chomsky’s words, “private corporations are tyrannies who account to no one other than themselves.” They are run for their own profit, not the benefit of the world or the public. In short, they are in it for themselves and no one else. If banks want to play Russian roulette with national economies, they’ll do it if they see profit for themselves.
I don’t believe either that the rot in the banking systems is solely to blame for our current economic difficulties. I have never believed that particular story. The turmoil in our financial systems is, I believe, a symptom of underlying economic instability rather than its cause. Banks may play a big part in that system and be central to its functioning but they do not exercise any overall control of the economy itself, but supply a service to it. The service is debt, more normally called credit. The realisation or appreciation of assets, or the prospect of future earnings offsets the credit risk. Credit is at risk, when economies contract, assets depreciate and earnings do not grow or diminish. When credit goes bad, banks make losses.
The so-called sub-prime crisis may not have happened unless the value of homes, of mortgage collateral, was called into question. The asset value of homes fell which meant that banks were unable to realise the security they had taken in return for the credit that they had extended.
My real concern is for the average person on the street. I don’t know a massive number of people, but I have talked to so many who are suffering or have suffered major economic hardship now. They have lost their jobs, their homes and in one case, I know someone who will be facing bankruptcy in the next couple of weeks. He was formerly a capable and successful businessman. I don’t need government to say, “We’re in recession. It’s official!” I know that to be the case as financial difficulties are multiplying around me all the time. I can see them with my own eyes. Everyone I know, every single person knows someone who is suffering real hardship now.
So what’s the answer? There are possibly two answers, but both amount to the same thing. It’s not that difficult. The answer is about democracy. In the dictionary definition, democracy "is government by the people in which the supreme power is vested in the people and exercised directly by them or by their elected agents under a free electoral system." In the phrase of Abraham Lincoln, democracy is a government "of the people, by the people, and for the people."
We need to decide whether democracy is what we want and be prepared to do something about it. We have to decide what we want in this world, if it’s public welfare or not. The wellbeing of banks does not and will not necessarily bring about public welfare or alleviate personal financial hardship. They will willingly take taxpayers’ money then spend it in achieving their own ends whether that’s mergers, acquisitions or anything else, so long as it feeds their own self-interest.
The free market ideology was upheld until big businesses started to flounder. Now everyone is talking about increased regulation and control of big business by government. I might ask, in order to achieve what end and for whose benefit?
The political process has become divorced from the people both in the UK and the USA. I do not know anyone who believes they have any real influence over the democratic process. Government is, therefore, no longer democratic or to use Chomsky’s words “there is a democratic deficit”. Whether it’s Republican or Democrat, New Labour or Conservative, nothing will change until we recover the essence of Lincoln’s dictum and we assume and take responsibility for public well-being.
Obama will not make a difference unless he works within some overall social organisation that restores democratically representative government. The real power structures within our society have little to do with government, but are capable of being transformed by government if it has the political will to do so. These power structures that are founded on economic self-interest will resist change by using every means at their disposal. It’s no small challenge.
I believe in democracy. I also believe in freedom, personal and social responsibility and self-determination. That’s about all.
I mentioned two options: First. we can pull out of free market economics to an extent and endeavour to restore economic equilibrium through increased government control and regulation. I am not sure it will work. Democratic government represents the will of the people. Business corporations represent their own interests. They are neither the same nor are they necessarily compatible. Our economic systems are failing. It may be that government intervention keeps the market, which is fundamentally unstable and inherently inefficient, on “life support”, but I wonder if the patient will ever recover. This is the first option. It’s about big government and government control. Nevertheless, it requires a fundamental re-alignment of the conduct of government with overall public interest and wider democratic participation.
I’ve had a number of personal crises in my life. They have all been about change and the need to change. I’ve never had a benevolent philanthropist throw money at me so I could carry on living as before. I have had to change. There is a lot of nonsense talked about the Chinese etymology of the word crisis saying that it signifies two words, “danger” and “opportunity”. This is incorrect. In fact the Chinese word crisis is derived from the something closer in meaning to “an incipient moment”, a moment in which something is in the process of becoming. I believe that a crisis is closely connected, not with catastrophe but, with the process of change itself.
My second option is also my preferred one and it involves turning the bailout on its head. It goes like this: We leave the markets and businesses alone to find their own solutions. They may or may not. It matters little. Government provides a safety net to the people and directs its resources entirely for the benefit of the people affected by any systemic economic failure. $700 billion should do it easily, and it would not be a bottomless pit either. In practical terms, this means that it would need to guarantee not the wellbeing of banks, but the safety of people’s money in those banks. It means that it would not legislate massive state initiatives to create jobs like the “new deal”, but support economic initiatives by the people themselves for the benefit and wellbeing of themselves and their own communities. It might even go further and promote work in environmental, health, education and ‘care for the elderly’ initiatives.
The key difference would be one of focus and of catering for people directing their efforts and resources for their own wellbeing, rather than for the benefit of the small minority who control large corporations. Large corporations may or may not survive in such a world. Their survival would be influenced by different factors, not by how much profit they made, but by how well they served a social need or purpose. I would vote for such a world.
It may be that the right solution is a hybrid of these two options. I would not rule out the direct intervention by government in a bank's administration or in facilitating a take-over in order to act in the public interest. My problem is in government using taxpayer's money to buy banks out of a problem that achieves little by way of improving corporate responsibility, and offers no obvious social benefit.
Sadly, I doubt if the answer will come with Barrack Obama, but he does offer the best chance of change. I hope he's not just different icing on the same old cake. There isn’t a hope in hell of getting out of this mess with McCain and Palin.
In conclusion, here’s today’s economic update from Europe. Shares in Europe’s main markets are down between 7% and 8% this morning.
The Bank of England deputy governor, Charles Bean said, "This is a once in a lifetime crisis, and possibly the largest financial crisis of its kind in human history."
The price of gold, typically, the place people put money in times of crisis has fallen by five per cent.
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Economics may be bad for your health! - Part 1
Recession! What recession?
So what is this new economic crisis? Are we moving towards the Armageddon of western economics? What does and will recession mean?
Economists define recession as a decline in the production of gross domestic product for six-months based on measures taken in two three month periods.
Neither the USA nor the UK are experiencing what is described as “negative growth” currently, although there is a widely held belief that we may be heading towards recession.
A lot of factors are being cited as the cause of our current economic difficulties, among which are:
1. The crash in the housing market.
The boom in the housing market was an absurd phenomenon.
House prices in the UK were rising at rates of more than six times the rate of inflation in some years.
Suddenly the world was awash with property millionaires. Someone who had bought a London house for £72,000 ($144,000) in 1983 and stayed put, woke up to find their property is worth £1.6 million in 2007! ($3.2 million). A new two bedroom apartment on the outskirts of Oxford, close to a railway line came onto the market last year at around £500,000 ($1 million). Think about it, one million dollars for a small apartment in a small city outside London!
The average age of a first time house buyer is currently somewhere in the mid-thirties age range. So where do the rest live? How do teachers, nurses, doctors, police and essential service staff ever afford these prices? The answer is they don’t.
It had to stop, and stop it did. House prices are going down in the UK. Economic reports from the USA say that house prices there are over-valued by at least 40%, although by UK standards house prices in the USA look dirt-cheap! Prices have fallen by up to 25% in the past year in (some parts of) the USA.
House price equity in an overblown, pumped-up market is fool’s gold. It is wealth created by a market without any corresponding new value. It has provided a mirage of prosperity by fuelling consumer spending and debt.
To put all this in perspective, the average house price in the UK (across all regions) is about £220k ($440k), the average salary is somewhere in the region of £22k - £26k ($44k - $52$k).
So people have taken risks with borrowing, sometimes taking out loans of between 8 and 10 times their annual salaries in order to own a home. It should come as no surprise therefore that the housing market is in deep trouble.
2. So-called high-risk lending, the “sub-prime” market is collapsing. Sub-prime lending involves lending money for greater returns to poorer people who would not otherwise be able to afford conventional home loans. It’s an economic contradiction that sustains poverty. If one is poor access to money comes at a higher price than if one is rich.
Falling house prices in the USA and to some extent, the UK, means a risk of negative home equity at a very high price. Home repossessions are increasing fast. There is an increasing rate of defaults that means that banks lose money and so do the mortgage companies.
3. So we have:
• Shortage of mortgage funding and banks teetering on the edge of solvency
• Decline in market confidence that affects all sectors of the economy
• Property prices that became vastly overvalued
• Increase in supply accompanying falling demand, with housing costs still running at levels in the UK that are inaccessible to average wage earners, young people and essential service providers
4. Next! There’s the ever-increasing oil price pushing up costs. There is the rising cost of food too that is not necessarily all tied to the cost of oil.
5. One more…the booming house price mirage fuelled consumer borrowing. A falling house market and lowered confidence in the rest of the economy means that people are taking on less debt and looking to save. This in turn means lower consumer spending. Lower consumer spending means lower production that increases the chance of a recession. It is interesting to me that that financial prudence, as I might see it, and a move away from consumption for consumption’s sake has an adverse economic consequence. I’ll come back to that in part 2.
Summary
There are a number of factors involved in our current economic difficulties, but the two main issues as I see them are the decline of an over-heated housing market and a decrease in consumer spending.
Part 2 will be about whether economic growth is beneficial to us all. My feelings are that it is not such a good thing after all. We may need to change the way we view our economic lives.
So what is this new economic crisis? Are we moving towards the Armageddon of western economics? What does and will recession mean?
Economists define recession as a decline in the production of gross domestic product for six-months based on measures taken in two three month periods.
Neither the USA nor the UK are experiencing what is described as “negative growth” currently, although there is a widely held belief that we may be heading towards recession.
A lot of factors are being cited as the cause of our current economic difficulties, among which are:
1. The crash in the housing market.
The boom in the housing market was an absurd phenomenon.
House prices in the UK were rising at rates of more than six times the rate of inflation in some years.
Suddenly the world was awash with property millionaires. Someone who had bought a London house for £72,000 ($144,000) in 1983 and stayed put, woke up to find their property is worth £1.6 million in 2007! ($3.2 million). A new two bedroom apartment on the outskirts of Oxford, close to a railway line came onto the market last year at around £500,000 ($1 million). Think about it, one million dollars for a small apartment in a small city outside London!
The average age of a first time house buyer is currently somewhere in the mid-thirties age range. So where do the rest live? How do teachers, nurses, doctors, police and essential service staff ever afford these prices? The answer is they don’t.
It had to stop, and stop it did. House prices are going down in the UK. Economic reports from the USA say that house prices there are over-valued by at least 40%, although by UK standards house prices in the USA look dirt-cheap! Prices have fallen by up to 25% in the past year in (some parts of) the USA.
House price equity in an overblown, pumped-up market is fool’s gold. It is wealth created by a market without any corresponding new value. It has provided a mirage of prosperity by fuelling consumer spending and debt.
To put all this in perspective, the average house price in the UK (across all regions) is about £220k ($440k), the average salary is somewhere in the region of £22k - £26k ($44k - $52$k).
So people have taken risks with borrowing, sometimes taking out loans of between 8 and 10 times their annual salaries in order to own a home. It should come as no surprise therefore that the housing market is in deep trouble.
2. So-called high-risk lending, the “sub-prime” market is collapsing. Sub-prime lending involves lending money for greater returns to poorer people who would not otherwise be able to afford conventional home loans. It’s an economic contradiction that sustains poverty. If one is poor access to money comes at a higher price than if one is rich.
Falling house prices in the USA and to some extent, the UK, means a risk of negative home equity at a very high price. Home repossessions are increasing fast. There is an increasing rate of defaults that means that banks lose money and so do the mortgage companies.
3. So we have:
• Shortage of mortgage funding and banks teetering on the edge of solvency
• Decline in market confidence that affects all sectors of the economy
• Property prices that became vastly overvalued
• Increase in supply accompanying falling demand, with housing costs still running at levels in the UK that are inaccessible to average wage earners, young people and essential service providers
4. Next! There’s the ever-increasing oil price pushing up costs. There is the rising cost of food too that is not necessarily all tied to the cost of oil.
5. One more…the booming house price mirage fuelled consumer borrowing. A falling house market and lowered confidence in the rest of the economy means that people are taking on less debt and looking to save. This in turn means lower consumer spending. Lower consumer spending means lower production that increases the chance of a recession. It is interesting to me that that financial prudence, as I might see it, and a move away from consumption for consumption’s sake has an adverse economic consequence. I’ll come back to that in part 2.
Summary
There are a number of factors involved in our current economic difficulties, but the two main issues as I see them are the decline of an over-heated housing market and a decrease in consumer spending.
Part 2 will be about whether economic growth is beneficial to us all. My feelings are that it is not such a good thing after all. We may need to change the way we view our economic lives.