A debt-filled New Year
Fraser Nelson 5:18pm
The Spectator is out today, with a cover story that I would commend to CoffeeHousers.
Failure to learn from history usually condemns a nation to repeating its mistakes. That's why we should be nervous that no one seems to have worked out what caused the crash. Little wonder: the
guys doing the analysis are the same guys who failed to spot the crisis building up, so it suits everyone to blame the banks. "How was I to know," says everyone from Gordon Brown to Joe
the Pundit, "that they were doing all these complex debt swap thingies? They deceived everyone, the bounders." There is another analysis – and it's our cover story, written by Johan
Norberg. He has been making his case in a short film (trailer here, if you can stand Brown’s cameo) and a book (for my money, the best written about the crisis).
I thought CoffeeHousers may be interested in the bones of his argument – which I flesh out, below.
His analysis is that the hangover is not the problem: the party was. Bubbles always burst. We should ask how a debt bubble was blown in the first place. "Crazy risk-taking by banks is a symptom of the easy money era. Yes, they did outrageous things – but from the tulip bubble onwards, people always do if the supply of money is not properly controlled. What did for Britain (and America) was a fatal fixation with interest rate targeting: the idea that if CPI was about 2 percent then the economy was stable. In fact, this "stability" masked an avalanche of dangerously cheap money, to needlessly counter a benign deflationary shock from China and the Far East. Prices of assets – from fine wine to houses – were soaring. But central banks, and most mainstream commentators, didn't think it was a problem. They all bought into the idea that price stability meant economic stability. The root of the crash was an intellectual error: a rotten idea. And that idea is still with us.
Here is my ten-point breakdown of Norberg's argument. All quotes are from his piece, except point 2 which is from his book. A rather technical point, but a crucial one.
1. There are eerie parallels between 2011 and 2003. “In 2003, after the dotcom crash and the 11 September attacks had sent America into recession, everybody wanted the debt-fuelled consumer binge to continue. Not that they said so in terms. Euphemisms were deployed, then as now: there should be government ‘support’, a little touch of Keynes. The Nobel-winning economist Paul Krugman urged Alan Greenspan to ‘create a housing bubble to replace the Nasdaq [stock market] bubble’. The Fed chairman obliged, cutting interest rates to a new low. In Britain, base interest rates halved between 2000 and 2003. Money was as cheap as it needed to be to get everybody borrowing again, and returning to the market. House prices boomed. It looked like prosperity. Bubbles so often do.”
2. The error of inflation targeting. "In a dynamic economy, with constant innovation, prices often decrease. Let's assume that the real underlying costs fall by 2 per cent, due to increased efficiency. But this development could be counteracted by an increase in the money supply so that price tags in stores indicate a price increase of 1 per cent. The central bank is likely to grab the wrong end of the stick, by concluding that there is no inflation worth mentioning. This will prompt it to cut rates."
Sometimes, the world just gets more efficient – and it should mean falling prices. Norberg quotes James Grant, editor of Grant's Interest Rate Observer (which was calling the asset bubble by its name from 2003 on) in noting that "the price of a basket of good exposed to international competition had fallen by 31 per cent in the years prior to 1886, before the United States had a central bank." As Grant says: "falling prices are a natural byproduct of human ingenuity. Print money to resist the decline, and the next thing you know there's a bubble."
3. Western governments' reliance on debt now is extraordinary. The G7 countries have, on average, 50 percent more debt in 2010 than in 2007. This is an average figure: the below,
using IMF data, charts how much debt they have taken on. No prizes for guessing which country raises the average:
4. David Cameron's famous baby. “For all the talk of austerity, governments everywhere plan to get through 2011 and beyond by borrowing like crazy. The world’s rich countries have increased their debt by some 50 per cent over the past three years, according to the IMF. Such statistics can too often seem meaningless, but during the British general election campaign David Cameron found a way to make them real. He unveiled a poster saying that a baby born today would owe £17,000 due to government debt. By his own estimates, that burden will rise to £21,000 within four years. Less than it would have been without the extra belt-tightening, to be sure, but a daunting figure none the less.”
5. The Russian Doll bailouts. “The crash happened because households consumed too much, sending their debts to the banks. The banks sent the debts to the governments — and, as we saw with Ireland, even governments might struggle to meet them. So they are sending their debts to the European Union. But to whom will the EU send the bills when its credit card is maxed out?”
6. The Irish bailout will not be the last of the sovereign debt crisis. “Greece and Ireland aren’t just illiquid, they are insolvent — and nothing is solved by taking new, bigger loans when they can’t pay the old ones. If Ireland or Greece default on their debt, forcing creditors to take steep losses, it might spook the markets and pull out a thread that unravels the garment.”
7. A Eurozone crisis cannot fail to impact Britain. “If the defaults start — or if it dawns on markets that the European Financial Stability Fund doesn’t have half of what it would take to save Spain, the world’s ninth largest economy — then investors might rush for the exit. And this, for David Cameron and George Osborne, would produce some deeply unpleasant surprises. What would happen to the British banks that have lent more than $110 billion to Spain?”
8. In the last debt crisis, the banks fell. This time, it might be governments. "In this regard, 2011 looks horribly like 2008. Yet again, banks are treading water, hoping
that they can continue to borrow — and trying to lay their hands on as much capital as possible to cover their losses. Yet their risk is the same as last time. We have seen how jittery world
markets can become, and how calamitous the consequences can be. It only took one big bank collapse — Lehman Brothers — to scare the markets so much that they avoided lending to anybody.
Then, it was banks that fell like dominoes. Next time, it might be governments."
9. China may be the next bubble to pop. “Beijing has printed yuan and pushed banks and local governments to spend like drunken Keynesians.
Absurdly, China’s money supply is now larger than America’s, even though its economy is a third of the size. We can see the results of this stimulus in stock market prices and in new
roads, bridges and housing complexes all over the country. Not that anyone wants to travel on those roads or live in those buildings. In August, China’s largest energy company reported that
an extraordinary 65.4 million residences have not consumed any electricity in the last six months — a fairly big clue that they lie empty. There are now entire ghost towns, like new Ordos in
northern China, where tens of thousands of buildings erected from scratch stand empty. And yet property prices in Ordos have doubled over three years. It’s not popular demand, it’s pure
speculation. In some quarters, China is being spoken of as the last, best hope for the world economy. But it might be the next bubble to pop.”
10. We may have tried to fix the old Ponzi scheme with a new one. “In the original Superman film, the hero rescues Lois Lane as she falls from a skyscraper. ‘Don’t worry, ma’am, I got you,’ he says, midair. ‘You got me? Who’s got you?’ she replies. This is the question that no one is asking now. If China is lending to us, who is lending to China? If the governments are saving the banks, then who will save the governments? If the European Union is offering a safety net, who would be there to bail out the EU? There are other questions not being asked: which country, in recent economic history, has successfully borrowed its way out of a debt crisis?”
So could 2011 be the year when the second debt bubble pops? Norberg finishes off with this point:
“’The problem with socialism,’ Lady Thatcher once said, ‘is that eventually you run out of other people’s money.’ This time, it is worse: we are running out of our children’s money, and our grandchildren’s money. We are assuming we will have a never-ending supply of borrowed money, and we have no backup plan if this supply chokes up. Things may feel safe at the moment. We can still borrow easily from international markets. So could Lehman Brothers on 12 September 2008 — the day before the bank imploded.”
Previous
kein
December 30th, 2010 5:56pm Report this commentfags and whisky anyone Oh pass the ammo
TrevorsDen
December 30th, 2010 6:25pm Report this commentSocialists and especially Brown could not bear to prescribe the medicine that the economy needed. They could not stomach the necessary cure any more than they could admit to giving the wrong diagnosis in the first place.
Labour postponed the pain (and the worst of the unemployment) until after the election, but now the spending they 'brought forward' (remember that gimmick?) has to be paid for.
Woody
December 30th, 2010 6:52pm Report this commentI'm sure Mrs Balls made a speech earlier this year where she said unemployment would keep on rising. Perhaps someone should dig this out and ram it down their throats everytime they hit the airwaves with their constant sneering and sniping.
Not a regular
December 30th, 2010 6:52pm Report this commentThe problem is Mr. Nelson is that you and Norberg are also part of the same problem. It is not a socialist or free market argument. In fact let me put it this way. For a conservative-free marketer-capitalist, whatever label you use to argue with a socialist-lefty-market interventionist, there must be some common agreement. It is not about socialist spending someone else's money or somehow the valiant acts of conservatism saving us from another crash. Both sides of the debate, appear to buy into the fact that someone any of this is 'real'. Money is not real. We created it as a representation of value for things. Now if we 'choose' to and that is the key part, choose to we can revalue that worth, embed new things as valuable. The point is that tinkering with the current system whether via regulating inflation, money supplies, borrowing, debt reduction are all things build on the 'idea' of money. There are lots of issues here to think about and little space to examine them.
TGF UKIP
December 30th, 2010 6:52pm Report this commentGlenn Beck has been saying all this for many, many months. We are unlikely, though, to see Glenn Beck being hailed by the bunch of Speccie metropolitans with the same level of approbation that Mr Norberg receives. The other Villagers wouldn't like it, you know.
Hugo Chav
December 30th, 2010 6:53pm Report this commentFraser,
I strongly recommend you seek out Ian Harnett at Absolute Strategy, that guy has had his finger on the pulse of the economy for the last three years, his calls have been the best that I've seen. Well worth getting on the trumpet to ask what he sees ahead.
Happy New Year
dearieme
December 30th, 2010 7:02pm Report this commentIt was in autumn 2003 that I realised that we were hellward bound, handcart-borne. With a becoming intellectual humility I thought I ought to find an economics writer who could explain to me what I dimly discerned. Peter Warburton was the man, with his excellent book http://www.amazon.com/exec/obidos/tg/detail/-/0713992727
Of course, when the storm began it turned out that I had anyway had more useful knowledge of economics than almost all economists anyway. Ironic, as the youngsters say; ironic.
Victor Southern
December 30th, 2010 7:02pm Report this commentI have become tired of pointing out that low interest rates can be a curse. They fuel house prices and the stock market and so encourage risk taking. They discourage saving and so banks no longer have enough real money to lend so they need to create "balance sheet money".
That may not be a popular view amongst professional economists and those who divine from bones or the palms of hands but it is the one that passes the commonsense test.
Jim
December 30th, 2010 7:17pm Report this commentWhen will socialists realise that pain postponed is pain increased, especially for those at the bottom of the pile?
For example if the Labour govt had taken measures in 03/04/05/06/07 to reduce welfare dependency, when those affected had infinitely greater chances of finding employment, there would be less people now being forced off benefits with no jobs to go to.
Similarly if hundreds of thousands of people had not been taken on to the public payroll in pointless roles, they would have found more productive employment elsewhere, and would not now face public sector job cuts at a point when jobs are hard to find.
And restraining the growth of public expenditure in the early to mid Noughties would have allowed the State to cushion the blow of the financial crisis to a greater extent than it can now.
But like kids let loose in a sweet shop, they are unable to resist every siren call for more spending.
When (if ever) will the electorate cotton on?
David Ossitt
December 30th, 2010 7:24pm Report this comment"’The problem with socialism,’ Lady Thatcher once said, ‘is that eventually you run out of other people’s money.’ This time, it is worse: we are running out of our children’s money, and our grandchildren’s money."
And who and what got us into this lousy, stinking, shitty place?
The blessed Margaret knew, socialism and the socialists, the bane of the twentieth century, bastard Brown took on a thriving economy and then for almost fourteen years spent our money like the mad man that he is.
And when that was gone he mortgaged our future, then our kid’s future and then that of the grandkids, all the while leaving booby traps and mines along the way, by his criminal use of The Private Finance Initiatives as a way of creating Public–Private Partnerships.
Explain in detail the workings of these PFI’s and PPP’s to any half bright sixth-former and he or she would recoil in horror.
Only a mad, bad, financially incompetent, buffoon would sign up for such cozenages scams but then it was Gordon Brown, what else could we expect.
We should hang the bastard.
Neil McEvoy
December 30th, 2010 7:24pm Report this commentMr Nelson, that's the best thing you've written in years.
not a regular reader
December 30th, 2010 7:25pm Report this commentOh, this might be a good read and counter. http://www.guardian.co.uk/uk/blog/2010/dec/30/supermac-was-right-1980-and-right-now
Sometimes in all the Con, Lib Dem, Lab crap, we forget that intellect is becoming unrated in party alliances.
yank
December 30th, 2010 7:34pm Report this commentWell, we've given all the crooks, thieves, liars and cheats (there may even be a few outside government, too) at least 2 years to price in state bankruptcies and manage fallout. Sorry, Villagers, but that's next on the agenda. Somebody's going down. Germany will decide who and when, since the rest are sitting in the corner with their dunce caps on. I just hope the Germans pick Illinois and/or California.
I'm laughing perhaps at us, but the revolution in China that's perpetually only a spark away is the real monster in all this. Everybody else will continue to lie and cheat their way through it all, but the Chicoms will have to use harsher methods, which we can only hope are confined by their current borders.
The Chicoms have been making a similar mistake the Japanese did a century and more ago... trying to modernize too rapidly. Slow and steady gets it.
They've been creating 1-2 New York Cities every year, and moving rural folk into them, with jobs, infrastructure, the works. It is of such a run up in scale that it's something we can't really understand, we have no benchmark. I'm sorta surprised that the Chinese went this route.
John birch
December 30th, 2010 8:10pm Report this commentDavid ossitt your remarks are spot on. He should be hung as a traitor to this country as well as financially incompetent .
Gary Williams
December 30th, 2010 8:49pm Report this commentF. Nelson: "That's why we should be nervous that no one seems to have worked out what caused the crash."
Excuse me? Some time ago, quite a few people worked out what caused it. The pity is that few of their number were politicians or journalists.
A small correction: BoE base rate was not "halved between 2000 and 2003." At the start of 2000, it was 5.50%. As of end-2003, it was 3.75%. The choice of those two dates was misleading cherry-picking: from end-2003 to mid-2007, when things started to get ugly, the rate steadily rose to 5.75%.
A larger correction: our overarching financial challenge today is not the bubble/crash/crunch. That was the equivalent to breaking your ribs, the treatment of which uncovered an advanced case of lung cancer.
The cancer is that, collectively, we insist on consuming more than what we produce. That can be solved only by producing more and consuming less. Economic cyclicality, even to extremes, makes that reconciliation more difficult, but not impossible. We can survive bubbles if we exercise self-control by spending only what we can afford. Without that self-control, an absence of bubbles wouldn't save us.
Hugo Chav
December 30th, 2010 9:59pm Report this commentNot a Regular,
May I suggest you pay close attention to Venezuela and the fiction of paper money. Rampant inflation, black market, standard of living sinking and if you can find the chart of their paper money versus Gold you'll see a country sinking.
Baron
December 30th, 2010 10:17pm Report this commentNorberg’s argument cannot be bettered, it’s spot on, it hits all the right notes except for this.
capitalism works only if those who abuse its rules go bankrupt; it's a must. The banks may not have been the top villain, yet those that broke the rules of the free market cum individual responsibility should have taken the hit whatever the consequences. Lots of pain? Yup, but not as much as what is to come.
the debt mountain ain’t a problem if the debt can be serviced; we can plod along as long as the cost of money stays low. Inflation, however, is inevitable, it’s the only way out of the debt predicament bar a total collapse of the capitalist system. When it arrives the great unwashed will bear the brunt of it (and the consequent high rates of interest) because of their numbers, no other segment of the society has the capacity to absorb the hugeness of the excess of the past credit creation insanity. Will they bear it?
the 5mn or so of people who have no stake whatever in the society and live on transfer payments unleashing their anger on it – they will have nothing to lose for they own nothing – will dwarf the recent student rioting by more than a mile.
laverda
December 30th, 2010 11:40pm Report this commentAy least the UK will be OK as we have our gold reserves don't we........
Michael Sweeney
December 31st, 2010 2:52am Report this commentI don't think Britain was particularly well governed under Blair/Brown (though I did under Major, who many Tories were glad to see lose in 1997). However, this is not just a 'socialist' problem, the City encouraged lighter regulation too. And it affected Republican America too. Our welfarist model is unsustainable, propped up by the boom beyond its sell-by date. But its going to get bloodier before people truly accept the implications of this.
Roy
December 31st, 2010 6:33am Report this commentThe comment: "– but from the tulip bubble onwards, people always do if the supply of money is not properly controlled"... Shows that still some have learned nothing, and continue to mention more "control". It is less control, less interference, and definitely no bale-outs that matter. Unless Mr Fraser means by control, a limit to printing money to what reserves of bullion the country holds? If this is done the country cannot come to grief.
The whole centre point to monetary collapse is politicians being too greedy and blind to their over ambitious conniving. Not until countries have a built-in safeguard in their constitution to this effect, will there be any change.
It is wrong to suggest we don't know what caused it, which goes along with what the politicians of the day would wish to hear, and protects the vast amount of dirty-dosh still being held.
David
December 31st, 2010 7:07am Report this commentThe article is rather tame when it comes to analyzing the real causes of the 2008 crash. The following charts tell the real story behind these bubbles:
http://rense.com/general92/stor.htm
Tony_E
December 31st, 2010 7:58am Report this commentAn interesting article, but for me there is only one answer to why we got here: Paper money.
When you have a curency which can be debased at will in response to the market or the needs of governments, you will always suffer bubbles. Governments will always act in their own short term interests, so therefore they will always want the standard of living to rise. If you can't make more product but your standard of living is rising, then it's a fallacy and will all come crashing down in the end. That's been happening here since at least the 60's, probably earlier.
The problem is that now, once we have given up the idea of real physical value in the transferrable note, (so that the bearer can no longer go to the bank and withdraw anything for that note which has hard value), then there is no way back without the ensuing personal poverty. (What we have in cash/savings is already effectively worthless because if we all tried to withdraw it, we would find it effectively didn't really exist).
The best we can hope for is that government pursues a policy which edges towards a stricter balance of payments target so that our disposable income only rises in line with our ability to create exportable products, be they physical or intellectual.
As for China, almost certainly it will have to re-adjust - it has been expanding far too fast, driven by its own dodgy money and our bubble bursting debt. The flows of money will have to even out and China will have to return to more modest growth otherwise its main customers will fold and no longer be able to buy from it.
oldtimer
December 31st, 2010 9:37am Report this commentNorberg`s book title reads:
Financial Fiasco: How America's Infatuation with Home Ownership and Easy Money Created the Economic Crisis
What is new and original about that? Others have previously pointed it out, some even acted on it at the time.
As for banks and risks, it seems clear that the Bank of England and the FSA - at least at the level of working officials - were aware of the risks being taken by banks. The problem was that those in charge, particularly at the FSA, did nothing about it. Unsurprising as some were Brown`s placemen and active particpants in the creation of the bubble (eg Northern Rock).
My expectation is that the politicians, and the bankers, eg the new Barclays CEO, are hoping that inflation will provide them with an escape route, as it has in the past. The fear must be that it will become uncontrolled, Weimar style. We live in very dangerous times.
PayDirt
December 31st, 2010 9:39am Report this commentSome questions: (1) debt, to be in debt usually means another is in credit, with the debtor eventually paying the creditor to balance the books, but with all these Countries in Debt it is not clear who is in credit, is anyone? The financial world is really in chaos with no proper accounting of what has value. (2) The balance sheet between Sovereigns will come to be seen as unjustified (cf First World War reparation debt forced on Germany) default is the outcome but what sort of War will follow? (3) Who is leading the world? No-one I can see.
Major Plonquer 1
December 31st, 2010 10:21am Report this commentTony_E - you are correct. Problem is, Britain doesn't make much of anything that anyone anywhere would be interested in buying. And the non-sellable stuff you make is made at super-high prices that have been driven up over the years by your brothers in the trades unions.
So unless you can find a market for the puke you scrape off your streets every Sunday morning I suspect you're screwed. 'Cept for Scotch Whisky of course.
Boudicca
December 31st, 2010 11:38am Report this commentDavid Ossitt
December 30th, 2010 7:24pm
Well said. Especially the last sentence. That Brown has been allowed to walk away from the devestation he has caused, with a public-funded pension to boot, is an indictment of our political system. We should have a system of impeaching our Prime Ministers for Malfeasance in Public Office. One that could have dealt with Blair as well for allowing the moron to stay as Chancellor for so long.
Gary Williams
December 31st, 2010 11:47am Report this commentDavid,
The two Rense charts (of growth in US private and National debt) are arresting, although their implications are not the same.
US private debt is mostly home mortgages. If a debt-free person goes from renting (which is an inevitable future expenditure) to buying with a mortgage, his indebtedness will mushroom although his annual outlay for housing may grow little if at all.
If his annual outlay does grow, to some extent he is free to offset it by reductions in other expenses which are not on credit.
There is undoubtedly a speculative element in property purchases, but there is also an important investment element. Therefore the growth in US mortgage debt is not quite as worrying as the chart suggests.
National debt is of course different. Were the government expenditure funded by debt used for investment, similar to home purchase, it wouldn't be so bad. As we know by looking around us, however, a declining % of government expenditure is for investment. A growing % of debt-funded government expenditure is being used for current consumption, which is why national debt across the G8 is so pernicious.
London Calling
December 31st, 2010 4:03pm Report this commentGreetings and a Happy New Year to all the Tators…
From: The Sunday Pictorial July 22nd 1917 page 7
Nuts: And: Wine
Mondays Bread is dark in hue
Tuesdays Bread is tough to chew
Wednesday’s bread is worse than coke
Thursday’s bread makes papa choke
Friday’s bread’s like ammunition
After Saturday’s bread you call in the physician
But the bread that is brought on the Sabbath day
Is enough to make any old atheist pray…
David Vinter
December 31st, 2010 6:27pm Report this commentBut as we head towards 7 billion of us, humans keep their jaws chopming away, and smile! They meet a farm labourer, and tell him---I've got a handful of notes at home, and some gold too!
You eat the buggers then said the labourer, I've just caught a couple of rabbits, and I've got a pig, and some chickens at home!
steve
January 5th, 2011 4:31pm Report this commentThe banking crisis was always going to happen and it was clear to many of us that Browns Potemkin economy was built around the mantra "low interest rates are the opium of the people". The government in cahoots with the banks were the drug dealers and the public were the credit junkies.
Even now people don't get it by claiming that browns suicidal economic policies were a success for most of his time at the treasury and only went awry in the final few years.
It was always going to explode in his/our face. His ten years in charge led inextricibly to the financial precepice.
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