The economics of Bob Crow

Bob Crow, 1961 – 2014

The reactions to the sudden death of RMT leader Bob Crow from friends and foes alike were unanimous about one thing; he was good for his members. Indeed, most of those who ride London’s underground can only dream of the tube drivers’ basic salary of £44,000 and 52 days holiday a year. But how much of this was due to Bob Crow?

A private enterprise will not pay a worker more than it thinks that worker will add to turnover, if it did it would be losing money on the employment. The private sector enterprise has only three sources of funding; debt (bank loans, corporate bond issues), equity (selling shares), and income. If it loses money and exhausts these sources by paying workers above a level commensurate with their productivity it will go bust. No matter how determined or skilful the union representative, the workers’ marginal productivity sets a cap on their wages.

But the situation is different for public or government backed enterprises, such as those Bob Crow faced across the negotiating table. They have a fourth source of funding; the taxpayer. In these circumstances unions can push pay claims ever higher. If a union seeks to push wages above a level commensurate with worker productivity and the public enterprise exhausts the funds it can raise from debt, equity, or income, it doesn’t go out of business; it receives taxpayer support. For the public enterprise, unlike its private counterpart, on the other side of the bottom line isn’t bankruptcy, it’s a bailout funded by taxpayers. This is why trade unions continue to thrive in the public sector but are largely absent in the private.

Indeed, despite their extravagant remuneration the productivity of tube drivers, what they add to output, is actually rather small. The big value adding inputs into the production of tube travel are mostly capital inputs; boring machines, trains, track, IT systems, ticket machines etc. It is quite possible, in fact, for tube trains to run without drivers at all. Indeed, as far back as the 1960s the Victoria line could have been built to run without drivers. It was only the insistence of trade unions that saw a role created for drivers to sit in the cab and press a couple of buttons – drivers who could become their paid up members. To avoid union headaches Margaret Thatcher built the Docklands Light Railway to run without drivers in the 1980s, which it has ever since with a safety record comparable to manned tube lines. If a factor of production, in this case labour, is being applied to production needlessly it is wasteful and unproductive. It should not be receiving high wages.

If Bob Crow was aware of the economic possibilities for his members offered by recourse to taxpayer’s money he was also acutely aware of the politics of the situation. He knew, as a former RMT employee put it to me, that “Boris wants to get re-elected as mayor and/or become PM. If he screws up the tube his chances of either are lessened. He has to balance the damage caused by, on the one hand ‘giving in to the unions’ and, on the other, chaos on the underground. The fact that he has to balance those factors makes the union’s position a strong one.”

Such was Bob Crow’s terrain and, like a Wellington, he understood it well. But it did not make him a labour relations genius any more than the Mediterranean coast and Qattara Depression made Montgomery a military genius. His membership prospered not so much because of his skills as a leader, but because of their status as public or semi-public employees whose pay claims were underwritten by the taxpayer. Bob Crow played his hand well but he had a strong hand to play. Those hoping for a more emollient approach from his successor ought to remember that they will inherit that hand.

Burton’s First Encounter with Taylor

Just a wonderful bit of writing

French lessons for Miliband and Balls

“Take it from me mate, don’t…”

“Bliss was it in that dawn to be alive” wrote Wordsworth in middle age, reflecting on the euphoria his younger self felt at the French Revolution. Ed Miliband felt a similar sense of elation when François Hollande was elected President of France in May 2012 albeit expressed in slightly more prosaic terms.

Mr Miliband said that President Hollande’s campaign “has shown that the centre-left can offer hope and win elections with a vision of a better, more equal and just world”. Mr Miliband declared “This new leadership is sorely needed as Europe seeks to escape from austerity” and assured us that “I know from our conversations in London earlier this year and from [Mr Hollande’s] victory speech tonight of his determination to help create a Europe of growth and jobs”

Alas, since he spoke of President Hollande’s “determination to help create a Europe of growth and jobs” French unemployment has risen from 10.2% to 10.9% and Britain’s has fallen from 8% to 7.1%. The French economy has averaged growth of 0.13% per year while Britain’s has averaged 0.16% a year.

Mr Hollande’s strategy was to tax and spend France back to prosperity. A raft of new taxes, most notoriously a 75% top rate of income tax, would pay for the hiring of 60,000 new teachers, the creation of 150,000 subsidised jobs, and a reduction in the retirement age. This strategy has failed. Like Louis XIV’s revocation of the Edict of Nantes in 1685 which flooded east London with entrepreneurial Huguenots, Mr Hollande has simply driven the French men and women who can afford to leave out of the country. Those who can’t are left stuck with unemployment and stagnation, Mr Miliband’s “better, more equal and just world”.

Yet, just as Mr Hollande abandons this strategy in favour of a €30 billion payroll tax cut and €50 billion worth of spending cuts in the next two years, ‘austerity’ if you like, Ed Miliband’s Labour Party are committing themselves to it afresh. Last Friday Shadow Chancellor Ed Balls made one of his increasingly rare appearances and committed a post-2015 Labour government to eliminating the deficit by 2020. The tool with which he intends to achieve this is a reintroduced 50 per cent top rate of income tax.

Mr Balls apparently needs to learn the lesson so painfully learned by France; that as per the Laffer Curve, beyond a certain level increasing tax rates ≠ increasing tax revenues. Indeed, in the last two years of the 50 per cent rate, 2011/2012 and 2012/2013, top rate taxpayers paid £41.3bn and £41.6bn in tax respectively. Under the 45 per cent rate that amount has risen to £49.36bn. Ed Balls was immediately in the unusual position of having to explain how he would fund a tax rise.

This presents the Conservatives with an opportunity. David Cameron and George Osborne should be pointing across the Channel and saying that Hollande’s abandoned France of high taxes, high government spending, rising unemployment, and falling growth, is Miliband’s Britain.

Ultimately the high ideals of the French Revolution were drowned in the blood of the Terror, replaced by the dictatorship of Napoleon, and a disillusioned Wordsworth retired to the Lake District and Romantic poetry. What will it take to educate Mr Miliband?

Debt limit nonsense

The sky’s the limit

Some things are stated as fact which are nothing of the kind. Right up until the Congressional deal raising the debt ceiling news anchors were parroting that without it the United States government would default. This is nonsense.

Over the next year the US government will take in around $3 trillion in taxes. The interest payments on its $16.9 trillion debt in that period are estimated at around $240 billion. As long as its income is greater than its debt repayments there is no reason whatsoever why the US government should default on those debt repayments.

It may choose to do so, deciding to anger China rather than domestic recipients of Federal money, but there is nothing automatic about it. But at some point the US government will default on somebody.

Since 2002 US government debt has risen from $6 trillion to nearly $17 trillion, a rise of 183%. Under George W. Bush it increased at $625 billion a year, and in 2008 Senator Obama was moved to declare “That’s irresponsible. It’s unpatriotic.” Under President Obama that debt has increased by $900 billion a year. It now stands at around 73% of GDP, or $131,368 for every man, woman, and child in America. Even with record low interest rates, by 2015 repayments on this debt will come to $50,000 a year for each American family ^[1].

And the situation is forecast to get worse. The Congressional Budget Office’s September 2013 Long-Term Budget Outlook warns that government spending is set to outstrip revenues in each of at least the next twenty-five years with the gap opening from 2% of GDP at its narrowest point in 2015 to 6.5% of GDP at its widest in 2038, “larger than in any year between 1947 and 2008”. As a result, after a slight improvement between 2014 and 2018, Federal government debt as a percentage of GDP is projected to rise from about 75% to around 100% in 2038.

The CBO identifies the drivers of this increased spending and debt as “increasing interest costs and growing spending for Social Security and the government’s major health care programs (Medicare, Medicaid, the Children’s Health Insurance Program, and subsidies to be provided through health insurance exchanges)”. Spending on the “major health care programs and Social Security”, the CBO writes, “would increase to a total of 14 percent of GDP by 2038, twice the 7 percent average of the past 40 years” and “The federal government’s net interest payments would grow to 5 percent of GDP, compared with an average of 2 percent over the past 40 years”.

The CBO’s conclusion is stark; “Unless substantial changes are made to the major health care programs and Social Security, those programs will absorb a much larger share of the economy’s total output in the future than they have in the past”. Sadly for the taxpayers of 2038 these are just the changes President Obama and Congressional Democrats steadfastly refuse to consider.

But a refusal to see reality doesn’t make that reality go away. These sorts of figures are unprecedented in peacetime and unsustainable and as the saying goes, ‘If something can’t continue it won’t’. The essential problem is that the US government, as with other western governments, has made spending commitments its tax base cannot support. And a promise that can’t be kept won’t be kept. Drastic change will come to Medicare, Medicaid, and Social Security, not because of ‘evil’ or ‘heartless’ Republicans, but because of math, because there isn’t the money to pay for them.

The desperately sad truth is that Uncle Sam won’t keep his current promise to pay pensions, pay for medical care for the poor or the elderly at a given level because he won’t be able to. This will amount to defaulting on elderly and sick Americans, the only question is whether it happens through some entitlement reform (whether the Democrats want it or not) or through meeting these commitments with devalued dollars (over to you Janet Yellen). Either way, if ‘default’ means a repudiation of a promise of payment this will be America’s default. The US government has a choice about ‘default’ now, it won’t in the future.

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[1] The Telegraph, 8 October 2013.

This article originally appeared at The Cobden Centre

Motown breaks down

The 2,500 seat Eastown Theatre hosted The Who and The Kinks. The Cass Tech High School taught Diana Ross and John DeLorean. Michigan Central Station, almost 100 feet long, 230 feet wide, and graced with 14 grand marble pillars, once had Franklin Roosevelt, Charlie Chaplin, and Thomas Edison pass along its platforms.

Nowadays these buildings are just three of the 78,000 abandoned and blighted structures in Detroit. Reminders of a bygone golden age, the authorities can’t afford to demolish them.

The decline and fall of Detroit, which recently filed for bankruptcy, is a staggering tale. In 1950 Detroit was home to 1,849,568 people, hundreds of thousands of them working in the booming motor industry. In 1955 80% of the planet’s cars were made in America, 40% by Detroit-based General Motors alone. GM’s German subsidiary, Opel, was only a little smaller than the largest non-American car maker, Volkswagen. And Toyota only built 23,000 cars that year compared to GM’s 4 million. In the 1950s the Detroit area had the highest median income and highest rate of home ownership of any major American city.

But as they grew together, so they died together. Between 1955 and 2000 global car production increased by 273% but the US motor industry saw little of that action, increasing its output by just 39%. Even at home, despite a hastily erected wall of tariffs and quotas, US car companies lost market share; between 1970 and 2000 Japanese car companies’ share of sales in the US rose from less than 5% to 30%. In the same period the share of US car manufacturers fell from 86% to a little over 50%.

The reason was productivity. In 2005 the average Toyota worker produced 16% more cars than the average GM worker and a staggering 128% more than the average worker at Daimler/Chrysler. Toyota made a profit of $12.5 billion, GM a loss of $10.9 billion.

In part as a result of the demise of the motor industry, less than half of Detroit’s over 16s are now employed. And as the jobs disappeared so did the workforce. In 2010 the population was down to 713,777, a fall of 61% in 60 years.

But the city’s government was left with the spending commitments and liabilities it had incurred in the not-so-bad times. One half of Detroit’s $18 billion debt is made up of pension and healthcare spending commitments to city employees. The share of city revenues being spent on debt servicing, pensions, and retiree healthcare has risen from 30% in 2010 to 40% today. It is forecast to rise to 65% by 2017.

The city tried to fund these commitments with higher taxes. Detroit imposes a per capita tax burden on its residents 80% higher than neighbouring Dearborn even though its residents have a per capita income 33% lower. Detroit residents face the highest property tax rates of any similarly sized city in Michigan, but with 3 bed, all brick, colonial houses on the market for under $10,000 many don’t bother paying. Nearly a third of property tax owed in Detroit went uncollected in 2011.

So Detroit slashed spending, even on ‘core’ functions of government. 40% of streetlights don’t work and aren’t being repaired. Last winter just 10 to 14 of the city’s 36 ambulances were in service at any time, some with enough miles on the clock to have circled the planet 10 times. In February, Detroit fire fighters were told not to use hydraulic ladders unless there is an “immediate threat to life” because they hadn’t been inspected in years.

But even with this, spending commitments without the tax base necessary to fund them have caused Detroit to add $700 million to its debt in the last seven years and brought it to bankruptcy. This is a real American horror story.

Is the death of Detroit “just one of those things” as Paul Krugman wrote on Monday? Or are there lessons to be drawn for the rest of us?

The essential problem of Detroit, that for decades its leaders have been writing cheques their tax base can’t cash, is true now to varying degrees of all western governments facing ageing populations. As I wrote elsewhere late last year

America’s unfunded liabilities (including Medicare, Medicaid and Social Security), rose by $11 trillion last year to $222 trillion. To put that in context, the entire US economy is just $15 trillion, of which $3 trillion a year is paid in tax. If you expropriated all the wealth of the richest 400 Americans…the $1.7 trillion you would get wouldn’t make a dent.

In Britain the Office of Budget Responsibility reported last week that with zero migration the costs of an ageing population would push government debt up to 174% of GDP by 2062. To hold it where it is Britain would need, the OBR estimates, immigration of 260,000 people a year.

Like the ruins described by Shelley’s “traveller from an antique land” the ruins of Detroit are a warning of hubris and complacency, of the belief that it’ll never happen to us. We should heed the warning.

This article originally appeared at The Cobden Centre

Hayek’s guidance for western politicians on MidEast

Freedom fighters

In his final book, The Fatal Conceit: The Errors of Socialism, Freidrich von Hayek wrote that: “The curious task of economics is to demonstrate to men how little they really know about what they imagine they can design”.

Few people are more in need of one of Hayek’s lessons than western politicians.

Nearly two and half years ago civil unrest broke out in a number of Middle Eastern countries. An excitable western media, this generation of journalists eager for its own Fall of the Berlin Wall, soon christened it the ‘Arab Spring’.

How misguided this characterisation was quickly became apparent. Whereas the Prague Spring of 1968 had actually been about freedom the ‘Arab Spring’ saw unpleasant secular regimes elbowed aside only to be replaced with at least as unpleasant Islamist regimes.

Every use of the phrase ‘Arab Spring’ became an insult to those Czechs and Slovaks who had risked their lives for freedom. Eventually even the credulous journalists who had coined the phrase stopped using it.

While the regimes in Libya and Egypt quickly collapsed, the one in Syria put up a fight. A civil war broke out and settled into a bloody stalemate. On one side are the relatively secular, bloodthirsty Ba’athists led by Bashar Assad, on the other are the equally bloodthirsty Islamist; Al Qaeda inspired rebels.

There are deeper currents swirling in Syria. Assad and his Shia followers (as well as the non-Muslims who back him fearing the fate of their co-religionists in places like Morsi’s Islamised Egypt) are on opposite sides from the Sunni rebels of a schism that divides the Muslim world as the Thirty Years War did the Christian world.

Behind them, on either side, stand the Muslim world’s great Sunni power, Saudi Arabia; and its leading Shia power, Iran.

Of these two contending sides in the civil war in Islam, it is not immediately clear that we should be celebrating the victory of militant Sunnis. It is even less clear that we ought to be intervening to ensure it. Nevertheless, that is what we now appear to be drifting towards in Syria.

It is happening with a notable lack of enthusiasm in the west. When Britain went to war with Russia in 1854 a song became popular in music halls which went:

We don’t want to fight but by jingo if we do,

We’ve got the ships,

We’ve got the men,

We’ve got the money too

There is no such excitement now. Jaundiced western electorates seem to have a clearer appreciation than their leaders of the fact that in 2013 we have neither the ships, men, nor money for this adventure.

But politicians in the west have incredible faith in their own power. They are constructivist rationalists in the tradition of Descartes, possessed of the belief that with the judicious application of their power they can construct an optimal social order.

Armed with this belief David Cameron and Barack Obama appear to believe they can topple Assad, replace him with Syria’s version of Herman van Rompuy, and watch the country turn into West Germany.

This was the central fallacy of neo-conservatism. Contrary to Hayek, who believed that successful social orders emerge, neo-cons believed that order could be imposed or consciously constructed.

Despite the evidence of the last few years, our leaders’ Cartesian faith appears unshaken. There is a very real danger that in striving for an unattainable optimal solution they end up landing us with a situation which is worse than we have now.

This article originally appeared at The Commentator

Who’s the real traitor? Obama or Snowden

Sham

On Tuesday, January 20th 2009, in front of a crowd of over one million and assisted by Samuel L. Jackson, Oprah Winfrey, and Beyoncé Knowles, Barack Obama made the following pledge:

“I do solemnly swear that I will faithfully execute the Office of President of the United States, and will to the best of my Ability, preserve, protect and defend the Constitution of the United States.”

We do not know what sort of surroundings, how big an audience, or whether any celebrities were in attendance when Edward Snowden, on beginning his work for National Security Agency contractor Booz Allen Hamilton, swore two oaths: “The first oath,” said Andrew P. Napolitano, a former judge of the Superior Court of New Jersey, “was to keep secret the classified materials to which he would be exposed in his work as a spy; the second oath was to uphold the Constitution”.

Two very different men in very different circumstances had sworn to uphold the Constitution of the United States of America. That document’s Fourth Amendment reads:

“The right of the people to be secure in their persons, houses, papers, and effects, against unreasonable searches and seizures, shall not be violated, and no Warrants shall issue, but upon probable cause, supported by Oath or affirmation, and particularly describing the place to be searched, and the persons or things to be seized.”

One of these men totally disregarded this Amendment of the very Constitution he was sworn to uphold. Instead, he oversaw a ‘security’ apparatus which used a court order to demand that Verizon, a mobile phone company:

“shall produce to the National Security Agency (NSA) upon service of this Order, and continue production on an ongoing daily basis thereafter for the duration of this Order, unless otherwise ordered by the Court, an electronic copy of the following tangible things: all call detail records or “telephony metadata” created by Verizon for communications (i) between the United States and abroad; or (ii) wholly within the United States, including local telephone calls…Telephony metadata includes comprehensive communications routing information, including but not limited to session identifying information (e.g., originating and terminating telephone number, International Mobile Subscriber Identity (IMSI) number, International Mobile station Equipment Identity (IMEI) number, etc.), trunk identifier, telephone calling card numbers, and time and duration of call.”

IT IS FURTHER ORDERED that no person shall disclose to any other person that the FBI or NSA has sought or obtained tangible things under this Order…”

A program called PRISM gave “the US government access to a vast quantity of emails, chat logs and other data directly from the servers of nine internet companies. These include Google, Facebook, Microsoft, Yahoo, AOL and Apple”.

No “probable cause”, no “Oath or affirmation”, no description of “the place to be searched, and the persons or things to be seized”. Just the mass harvesting of data on the private communications of American citizens.

The other man, by contrast, when he found that one of his two oaths flatly contradicted the other, told people that this was going on, that the Constitution he had quietly sworn to uphold was being trampled on. And it is Edward Snowden, not Barack Obama, who is being branded a ‘traitor’ by all sides.

This article originally appeared at The Commentator

Gold vs Silver – The 1896 US Presidential election

A photographic negative of recent election results

To the south are the debtors. With their incomes slumping and debt burdens rising they demand that the monetary authorities act, wanting a little inflation to ease the load. To the north are the creditors. Anxious that the rising wages from their manufacturing output will buy tomorrow what it will buy today they, by contrast, demand monetary discipline.

This is an apt description of contemporary Europe. It is, in fact, a description of the United States in the late 19th century. For the PIIGS we have the indebted farmers of the south and Great Plains demanding the inflationary coinage of silver. For the Germans, protecting the principle of (relatively) sound money, we have the bankers and industrial workers of the north-eastern states urging sound money and adherence to the gold standard.

The United States Constitution gave Congress the power “To coin Money, regulate the Value thereof, and of foreign Coin” and a Coinage Act was passed in 1792. This provided for the free coinage of silver and gold, a bimetallic system, with silver being coined at the rate of $1 for 371.25 grains of pure silver and gold at 24.75 grains of pure gold, a ratio of 15:1. This held while this mint ratio matched the market price ratio. But when, as was likely, they diverged then the metal undervalued at the mint flooded out and the other became the de facto monometallic money. After 1792 gold was undervalued and a de facto silver standard came about; after an alteration of the mint ratio in 1834 silver was undervalued and a de facto gold standard came about.

Messy and protracted attempts to restore convertibility after the Civil War inflation culminated in the fateful Coinage Act of 1873. Considering the controversy it would subsequently generate this Act passed rather unremarked but it was a clear break in American monetary affairs. While it allowed for free coinage of gold to resume in 1879 it said nothing about silver. This de jure demonetising of silver was little noticed as it had been de facto demonetised since 1834.

Two things returned the monetary question to prominence. One was a rise in the gold/silver ratio from around 16:1 in the early 1870s to 30:1 by 1896 owing to an increased international demand for gold and supply of silver. Another was agricultural hardship. Between 1872 and 1895 on a US Farm Average wheat prices fell by 59%. The price of cotton fell by 55.5% between 1881 and 1890. This crippled heavily indebted farmers in the south and Midwest.

There were two explanations for this. One credited dramatic agricultural productivity increases which saw cotton production increase by 111% and wheat production by 446% between 1859 and 1919. The activist Edward Atkinson wrote “[T]here is not a single commodity which has been subject to a considerable fall in price since 1873 or 1865, of which that change or decline in price cannot be traced to specific applications of science or invention…either to the production or distribution of that specific article without any reference whatever to the change in the ratio of gold to silver”

The other, favoured in agricultural areas, blamed a deflationary shrinkage in the money supply following the 1873 demonetisation of silver, which ‘Silverites’ called ‘The crime of 1873’. Figures emerged showing that money per capita in circulation had fallen from a peak of $31.18 in 1865 to $20.00 between 1875 and 1896. “Money in the business world and blood in the body perform the same functions and seem to be governed by similar laws” commented Illinois governor John Peter Altgeld, “When the quantity of either is reduced the patient becomes weak and what blood or money is left rushes to the heart, or center, while the extremities grow cold”

A succession of organisations arose seeking the remonetisation of silver at 16:1, a de facto silver standard. The most successful was the Populist Party under whose pressure the Democrats adopted a free silver policy in 1896. Both parties nominated Nebraska’s William Jennings Bryan for president that year. Bryan, gifted orator to his supporters, demagogue to his opponents, thundered famously at the Democratic convention in Chicago “You shall not press down upon the brow of labor this crown of thorns, you shall not crucify mankind upon a cross of gold”. To Bryan his opponents were “creditors; they hold our bonds, and our mortgages, and as the dollars increase in purchasing power, our debts increase and the holders of our bonds and mortgages gather in an unearned increment”.

The Republicans raised the gold standard with little enthusiasm, their traditional economic panacea was protectionism. Their nominee, Ohio’s William McKinley, had made his reputation on the tariff issue. Unlike Bryan, he won the nomination thanks to diligent preparation. While Bryan stumped 18,000 miles round the country McKinley, reasoning “I might just as well put up a trapeze on my front lawn and compete with some professional athlete as go out speaking against Bryan”, stayed in Canton, Ohio. There he pushed the themes of the protectionism and sound money; “We know what partial free trade has done for the labor of the United States. It has diminished its employment and earnings. We do not propose now to inaugurate a currency system that will cheat labor in its pay”.

McKinley won. Just as silver had a popular constituency so did gold. It was found among industrial workers, many of them German immigrants, who saw their real wages increase by 18% between 1879 and 1889. When, in previously Democrat and heavily German Milwaukee, the Democratic candidate said that “gold, silver, copper, paper, sauerkraut or sausages” could serve as money Milwaukee went Republican.

And almost as soon as the election was over prices began to rise as new gold discoveries increased the money supply. Whether this was due to luck or equilibrating tendencies in the gold standard is still disputed.  And here, if not before, the historical analogy breaks down. There is no such light at the end of the Euro-tunnel.

This is an early draft of an article which appeared in The Salisbury Review

David ‘Whoops!’ Blanchflower strikes again

Back to the wall again

You…hang on, what’s that noise?

Never mind.

You may have seen that your humble narrator has had one or two exchanges in the past with arch-Keynesian, wannabe Krugman, and Columbo dress-a-like David Blanchflower. They centered on his now infamous 2009 prediction that

“If spending cuts are made too early and the monetary and fiscal stimuli are withdrawn, unemployment could easily reach four million… If large numbers of public sector workers, perhaps as many as a million, are made redundant and there are substantial cuts in public spending in 2010, as proposed by some in the Conservative Party, five million unemployed or more is not inconceivable.”

Blanchflower, being rather a fragile sort, blocked me after our latest discussion of this (I’m in good company there) but others have continued to hold him to account and Blanchflower has continued to defend it.

In the course of defence just 11 days ago Blanchflower tweeted the following

But hold on, what’s this? It’s the Office of National Statistics saying that, you guessed it, that double dip never was. Blanchflower’s thumb will be working overtime trying to explain away this one.

Oh, that sound, I’ve figured out what it is; it’s Blanchflower’s credibility disappearing down the toilet.

EDIT

Also embarrassing for such a Labour partisan as Blanchflower is the fact that it now appears that the economy did much worse under Labour, slumping much further in 2009 and recovering less strongly before the election in May 2010.

Source: Daily Mail

Bubble. Burst. Liquidity. Repeat

Increasing both

In March 2000 the dot com bubble burst. From a peak of 5,048.62 on March 10th, 24 percent up on late 1999, the NASDAQ Composite index had fallen to half that by late 2000. GDP growth slumped and unemployment steadily climbed from under 4 percent in late 2000 to a peak of 6.25 percent in mid-2003.

On January 3^rd, 2001, Alan Greenspan acted and cut the Fed funds rate to 6 percent. By June 2003 it was down to 1 percent where it stayed until June 2004. The effects are well known. This wave of liquidity was directed by government action like the Community Reinvestment Act, government bodies like Fannie Mae and Freddie Mac, and a minefield of moral hazard in a financial sector which knew it would be bailed out of any trouble, into a housing bubble.

That bubble burst too. With inflation on its way up from 2 percent in mid-2003 to 4.7 percent in October 2005, Greenspan gradually raised the Fed funds rate, reaching 5.25 percent in June 2006. But this crippled many people who had borrowed at lower rates to buy property. The number of new foreclosure starts in the US increased by more than 50 percent to 1.1 million between 2006 and 2007.

Assets backed with these non-performing loans crashed in value. Banks holding them saw their balance sheets ravaged. Seeing counterparty risk everywhere, banks stopped lending to each other and the LIBOR, usually about 0.15 percent above where the market thinks the bank rate will be in three months’ time, shot up to over 6.5 percent in August 2007. The credit crunch had arrived.

And Greenspan, his academic successor Ben Bernanke, and central bankers around the world reacted as they had to the bursting of the dot com bubble. The Fed funds rate went back down from 5.25 percent in September 2007 to 0.25 percent in December 2008. Likewise, between July 2007 and March 2009 the Bank of England slashed its Base Rate from 5.75 percent to 0.5 percent. Even the supposedly cautious European Central Bank reduced its key rate from 4.25 percent in summer 2008 to 1 percent by the spring of 2009.

When this failed to have the desired stimulative effect central bankers began trying to pull down the long end of the yield curve. Under Quantitative Easing the Bank of England spent £375 billion of newly printed money on British government debt. The Federal Reserve is spending $85 billion dollars a month on bonds.

There is a pattern here. A bubble in assets (dot com stocks) bursts and central banks react by hosing liquidity into the system. But this liquidity inflates another bubble (property) and when that bursts central banks react by hosing liquidity into the system…

In the high Keynesian noon of the post-war period it was widely thought that monetary policy was ineffective for macroeconomic management (it is debatable how much this is actually owed to Keynes). All that could be hoped for from monetary authorities was support for the fiscal policies which really had the clout to equilibrate the economy.

But this Keynesian paradigm fell apart with the stagflation of the 1970s. Money mattered was the lesson and it became the primary tool of macroeconomic management, replacing fiscal action, at least until the ‘Return of the Master’ following the credit crunch.

But what has this meant in practice? As interest rates are lowered in response to an adverse shock investment, calculations change, especially when, like Alan Greenspan, those behind the policy publicly promise its continuance. To the extent that this fosters a wealth effect, consumption, as well as investment, may be stimulated. And this, in fact, is exactly the way the policy is supposed to work.

But the rates cannot stay that low indefinitely, nor, despite the jawboning by monetary policymakers, are they intended to. At some point they will rise. Again, this actually is the way the policy is supposed to work.

And when those rates do rise what happens to those marginal investors who made their decision when rates were at their lowest? What happened to the NINJAs who bought condos in Michigan when interest rates were 1 percent when the rates went up in 2006? They were scuppered. And what will happen to all the enterprises which are currently dependent on interest rates remaining at their historic lows when those rates start to rise? It is because more people are now asking that question that markets have turned skittish recently, since Ben Bernanke even began to discuss a possible future ‘tapering’ of Quantitative Easing.

Those rates will have to rise at some point. But, when they do, whichever bubble we have now will burst. Our monetary authorities have printed themselves into a corner.

This is what passes for macroeconomic management. As one of the high priests of this bubble-onomics, Paul Krugman, advised in 2002 in the wake of the dot com bust “To fight this recession the Fed needs…soaring household spending to offset moribund business investment…Alan Greenspan needs to create a housing bubble to replace the Nasdaq bubble”. And no, that’s not taken out of context.

One of the great myths in economics is that of some sort of stable equilibrium. It is apparent that active monetary policy is little better at producing that than fiscal policy proved. Instead the economy is characterised by crises of increasing frequency and amplitude and the only solutions policymakers appear to have to deal with them will buy ever shorter-lived respite at the cost of increasing both the frequency and amplitude of crises.

We are in an equilibrium of sorts, but it is an equilibrium of crises.

This article originally appeared at The Commentator