Is the Chinese Economy a Giant Ponzi Scheme?

There has been quite of lot of justified concern among economics pundits about the Chinese economy with some, like Will Hutton,  likening the problems there to a Ponzi scheme. A Ponzi scheme operates rather like a chain letter where the  earlier entrants into a savings scheme are paid directly from the contributions of later entrants. It is a simple fraud.  It has to break down sooner or later. Whatever the shortcomings of Chinese economic regulation may be we don’t have the evidence to accuse the authorities there of allowing these schemes.

The China situation is better described as one of debt-deflation. Money is created  and then spent in the private sector when banks make loans. This spending stimulates the market: shares and asset prices prices rise, growth spurts, but the newly created money dwindles in the economy as it is spent and respent with the Govt taking its tax cut on every transaction. But the debts remain and accumulate – slowing down the economy. So more bank lending is needed to keep it going and the same thing happens again. Steve Keen has shown that everything looks OK providing the rate of bank lending is accelerating. But as it can’t do that forever, the effect of the bank lending starts to have a net negative effect and then we can have a slump if the level of private sector debt becomes too high.

The immediate fix is for government to  spend, large amounts of cash usually called liquidity, to keep the economy going. Mosler’s Law states that this should always be possible but any crash or   slump is still very disruptive.  A better solution in the longer term is to rely on monetary policy (ie the variation of interest rates and the ease of bank lending) only to a very limited extent in the regulation of the economy.

 

The UK Autumn Budget Statement – More Neoliberal Nonsense!

The Autumn statement would not be so bad if it was economically coherent, with the spending and taxing plans agreeable, or otherwise, according to one’s political opinion. However, it does not make any sense. Not only does it not “add up”, it is inconsistent with all the principles of arithmetic.

The right wing Tory MP John Redwood makes the point :

“In total the new estimates show us paying an extra £105 billion in tax over the five years”

George Osborne says:

” we will reach a surplus of £10.1 billion in 2019/20″

Note: it’s not just “about £10 billion” its  “£10.1 billion”. We’ve all got to admire just how precise George and his Treasury economists can be about these five year forecasts! As if !

There’s no chance of this happening with the UK running a ~ £90 billion deficit in its external deficit due to trade and other international payments.  It would mean that the UK economy would have to find ~ £100 billion every year to pay the import bill and also provide the government with its £10 billion surplus.

This, presumably, is close enough to John Redwood’s ” extra £105 billion in tax”?

George Osborne says that  “Britain will be out of the red and into the black” which is completely untrue. These figures mean the British economy will be in the red to the extent of ~£100 billion to pay for the Govt being ~£10 billion in the black,  and Britain’s overseas trading partners being ~£90 billion in the black.

It can’t possibly happen that way,  unless somehow the trade deficit can be turned into a trade surplus, and that aspect is totally ignored in George Osborne’s grand plan. The UK economy could not sustain a net loss of £100 billion even for one year – never mind on an annual basis. George Osborne will only send the economy into a downward spiral trying to achieve the impossible. An economy in a depressed state will also deliver depressed levels of taxation revenue.

In a couple of years time, the excuse for the plan failing , as it inevitably will , is likely to be that even though the Government has kept spending under control, taxation revenues will have not come in as expected. This will be attributed to: Problems in the eurozone, problems with world trade, problems with loss of revenue from North Sea oil, a new war in the Middle East maybe?

In other words, the same kind of ‘excuses’ as were put forward after the last similar plan failed, in the years following the Tory win in 2010, except the Govt could blame the Lib Dems then! If the Government cared to look for a reason, rather than an excuse, they would explain that their deficit has to be the sum of what everyone else saves. They don’t have direct control of that.

There’s a saying , usually incorrectly attributed to Einstein, about doing the same thing over and over but expecting different results, being a sign of madness.  Are the Tories mad, though, or just plain bad?

A Simple Spreadsheet Model of Government Spending

There is no intention on my part to provide Steve Keen any competition for  his excellent Minsky program but I thought I would have a  try to explain some of the economic ideas of this blog in figures rather than just in the usual words, so I put together this spreadsheet. Which you can download  here. (Just make sure that it doesn’t get renamed when downloading. It needs to be called econ.xls for the macros to work). It is quite easy to use.

As spending has to come before taxation we first have to spend some money into the economy. I’ve chosen $500. Just consider the $ symbol to represent whatever currency you like of course.

The recipients of this money are three users of the currency (A, B and C) who receive the above amounts for services rendered. Just to keep it simple we only have these three users in the economy. The payments are decided in a quasi random way in the program so you won’t see the same figures but they should add up to the total spend by the government. Press the RESET button and you’ll see this.

Next, with the Tax level set at 0%, press the second macro button. You’ll see that user A uses his money to buy from user B. Then user B buys from user C and user C buys from user A.

As the tax level is set at 0% the goverment isn’t receiving any revenue so we now need to change this to 20%. Press the RESET.

Press the second macro and each time we’ll see the effect of a single transaction. ( meaning that all three users are buying and selling from each other). Notice that cash assets are equal to the government’s deficit and as the revenue rises the cash assets fall and the deficit falls too. Eventually the deficit falls to zero. We can raise tax rates to 30% or whatever and though the deficit falls faster it doesn’t go into surplus even with high tax rate. Press the RESET.

We’ll next allow our users to put some cash away in a savings account. We’ll allow them $5. As there are three users , pressing Macro button 3# should show $15. We repeat the exercise and surprise, surprise, no matter how many transactions we have, we end up with a deficit of $15.

Of course if I were George Osborne I’d shriek in horror at this $15 deficit
🙂 and call in the Office of Budget Responsibility. They would no doubt advise that the way to restore the spreadsheet to showing a surplus was to cut spending and raise taxes. So we cut spending to $450 and raise taxes to 25% and give the program another go. “That’s odd” George would be thinking “I’ve done what the OBR has advised but still my deficit is persistent!”

Next George could try Nigel Lawson. He knows a thing or two about producing a surplus. He managed it in the late 80’s by encouraging lots of borrowing. That’s what he’d suggest again. So George would type -$20 (minus $20) in the savings account for each user. Press macro #3 and try again. A few taps later on the second macro and Hey Presto! We have, or rather George now has his surplus. If we are one of those users, we are the ones in deficit!

If this wasn’t so serious and wasn’t ruining the lives of our young people this might be all rather amusing.  How is it possible that such a cretin can be paid over £130,000 pa for f***ing up the economy?
………………….
Edit:
“Stuey” (below) asked an important question which might just bear repeating here with my answer.

Q: When I create a debt for the users, government runs a surplus. But isn’t that because the loan would have come from the government in the spreadsheet? Loans usually come from private banks. Doesn’t that make a difference?

A: It doesn’t make any real difference. We can easily put our three currency users into debt by clicking on the third macro.

Say we give them $100 worth of debt and the cash to match. That could be an overdraft at a private bank. So they’d have the debt but an extra $100 of cash ie spending money to start with. We click away on the second macro and the govt has a $100 surplus. Everything looks good – superficially.

If all the users banked at the same private bank the transactions would be recorded in the IOUs of that bank. Except, the tax bill on the transactions would have to be paid from the private bank’s reserves – in real central bank money.

So, at the end of the process, the users are collectively in debt to the tune of $100. The private bank has an asset of those debts but it has also lost assets of $100 from its reserve account. So the PB ends up all square. The debts in the economy remain, however, until they are repaid – unlike in the spreadsheet when they are extinguished by the reset button.

It is this accumulation of private debt in the economy which is the basis of Steve Keen’s debt deflation concept. The problem of increasing private debt levels can only be temporarily fixed by encouraging the creation of yet more private debt. But that’s a bit like a junkie needing a bigger and bigger fix. He needs at some point to choose a healthier lifestyle.
…………………….
PS I do this kind of database (usually Access) and spreadsheet programming in my day job too, usually in an engineering context. If you have any requirements send me an email:   peter_martin_2001@hotmail.com

 

 

 

 

Where does the Money come from in a Monopoly game?

It has been some time since I last played Monopoly. The Board Game.  As I remember we have several players and a banker who assumes a similar role to government in our economy. He hands out money at the start of the game. Whenever we pass GO, or draw a lucky card from the community chest we get a bit more. He charges us tax,  super-tax, and might put us in jail from time to time.

We don’t like it when that happens, but where does the money come from in a Monopoly game? The more right wing players might argue it comes from other players when they land on the their Mayfair or Park Lane properties which have houses and hotels on them! They like to think that wealth creates money rather than the reverse. But those of us who take a wider view know it all comes from the banker originally.

The government/banker is always in debt. He has to be. His debts are the players’ monetary assets. Penny for penny. Would the game work at all if he insisted on always balancing his budget?

PS Apologies if this is a statement of the bleeding obvious! But, many of our highly educated (over-educated?)  politicians still seem to be in need of such.

Do we really have austerity economics in the UK?

Many right wing commentators make the point that public spending is higher now than under the last Labour Government in both real and nominal terms. They dispute the charge made against the present government by the left that they are engaging in the ‘austerity economics’.  Even the deficit (they mean the government’s budget deficit)  they will admit, when pushed,  is higher than the last Labour government’s deficit. So why are we being so harsh when they are clearly doing their best? If we want austerity , they argue, just look at what happens in the Eurozone.

Is there any justification for their defence? Possibly. GDP per person is just about the same as it was a decade ago. There were no accusations of austerity economics then and most voters  in the UK felt fairly well off. Or, at least they did in sufficient numbers to re-elect a Labour Government in 2005. So, why is the general feeling that we are worse off now than we were then? If the published figures are correct, and there is no reason to dispute them as far as I know, then the problem must be one of distribution of the available income.

Ironically, the best defence the Tories have against the charge of austerity economics is that there would be no austerity if everyone had a fairer share of what was available. They might not go for that though!  GDP per person is now twice as high as it was when Mrs Thatcher first won a general election. She and her government were of the opinion that the left were reactionary in quibbling about the distribution of the proverbial cake, and that it was better for all if we just concentrated our efforts into making a bigger cake.

Well, we’ve done that. The cake is now twice the size, but there are more homeless now than there were then, with higher levels of unemployment and underemployment. Terms like “Zero Hours Contracts”  and “Food Banks”are in existence now which weren’t then. So why the problem? It has to be caused by how the available wealth and income is divided.  There is no alternative explanation.

That would be the socialist explanation of why we have austerity. An economist would perhaps adopt a different tack as has Professor Bill Mitchell:

“Austerity occurs when the government runs deficits that are too small relative to the spending and saving decisions of the non-government sector. In this context, it is moot where the revenue comes from. The impacts of running insufficient fiscal deficits usually does impact on the poor and disadvantaged, most notably, because it causes mass unemployment and/or underemployment. And I don’t diminish the concern we should have for those distributional consequences. But from a macroeconomics perspective that is not the point. Austerity is about the sufficiency of the deficit contribution to total spending and national income generation.”

So how does this work with the present bout of austerity in the UK?

John Redwood recently made the following claim on his blog:

“The most recent figures show the UK deficit gradually reducing, with tax revenues growing more quickly than the growth in public spending, as planned.”

There are two problems here: Firstly he, I would suggest David Cameron and George Osborne too,  thinks that reduction is a good thing. Secondly,  he thinks the UK’s deficit is the same as the Govt’s budget deficit which it clearly isn’t. A better description of the UK’s deficit is the net loss of ££ to pay for the net import bill and which is currently some 5% of GDP.

So, it must follow that if Government reduces its own deficit to below 5%, as it has recently done, that it is simply pushing the economy into recession. That’s austerity. Everyone will run increasingly short of money. Gross aggregate demand can then only be maintained by increased private sector borrowing which of course just inflates the bubble economy.

London property is rated as the most overvalued in the world with a bubble index of 1.88 and the rest of SE England can’t be far behind.

http://www.theguardian.com/money/2015/oct/29/london-house-prices-most-overvalued-world-ubs

If the Government wants to run a a 5% deficit in trade it has to run something like a 7-8% deficit in its budget to allow those in the economy who wish to save (rather than borrow) some capacity to do so.

Pushing it down to only 4% is a recipe for disaster. The economy is now hanging by a thread. The bubble will burst sooner rather than later and we all know what happens to real economies when bubble economies burst.

Even looking at this kind of economics from a right wing perspective, I can’t see it makes any sense. Firstly it will reduce the electoral chances of the Tory Party. Voters who become economically disadvantaged and become reliant on State support will vote for parties offering better rather than worse support. Secondly, it will hinder their desire for a smaller state. That is only going to be possible when workers have sufficient spending power to afford private sector alternatives to those services the State now provides.

“We need deficits because people want to buy gilts” – Richard Murphy

Richard Murphy published an interesting  article “On budget surpluses and the economic illiteracy of the Fiscal Charter”  yesterday in which he made several important points such as “we need deficits because people want to buy gilts” and “if the government runs a surplus someone else has to run a deficit”.

Absolutely right and well said, Richard! I hope everyone who’s even the slightest bit worried about our deficit and so-called “national debt” reads this very important piece of what will be ‘news’ to them. Maybe John McDonnell has finally seen the light? There’s nothing wrong with a a change of mind when new evidence and new arguments compel that. Intelligent people change their views all the time as more information becomes avaialble.

The question to be resolved, and I must admit I’m not totally clear on the answer, is if we should sell gilts. Is the fact that people want to buy them a good enough reason to sell them? Why can’t we just allow people to put their money on deposit. Offer the a fixed interest rate, say 2%, and tell them “That’s it. Take it or leave it”.

Some would say 2% was way too high. We should pay 0%. So what will happen then? If we discourage people saving, deliberately creating enough inflation to make 0% , or even 2% very unattractive, we’ll theoretically have no deficits at all.

Because Government Deficit = Savings of the Non-Government

Is that what people really want? Is George Osborne aware that what he needs to do to achieve his surplus is create more inflation and stop selling gilts?

Want to reduce your deficit, Mr Osborne? Stop your boys burning those £50 notes* !

* Or at least ask them to tell you about it!

The Oxford University based Bullingdon club has attracted controversy of late, in large part  due to certain unsavoury practices  indulged in by its young, privileged, elitist but poorly behaved members. Their current initiation ceremony is reported to include the burning of a  £50 note in front of a beggar or homeless person.

.

Former members of the club are now a well ensconced part of the UK political establishment. These include the current Prime Minister Mr David Cameron (In photo, second from the left standing) , the Chancellor of the Exchequer Mr George Osborne, and the Mayor of London Mr Boris Johnson (far right sitting)

A key source of worry for our worthy politicians is the UK’s government budget deficit which now runs at approximately 4% of GDP. This is the gap between what the government spends into the economy and what it receives back in taxation.  The budget deficit is often referenced in support of their argument that we are all “living beyond our means”,  that our “credit card is maxed out”, and that cutbacks in spending  and increases in taxes are unfortunately necessary to “cut our coat according to our cloth” etc etc.

So in this context, we might ask just what macroeconomic impact the burning of our currency might have? It is course illegal to deface or destroy currency. Why should that be?

It does have an effect. If these wealthy young men had chosen to give £50 to a homeless person that money would no doubt have been quickly spent. It would have been a stimulus to the economy.  The destruction of £50 has the opposite effect. It is exactly the same as if we had handed that £50 note over to the government in taxation, where the government routinely puts old notes through the shredder.  If Mr Osborne knows of specific instances where currency has been deliberately destroyed he is quite entitled to count that as voluntary taxation. His deficit would be reduced commensurately.

As he can’t know just what happens to our currency he has to assume it still exists and that it is just being saved somewhere. The net effect is still the same. To keep the economy functioning,  at full capacity,  any money which has been taken out of circulation either by its destruction or because it is being stored in a safe or bank account has to be respent back into the economy by government on our behalf. It’s neither here nor there  whether the budget is in deficit or in surplus.

We don’t need to know how much is being burnt and how much is just being stored. If any government overdoes the spending, relative to the levels of taxation, we’ll have too much inflation, but if it underdoes it , like now, we’ll have deflation and high levels of unemployment and underemployment.

Is Government Spending Already by PQE?

We can think that all spending by government is already by the creation of new money, which is the general understanding of PQE (otherwise known as  Overt Monetary Financing of Government), using the concept that money is an IOU of a sovereign currency issuing government.

So, just as you or I have no use for our own IOUs, we tear them up when we get them back, neither has government. All money collected  in the form of taxation or in bond sales is simply shredded. Destroyed -either physically or digitally. When govt spends, it does so by issuing new IOUs. ie Issuing new money.

So what is the point of taxation? It’s to prevent high inflation as has already been mentioned in previous posts.

And the point of selling gilts (bonds)? It is to set longer term interest rates. Generally speaking: The more that are sold by auction, the lower their price, and the higher their yield. The higher their yield the higher are longer term interest rates.

If Government wants lower interest rates in the longer term it should sell fewer gilts, yet still create as many new IOUs, as many new ££, as it needs for spending purposes. Its spending decisions have to be such that they won’t produce too much inflation, of course,  which would require the raising of taxes. The balance between spending and taxation remains the subject of political debate as always.

A better idea might be to stop selling gilts completely and allow savers, ie the hitherto bond purchasers, to put their money on account with the BoE ( which is best considered as part of Treasury) and set the interest rate payable just as a high street bank would set the interest to us on our longer term savings. Short term interest rates are already set this way so the concept, and practice, just needs to be extended to include all savings. The interest rate would probably be higher for a longer deposit period, again as we might expect from our own bank.

And what about the exchange rate?

If the government offers lower interest rates the £ might be expected to fall, and higher rates will probably cause it to rise. If we stay with the idea of selling gilts, and stick with the concept that PQE  is somehow different,  we can say there will be less need for the government to ‘borrow’  and therefore less need to pay out interest.

This will have the same effect on the exchange rate as directly reducing interest rates.  It is just looking at the process from a different perspective.

PQE, as is conventionally understood, could be part of the government’s exchange rate strategy. That is if it wants one, and that could be the subject of another discussion! If it wants a lower pound, it does more PQE. A higher £ means less PQE. It depends on what sort of trade deficit we want to run. If we are happy to run a high deficit, and there is no reason why we shouldn’t, we can keep the pound high, but if we want to reduce it we will need a lower £.

Goodbye to £5 and £10 notes?

The  Bank of England’s chief economist Andy Haldane’s speech. caused some raised  eyebrows recently. It sounds like he knows we’re in for some tough economic times ahead. Things are so desperate that it  might require the abolition of cash in the economy!  People will be forced to hold money in banks and see its value dwindle.

As Andy Haldane has put it “A more radical proposal still would be to remove the ZLB (zero lower bound) constraint entirely by abolishing paper currency.”

We could perhaps begrudgingly say Andy Haldane has shown political and economic courage in saying this. If we are being charitable we could credit Mr Haldane for highlighting the intellectual bankruptcy of most mainstream modern economic thinking. If we wished to be less charitable we’d have to say the idea of abolishing cash is about as stupid as it gets!

I hope it is the former and that cash won’t be abolished. But this isn’t the first time we’ve heard this silly argument argument from monetarist economists and in particular from Kenneth Rogoff. See  here  and  here. That they feel the need to make it shows they still haven’t really grasped that interest rates can’t have the controlling  effect they think they have on the wider economy.

When intelligent men like Rogoff and Haldane have silly ideas, political ideology is usually to blame. The main argument for banning cash, other than to hinder criminals and tax-dodgers, which is no stronger an argument now than it has ever been, is to facilitate sharply negative interest rates. But if we want to stimulate the economy, as we do right now, there’s an obvious and much easier alternative: ie loosen fiscal policy. Increase government spending and reduce levels of taxation.

The only reason to suggest something as outlandish as banning printed currency is that you believe this alternative to be impossible. Or, rather impossible according to one’s own political ideology.

Monetarism all sounds fine – superficially. When times are good interest rates are increased to slow the economy down. When times are bad they are lowered to stimulate lending and get it moving again. There’s no need for government to be involved at all. They can concentrate on balancing the books like any good business should.

Except that every stimulus leads to the build up of private debt in the economy. This build up slows down economic activity, and so we later have to have another reduction in interest rates. Then another and yet another after that . If we get it all wrong then there can even be a giant crash in the economy when those who’ve taken on too much private debt go bust and cause their creditors to go bust too.

So, eventually we arrive at the situation, as we have now, where interest rates in much of the western world  are close to zero and they need to go negative according to the theory to stimulate the economy again. Economists with more intelligence are saying “Whoa! There must be something wrong with the theory”. Others with less insight are saying “But this is just the special case of the zero lower bound” and those with no insight at all, or are stupefied by their own political ideology, are ploughing on regardless and calling for the abolition of cash!

Leaving aside the argument that many of us quite like the convenience of using cash, it’s much quicker than messing about with credit cards at the petrol station for example, it is a genuinely bad idea to go down the road of negative interest rates which will lead to an ever increasing build up of private debt in the economy.

Mainstream (ie Neo -Classical and Monetarist in outlook) economists didn’t spot the onset of the GFC because they didn’t  know where to look for the warning signals. The role of private debt in leading to booms and busts was denied. Expanding the “money supply” was the only standard remedy for stimulating economic activity and the risk of creating asset bubbles was largely ignored with disastrous consequences.

I may come back to the question of private debt in the economy later but for now I’ll just reference Prof Steve Keen’s excellent blog on the perils of debt deflation.

What is People’s Quantitative Easing?

PQE,  sometimes known as Overt Monetary Financing, is the process of creating new money, issued by the central bank in exchange for government bonds. This is then directly spent into the economy to stimulate economic activity. Whereas conventional Quantitative Easing is primarily to provide liquidity to banks and other financial institutions – Some might say it is to give them money which can create asset price bubbles, and other price distortions! – PQE is much simpler and free of many complications.  PQE  can be part of powerful fiscal policy to remedy the  problems of recession and depression.

Mention PQE, however, a term coined I believe by Richard Murphy, and it won’t be long before Zimbabwe and the Weimar Republic will be used as examples of why it’s not a good idea! That’s OTT, but nevertheless the objection of possible inflation needs to be addressed.

PQE could possibly cause inflation. All government spending, as with all spending, deficit or otherwise, carries an inflationary potential .

Deficit spending is necessary to keep the economy functioning when users of the currency wish to save some of it. Those who doubt that might just like to consider the very simple economy of a baby sitting circle. If everyone in the circle readily spent a token and received a night’s baby sitting in equal measure to their willingness to do a night’s baby sitting to receive a token, there’d be no problem at all. But, say, for whatever reason, some of the sitters decided to accumulate tokens. Fairly quickly there would be a shortage and the system would cease to function. There would be a demand, from those without tokens, that the baby sitting council should issue extra ones. Those with a stockpile of tokens would object, saying the “printing” of new tokens would devalue their existing tokens.

If the hoarders lent the tokens back to the council they could be pacified with some reward. Just as lenders of pounds to the government are pacified with a reward of extra pounds. But if the hoarders of the tokens saved them in a piggy bank and refused to lend them back, all the council could do would be to create new tokens and inject them into the system. This would be the equivalent of PQE.

Is one method more or less inflationary than the other? There’s not much in it. Arguably PQE would be less inflationary because there are no extra rewards needed. If the issuing of new tokens, by either method, was just enough to restart the system, not too much and not too little, then neither method would be inflationary.

So who are the hoarders in the real economy? The central banks of the big exporters are the biggest. The big exporters don’t want to spend all they earn by selling goods and services into the British economy. So they buy Government bonds and so effectively lend back their surplus tokens, or ££. The wealthy are the other main ‘culprits’. They tend to accumulate more ££ than they need.

But what if not everyone recycled their extra tokens back through the banking system? Suppose they kept hoards of cash in safes or bank deposit boxes? The government can’t borrow those back. All it can do is create some new tokens. PQE in other words.

The government can’t know just how fast money is moving or if lots of it is being stored this way. What it can expect is the combination of low interest rates and low inflation will make it more attractive for many users of currency who may be engaging in illegal, or borderline, transactions and so wish to hide their finances, will  to store their cash this way.  However, Government can easily monitor inflation. If it is engaging in PQE and inflation starts to be a problem it needs to back off. Alternatively if it’s not a problem it can do a bit more. The government needs to be careful, but shouldn’t be so scared of the idea that it doesn’t even try it out.