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Global outlook (Crikey post)

May 17th, 2009

If not for the drastic downward revision of expectations that has taken place since the financial meltdown of September-October 2008, the Budget’s forecasts for global economic conditions would look exceedingly gloomy. As it is, they look to be based on a fairly rosy scenario, in which advanced countries experience a GDP contraction of just under 4 per cent in 2009 before stabilising in 2010 and recovering in 2011.

The prospect of a complete collapse in the global financial system, very real until a couple of months ago, seems to have been averted. Risk measures such as the LIBOR spread have returned to normal levels, and, for firms and households with strong balance sheets and a desire to invest, credit is available. Taken at face value, the reports from the ‘stress testing’ of US financial institutions suggest that the major banks can be returned to a sustainable position without the need for full-scale nationalisation.

Although complete collapse now seems unlikely, the prospect of a long period of depressed growth, similar to Japan in the 1990s, cannot yet be dismissed. The stress tests, produced after considerable negotiation between the banks and the US Treasury, represent a statement of hope rather than a coldly objective assessment.

Closer to home, there are similar concerns with respect to our Asian trading partners. If their recovery is delayed, the same will probably be true here. And if the Chinese economy falls into recession, the impact would be very serious.

There is some potential upside. A stronger than expected recovery in the US and the adoption of more expansionary policies in the eurozone could see the global economy outperform the Budget estimates. But, overall, the global economy presents more risks than opportunities.

Hard Target buy

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  1. Kevin Cox
    May 17th, 2009 at 22:20 | #1

    The fact that economists cannot predict with any degree of certainty how an economy will perform is an indictment on the way we have constructed our economic systems.

    A problem is the global uniformity of our monetary systems. It is a system failure that a problem in the money system in one part of the world, in one sector of one economy should escalate to the extent it did. However, if we view economic systems as complex adaptive systems then experiments in modelling such systems shows the dangers of the heterogeneity of control systems.

    We would not be in this problem if we used different methods of increasing the money supply instead of solely relying on creating loans or buying bad loans. Using loans to increase the money supply is an unstable mechanism.

    Stimulating the economy through the issuing of more debt does not solve the underlying problem. What the result will be is uncertain but it is unlikely to be a stable system.

    It is my guess that the Chinese who do not have a floating currency and who increase the money supply in ways other than the loaning money will not experience a recession – just a slight slowing of growth as their economy adjusts to the external world.

    Australia should be able to do better and I suggest we take a closer look at the way we adjust the supply of money and start to use other methods.

  2. Ernestine Gross
    May 17th, 2009 at 23:27 | #2

    JQ,

    First of all, thank you for the posts on the budget lock-up and the crikey posts.

    There are a few observations and questions on which I’d like to get your opinion or answers::

    1. Macro-economics. The almost universal policy response of expansionary fiscal policy (‘stimulus’) to the acute danger of a complete global financial break-down with unknown consequences for the material wellbeing of people in this global economy was about the only short term measure available.

    The short-term has passed. What next?

    The expansionary fiscal policy is old fashioned Keynesian, as you pointed out several times. Isn’t this evidence that the late 20th century neo-liberal* leap forward to the 19th century economic doctrines is at least partially responsible for the lack of progress in applied economics since Keynes?

    Isn’t it a worry, given what we know about resource constraints and environmental problems all over the place, that the focus on macro-economic variables, such as ‘growth’ (in GDP) is again central to policy discussions?

    Isn’t it time to go outside the conceptual framework of macro-economic variables?

    Isn’t it time to get a better and publicly more widely accepted notion of ‘the economy’ than that outlined by macro-economic variables?

    Isn’t it obvious that macro-economics, like accounting, is too bound up with monetary values?

    Isn’t it the case that the fascination with monetary values got us into the GFC mess (and the environmental mess) in the first place? If so, why continue?

    * Thatcherism, supply-side economics, Reagonomics, economic rationalism, naïve market economics….

    2. Business as usual. As soon as the immediate danger of total collapse has passed, the financial sector continues with more of the same. Two examples.

    a) One of the four pillar banks in the local economy is trying to attract new customers for credit card debt by offering 4.99% p.a. for 9 months on credit purchases to new credit card applicants who are “existing customers” (open a savings account today, qualify as an existing customer tomorrow). How much future budget deficit should one allow for now to plan for the consequences of a successful bank strategy?

    b) Re-post from Monday message board:
    “Alert: A securitisation thing, 5 years in the making, is showing its head:
    http://business.smh.com.au/business/betting-on-the-house-20090513-b3cs.html

    Sometime last year, around the time of the Lehman collapse, I posted a satirical comment on securitisation that attracted the wrath of one commenter.

    The difference between the content of my then hypothetical and satirical example and the above referenced scheme is ownership.

    In my example, the non-sense securities were written voluntarily by the owners of a house and its content.

    The real life scheme, described in the smh, skips the owners of houses and goes straight to the gambling using statistical averages as ‘underlying securities’. But statistical averages are not securities! (This is worse than CDOs – not even Merton’s excellent paper on risky debt is helpful on this one – happy to be shown to be wrong.)

    If the proposed scheme is getting regulatory clearance then ‘they’ (regulators and banks) have learnt nothing from the global financial crisis.” What do you think?

    Sorry for the lengthy post but we are living in very interesting times.

  3. SeanG
    May 18th, 2009 at 04:30 | #3

    Kevin,

    I will be very careful of trying to control money supply via controlling capital flows. China has a massive foreign currency reserves which they are now using to keep the Yuan devalued to keep their export industry competitive, to pay massive amounts of cash into the system and to buy up foreign debt to increase their ability to influence economic policy.

    We cannot do that unless we have such a strong export market that we can build up a massive cash reserves. I severely doubt we can do that.

  4. Kevin Cox
    May 18th, 2009 at 06:52 | #4

    SeanG,

    I agree with you that we have to be careful when controlling the money supply. The method we currently use is not working too well and we have to do better.

    I have been trying to explain another way to increase the money supply. I think I may have finally found the way to describe it after reading the book “Complex Adaptive Systems”. Please have a look at http://stableproductivemoney.wordpress.com/2009/05/18/amasset-an-economic-tool-for-managing-economies/

    and see if it makes sense.

  5. jquiggin
    May 18th, 2009 at 08:46 | #5

    Ernestine

    1.I agree that GDP is a short term measure, and that, in the long term, we need to think about a net national income measure. I’ve written about this before

    2. I’ll take a closer look at the index suggestion, but you aren’t alone in the concern that the financial sector wants to go straight back to its bad old ways, and may well have the lobbying muscle to make this happen.

  6. Ernestine Gross
    May 18th, 2009 at 09:43 | #6

    JQ, thanks for the “before” – the 2003 thread was before my time of reading your blog.

  7. Kevin Cox
    May 18th, 2009 at 11:20 | #7

    Ernestine and JQ,

    Please take a look at the link above which proposes an add on to the existing system. Adding this tool to a governments fiscal and monetary methods helps solve many of the issues with the current financial and “real” systems. It will be easy to implement because it leaves the existing system intact. It has built in compliance, rules and regulations. This means we can implement it without requiring years of analysis and few changes to the legal and administrative processes.

    We can do it incrementally and learn from our mistakes because we will be able to easily measure outcomes and adjust the system accordingly.

  8. carbonsink
    May 18th, 2009 at 11:21 | #8

    There are some genuinely encouraging signs coming out of the the US but I’m not buying the China-led global recovery in the second half of 09 that many people are talking up ATM. Chinese domestic demand is not going to replace the hole left by the collapse in external demand in the short term. Maybe it will over 10-20 years, but not in the next 6 months.

    The Chinese authorities seem very focused on supporting the export sector, but who are they going to sell stuff to if the US consumer continues to sit on their wallet?

  9. Ernestine Gross
    May 18th, 2009 at 11:51 | #9

    Kevin Cox, I’ve read your posts for quite a while but I am not ready to comment.

    Let me try out whether I understand the crucial aspect: I understand you try to make different types of money explicit. True or False?

  10. Kevin Cox
    May 18th, 2009 at 20:15 | #10

    Ernestine,

    I have used a different name for the system (amasset) because people normally try to fit it into the existing model of our economic system. So while it does use some money for explicit purposes we need to ensure it is spent wisely. The answer to your question is yes it is initially explicitly tagged but no that is not the main idea. The idea is a combination of many ideas.

    One idea is to tag some money for a particular purpose.

    The next part is where the money comes from. It makes a lot of sense for infrastructure purposes to use the money we create to increase the money supply instead of creating money by loaning money we do not have. This ensures that increases in the money supply create new assets.

    The next part is to whom to give the money. We need to give it to a lot of people so we get a true market place. I suggest giving it to people who are contributing the least to the problem we are addressing. If the government spends it through a budget process there is no market place because there is only one buyer.

    The next part is where to spend the money and ensure it is spent on the purpose. I suggest we do it in a true transparent market place where any supplier can join provided they can back their claim to achieve the system purpose.

    In effect what this will achieve is a “sub economy” defined by the money we give to the buyers in the market place.

    Once the money has been used in the market place it becomes regular money.

    All of the above are not new. What is new is putting it together in a systematic planned way.

    The main argument I have heard against it as “a system” is that it would be too expensive. My response is that the systems to run this are already in existence. There are many electronic money systems, identification systems, electronic market places, and allocation systems.

    The second argument is that we cannot enforce compliance in the use of the money. That problem is solved by making the system a voluntary one and excluding those who abuse it. That is the way markets like EBay work.

    The third argument is that you cannot give people money and expect them to spend it wisely. My answer to that is that if you give people money but constrain them in how they can spend it then people will spend it to give them the best value.

    It is certainly worth a try and we can start with something we really need to do like get investment into ways of reducing ghg concentration in the atmosphere.

  11. Alice
    May 18th, 2009 at 21:37 | #11

    Ernestine – I think you have got to the essence of the problem…in this comment

    “Isn’t it obvious that macro-economics, like accounting, is too bound up with monetary values?”

    There are simply not enough qualitative KPIS in the measurement of is “good” for the economy (to use a pat business expression)

    Many social non monetary indicators are basically ignored…

  12. Ernestine Gross
    May 18th, 2009 at 22:01 | #12

    Kevin, from the foregoing I conclude that your amasset system is the proposal that the issuer of currency unit, the government via its monetary authority,is to provide interest free ‘funds’ for specific purposes with unspecified ‘backing’ (” back their claim to achieve the system purpose”). I don’t think you can conclude anything from this proposal about increases in ‘money supply’. Further, what is the difference between the government financing ‘wise’ projects by printing money and letting suppliers compete for the project construction? I can’t see any difference – unless there is a hidden ownership assumption. It seems to me your underlying conceptual framework is a monetarist model of ‘money’. Sorry I can’t be of more help.
    EG.

  13. Alice
    May 18th, 2009 at 22:19 | #13

    Hi Ernestine
    I said Id post a link to some interesting Higher ed stats some of which go back annually to 1949.

    http://www.dest.gov.au/sectors/higher_education/publications_resources/statistics/publications_higher_education_statistics_collections.htm#studpubs

    Its an excel table listed under “time series” towards the bottom.

  14. Kevin Cox
    May 19th, 2009 at 04:54 | #14

    Ernestine,

    There is no hidden ownership assumption. That is a critical part of the idea. The money must be given to many people who then make a choice (albeit a restricted choice) on how it is spent. When government spends there is only one buyer and hence a less adaptable, less efficient market.

    Money becomes “real currency” when it can be used for anything and can earn interest. When we create money by making a loan without money already in existence the money can be used for anything and earns interest before there is an asset to support it.

    With this proposal we create “real currency” only after an asset (or generator of value) is built.

    The release of new money into the community only after an asset has been built will lead to a stable zero inflation money measure.

    We see time after time that using loans to increase the money supply leads inevitably to inflation. Inflation is institutionalised and we even have a target for it.

    Inflation leads to inefficiencies because it changes the unit of measurement. Imagine how hard it would be if each year we changed the meaning of a km. Having a target inflation is the same as targetting a 1% to 2% reduction in the length of a km each year. You would laugh if someone proposed that we do that yet we tolerate it with our measurement of value.

    We need to have a more efficient method of spending community money than the one we use at the moment.

    We need to create a money system where money retains its meaning. That means no inflation or deflation of the money measure of value.

    We need to have a method of building community resources while benefiting individuals. That is we need a solution to the “tragedy of the commons”.

    What I am proposing will achieve all these objectives – and it is so simple to do.

  15. Kevin Cox
    May 19th, 2009 at 05:33 | #15

    Alice and Ernestine,

    I too agree with the statement “Isn’t it obvious that macro-economics, like accounting, is too bound up with monetary values?”

    This idea that we can reduce everything to money terms has to stop because it does not work. Money, amongst other things we ask it do, is a tool for helping us allocate resources. To now ask it, for example, to be the tool to reduce ghg emissions is foolish and unnecessary.

    Whoever thought up the idea of creating a market for emissions as a way to reduce emissions was misguided.

    To reduce emissions we have to invest in ways to reduce emissions not think of ways for people to buy the permit to pollute.

    We get this sort of thinking all the time. We think we can control anything by putting a price on it and that will now somehow lead to achieving other non monetary objectives.

    Another way to achieve our goals is to measure them in non monetary terms and then use the money system to allocate resources to achieve our goals in the most economically efficient manner. We should not try to measure other non monetary goals in monetary terms.

  16. Ernestine Gross
    May 19th, 2009 at 07:29 | #16

    Kevin Cox @14 and 15,

    I certainly agree with you that the existing financial system is in want of improvement. However, I can’t see how your proposal is to achieve the goal. It would be most helpful if you would provide a full theoretical model of the economic system you have in mind, using the methodology of math econ. This helps communication.

    It seems to me you are selective as to when markets are desirable and when not (cf 14 and 15 – markets are ‘good’ in 14 but not in 15).

    Regarding ‘emission trading’: The term ‘emission trading’ is misleading. The full descriptive term is ‘cap and trade’. That is, the total amount of emission is to be ‘capped’ (which includes a successive reduction in emission quantities)and only permits which quantitatively correspond to total allowable emissions per period are issued as tradeable pollution allowances..

  17. SeanG
    May 19th, 2009 at 17:27 | #17

    ProfQ,

    I have three charts in the office which show secured, unsecured and corporate lending all significantly decreasing… so what are you on about with available credit?

    Global Financial Crisis – the operative word is “financial”. Expansionary fiscal policies will have a considerably lower multiplier than you think that they will have because of the restriction in available credit for companies to expand.

  18. Alice
    May 19th, 2009 at 21:54 | #18

    Expansionary fiscal policies will have a considerably lower multiplier than you think that they will have because of the restriction in available credit for companies to expand.

    Sean – this is incorrect. Debt is not the only form of financing for expansion. There is profit (equity) forms, provided managers can restrain their salary appetites and encourage nervous investors back (it may mean they actually have to demonstrate real production – wont that make a nice change?).

    It may even produce more sustainable growth (less debt reliant expansion). The credit creation factor is not in the fiscal policy multiplier at all Sean and any income tax reductions will increase the multiplier.

  19. SeanG
    May 19th, 2009 at 22:49 | #19

    Alice,

    Generally, fiscal multipliers tend to be overstated.

    Specifically, the fiscal multipliers in this case will be severely overstated because of a restriction in credit to the companies who are reliant on overdrafts and loans. You talk about equity financing – yes there have been a lot of issuances of equity but it is more expensive than debt and it does not help small and medium sized enterprises.

    Inform us how a company that cannot get its overdraft extended is going to survive with the governments fiscal expansionary policies? After all, if fiscal expansion would work then the US would be out of recession already.

  20. Alice
    May 19th, 2009 at 23:00 | #20

    19# Sean,

    They will survive with slower more sustainable growth by selling some assets or a myriad of ways firms survive, like getting equity partners in (how about debt reduction as demand actually gives them some sales Sean?)Then there is putting pressure on suppliers for cost reductions, getting their accounts receivables in quicker, taking longer to pay their creditors, paring down any provisional accounts etc, reducing expenses. Equity may be more expensive sometimes, but not always. If they cant survive without the overdraft then they are marginal anyway in an environment like this. Rationalisations are happening now and will be happening less after the stimulus Sean (not more) and if they are it wont be due to the fiscal stimulus but the poor economic conditions. Some pain for some firms is inevitable no matter what form a stimulus takes.

  21. SeanG
    May 19th, 2009 at 23:25 | #21

    Alice,

    Who will buy? You need credit to buy and credit was severely restricted. Only a few organisations can afford to purchase assets.

    Sales are not the problem – I have a nice graph of US, EU and UK sales through this recession (which is hurting far more than in Australia) that disproves that theory. Consumer sales are incredibly hard to forecast but suffice to say it was not consumer sales that led to the collapse in trade.

    “Then there is putting pressure on suppliers for cost reductions, getting their accounts receivables in quicker, taking longer to pay their creditors, paring down any provisional accounts etc, reducing expenses.”

    Think about that – what happens when big companies pay later and force smaller companies to repay receivables earlier? It is called going out of business.

    Imagine that you have to pay a supplier today but your customer pays in 90 days (instead of the usual 30-60) and the bank is not extending the overdraft…

  22. SeanG
    May 19th, 2009 at 23:29 | #22

    Alice,

    There are ways for the government to extend credit but infrastructure expenditure is not one of them. Creditor insurance for instance, is an example.

  23. Alice
    May 20th, 2009 at 06:13 | #23

    Sean – these are standard accounting tightenings but as I mentioned you cant prevent all firms from failing in a recession – fiscal and monetary policies can only stimulate and to the extent they work is better than nothing at all..and I know perhaps some would disagree with me and say nothing at all is better..

  24. Kevin Cox
    May 20th, 2009 at 07:18 | #24

    Ernestine,

    The modelling approach used in math economics is very poor at describing a complex world with many interactions and dynamic feedback. Serious successful modelling in other areas has moved a long way from math econ techniques.

    It would take a lifetime of work to even get an approximation of what I talking about into the existing mathematical models and at the end the models would be a very very poor reflection on reality and would worthless.

    I think the biggest problem facing economics as it is taught and practiced is the dependence of existing mathematical models for thinking about economics and for attempting to predict what will happen. They models are a poor reflection on reality and cannot even model the past.

    Mathematical models are useful to get insights into what might be important but they are probably worse than useless as prediction mechanisms because people might believe them and the belief in turn affects the system.

    A better modelling approach to traditional maths modelling is computational modelling. This approach requires fewer assumptions and can give insights into the phenomena of “emergent properties”. However, it is still not good enough.

    An approach is to use math econ modelling to get insights, and similarly to use computational models to get insights but to use real world monitoring as the way to control the economy. This is what happens anyway but let us be more precise in our monitoring.

    What we do now is to make a best guess on what to do and then see what happens. What we need to do is to make changes to this system of measurement and see the effects in “real time”.

    In this day and age it is ridiculous that we have to wait months to get basic data like number of people unemployed and then we only get monthly figures and not daily figures.

    It is absurd that we still cannot figure out who owes who what as banks around the world teeter on the edge of insolvency.

    It is a nonsense that the USA has given up on even trying to measure the M3 money supply.

    The treasurer should have at his disposal a dynamic display of the economy as it currently exists. This display should pictorially represent the economy in much the same way as a weather map reflects the weather. The treasure should be able to see what has happened in the past and s(he) should be able to see what is likely to happen with different policy options.

    It is a national disgrace that months after we had the first fiscal stimulus we still cannot agree on what effect it had on the economy.

    In the meantime we need to start to introduce diversity into our approach. My suggestion is one such idea. It is “obvious” trying it out in one state or region for one problem (such as ghg emission reduction) will do little harm and potentially a lot of good. We can introduce this variation into the system and closely monitor what happens to key indicators. We will soon see if it works then later we can sit down and understand if our original ideas where the reason it worked.

    That is what other organisations do – why not the government?

    We are currently deploying a complex system into different companies. We made our best guess on how it will work but we did not try to get it right by planning it in detail. We started with what they had, introduced a few changes and observed and measured what happened.

    We are continuing along this path and we introduce changes each week and we observe if they make a difference. That is we have built a learning adapting system that is rapidly evolving in the light of experience.

    Complex systems cannot be designed in complete detail before we start to build them. A good heuristic for any system development is that if it takes more than six months to get started it will fail. (What chance does that give the emissions cap and trade system of succeeding?)

    Economies cannot be modelled so that we know what will happen in the long term with any high degree of certainty. They can – like the weather be predicted for a short time ahead – but the longer the time the greater the variation. With economic systems we can do better than weather prediction because we can change the way the economy works by observing it in real time and making adjustments. We do it in a small ways such as the Reserve Bank setting interest rates.

    The mechanism I am suggesting is one way to give finer control over the system by decoupling different sections of the economy. We can set such systems going, measure what happens and adjust.

  25. Ernestine Gross
    May 20th, 2009 at 08:36 | #25

    Kevin,

    There are a few points on methodology with which I may agree with you (I am uncertain because ‘math econ’ and math models in economics can mean anything from reduced form equations to general equilibrium models, dynamic models and simulation models. You may be surprised that Zeeman’s catastrophy models have been applied in economics as long ago as the mid-1970s with interesting insights for macro-economic policy, eg Blad)

    I fully agree that complex systems can’t be designed in detail (that is why I tried to find the critical variable in your verbal description,which distinguishes your …? from existing theoretical approaches). Moreover, the notion of ‘prediction’ would have to be different from that we are accustomed to from high school physics (eg water always runs down-hill..).

    Where I disagree with you is that anything useful can be learned for the purpose of institional design of an economy from the modus operation of corporations, in particular multinational corporations.

  26. Methusela
    May 30th, 2009 at 22:25 | #26

    JQ

    Is this not an example of your backtracking on the GFC?

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