Bob Diamond resigns

[mjdgreg]

Well balanced post BFYP. We'll just have to disagree on a few points. I'll be fleshing out my policy a bit more in the near future to explain why I came up with my list. It's a big job so people will have to just bear with me for a while.

[Filo]

Still refusing to answer the question Mick?

[BillyStubbsTears]

BFYP.

A question for you:

Why does a reduction in inflation mean that there is scope to raise interest rates? Raising interest rates is the classic response to an overheating economy, in which there is a danger of excess demand leading to raised inflation. Our prime current problem (and that of the USA and Europe) is the precise opposite of that. We have a massive gap in demand relative to what the economy could be producing. That is the reason that we have tipped back into a severe recession. Raising interest rates in such a situation is economic lunacy, since it would suppress demand still further.

This entire discussion unfortunately shows how the root of the problem has not been grasped by the population.

We are in a terrifyingly dangerous economic situation, where demand has collapsed. The standard approach to re-igniting demand over the last 50 or so years has been to cut interest rates, make it easier for companies to borrow to invest and get the economy moving again. Then you raise interest rates once the economy is pulling away, to stop things overheating.

We've tried that and, whilst it has helped, it isn't nearly enough. But to think, as many on the lunatic right-wing fringe do that the conclusion of that is that interest rates should be raised is mad.

The next, rarely used big step is QE. The idea here is to massively increase the amount of currency in circulation, in an attempt to convince people that they should spend it. What happens in a demand-slump recession/Depression is that the rate at which money goes round the economy collapses. If more and more people and businesses decide to hold onto money rather than spend it, the size of the economic market contracts. There's no argument about that - it's a simple fact. (You can think about that by considering the limit in which EVERYONE held on to ALL their money and spent nothing. We'd all have the money that we started with, but no-one would have any work because no-one would be paying for any goods or services.)

We're a long way into the demand collapse situation now, with a very large number of individuals and companies trying to cut back on their expenditure. That is a very logical thing for them each to do, considering their own individual circumstances. But it is precisely the WRONG thing for the country as a whole when very large numbers of individuals and companies all do it at the same time. We know that, because it has happened time and again through history, always with catastrophic economic effects. And the same catastrophic effects are being visited on us and Europe right now, for exactly the same reasons.

So, QE is an attempt to get more money into circulation, in an attempt to convince more people to spend and to get the economy working again. Again, it's helped, but it's clearly not enough on its own.

By the way, the doom-mongers on the Right who say that QE will lead to rampant inflation have been proved utterly wrong by events. In both the UK and USA there has been MASSIVE QE, yet inflation is falling, after a brief rise due mainly to increases in global commodity prices. The long-term bond rates for both countries strongly suggest that the Markets believe that inflation will remain low for the rest of this decade, despite QE, and there are renewed fears starting to emerge that we are heading back into outright DEflation, which really WOULD be the nightmare scenario. The lunatic Right will continue to say that inflation WILL rise in the long run. But as a very great man once said, in the long run, we are all dead. What matters is getting things right in the short and medium term, and QE has a part to play in that.

I'll repeat what I've said times many in this thread, there is no example in economic history of a mature Western market economy getting itself out of this kind of demand-collapse Depression without major increases in demand produced by increased Govt spending. To the person who has not studied this in detail, it sounds illogical to suggest this in a situation where Government debt is already high, but there is simply no credible alternative. None. Anywhere. Ever.

[mjdgreg]

Here's my first part of understanding the economy. There will be more to follow.

To understand the economy better I’ve come up with a hypothetical example that shows why we’re in the mess we’re in and why borrowing and spending more money will only make matters worse. This isn’t going to be easy to understand and you may have to read it a few times before the penny drops.

In the following example I’m going to assume that a country has a gross domestic product of £1,000. Let’s imagine that the government raises taxes from the population of 25% of GDP and this money is then used for public spending. Unfortunately politicians being what they are, instead spend 30% of GDP. This then means that they have to borrow the difference which is £50 (5% of £1,000).
 
Because the country has got little debt this attracts a low interest rate. This is because those who buy the debt are very confident that the country can afford to pay them back. So we end up with the country having a debt of only 5% of GDP (£50). If the interest rate is say 4%, this equates to an interest payment of £2 per annum which is only 0.2% of GDP. Doesn’t sound too bad does it?

Unfortunately this goes on year after year. Let’s assume that public spending grows at the same rate as the country grows. Also let’s assume that the debt keeps growing at an average of 5% of GDP per annum. If we assume a growth rate of say 3% per annum, after 24 years the economy will have doubled to around £2,000 GDP. This will mean that the debt has grown to about £1,800, which is now a debt-to-GDP ratio of 90% (90% of £2,000 is £1,800). This has happened because debt has grown faster than the country's economy by 2% per annum (3% growth rate, 5% debt interest).

If the country had held public spending down to a level where it grew slower than GDP, so below 3%, it would have reduced the requirement for debt, thus making the debt-to-GDP ratio lower. This would have happened even if the National Debt had grown. So to summarise, it is possible to grow your way out of a debt problem as long as the growth of public spending is less than the growth of the economy. If only we had politicians that would do this but unfortunately they can’t resist the urge to over-spend, especially Labour politicians.

In my next instalment I'll explore what happens if public spending grows to about 50% of GDP, rather than 25% or 30% over the 24 years.

[BillyStubbsTears]

Mick.

Your post can be put rather more concisely.

If a Govt's deficit as a proportion of GDP is consistently higher than GDP growth, the Govt debt will grow as a percentage of GDP. You have said precisely no more and no less than this.

I am utterly overwhelmed by this quite dazzling insight. I strongly suspect that no economist in world history has previously latched onto this. This has the potential to transform world economics. I bet Keynes and Friedman, if alive today, would be sticking pins in their genitalia, such would be their self-loathing at having overlooked this concept.

The world salutes your unrivalled genius.

I'm waiting on the edge of my seat to find out what happens in your next installments.

[mjdgreg]

mjdgreg

Your post can be put rather more concisely.

If a Govt's deficit as a proportion of GDP is consistently higher than GDP growth, the Govt debt will grow as a percentage of GDP. You have said precisely no more and no less than this.

I am utterly overwhelmed by this quite dazzling insight. I strongly suspect that no economist in world history has previously latched onto this. This has the potential to transform world economics. I bet Keynes and Friedman, if alive today, would be sticking pins in their genitalia, such would be their self-loathing at having overlooked this concept.

The world salutes your unrivalled genius.

I'm waiting on the edge of my seat to find out what happens in your next installments.

Everything I've posted is as easy as A B C to me. Unfortunately our media doesn't do a very good job of educating the great unwashed. So this post is aimed at them and not the likes of you and I.

I always explain my arguments in easy to understand language whereas you like to try and blind everyone with science. You don't fool me though. When I've finished they will be in no doubt whatsoever that Keynes is a crank and your strategy would turn us into a third world country.

[BillyStubbsTears]

I'm sat here like Kwai Chang Caine at the feet of the old blind master Po.

Let the learning begin...


PS: I think you probably meant "you and me" at the end of that first paragraph, but I'll let it pass.

[mjdgreg]

PS: I think you probably meant "you and me" at the end of that first paragraph, but I'll let it pass.

Be warned. If you want to go up against me on grammar you will come off a very poor second.

[BillyStubbsTears]

Master Po, I do not doubt it. I say these things only in confidence to you, so that you may modify your posts in order to ensure that others do not think less of you.

[Filo]

Still refusing to answer the question Mick?

Meanwhile, back at the ranch!

[mjdgreg]

Master Po, I do not doubt it. I say these things only in confidence to you, so that you may modify your posts in order to ensure that others do not think less of you.

I'm going to do a test. I'll be making some deliberate mistakes in grammar in future just to see if you can spot them. Then we'll sea how good you are.

[BillyStubbsTears]

Will that be after you've answered Filo or before?

[BillyStubbsTears]

Mick

You do realise that I don't give a flying f**k if your grammar is better than mine. You DO realise that don't you? You do realise that I only posted comments on your grammar to point out the facile imbecility of someone who takes it upon themselves to vociferously criticise other people's grammar.

The whole concept of complaining about grammar on a non language-relate forum is tedious in the extreme. As Oscar Wilde once said, it is the last refuge of a tit who has lost all sense of self-respect. But since you DID insist on bringing the subject up over and over and over again, I thought you would like to have your manifold errors pointed out, just so you can improve your game in the future.

I'm SURE your grammar is better than mine Mick. I'm certain of it. I salute your grasp of it.

[mushRTID]

This thread is hilarious. Just putting it out there.

[mjdgreg]

Thank you mushRTID. You confirm what I already knew and what Billy has failed to see. That's why I recommended the humour bypass reversal operation.

[Filo]

And still no answer 

[mjdgreg]

Will that be after you've answered Filo or before?

You've failed already! My post that you replied to contained the following delibarate error:

I'm going to do a test. I'll be making some deliberate mistakes in grammar in future just to see if you can spot them. Then we'll sea how good you are.

I've highlighted the error just in case you still failed to spot it. It should have been 'see' not 'sea.' See, I did warn you.

[mjdgreg]

And still no answer

I know. I've been waiting for sevaral weeks now for you to find some of the hundreds of contradictions you say I've made. Lucky for you that I am very patient.

[Filo]

And still no answer

I know. I've been waiting for sevaral weeks now for you to find some of the hundreds of contradictions you say I've made. Lucky for you that I am very patient.

Says it all really, you refuse to confirm how cosy you are with Marydene Rover, because you know if you deny it you`ll be telling porky`s, your charade is over Mick, the whole forum knows you`re a fraud, time to come clean and stop making yourself look more foolish than you already are! I`ve beaten you hands down, everyone can see that, yourself included, game, set and match!

[BillyStubbsTears]

Will that be after you've answered Filo or before?

You've failed already! My post that you replied to contained the following delibarate error:

I'm going to do a test. I'll be making some deliberate mistakes in grammar in future just to see if you can spot them. Then we'll sea how good you are.

I've highlighted the error just in case you still failed to spot it. It should have been 'see' not 'sea.' See, I did warn you.

Ooof! Kerpowww!!

You got me Mick. Gee, but you're a canny one...

[mjdgreg]

You've failed already! My post that you replied to contained the following delibarate error:

Quote
I'm going to do a test. I'll be making some deliberate mistakes in grammar in future just to see if you can spot them. Then we'll sea how good you are.

I've highlighted the error just in case you still failed to spot it. It should have been 'see' not 'sea.' See, I did warn you.


Ooof! Kerpowww!!

You got me Mick. Gee, but you're a canny one...

Got you again! I've highlighted the error for you. I said ' My post that you replied to contained the following delibarate error.' That should be deliberate not delibarate. pmsl....

Also, I've checked with WordHippo and 'Gee', 'Ooof' and Kerpowww are not words. I think you must have been reading too many Batman comics. Also it should be 'You've got me'. All in all a pretty poor effort. Don't say I didn't worn you.

[mjdgreg]

Here's my next instalment in understanding the economy which follows on from my previous one.

Now let’s see what happens if public spending grows to about 50% of GDP, rather than 25% or 30% over the 24 years. (When Labour left office it was over 50%). This means that the productive part of the economy (the private sector) must pay about 50% of its production in taxes. Also the debt is now growing out of control. The consequence of this is that the private sector has less money and so the growth of the economy slows.

Then along comes a very nasty financial crisis. The revenues of the government fall as the economy shrinks. If the economy shrinks by 3% and total taxes are 50%, then tax revenue falls to £970 (£1000 less 3%). But the government does not cut back. Indeed, because it must pay unemployment benefits and welfare (because unemployment rises in a recession), its expenses actually rise by 5%! So it now needs £1,050 to pay all its budgeted expenses and it must now borrow £80 (£970 + £80= £1050) to pay everyone it has promised to pay, in addition to the £100 it was already borrowing every year to cover its deficit. So we now end up borrowing a total of £180 a year, which is 9% of GDP (remember our GDP is now £2000 so 9% of £2000 is £180). When Labour left office, our budget deficit was over 10% a year.

Now debt-to-GDP is rising by about 5% a year. Not a large number in the grand scheme of things and everyone knows that the recession will soon be over and the deficits will come down as the economy starts to grow again. Sovereign governments never default on their debts according to our politicians. They can always raise taxes or cut spending (so they say).

Things tick along nicely and the bond market continues to buy the debt, until one day they realise that the debt has risen to 120% of GDP. Then the bond market gets nervous and says that instead of 4% it wants 7%. Now the interest payments are over 8% of GDP and account for over 16% of government spending, which means the government must either cut back on public spending, or raise taxes, or borrow more money. Or a combination of all of these options. But cutting spending, raising taxes and borrowing more money have consequences. They reduce the opportunity for GDP growth as the economy adjusts and increase the National Debt.

What if that interest rate cost rose to 10%? Then the interest cost to the government would become 20% of its expenses and would be rising faster than the country could grow, even in the best of times. And if they continued to borrow at 7% and the country did not grow, those interest expenses would rise at least 7% a year (as long as interest rates didn't go up).

Then what would happen if the other countries who had been buying the government's debt looked at the basic maths of the situation and realised that, another step or two down the current path of government spending, there was no way they would be able to get their money back?

Now, government bond investors invest in government bonds because they actually think there is not supposed to be any risk. They want their money to be safe. If they wanted risk, there are lots of opportunities to invest with the potential for more reward.

The moment that government bond investors begin to think they might be at risk, they leave. History suggests they tend to leave seemingly all at once.  Someone fires the starting gun, and they all head for the exits. They start selling their bonds to speculators at discounts, which makes the effective interest rates in the market rise, sometimes by a lot. That means that if a country wants to borrow more money, it will have to pay the effective price in the market, or maybe as much as 15-20%  if, and it’s a big if, it can even get someone to buy the bonds, which of course makes it even more difficult to pay their debt as interest costs rise.

This is the path Labour were taking us down and it has to stop. In my next instalment I’ll explain a bit more about the bond holders and what happens when governments are unable to pay their debts.

[The L J Monk]

Mick - what's amazing is that someone else had the exact same thoughts, and phrased them almost identically, back in January:

http://articles.businessinsider.com/2012-01-14/markets/30626783_1_s-p-european-commission-global-growth/3

Eerily, your first "educational" post on economics was also penned by the same guy, in the same article, back in January:

http://articles.businessinsider.com/2012-01-14/markets/30626783_1_s-p-european-commission-global-growth/2

[mushRTID]

This is the thread that just keeps on giving.

[mjdgreg]

mjdgreg - what's amazing is that someone else had the exact same thoughts, and phrased them almost identically, back in January:

You have a very vivid imagination. Why is it a surprise that you can find views similar to mine if you spend hours trawling the internet? Also, don't forget that I have a photographic memory and can instantly recall information with no effort at all. Why do you think I am so super intelligent? It's partly due to my photographic memory. I suggest you spend your time reading my posts instead of trawling the internet and get an education on the economy. You never know one day you may see the light and be free of being a leftie crank.

[Marydene Rover]

Very informative series you have put together thank you Mjdgreg, I'm no expert on these matter and I am a natural leftie labour voter. I would appreciate BST's response to help me understand the counter argument.
I hope he hasn't given up and withdrawn from the debate.

[mjdgreg]

Very informative series you have put together thank you Mjdgreg, I'm no expert on these matter and I am a natural leftie labour voter. I would appreciate BST's response to help me understand the counter argument.
I hope he hasn't given up and withdrawn from the debate.

Don't hold your breath. I think even he has realised that he has conclusively lost the debate and that there isn't a counter argument. Billy would have you believe that more spending is the solution. It is over-spending that has got us to where we are now. He would have you believe that the coalition have introduced swingeing cuts. They haven't.The Labour party have done an excellent job in convincing everyone that this is the case. Nothing could be further from the truth. In fact, the coalition is borrowing almost as much over five years as Labour did over thirteen!!!

Labour have left us well and truly in the shit big-time and we are nowhere near feeling the consequences yet. Here is an article that I could have written myself that exposes the big lie that our gullible population (and bond markets) has swallowed. If anyone can still call themselves a Labour supporter after reading this article then there is no hope for them.

http://www.dailymail.co.uk/news/article-2146571/Cuts-What-cuts-Ignore-BBC-Left-public-spending-HIGHER-Labour.html

[mjdgreg]

Here’s the next instalment in my understanding of the economy for the great unwashed.

I’m now going to add a twist. The other countries that have bought those bonds are not actually countries, but are actually banks in other countries.  Because the regulators of those banks knew it was impossible (or so they thought), that a sovereign country might default, they allowed their banks to buy 30 times as much sovereign debt as they had capital in their banks!!! They did not have to have any reserves to protect themselves against any losses because in theory there could never be any losses.

 So in effect these were "free" profits for the banks. You pay 2% to people who deposit with you and then buy bonds paying at 4%. You make a 2% spread, so make 2% profit  which you then do 30 times. Now you are making 60% profits (30 x 2%) on your capital and deposits. It is a very nice business – as long as everyone pays the interest. Because it is such a good business, you just roll over the debt every time the bond comes due, because you want more easy profits.

Let's say that banks bought up to 10% of their total government sovereign-debt holdings in our problem country (think Greece, Ireland, Portugal, Spain, Italy etc). If the country gets into trouble and says, we will only pay 50% of our debt, then that means the banks lose 5% of their total assets (they’ve lost half of 10% of their total government sovereign-debt holdings in our problem country, which is where we get the 5% of total assets from). But they only have about 3% capital, because they were allowed to leverage. Because they don’t have 5% capital to cover the losses that means they are functionally bankrupt. This ludicrous leveraging system was so be-loved of Gordon Brown and the incompetent Bank of England.

Because the banking system is effectively bankrupt, other countries now have to step in and take the losses (and perhaps wipe out the shareholders and owners of their banks). That would be bad for the other countries, as that much spare cash is not just lying around in government coffers. They are ALL borrowing money already and have their own deficits to worry about.

So everyone gets together and they tell the bankrupt country (because that is what it really is), we will lend you more money to keep you alive, but you must agree to balance your budget. Since that is the only way the problem country can get more money, they initially say, "Sure. We can do that. Just give us some money now so we can get it figured out and get everything under control."

In the world of government, living within your means is called austerity. And it's an uphill slog. Let's say your deficit started out at 15% of GDP (somewhat like Greece's). If you agree to cut that deficit by 4% a year for four years running, if everything stays the same, you could be back in balance. But the other countries would have to agree to lend you the difference between what you budgeted to spend and what you took in as tax revenues, just to keep things going. Otherwise you'd have to default on your debt. If the countries simply have to guarantee the loans and not actually spend the money, it is a lot easier than having to find real money to save their banks, so they agree.

But the cuts you have to make are not as easy as everyone hoped. It seems that employees don't like having their pay cut, and unions don't want pensions cut, and retirees certainly expect the government to fulfil its promises.

So you raise taxes and cut spending by about 4% the first year. But a funny thing happens. That reduces the private economy by about 4%, so the base on which taxes are collected is reduced, which means less revenue is raised, which means that the deficit is much worse than projected. Then the following year you have to make another 4% in cuts, plus the last shortfall, just to stick to the plan and get to the agreed-upon deficit, in order to get more loan money. It becomes a very vicious circle.

In my next instalment we'll look at the endgame.

[GM-MarkB]

Very informative series you have put together thank you Mjdgreg, I'm no expert on these matter and I am a natural leftie labour voter. I would appreciate BST's response to help me understand the counter argument.
I hope he hasn't given up and withdrawn from the debate.

Breaking News....

Mick fails to correct a gramatical error in one his alias' posts......

Filo wins by TKO

[mjdgreg]

Breaking News....

mjdgreg fails to correct a gramatical error in one his alias' posts......

Filo wins by TKO

You need to concentrate more on my posts. I've been leaving the odd grammatical error on purpose  for Gypsy Rose Stubbs to find not Filo (or you).