steve keen

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Deflation is Here — And The Government is Poised to Make it Worse

Consumer prices may not be deflating as quickly as Labour’s electoral chances did earlier this month, but — even after £300 billion of quantitative easing — price deflation for the first time in more than half a century is finally here. The Bank of England continues to throw everything at keeping prices rising at close to their 2 percent target. Yet it’s not working. And this is not just about cheaper oil. Core inflation has also been dropping like a rock.

I argued that “deflation was looming” for Britain last year, and feel a little vindicated that it has come to pass. But I don’t feel at all gratified about the thing itself.

In a highly indebted economy such as Britain’s — where private debt dwarfs government debt — deflation is a dangerous thing. Past debts — and the interest rates paid on those debts — are nominally rigid. Unless specifically stipulated as being inflation-adjusted (like TIPS) they don’t scale to price changes in the broader economy.

Under positive rates of inflation, inflation assists in keeping debt under control, by shrinking the present amount of goods and services and labour that equate to a nominal amount of currency. Under deflation, the opposite process occurs, and the nominal value of currency — as well as that of historical debt — rises, making the debt harder to service and pay down, especially with the ongoing accumulation of interest.

On the face of it, that is good news for net savers and bad news for net debtors. But raising the difficulty of deleveraging and debt service can often be bad for both, because debtors who cannot pay default, bankrupting themselves and injuring their creditors. It can also depress the economy, as individuals and firms are forced to stop spending and investing and start devoting more and more of their income to the rising real cost of deleveraging.

With growth last quarter dropping to 0.3 percent from 0.6 percent, this process might very well already be under way. This raises the prospect of the nightmarish debt-deflationary spiral above.

The last thing that the economy needs under that circumstance is more money being sucked out of it through slashing public spending. Sucking money out of the economy will make deleveraging even more difficult for debtors, and slow growth further as individuals and firms adjust their spending plans to lower levels of national and individual income. Yet that is the manifesto that the country elected to power in the election earlier this month. And although Osborne and Cameron can get out of it — via offsetting cuts in spending with tax cuts — if they go through with their election promises, the prospect of recession, continued deflation and rising levels of unemployment loom clearly.

What the economy really needed in 2010 was a deep and long commitment to public stimulus to provide the economic growth needed to let the private sector deleverage. Unlike the public sector, which is a sovereign creditor borrowing in its own currency — the private sector is far from a secure debtor. Private borrowers can — unlike the central government — “become the next Greece” and run out of money.

With interest rates in the last parliament having sunk down to new historic lows, such a thing was affordable and achievable. Instead, by trying to do public deleveraging at the same time as the private sector was deleveraging Osborne, Cameron and Clegg chose a much rockier path, one in which private deleveraging and public deleveraging are slow and grinding. With private debt levels still very high, the country remains vulnerable to another deleveraging-driven recession.

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Reinhart & Rogoff’s Scary Red Line

One frustrating fact regarding Reinhart & Rogoff’s controversial paper Growth in a Time of Debt — which incidentally was never peer reviewed, even in spite of its publication in the American Economic Review — is that the arbitrary threshold for diminished growth of “above 90%” seems to have no relation whatever with recent events in the United States.

When the financial crisis happened in 2008, and the United States was plunged into deep recession the public debt was actually moderate — higher than the level that Bush inherited in 2000, but less than the level Bill Clinton inherited in 1992. After the crisis, the deficit soared, but as soon as the deficit rose above Reinhart and Rogoff’s red line real growth actually picked up again.

scaryredline

This very much suggests that in this case the soaring debt was a reaction to recession. Lowered growth preceded soaring public debt, not vice verse.

This is a result supported by econometric analysis. Arindrajit Dube finds a much stronger association in Reinhart and Rogoff’s data between a high debt-to-GDP ratio and weak growth in the past three years than between a high debt-to-GDP ratio and weak growth in the following three years, strongly implying that America’s experience of weak growth preceding soaring public debt is the norm not the exception:

dube_rr_2_v2

Reinhart and Rogoff claim that their empirical study never made any claims about causality, although their 2011 editorial for Bloomberg reads as an exposition for the virtues of austerity:

As public debt in advanced countries reaches levels not seen since the end of World War II, there is considerable debate about the urgency of taming deficits with the aim of stabilizing and ultimately reducing debt as a percentage of gross domestic product.

Our empirical research on the history of financial crises and the relationship between growth and public liabilities supports the view that current debt trajectories are a risk to long-term growth and stability, with many advanced economies already reaching or exceeding the important marker of 90 percent of GDP. Nevertheless, many prominent public intellectuals continue to argue that debt phobia is wildly overblown. Countries such as the U.S., Japan and the U.K. aren’t like Greece, nor does the market treat them as such.

Reinhart and Rogoff’s interpretation, then, is clearly that the debt trajectory itself – as opposed to underlying factors driving the debt trajectory — that is the risk, which is a claim unsupported by their own and other research. But the problem is larger than this.

Other empirical work on debt has focused on a broader range of debt while still following Reinhart and Rogoff in attempting to draw arbitrary danger lines on graphs. Cechetti (2011) attempts to factor in household debt (drawing a danger line at 85% of GDP) and corporate debt (90% of GDP) as well as government debt (85%), implying a cumulative danger line of 260% in total credit market debt:

TCMDOredline

Total debt seems to have been a more appropriate metric than public debt, because it was in the danger zone when the crisis hit, and after the crisis hit total debt began gradually deleveraging after forty years of steady rises as a percentage of GDP, implying a deep and mechanistic connection. But there is still a lot of room between the crossing of the red line, and the beginning of the deleveraging phase. The red line itself doesn’t tell us anything about the phenomenon of 2008, or the period preceding 1929, where a similar phenomenon occurred, other than implying in a nonspecific way that the rising debt load was becoming unsustainable.

Drawing an arbitrary line on a graph implies that negative effects associated with excessive debt are a linear phenomenon; cross the line, and bad things are more likely to occur. This is an unsophisticated approach. The bursting of debt bubbles is a nonlinear and dynamic process that occurs when credit dries up, and leverage collapses. This specific effect is not tied to any specific nominal debt level, but instead to an unpredictable mixture of market participants’ expectations about the economy, profit taking, default rates, the actions of the central bank, input costs (e.g. energy), geopolitics, etc.

Steve Keen’s modification of Goodwin’s models may be an important step toward a clearer and more mechanistic understanding of the credit cycle and how an economy can be driven into a Minsky Moment.  One of the keys to modelling Minsky’s notion of a credit-driven euphoria giving way to credit contraction, asset price falls and despair is the notion of credit acceleration, the speed at which growth in credit grows. While total credit growth acceleration is clearly a signal of an impending Minsky Moment and debt deflation, drawing scary red thresholds is a fundamentally fruitless exercise, especially in sole regard to government debt levels which do not appear to drive an economy into a Minsky Moment followed by deleveraging and weakened growth and employment.

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This Time It’s Different 2013 Edition

A small note on the frankly hilarious news that the Dow Jones Industrial Average smashed through to all-time-highs.

First of all, while stock prices are soaring, household income and household confidence are slumping to all-time lows. Employment remains depressed, energy remains expensive, housing remains depressed, wages and salaries as a percentage of GDP keep falling, and the economy remains in a deleveraging cycle. Essentially, these are not the conditions for strong organic business growth, for a sustainable boom. We’re going through a structural economic adjustment, and suffering the consequences of a huge 40-year debt-fuelled boom. While the fundamentals remain weak, it can only be expected that equity markets should remain weak. But that is patently not what has happened.

In fact, it has been engineered that way. Bernanke has been explicitly targeting equities, hoping to trigger a beneficent spiral that he calls “the wealth effect” — stock prices go up, people feel richer and spend, and the economy recovers. But with fundamentals still depressed, this boom cannot be sustained.

There are several popular memes doing the rounds to suggest, of course, that this time is different and that the boom times are here to stay, including the utterly hilarious notion that the Dow Jones is now a “safe haven”. They are all variations on one theme — that Bernanke is supporting the recovery, and will do whatever it takes to continue to support it. Markets seem to be taking this as a sign that the recovery is real and here to stay. But this is obviously false, and it is this delusion that — as Hyman Minsky clearly explained last century — is so dangerous.

There are many events and eventualities under which throwing more money at the market will make no difference. Central banks cannot reverse a war, or a negative trade shock, or a negative production shock, or a negative energy shock simply by throwing money at it. And there are severe limits to their power to counteract financial contractions outside their jurisdiction (although in all fairness the Federal Reserve has expanded these limits in extending liquidity lines to foreign banks). Sooner or later the engineered recovery will be broken by an event outside the control of central bankers and politicians. In creating a false stability, the Federal Reserve has actually destabilised the economy, by distorting investors’ perceptions.

But, of course, some analysts think that this time really is different. Here’s a chart from Goldman showing the S&P500 by sectoral composition:

screen shot 2013-03-06 at 4.50.16 am

The implication here is clear — with no obvious sectoral bulge like that of the late 1970s, the tech bubble, and the financial bubble — there is no bubble. But what if the bubble is spread evenly over multiple sectors? After all, the Federal Reserve has been reinflating Wall Street in general rather than any one sector in particular.

Wall Street leverage is, unsurprisingly, approaching 2007 levels:

2005

Is this the final blowout top? I’m not sure. But I would be shocked to see this bubble live beyond 2013, or 2014 at the latest. I don’t know which straw will break the illusion. Middle eastern war? Hostility between China and Japan? North Korea? Chinese real estate and subprime meltdown? Student debt? Eurozone? Natural disasters? Who knows…

The wider implications may not be as bad as 2008. The debt bubble has already burst, and the deleveraging cycle has already begun. Total debt is slowly shrinking. It is plausible that we will only see a steep correction in stocks, rather than some kind of wider economic calamity. On the other hand, it is also plausible that this bursting bubble may herald a deeper, darker new phase of the depression.

With every day that the DJIA climbs to new all-time highs, more suckers will be drawn into the market. But it won’t last. Insiders have already gone aggressively bearish. This time isn’t different.

thistimeisdifferent

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Not Rational Utility Maximisers

One cornerstone of neoclassical economic thought is the assumption in microeconomics (and microfounded macroeconomics) that humans behave as “rational utility maximisers”.

Yet this assumption is increasingly outdated. Empirical findings in behavioural economics show that the neoclassical assumption of utility maximisation has very little basis in reality.

First, it is crucial to define what we mean by utility maximisation. Paul Samuelson, one of the grandfathers of the neoclassical New Keynesian school defined consumer rationality as follows:

• Completeness — Given any 2 bundles of commodities A & B , the consumer can decide whether he prefers A to B (A≻B), B to A (B≻A), or is indifferent between them (B≈A).

• Transitivity — If (A≻B) and (B≻C) then (A≻C).

• Non-satiation — More is preferred to less.

• Convexity — Marginal utility falls as consumption of any good rises.

This definition remains dominant in neoclassical economics today.

Sippel (1997) tested whether consumers really adhered to these four rules. He gave his student test subjects a budget, and a set of eight priced commodities to spend their budget on:

UtilityMaximisation

This was repeated ten times, with ten different budget and price combinations. Sippel found that 11 out of 12 of his test subjects’ behaviour failed to meet Samuelson’s criteria for rational utility maximisation. Sippel repeated the experiment later with thirty test subjects, finding that 22 out of 30 did not meet Samuelson’s criteria. Sippel concluded:

We conclude that the evidence for the utility maximisation hypothesis is at best mixed. While there are subjects who appear to be optimising, the majority of them do not.

It is interesting that some individuals obey the rules set out by Samuelson, and that some don’t. Human behaviour is highly variable from individual to individual. If the hypothesis of utility maximisation is right about a subset of individuals, but wrong about much of the general population, then this underlines the variability of human behaviour. And different circumstances call for different decision-making frameworks — some individuals may act like rational utility maximisers under some sets of circumstances and not others. This is really an area that deserves much, much more empirical study.

The evidence so far suggests that humans are complex animals whose decisions are multi-dimensional. This could be because our brains have evolved to use different neuro-circuitry for different decisions. According to the behavioural economist Daniel McFadden:

Our brains seem to operate like committees, assigning some tasks to the limbic system, others to the frontal system. The “switchboard” does not seem to achieve complete, consistent communication between different parts of the brain. Pleasure and pain are experienced in the limbic system, but not on one fixed “utility” or “self-interest” scale. Pleasure and pain have distinct neural pathways, and these pathways adapt quickly to homeostasis, with sensation coming from changes rather than levels. Overall, presumably as a product of evolution, our brains are organized well enough to keep us alive, fed, reproducing, and responsive to but not overwhelmed by sensation, but they are not hedonometers.

All of this points to the idea that microeconomics needs a new framework based on neurological and behavioural evidence, not decades-old assumptions that are unsupported by empirical evidence.

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The Interconnective Web of Global Debt

It’s very big:

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Andrew Haldane:

Interconnected networks exhibit a knife-edge, or tipping point, property. Within a certain range, connections serve as a shock-absorber. The system acts as a mutual insurance device with disturbances dispersed and dissipated. But beyond a certain range, the system can tip the wrong side of the knife-edge. Interconnections serve as shock-ampli ers, not dampeners, as losses cascade.The system acts not as a mutual insurance device but as a mutual incendiary device.

A mutual incendiary device sounds about right.

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Comparative Advantage and Global Trade Fragility

One of the cornerstones of the global economic status quo is globalisation and integration of markets. Here’s the growth in world trade as a percentage of global GDP since the 1970s:

worldtrade

There have been two key forces behind this outgrowth in global trade. First of all, the American military acting as hegemonic global policeman with bases in more than 150 countries and backed has created a situation generally known as the Pax Americana where goods and intermediaries can be shipped around the globe with minimal fear of piracy, seizure, theft, etc. Second, the international community has incentivised trade liberalisation through the policies of organisations including the International Monetary Fund (IMF), and World Trade Organization (WTO) requiring nations requesting loans or aid to open their markets to foreign trade competitors.

Most global policymakers and trade economists remain committed to and ultra-bullish about the agenda of global integration of markets. The OECD claims:

If G20 economies reduced trade barriers by 50%, they could gain:

More jobs: 0.3% to 3.3% rise in jobs for lower-skilled workers and 0.9 to 3.9% for higher-skilled workers, depending on the country.

Higher real wages 1.8% to 8% increase in real wages for lower-skilled workers and 0.8% to 8.1% for higher-skilled workers, depending on the country.

Increased exports: All G20 countries would see a boost in exports if trade barriers were halved. In the long run, many G20 countries could see their exports rise by 20% and in the Eurozone by more than 10%.

The overarching intellectual motivation for these policies is found in the work of the English classical economist David Ricardo and his neoclassical successors. The concept of comparative advantage introduced by Ricardo and expanded and formalised via equilibrium models by neoclassical economists including Samuelson, Mankiw, Hecksher and Ohlin (etc) has underpinned most of these policies.

Comparative advantage is the idea that nations benefit from specialising in what they are best at. Ricardo introduced the notion during debates about Britain opening her markets to European trade. Ricardo pointed out that total output and welfare would be greater for all countries in total if they specialised in what they were best at, and traded with each other to get what they wanted.

This principle works in Ricardo’s simple verbal model (and in the more sophisticated equilibrium models developed since). However empirical studies and meta-studies of modern day trade liberalisation suggest that there are some problems with this theory in practice.

Dani Rodrik noted in 2001:

Do lower trade barriers spur greater economic progress? The available studies reveal no systematic relationship between a country’s average level of tariff and nontariff barriers and its subsequent economic growth rate. If anything, the evidence for the 1990s indicates a positive relationship between import tariffs and economic growth.

The evidence on the benefits of liberalizing capital flows is even weaker. In theory, the appeal of capital mobility seems obvious: If capital is free to enter (and leave) markets based on the potential return on investment, the result will be an efficient allocation of global resources. But in reality, financial markets are inherently unstable, subject to bubbles (rational or otherwise), panics, shortsightedness, and self-fulfilling prophecies. There is plenty of evidence that financial liberalization is often followed by financial crash — just ask Mexico, Thailand, or Turkey — while there is little convincing evidence to suggest that higher rates of economic growth follow capital-account liberalization.

So what’s the difference between theory and reality?

There are a number of potential reasons why the theoretical promise of comparative advantage has not played out in reality.

First is graft and corruption. If countries are taking on loans from international institutions, and those loans are being deposited in the Swiss bank accounts of corrupt officials or businessmen instead of being spent on improving industry, skills or infrastructure, then what chance do developing countries have of developing?

Second is the danger of bubbles during the liberalisation process. Global capital flows into newly-liberalised countries can stoke bubbles in almost every sector (but especially equities, real estate, etc). When the bubble bursts, capital flows out, leaving the domestic economy deeply depressed.

Third is the social upheaval costs to labour, skills and institutions. As we have seen in the United States, manufacturing jobs and skills migrated abroad. Workers often cannot be retrained cheaply and easily, and often do not want or cannot afford to migrate to wherever their skills would be best-compensated. This stickiness can result in endemic unemployment and resultant economic weakness.

Fourth is the cost to capital stock.

As Steve Keen noted:

Some capital is necessarily destroyed by the opening up of trade.

Since capital is destroyed when trade is liberalised, the watertight argument that trade necessarily improves material welfare springs a leak.

Converting capital stock again and again to keep up with changing economic winds can be an expensive, difficult and mistake-ridden process.

Fifth is the problem of trade fragility.  Events like natural disasters and foreign wars can disrupt production and trade flows. Specialisation could cripple a country that depends on imports from foreign disrupted countries. Dependency on imported goods and intermediates renders countries vulnerable to shocks outside their borders. Wars and disasters that affect exporters have at times seriously disrupted and damaged the economies of importers, and vice versa.

The fact that trade liberalisation can have large social costs, create economic fragility and produce asset bubbles is a cause for pause. Is IMF-imposed globalisation opposed by the wider public really producing freer markets, or is it a misguided central planning experiment? Has the dogmatic pursuit of globalisation left global industry fragile to supply chain shocks caused by natural disasters and wars? Can the status quo really even be considered free trade, given that it is supported and smoothed by huge military-industrial subsidies? Does freedom of trade not also include freedom of nations to choose to protect domestic industries, institutions and supply chains from foreign competition? Why should the industries of developing countries be expected to compete against corporate multinational juggernauts?

While global trade may have provide a major disincentive against trade-disrupting wars, it seems probable that it has created a deep underlying systemic fragility. Trade interdependence means that regional or domestic shocks to production like a war or natural disaster may have consequences throughout the entire world, transmitted through dependencies. Similarly to the interconnective global financial system and the 2008 financial crisis, geopolitical shocks in coming years may well be magnified by globalisation.

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Negative Nominal Interest Rates?

A number of economists and economics writers have considered the possibility of allowing the Federal Reserve to drop interest rates below zero in order to make holding onto money costlier and encouraging individuals and firms to spend, spend, spend.

Miles Kimball details one such plan:

The US Federal Reserve’s new determination to keep buying mortgage-backed securities until the economy gets better, better known as quantitative easing, is controversial. Although a few commentators don’t think the economy needs any more stimulus, many others are unnerved because the Fed is using untested tools. (For example, see Michael Snyder’s collection of “10 Shocking Quotes About What QE3 Is Going To Do To America.”) Normally the Fed simply lowers short-term interest rates (and in particular the federal funds rate at which banks lend to each other overnight) by purchasing three-month Treasury bills. But it has basically hit the floor on the federal funds rate. If the Fed could lower the federal funds rate as far as chairman Ben Bernanke and his colleagues wanted, it would be much less controversial. The monetary policy cognoscenti would be comfortable with a tool they know well, and those who don’t understand monetary policy as well would be more likely to trust that the Fed knew what it was doing. By contrast, buying large quantities of long-term government bonds or mortgage-backed securities is seen as exotic and threatening by monetary policy outsiders; and it gives monetary policy insiders the uneasy feeling that they don’t know their footing and could fall into some unexpected crevasse at any time.

So why can’t the Fed just lower the federal funds rate further? The problem may surprise you: it is those green pieces of paper in your wallet. Because they earn an interest rate of zero, no one is willing to lend at an interest rate more than a hair below zero. In Denmark, the central bank actually set the interest rate to negative -.2 % per year toward the end of August this year, which people might be willing to accept for the convenience of a certificate of deposit instead of a pile of currency, but it would be hard to go much lower before people did prefer a pile of currency. Let me make this concrete. In an economic situation like the one we are now in, we would like to encourage a company thinking about building a factory in a couple of years to build that factory now instead. If someone would lend to them at an interest rate of -3.33% per year, the company could borrow $1 million to build the factory now, and pay back something like $900,000 on the loan three years later. (Despite the negative interest rate, compounding makes the amount to be paid back a bit bigger, but not by much.) That would be a good enough deal that the company might move up its schedule for building the factory.  But everything runs aground on the fact that any potential lender, just by putting $1 million worth of green pieces of paper in a vault could get back $1 million three years later, which is a lot better than getting back a little over $900,000 three years later.  The fact that people could store paper money and get an interest rate of zero, minus storage costs, has deterred the Fed from bothering to lower the interest rate a bit more and forcing them to store paper money to get the best rate (as Denmark’s central bank may cause people to do).

The bottom line is that all we have to do to give the Fed (and other central banks) unlimited power to lower short-term interest rates is to demote paper currency from its role as a yardstick for prices and other economic values—what economists call the “unit of account” function of money. Paper currency could still continue to exist, but prices would be set in terms of electronic dollars (or abroad, electronic euros or yen), with paper dollars potentially being exchanged at a discount compared to electronic dollars. More and more, people use some form of electronic payment already, with debit cards and credit cards, so this wouldn’t be such a big change. It would be a little less convenient for those who insisted on continuing to use currency, but even there, it would just be a matter of figuring out with a pocket calculator how many extra paper dollars it would take to make up for the fact that each one was worth less than an electronic dollar. That’s it, and we wouldn’t have to worry about the Fed or any other central bank ever again seeming relatively powerless in the face of a long slump.

First of all, I question the feasibility of even producing a negative rate of interest, even via electronic currency. Electronic currency has practically zero storage costs. What is to stop offshore or black market banking entities offering a non-negative interest rate? After all, it is not hard to offer a higher-than-negative rate of interest for the privilege of holding (and leveraging) currency. A true negative interest rate environment may prove as unattainable as division by zero.

But assuming that such a thing is achievable, I think that a negative rate of interest will completely undermine the entire economic system in clear and visible ways that I shall discuss below (“white swans”), and probably also — because such a system has never been tried, and it is a radical departure from the present norms — in unpredictable and emergent ways (“black swans”).

Money has historically had multiple functions; a medium of exchange, a unit of account, a store of purchasing power. To institute a zero interest rate policy is to disable money’s role as a store of purchasing power. But to institute a negative interest rate policy is to reverse money’s role as a store of purchasing power, and turn money into a drain on purchasing power.

Money evolved organically to possess all three of these characteristics, because all three characteristics have been economically important and useful. To try to strip currency of one of its essential functions is to risk the rejection of that currency.

How would I react in the case of negative nominal interest rates? I’d convert into a liquid medium that was not subject to a negative rate of interest. That could be a nonmonetary asset, a foreign currency, a digital currency or a precious metal. I would actively seek ways to opt out of using the negative-yielding currency at all — if I could get by using alternative currencies, digital currencies, barter, then I would.  I would only ever possess a negative-yielding currency for transactions (e.g. taxes) in which the other party insisted upon the negative-yielding currency, and would then only hold it for a minimal period of time. It seems only reasonable that other individuals — seeking to avoid a draining asset — would maximise their utility by rejecting the draining currency whenever and wherever possible.

In Kimball’s theory, this unwillingness to hold currency is supposed to stimulate the economy by encouraging productive economic activity and investment. But is that necessarily true? I don’t think so. So long as there are alternative stores of purchasing power, there is no guarantee that this policy would result in a higher rate of  economic activity.

And it will drive economic activity underground. While governments may relish the prospect of higher tax revenues (due to more economic activity becoming electronic, and therefore trackable and traceable), in the present depressionary environment recorded and taxable economic activity could even fall as more economic activity goes underground to avoid negative rates. Increasingly authoritarian measures might be taken — probably at great cost — to encourage citizens into using the negative-yielding legal tender.

Banking would be turned upside down. Lending at a negative rate of interest — and suffering from the likely reality that negative rates discourages deposits — banks would be forced to look to riskier or offshore or black market activities to achieve profits. Even if banks continued to lend at low positive rates, the negative rates of interest offered to depositors would surely lead to a mass depositor exodus (perhaps to offshore or black market banks offering higher rates), probably leading to liquidity crises and banking panics.

As Izabella Kaminska wrote in July:

The simple fact of the matter is that in a negative carry world – or a flat yield environment for that matter – there is no role or purpose for banks because banks are forced into economically destructive practices in order to stay profitable.

Additionally, a negative-yielding environment will result in reduced income for those on a fixed income. One interesting effect of the present zero-interest rate environment is that more elderly people — presumably starved of sufficient retirement income — are returning to the labour force, which is in turn crowding out younger inexperienced workers, who are suffering from very high rates of unemployment and underemployment. A negative-yielding environment would probably exacerbate this effect.

So on the surface, the possibility of negative nominal rates seems deeply problematic.

Japan has spent almost twenty years at the zero bound, in spite of multiple rounds of quantitative easing and stimulus. Yet Japan remains mired in depression. The fact remains that both conventional and unconventional monetary policy has proven ineffective in resuscitating Japanese growth. My hypothesis remains that the real issue is the weight of excessive total debt (Japan’s total debt load remains as precipitously high as ever) and that no amount of rate cuts, quantitative easing or unconventional monetary intervention will prove effective. I hypothesise that a return to growth for a depressionary post-bubble economy requires a substantial chunk of the debt load (and thus future debt service costs) being either liquidated, forgiven or (often very difficult and slow) paid down.

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Helicopters Grounded?

Having recently uncovered in its own research that quantitative easing is enriching the richest 5%, and the British economy still mired in the doldrums even in spite of hundreds of billions of easing,  the Bank of England announced last week that it was grounding its fleet of helicopters dropping cash onto the big banks and suspending the quantitative easing program.

Yet, this may not be the end for British monetary activism.

Anatole Kaletsky wrote last month:

This week an even more radical debate burst  into the open in Britain. Sir Mervyn King, governor of the Bank of England, found himself fighting a rearguard action against a groundswell of support for “dropping money from helicopters” – something proposed by Milton Friedman in 1969 as the ultimate cure for intractable economic depressions and recently described in this column as “Quantitative Easing for the People.”

King had to speak out because the sort of calculations presented here last summer started to catch on in Britain. The BoE has spent £50 billion over the past six months to support bond prices. That could instead have financed a cash handout of £830 for every man, woman and child in Britain, or £3,300 for a typical family of four. In the United States, the $40 billion the Fed has promised to transfer monthly, with no time limit, to banks and bond funds, could instead finance a monthly cash payment of $500 per family – to be continued indefinitely until full employment is restored.

Has the Bank of England stopped one program in anticipation of beginning another? Will be the Bank of England begin to inject cash directly to the public, bypassing the banks?

It is more than possible.

Could this mean some kind of debt jubilee? That is less likely — policymakers seem to remain fixated on demand and consumption, when the greatest obstacle to economic activity is the total level of debt.

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The Data That Won It For Obama

I wondered during the final debate whether Mitt Romney might steal a phrase from Ronald Reagan and ask Americans if they were better off than they were four years ago. It has worked for the Republicans before, and all the polling data pointed to the idea that voters were looking at the economy as the top issue.

Yet Romney did no such thing. Perhaps that was because by a number of significant measures, many Americans are better off than they were three or four years ago when America was mired in the epicentre of a global economic crisis. While America is in many cases just catching up to ground lost in the 2008 crash, and while many significant and real doubts remain about the underlying fundamentals of the American and global economies, the American economy has reinflated since early 2009.

Real GDP growth has been sustained:

The S&P500 has gone upward:

So has industrial production:

And total wages and salaries:

And here’s corporate profits:

And although total employment remains significantly depressed, headline unemployment has fallen (and those who have dropped out of the labour force have been entitled to expanded welfare programs):

It seems — although this was a very divided election — that these data provided enough juice to give just enough Americans the sense that although they may not be better off than they were at the turn of the millennium, under Obama things are improving just enough.

Certainly, some groups who have not fared well due to low interest rates such as seniors rejected Obama, too. Other groups, like women, deserted the Republicans on social issues. Yet Republicans looking for reasons why Romney ultimately lost probably need look no further than slow but steady reinflation.

Beneath the surface, this tepid reinflation is very much akin to the economy that got Bush re-elected in 2004. That recovery ended in mania and a bubble and finally a crash when subprime imploded in 2008. It is more than possible that this recovery is equally unsustainable and will end the same way, in crushing disappointment and grinding deflation.

Debt — the fuel of bubbles — is slowly growing again, from a perilously high starting point:

Deleveraging in the new quantitatively-eased environment has been very, very slow. This is a delicate and dangerous balancing act. Total debt levels as a percentage of the economy remain humungous and are a grinding weight on the underlying economy:

The Obama-Bernanke reinflation may well be an illusion built on the shakiest of foundations. And it may end more painfully than even the disastrous Bush-Greenspan reinflation. Yet it was enough to guarantee Obama re-election.

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What is Profit?

In neoclassical macroeconomic models that assume perfect competition, there can in the long run be no such thing as profit — defined as revenue left over after all costs have been subtracted.

Clearly, in the real world where many businesses have lived and died profitably there is no such thing as perfect competition, and therefore the neoclassical models that treat profit as a short-run anomaly are working from an unrealistic assumption.

My definition of profit is that profit is what happens when a business’s input transactions are priced less than its output transactions. That is, the sum of the cost of a business’s inputs from those it buys is transacted for a lower price than the sum of those it sells its goods and services to. Because transactions are assumed to be voluntary — and when they are not voluntary, any residual gain is theft, not profit — and businesses are assumed to try to negotiate the best price in both inputs and outputs, any profit is due to those who purchase the business’s output valuing the output higher than those who sold the business its inputs. That an output or input transactor would accept a profit-creating price could be for any number of perceived reasons: convenience, or expertise, or prestige, or necessity, or even outright trickery. Their decision to accept the price is subject to their own subjective valuation, and it is the difference between prices that creates the profit.

Marx and Lenin represented this idea as surplus value; that businesses make a profit by extracting uncompensated labour value out of their workers. But why not the other transactors? In my view, profit is derived from the sum of the business’s transactions with all of its transactors: consumers, supplies, labour (etc). Workers (etc) cannot extract a greater share of the firm’s revenue than they can negotiate, and at various points in history (including the present day) the working class seems to have had little real leverage for negotiation.

In my view, any model that attempts to represent real world markets should begin from the historical fact of profit and loss, and the historical fact of a disequilibrium between input transactions and output transactions.