Archive for the ‘Economic Ideas’ Category


It was November 2012 when Jens Weidmann, President of the Bundesbank, likened quantitative easing, or QE, to a Faustian pact with the devil.  But it was even earlier, back in 2010, when Brazil’s finance minister talked about currency wars.

It was during that era that QE was seen as leading a kind of race to the bottom, as countries fell over themselves to try and achieve a cheaper currency.  It didn’t work out like that, of course. It is no more possible for every country to have a cheaper currency then it is for every Premiership football team to win on the same day.

The critics of QE were legion. They said QE was behind currency wars, and that the inevitable result would be hyperinflation. And they saw the words of Jens Weidmann as a kind of official endorsement of that view.

It was in this environment that the buy gold bandwagon got moving. BUY GOLD, they said. It was the only safe refuge in a world gone mad under QE.

They overlooked that across the world there was a chronic shortage of demand, a savings glut and that the west was suffering from a balance sheet recession.

There are lots of things wrong with QE, the main critique might be that it is a blunt weapon. But it was never likely to lead to hyperinflation, not in a world starved of demand.

But what it did do was lead to a cheaper dollar. And when the dollar fell, so gold rose.

Back in 1999, when UK chancellor Gordon Brown sold the UK government’s gold supply, the yellow metal was trading at less than $300 an ounce. In the summer of 2009 it was trading at just shy of $900. Those two years stood either end of the great gold market, when it rose in value by around 300 per cent.

Gold continued to rise in the aftermath of the crisis of 2008. In September 2009 it was trading at $1,000 and in August 2011 it finally passed $1,900. That was when the gold hype was at its peak.

But in 2015, currency wars has turned to currency normality and inflation stands at close to zero across the developed world. QE didn’t create hyperinflation, it was not even enough to fight the threat of deflation.

In 2015 the US economy began to improve, the Fed made noises about increasing interest rates, the dollar rose, the euro fell, and gold went out of fashion.

As of this moment (21 July 2015) it is trading at $1,108 an ounce.

Why didn’t gold rise above $2,000, or even $3,000 as was once predicted? The reason is simple. QE was the not the devil’s tool it was made out to be, the global economy suffered from lack of demand.  The risk of hyperinflation was built upon a myth.


You may have heard of Solomon Asch. He was the psychologist who helped to introduce us to the idea of group compliance. In his famous experiment, subjects were handed two pieces of paper. On one was drawn a line; on the other three lines. One of the lines on the second sheet was the same length as the line on the first; the other two lines were obviously different.

Subjects were asked to identify which line on the second sheet was the same length as the line on the first. It was an easy test, and nearly all subjects got it right.

Then he played a trick on them. Subjects were put into a group situation. Unknown to them, the rest of the group were actors, and each actor deliberately pointed to the wrong line. It is not hard to imagine how the subjects reacted; their sense of panic or of self-doubt. In fact, in the original Asch experiment no less 74 per cent of those who took part complied with the group, getting the obvious right answer wrong on at least one occasion.

The Asch experiment illustrates how bubbles, even wars, can occur, as individuals comply with the crowd. It is interesting to note, however, that if one actor goes against the rest, and guesses correctly – or perhaps wrongly but with a different wrong answer from everyone else – the subject was far more likely to go against the crowd. It does not take much to break crowd compliance.

The Asch experiment has been repeated worldwide, and it was found that group compliance tended to be slightly higher in countries seen as having a more cooperative and less individualistic culture, such as China. Now don’t over-egg this one. The difference is not that great, but it does go to show that – contrary to what some argue when they say China is different – there are reasons to think China is just as susceptible to bubbles as the rest of us.

© Investment & Business News 2013


“Software (Google and Amazon), hardware and design (Apple), social networking (Facebook and Twitter), biotech, pharmaceuticals, robotics, nanotechnology, entertainment and retail (Wal-Mart)” – these are the bedrocks of modern capitalism. And without high rewards for the innovators – the people who broke the mould and gave us great new innovations – the rest of us would still be living in the Stone Age, or at least we would be poorer than we are, or so says Daron Acemoglu from MIT.

The US could become a lot more equal and a fairer place, but the rest of us, with our more liberal views would be the losers. Is that right? Can the more cuddly and idealist parts of this world only survive thanks to the more cut-throat and harsher realities of the US system?

“The United States does not have the type of welfare state that many European countries, including Denmark, Finland, Norway and Sweden, have developed, and despite recent health-care reforms, many Americans do not enjoy the type of high-quality health care that their counterparts in these other countries do. They also receive much shorter vacations and more limited maternity leave, and do not have access to a variety of other public services that are more broadly provided in many continental European countries.

Perhaps more importantly, poverty and inequality are much higher in the United States and have been increasing over the last three decades, while they have been broadly stable in Denmark, Finland, Norway and Sweden,” or so says Daron Acemoglu from MIT; James A Robinson from Harvard, and Thierry Verdier from the Paris School of Economics in a paper published last year. See: Can’t We All Be More Like Scandinavians? Asymmetric Growth and Institutions in an Interdependent World 

But, continues the paper: “American society that makes possible the more cuddly Scandinavian societies based on a comprehensive social safety net, the welfare state and more limited inequality. The basic idea we propose is simple and is developed in the context of a canonical model of endogenous technological change at the world level.

The main building block of our model is technological interdependence across countries: technological innovations, particularly by the most technologically advanced countries, contribute to the world technology frontier, and other countries can build on the world technology frontier. We combine this with the idea that technological innovations require incentives for workers and entrepreneurs.”

Okay, so that is what the paper says. To put it more succinctly, the US does appear to be more innovative than, say, Scandinavia, with more patents per head for example. So maybe we should all be grateful that the US system is so ruthless.

But here is an alternative, point of view. In his book ‘Sex, Science and Profits’, Terence Kealey quoted Robert Stephenson who said: “The locomotive is not the invention of one man but of a nation of engineers,” and the industrialist A J Mundella, who said: “Every invention we have made and patented (and some have created almost a revolution in the trade) has been the invention of overlookers, or ordinary working men, or skilled mechanics, in every instance.” In short, it was not the case that that the great innovations have been down to highly remunerated entrepreneurs; rather they have often been down to ordinary folks on the payroll, who received little more than a pat on the back for their troubles.

There is one other downside to a system in which there is a massive gap between, say, the top 5 per cent and everyone else. Because doctors often fall into the top 5 per cent in terms of ability and certain exam results, it means that society as a whole struggles to be able to pay for its doctors. If doctors earned less, the NHS would be easier to fund. But if they did, maybe there would be fewer doctors to go around.

Maybe the authors of this report have causation the wrong way round. Sure the US may be more innovative than Scandinavia and less equal, but does that mean one caused the other.

Maybe the US is innovative because it has different attitudes to failure, and its system gives greater scope for experimenting.

For every entrepreneur who makes it big, there are many who fail abjectly, and maybe they fail because they were just unlucky. The difference between those who make it and those who don’t may be as much down to luck as pure ability or hard work.

In any case, there is lots of research to show that money is not the main driver of either entrepreneurs or indeed inventors.

And yet there is something irrational about us all. Why is that more people enter the lottery when the prizes are bigger, even though the chances of winning are not affected? Do you really care if you win £5 million or £30 million on the lottery? Would it really make much difference to your happiness? Yet more of us take part when the prize money is for the bigger amount.

It may be irrational; it may unfair; it may not really add up, and it may not apply to us all of us, but the thing that drives many entrepreneurs to take massive risks, and work through the night, night after night is the promise of great riches. Maybe Messrs Acemoglu, Robinson and Verdier have a point.

© Investment & Business News 2013

Money in hand

Vince Cable has a cunning plan to kick life into the UK economy. It is called a British Business Bank. “We need bold action to fix what has always been a weakness of the UK economy,” he said last week, but there is a question mark. Is Vince’s plan bold enough?

David Petrie, head of corporate finance for the Institute of Chartered Accountants in England and Wales, has doubts. “It is shaping up to be a missed opportunity to make a real difference, especially to micro and smaller businesses,” he has said. So what’s wrong?

First of all, he reckons small businesses are being side lined. Secondly, he is worried that the business bank will not work directly with businesses, but will be one step removed.

Thirdly, he says the money being talked about is nowhere near enough. He reckons the bank will need a minimum of £10 billion of capital.

And fourthly, he says the plans unveiled by Vince Cable amount to little more than a respray of the old Capital for Enterprise scheme.

Mr Petrie’s observations are worrying, but – sadly – probably about right. It is a sort of puzzle. The UK government throws billions at mortgages, the Bank of England prints £375 billion to buy government bonds under its quantitative easing programme, and Vince’s new business bank will have £1 billion of new money.

He says the UK needs bold action, but what we get is timid packaging and the re-jigging of old initiatives that didn’t do much the first time around. Banks have not been failing business for the last few years; they have been failing UK businesses for a decade or longer. For way too long it has much easier to get a mortgage, or even a loan to pay for a holiday than to get funding for a business.

Back in November 2008, Edmund Phelps, a former winner of the Nobel Memorial Prize in Economics, said in an interview with ‘Spiegel Online’: “A fundamental issue that regulatory discussions must confront… is what function society needs the banking industry to perform. Increasingly over the past two decades, the banks have tried to make money with mortgages, residential and commercial. As this has proved difficult, the banks will either have to shrink their supply of credit to the economy as a whole or else redirect some [of] their credit to the business sector.”

But the problem runs deeper than banks. It lies deep within the British and indeed European psyche.
In his book ‘Them and Us’, Will Hutton says: “The European Flash Barometer found that around 43 per cent of people in the UK (compared with 19 per cent in the US) believe that a new business should not be created if there is a risk it may fail.”

The more potentially innovative a business is, the more the chances are it will fail. Bank lending to innovative business does not make sense, because the probability that the business may fail is too high. It only makes sense to back an innovative business if the provider of capital has shares in the upside if things go well – that is to say a share in profits. That way, the successful funding deals can make up for the ones that don’t work. This is the issue a business bank needs to grasp.

© Investment & Business News 2013


It’s a bit odd isn’t it? How can you reduce debt by spending more? That great raconteur of our times George Osborne likes to point out the evident ridiculousness of such an idea. With that cheeky grin of his, he says: “I don’t believe you can cut debt by spending more.”

And yet, despite the silliness of the very suggestion, UK debt is not falling. It is not like that in the US, however, where the government has been far more Keynesian in its approach.

The US deficit this year is expected to be $642 billion, or so estimates the Congressional Budget Office. To put that in context, last year the deficit was $1.1 trillion. It will, in fact, be the first time since 2008 that the US deficit is less than $1 trillion. And, by the way, not so long ago the Congressional Budget Office was projecting a deficit of almost $200 billion more than that.

Looking forward, the deficit is expected to fall even further, dropping to $378 billion in 2015.

The good news does not stop there, however. US household debt has fallen from $12.7 trillion in 2008, to $11.2 trillion at the end of last year. In fact, according to IMF data, US household debt to income has fallen from a ratio of 1.3 in the mid-noughties to around 1.05. In fact, the ratio is now higher in the Eurozone.

Back to the public deficit, and two main factors explain the fall. The expiry of George Dubya Bush’s payroll tax credit means more income is coming in. Recovering US housing prices mean the US government expects a windfall from Fannie Mae and Freddie Mac.

You would expect cheers over the news in the US, wouldn’t you? Well no doubt Mr Obama is cheering, but oddly economists and politicians on the left and right are fretting.

On the right they don’t like it. They fear that they are losing the moral high ground. How can they demand tax and spending cuts to get debt under control when it is falling so fast anyway? The truth is that the arch Austerians have a philosophical problem with any form of government spending except on perhaps on law, order and defence. They want to see cuts, whatever is happening to debt.

On the left, they don’t like it because they think the US needs more government spending; it needs more Keynesian policies, and the fact that debt is falling is symptomatic of a lack of government stimulus.

In the longer term two problems remain.

By the mid-2020s government debt is expected to rise again as the baby boomer generation retires – this problem can be overcome, however, by raising the retirement age.

A more serious challenge may relate to the burgeoning level of student debt. Nobel Laureate Joseph Stligtz reckons this is the next debt crisis in waiting. See: Student Debt and the Crushing of the American Dream

© Investment & Business News 2013


Here is your starter for ten points. Who was Chancellor of the Exchequer when the UK re-entered the gold standard? Bzzzz. Yes, that’s right, it was Winston Churchill.

Now for your next question, who was chancellor in the 1930s, and adopted economic policies not dissimilar from those being applied in Japan today, and with very impressive results? Not sure? Well, it was Neville Chamberlain.

It is quite ironic. Churchill was a brilliant war time leader, but he was a disaster as a finance minister. In the case of Chamberlain, it was the other way round. So what did Chamberlain do and what are the parallels with today?

Back then the UK was in what Nobel Laureate Paul Krugman calls liquidity trap conditions. Interest rates were about as low as they could go, but still the economic performance was awful.

Chamberlain, let’s call it Chamberonomics, went for zero – or near zero – interest rates, a weaker currency and a targeted price level entailing some inflation. Economist Lars EO Svensson calls it The Foolproof Method

The point to remember here is that if the economy is seeing deflation – as it did in the UK during the early 1930s, as it has been in Japan over the last two decades, and as may well in the Eurozone over the remainder of this decade – it becomes very difficult to reduce government debt to GDP.

Think about it, if prices are falling, the economy can be expanding even if GDP measured in pounds shillings and pence is contracting. So if the nominal value of GDP is falling, in order to reduce debt to GDP, it is necessary to make even more severe cuts, or impose even higher tax rises.

So by trying to create some inflation, Chamberlain was able to create the conditions for economic recovery. And at least to an extent this policy worked, with GDP expanding by an average of 4 per cent between 1933 and 1936.

And all this pretty much describes the policies being adopted by Shinzo Abe, Japan’s new (ish) – and by the way he has held the position before – Prime Minister.

They call Abe’s approach Abeonomics, but maybe they should call it Chamberonomics. And by the way, the success enjoyed by the UK during the mid-1930s was also helped by a house building boom – something George Osborne says he is trying to create with his Help to Buy scheme – although whether he is in effect trying to bribe the electorate with an artificial boom in house prices is a moot point.

© Investment & Business News 2013

It is one of those Victor Meldrew theories. In other words, it is easy to say: “I don’t believe it.”

Economic theory, at least some of it, says government spending does not lead to more growth in an economy. The theory says that households spot that the government is spending more, and say to themselves, “aye aye, tax will rise,” and start spending less as a result, which cancels out the effect of the government stimulus.

At least that is what the “Lucas Critique” developed by Robert Lucas, for which he won a Nobel Prize in 1995, says. Some go further and say Barack Obama caused the global financial meltdown. They say even though the US recession began before Obama was President, the US electorate anticipated his victory, and thus cut back on their expenditure.

So there you have it. The Multiplier from a fiscal stimulus is zero. It is odd, because the IMF recently said that right now the multiplier is between 0.9 and 1.7.

The Lucas Critique is famous for its elegant maths. But just because something is elegant it does not mean it is right. And if it is the case that as the government spends more, we spend less, explain this: Gillian Tett pointed out in the ‘FT’ that US consumers seem to be varying their monthly spend around pay day far more often these days.

She quoted the boss of one of the US’s largest food and drinks companies as saying: “Since 2007, spending patterns have become extremely volatile. More and more consumers appear to be living hand-to-mouth, buying goods only when their pay checks, food stamps or benefit money arrive. And this change has not simply occurred in the poorest areas: even middle-class districts are prone to these swings. Hence the need to study local pay and benefit cycles.” See: The cost of hand-to-mouth living

So if that is so, how can they at the same time be so willing to save more if governments start spending more?

© Investment & Business News 2013


Ken Rogoff and Carman Reinhart – the two academics who wrote that rather controversial paper suggesting that when public debt to GDP rises over 90 per cent, growth falls sharply – have come out fighting. And you know what, their observations not only make a lot of sense, they are pretty much smack on in agreement with what has long been argued here.

Let’s be fair to Rogoff and Reinhart, they are not arch Austerians. It is just that their work is often quoted by arch Austerians. And when serious loopholes were found in it, the likes of Krugman practically danced on what some say was Rogoff and Reinhart’s grave. The Austerians responded by saying that the errors found in the Rogoff Reinhart model were trivial, and did not unduly affect the conclusion.

Sometimes, however, you need to stop listening to the interpreters and listen to the original instead.

Take as an example this extract from the Rogoff and Reinhart paper: The Aftermath of Financial Crises published in 2009.    “The main cause of debt explosions,” states the paper, “is usually not the widely cited costs of bailing out and recapitalizing the banking system. The collapse in tax revenues in the wake of deep and prolonged economic contractions is a critical factor in explaining the large budget deficits and increases in debt that follow the crisis.” In short, the paper states the case of the anti-Austerians; government debt does not cause GDP to slow, rather slowing GDP causes government debt to rise.

Rogoff himself has gone on record as saying that the conclusions of the paper he co-wrote are often exaggerated.

In today’s FT, Rogoff and Reinhart produced an article that says it, clearly in black and white.

“To be clear,” they said, “no one should be arguing to stabilise debt, much less bring it down, until growth is more solidly entrenched.”

“Nevertheless,” they continue, “given current debt levels, enhanced stimulus should only be taken selectively and with due caution. A higher borrowing trajectory is warranted, given weak demand and low interest rates, where governments can identify high-return infrastructure projects. Borrowing to finance productive infrastructure raises long-run potential growth, ultimately pulling debt ratios lower. We have argued this consistently since the outset of the crisis.” See: Austerity is not the only answer to a debt problem 

Hear, hear to that. We need both. We need austerity and stimulus. This is no contradiction.

We need investment into infrastructure, energy, education, and (this is the one that ‘Investment and Business News’ has spoken up for more than anything else) into entrepreneurs.

But actually, move away from Rogoff and Reinhart and look instead at the National Institute of Economic and Social Research (NIESR), which under its director Jonathan Portes has looked very Keynesian in its attitude towards government debt and stimulus.

In NIESR’s latest paper on the growth prospects of the UK economy it recommended: “Investment in education, innovation and infrastructure is essential for future economic growth.” The paper stated: “With 10-year government bonds attracting yields of less than 2 per cent, the government can finance additional investment in much needed infrastructure at little cost. With an economy in such a depressed state the fiscal multipliers are likely to be far higher than in normal times.”

In short, the darling boy and girl of the Austerians, and NIESR, headed by one of the UK’s most articulate and apparently switched on Keynesians, are saying much the same thing.

Of course we need to see austerity, not just in Britain, but across much of Europe. In Greece, the public sector has been a drain on the economy for decades.

Of course we need stimulus, no stimulus at a time when households and companies are saving more will automatically mean less GDP.

So we need austerity in areas of the public sector that are bloated. We need stimulus in areas that will create not only more jobs in the short term, but also improved productivity in the long term.

What we don’t need are stimuli that just hand money to households and companies via tax cuts. Much of this money will be saved. There is no point in the government borrowing money to fund tax cuts that help the private sector to save more.

© Investment & Business News 2013

Last June BBC 2’s ‘Newsnight’ had a kind of Paul Krugman special. The Nobel Laureate and arch supporter of Keynesianism was on the show for almost its entire duration. And a big hullaballoo it created too.

But one particular piece of controversy, relating to the Baltics and how their experience may provide evidence that austerity can work, won’t die down.

On the show, Krugman debated austerity with venture capitalist Jon Moulton and Tory MP Andrea Leadsom. Krugman made good points, and on balance probably won the argument, but then again, say critics, it was hardly fair, pitching a Nobel Laureate against two humble citizens – an MP and a man whose main claim to fame is that he is merely one of the UK’s most successful investors.

But in the debate Moulton did say something that appeared to stump Krugman. “What about Estonia?” asked Moulton. “Surely,” he said to Krugman, ”even you admit this country had growth while seeing austerity.”

To which Krugman muttered something under his breath, but it was clear he had been caught out. He didn’t know. So there you have it, a Nobel Laureate knew little about an economy as big and important as Estonia.

Ever since then, both Krugman and Martin Wolf – his ally at the ‘FT’ – have not missed a chance to point out why Estonia and the rest of the Baltics do not support the pro-austerity argument. Wolf was at it again, this week.

In essence, the argument presented by Krugman and Wolf is this. Sure, the Baltic economies are growing, but total production is well below peak. Since that is the case you can hardly count these countries as example of austerity working.

The debate rolls on, but to give Krugman credit, he does seem to have come up with a new and pretty impressive argument.

To the point that Baltics have not recovered lost output, the Austerians say that peak GDP was in fact illusionary, and thus you have to ignore the fall in GDP. But Krugman has responded.

If that is the case, and he says he doubts it is, and pre-recession GDP was not real, then that means Estonia didn’t – by definition – fall into depression.

This is an important point. Krugman and co say you can’t recover from depression while imposing austerity. The Austerians say you can, and cite Estonia as an example, but by their very own logic, Estonia never experienced depression in the first place.

Maybe it’s all academic, but it is worth noting.

Another point needs to be mentioned, however. The real problem with austerity is not that it can’t work when applied by a small country – maybe it can – rather it is that when the global economy applies austerity things start to become very dangerous.

© Investment & Business News 2013

“We are all Keynesians now,” or so said Milton Friedman in 1965. Later, President Nixon said: “I am now a Keynesian in economics”, and popular misconception has thrown up the view that it was Nixon who made the comment about us all being Keynesian.

Political leaders in South America could say it now, too. Leaders across the continent would sound eminently consistent if they too said: “We are all Keynesians now.” It is just that they aren’t and neither was Nixon, and neither was Friedman. Keynes advocated a certain set of policies under certain conditions: namely when monetary policy no longer worked no matter how low interest rates were, and when people still weren’t spending. He called the use of monetary policy in such times pushing on string.

Others call it liquidity trap conditions.

Right now in South America, monetary policy is not pushing on string, and there is no liquidity trap. Ditto the US economy in the 1960s. The policies that were adopted in the 1960s and to a lesser extent in South America today may be called Keynesian by some, but it is doubtful that Keynes would have called them that.

Keynes would have called for the remedies he famously advocated only when interest rates had fallen so low, that they cannot fall any lower. That is to say, about now in the US, the UK, Europe and Japan, but not in South America.

If you are running late and stuck in traffic, hitting the gas won’t help. But if you are running late, and the motorway is empty, and devoid of speed cameras, then upping your speed will help you to complete the journey quicker. Critics of Keynes who said his ideas didn’t work in the 1960s and thus won’t work now, are like someone who concludes, after a day spent in heavy traffic, that there is never any advantage in driving over 30 miles per hour.

© Investment & Business News 2013