Austerity Lecture

https://www.youtube.com/watch?v=JQuHSQXxsjM

Intro

Speaker: Mark Blyth, Professor at Brown University. Author of Great Transformations. Ph.D from Columbia in Economics.

Refers to himself as a great example of welfare empowered social mobility - having gone from orphan to Ivy League professor.

Asset protection + tax cuts + 2 wars = 61% debt/gdp by 2006.

A shortage of T-bills (shrinking debt in early 2000s and increased demand from China) produced a run on the repo market - using AAA mortgages as collateral for repo collateral. This cascaded to a liquidity crunch.

There was no large growth in public spending, the only major growth was asset protection. He argues "We are not in much of a mess" - because we have not been cutting. Our growth projections are looking ok, Britian looks worse and Europe looks bad. Greece had done more damage to it's economy that Germany did to it's own in WWII, in the same period of time.

Debt as %GDP

• USA : 105%
• UK  : 90%
• Spain : 70%
• Japan : 140%
• Italy : 120%
• Ireland : 100%
• Greece : 160%
• Germany : 70%
• France : 80%
• Canada : 80%

Story 1 (The Official Story and Total Crap)

Greece debt had a 25% interest rate (equal default risk), France and Italy were around 15%. As the Euro, generalized in the German Bundis Banks, rolls out everyone converged on the German interest rate (low ~4%) - which is odd. The thinking was that if Germany is printing the money, other countries can't inflate or devalue their way out of debt. The only two options are austerity or fix the broken economies.

Most countries in Europe are running a trade deficit, except Germany. Wages went up driven by cheap debt.

The core of this argument is that the southern countries (the ones whose economies are now collapsing) borrowed too much.

But... and this is where it falls apart... Britian has 1T$ in bad assets and Germany has 500B$ in bad assets - far more than any handful of southern countries.

Story 2 (What actually happened)

You can't have over borrowing without over lending.

European banks leveraged up knowing that if they failed, they had to be saved by the state because their failure could damage their country. They leveraged up (40 to 1) with the high risk debt (Germany, Italy, France) but as the Euro was introduced as those avenues of high return disappeared, they made up for it with volume. The mentality was carried over and banks were able to present a systemic risk to the European Union - except that Germany doesn't bail banks, so as they started to fail, Germany let them fail. The result was core banks holding large quantities of bad bad ranging from 10-40% of GDP. Assets held in Germany, France and UK are double the annual GDP of the entire EU. In France, a single bank has assets equal to 100% of GDP, all told, bank assets are more than 400% of GDP.

For the state there are four answers to these types of problems. Inflate, de-value, austerity or "A Bernanke". The later is taking all the bad assets from banks and moving them to the Federal Reserves books and flush the whole system with liquidity (preventing a crunch).

Now, in the US, the top 7 banks only hold assets equal to 61% of GDP - no single bank, even accounting for systemic effects, can take down the whole system. Even total bank assets in the US is less than 120% of GDP. At the height of the crisis US banks were leveraged 30:1, they're now down to 15:1. Eventually, the bad assets (mortgages) will have value again and can be sold back to the banks.

His argument, this whole thing is about preventing massive collapse in the core (German and French) banks. If they start selling off bad assets, it will cascade. [needs review 22:00]

Beyond Story 2

You can't solve a banking problem with a budget cut. You can run a gold standard in a democracy. You can't solve a solvency problem with a liquidity instrument.

The market is worried about the EU breaking up - it needs guarantees that it won't. When all the economies try to cut spending at the same time - no one is spending and the economy stops moving. Every country that has undergone an austerity program now has more debt than when they started.

So why did anyone think was a good idea

Liberalisms Emetic Economics

The English revolution establish markets, but markets lead to massive income inequalities. So you need a state to 1) make markets and 2) protect the rich from being killed by the poor. But any state strong enough to protect it's people is also strong enough to take their money and is expensive to run.

One solution is debt - the rich loan the money to the state, the state uses the money and pays it back with interest. But for this to work, the government has to offer an interest rate higher than the market would produce which will crowd out competition for investment opportunities. This debt perverse parsimony (bankruptcy of the state).

The rich regarding the state: "Can't live with it, can't live with out it, don't want to pay for it".

Testing Predictions

Hume, one of the originators of the above problems, predicted the massive growth of debt and collapse of the British economy by the late 1700s. Debt did grow to 240% of GDP at the end of the Napoleonic wars, but the British empire experienced it's enormous expansion.

Two Liberal Stories

1. "Can't live with it, can't live with out it, don't want to pay for it".
2. "Accepting the need for it and to pay for it" - John Stewart Mill

This produced a theory that banks produce too much credit - entrepreneurs get confused by price signals, and produce too much. Then the credit dries up. The classic boom-bust cycle.

An important historical note, both the nazi party and the ruling party (military) in Japan in WWII came to power by opposing austerity. Some will oppose it and gain a populist movement (we're seeing the same thing in Greece with Golden Dawn).

What We Learned

• Fallacies of composition and non-scalability in labor and money markets - there are systemic non-linearities
• People following each others investment signals leads to feedback oscillations
• "Consumption, to repeat the obvious, is the sole end of economic activity"

Also

• Democracy is asset insurance for the Rich
• Redistribution and Debt is reinsurance for Democracy
• Austerity is Anorexia for the Economy

Liquidity Trap: In a depression, everyone want to remain liquid so that when things start to get better, people can move their money to the best places. But the recovery doesn't start while everyone stays liquid.

Germany

1873 - founders crisis, their stock market crashed and discredited liberal economic ideas (liberal as in market liberal). This caused re-evaluation. One scholar looked at England (from whom they were taking financial advice) and realized that if England followed their own advise, they'd be focusing on wool production. Instead they were focusing on running the world. So they developed a big government to drive growth fueled by external demand - Keynseianism breaks down. You don't want to stabilize consumption if you're export dependent.

This is the foundation of the Euro. Generalized "Ordoliberalism". But when the credit bubble pops, everyone is dependent on exports, which doesn't work for countries running an export deficit.

The Theory

If the government cuts spending, then everyone calculates their lifetime aggregate gain from lowered taxes which translates to them needing to save less now to pay taxes later so we all go to Ikea and buy a couch. This is ludicrous.

The Reality

Cutting in a slump produces a bigger slump. You want to cut during growth - but good luck with that.

The IMF now calculates that when you cut 1 dollar from government budgets you lose 1.5-1.7 of spending.

Questions

How to earn profits in a positive inflationary cycle? Take the Abudabi investment strategy "We own half a percent of everything that isn't nailed down" because you don't know where the growth is coming from. Stay away from debt market.

How can an individual state like Ireland try to fix things in their country? They can't, they're kind of screwed. Also, Argentina is the graveyard of all bad economic policies. Countries like Ireland actually run into a logistics problem that they don't have the physical money.

What about Iceland? Iceland is an example of "No good dead goes unpunished". We should have let the banks fail. Even though they are de-leveraged now, they are more concentrated. As to-big-to-fail as they were then, they are even too-bigger-to-fail now. UBS was fined 1.2B$ for funding terrorism and drug cartels. They weren't charged with a crime, US investments are required to with draw. So they weren't charged. Iceland let their banks fail. The number-crunchers in the banks had to go get real jobs. The domestic economy ended up being fueled by start-ups (particularly online gaming). Their unemployment is 1% higher than Germany. People didn't like this so they were voted out of power and the people running the banks in the first place are back in.

Australia? Still in the pre-collapse bubble driven by mining boom that China is the buyer. You can see this because the Australian dollar and Chinese yuan move perfectly in tandem. "People say China owns the US, actually we've been giving them bits of paper that yield 2% annually and they've been giving us TVs - it's a really sweet deal. But it's actually true in Australia - they really do own your assets", assets delivered with a slight pause in the middle.

Brazil? They had the highest Gini co-efficient for years. So people were spending a fortune on kidnap insurance and private security. Then they move to "democracy as asset insurance". The state bank helped finance Brazilian multinationals, which it now taxes on its earnings abroad, bringing it back into the country to finance it's welfare system. Income as gone up, but become more equal. This made the country a great investment opportunity, which is bad for a export dependent country. So incoming investments pay a transaction tax and deposit to make sure they stay for longer periods, not day trading.

Other

This came from another Blyth video I was watching, but I wanted to make note of it: "Growth rates and taxed are extremely uncorrelated - ask the Swedes". Shortly after, "The top marginal tax rate under Eisenhower was 91%, we've been cutting ever since and the economy has gotten smaller and weaker". The bottom 40% hasn't had a real wage increase since 1979.