Citizen Action Monitor

The causes of the 2008 crisis remain unresolved, any future downturn will be much worse

There are three possible scenarios: strong recovery, managed depression, mother of all crashes.

No 1804 Posted by fw, October 20, 2016

“Can I give you an impression of what the world will look like: There will be ten percent who will do very well, some of you. You will pay the twenty percent to control the other seventy percent which will be on the brink of starvation. That’s the world that you’re going to look at.”Satyajit Das (Source: The end of growth? A CIS talk by the author of “Extreme Money Video by Satyajit Das, Centre for Independent Studies, May 28, 2012 (length 1:28:36).

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On June 19 of this year, I reposted another article by Satyajit Das, former banker, now risk consultant, warning about the risks of financial derivatives years before the Great Meltdown of 2008. That article was titled, We are on the brink of experiencing the next financial crisis, says leading financial authority.

Satyajit Das

Satyajit Das

Sad to say that today’s article by Das is equally foreboding. Don’t be misled by stock market surges. The financial crisis stemming from the Great Meltdown of 2008 remains unresolved. It is very unlikely that the strategies currently in place will lead to a strong recovery; Das explains what these strategies are and why they will fail. The prospects of success of a second scenario — a managed depression — which he outlines, seem slim indeed. And that leaves the third scenario – the mother of all crashes — featuring: problems on a global and emerging market scale; financial system failures; defaults which trigger problems in the banking system; falls in employment, consumption and investment; capital flight from vulnerable nations, banks and investment vehicles.

Tighten your seatbelts, folks. If Das is right, we’re in for a rough ride ahead. And it’s unlikely that Team Trudeau, which appears to be banking largely on TPP, CETA, and expanded oil and gas production to drive economic growth, will be able to comprehend the integrated complexity of the global economy.

So, let’s hope that Das, as smart a guy as he seems to be, gets this call wrong. He has been predicting doom and gloom since 2008 and the sky hasn’t fallen – yet.

Below is a repost of his article in the Independent (UK) with my added subheadings and bulleted reformatting. There is also a much longer version of Das’ article here: Crash Course Part 3 The Age of Stagnation? by Satyajit Das, EconoMonitor, September 14, 2016 – This longer version is 1484 words, compared to the version below at about 950 words. The ending is just as bleak in the longer version.

At the bottom of this post is a reader’s longish, informed comment posted in the Independent: this remark, in particular, caught my attention: “The capitalist sector had caused the crash, not the public sector. But the public sector had to pay with increased debt and a reduction in the role of the state as support for growth and as a safety net for those who lost their jobs, homes and incomes.”

To read Das’ piece in the Independent, click on the following linked title.

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The global economy is no Lazarus – the outlook is bleak by Satyajit Das, Independent, May 22, 2016

The causes of the 2008 crisis remain unresolved, any future downturn will be much worse

Any new crisis is likely to be a further phase of the 2008 crisis, reflecting the fact that the causes remain largely unresolved. A future downturn will be much worse this time around.

There are three possible scenarios facing the global economy.

1/ The strategies in place lead to a strong recovery

The first is the Lazarus* economy, where the strategies in place lead to a strong recovery. [*Biblical reference: Lazarus, a poor man facing hardship, is ignored every day by a passing rich man. Lazarus and the rich man die. Lazarus is rewarded and goes to Abraham’s side. The rich man is punished and sent to Hades. Today, Lazarus is the working man and woman, ignored by the rich 1%. The difference is the wealthy and powerful do not go to Hades].

  • The US leads the way.
  • Europe improves as the required internal transfers and rebalancing takes place with Germany accepting debt mutualisation to preserve the Euro.
  • Abe-nomics revives the Japanese economy.
  • China makes a successful transition from debt financed investment to consumption. A financial crisis in China from the real-estate bubble, stock price falls and massive industrial overcapacity is avoided.
  • Other emerging economies stabilise and recover as overdue structural reforms are made.
  • Growth and rising inflation reduce the debt burden.
  • Monetary policy is normalised gradually. Higher tax revenues improve government finances.
  • There is strong international policy co-ordination, avoiding destructive economic wars between nations.
  • Even a new, Bretton Woods-like international financial structure may be agreed.

Why a strong recovery is unlikely

Such an outcome is unlikely.

  • The fact that current policies have not led to a recovery after six years suggests that they are ineffective.
  • A general lack of demand combined with demographics, slower improvements in productivity, reduced rates of innovation, resource constraints, environmental factors and rising inequality is likely to constrain growth.
  • Overcapacity, technological improvements, competitive devaluations and a lack of pricing power is likely to keep inflation low, despite loose monetary conditions.

2/ Managed depression

The second scenario is a managed depression, a Japan-like prolonged stagnation.

  • Economic growth remains weak and volatile.
  • Inflation remains low.
  • Debt levels continue to remain high or rise.
  • The problems become chronic requiring constant intervention in the form of fiscal stimulus and accommodative monetary policy, low rates and periodic QE programs to avoid deterioration.
  • Financial repression becomes a constant with nations transferring wealth from savers to borrowers to manage the economy.
  • Competition for growth and markets drives beggar-thy-neighbour policies, resulting in slowdowns in trade and capital movements.
  • While there are variations between nations, overall the global economy becomes zombie-like, with entire nations, businesses and households trapped in a low growth, over-indebted state essentially on permanent life support.
  • Resource allocation breaks down with more and more wealth trapped in low returning or unproductive activity.
  • Authorities may be able to use policy instruments to maintain an uneasy equilibrium for a period of time. But it may prove unsustainable over time.
  • The ability to finance governments and stresses on central banks from excessive debt monetisation will ultimately constrain such strategies.
  • In addition, asset price inflation and the growing debt burden encouraged by low rates will create dangerous financial instability. The response of electorates to the slow reduction of living standards by stealth places political limits on this approach.
  • Ultimately, a major correction will become unavoidable, as confidence in policymaker’s ability to control the situation diminishes.

3/ The mother of all crashes

The final scenario is the mother of all crashes.

  • Financial system failures occur as a significant number of sovereigns, corporate and households are unable to service their debt.
  • Defaults trigger problems in the banking system which leads to a major liquidity contraction, which in turn feeds back into real economic activity.
  • Falls in employment, consumption and investment drive a severe contraction.
  • Concerns about safety and security of savings create capital flight from vulnerable nations, banks and investment vehicles.
  • The problems are global with developed and emerging markets affected.
  • Any new crisis is likely to be a further phase of the 2008 crisis, reflecting the fact that the causes remain largely unresolved.

But a future downturn will be exacerbated by several factors.

  • First, the problems now are larger and more global. Emerging markets face difficulties and will not be a source of succour as in 2009.
  • Second, there is now limited capacity of policy makers to respond.
  • The stabilisation since 2008 has been the result of fiscal deficits in combination with lower interest rates and QE. Today, strained government finances mean that running budget deficits on the scale that was done after 2008 will be more difficult.
  • In the US, rates were lowered from 5.25 per cent to zero, injecting around 20 per cent of income into the economy. This boosted economic activity and crucially avoided widespread defaults and collapse of the banking system, ensuring a short recession. The fact that rates are much lower, in some cases negative, means that further monetary measures will be far less effective.
  • Third, faith in policy makers is waning as a result of their ineffectiveness in engineering a recovery on the scale promised.
  • The failure of existing policies is pushing central banks into more extreme and desperate action, such as negative interest rates (effectively paying people to borrow) and large currency devaluations. The unintended financial consequences of monetary experiments on an unprecedented scale are unpredictable.
  • The risk of policy errors or poor execution, such as premature increases in rates, or withdrawal of liquidity support, is increasing.
  • Most investors remain oblivious, assuming that the risk is in the price or that they are prepared and will be able to adjust their portfolio in time.

They would do well to heed Cassius’s warning in Julius Caesar: “The storm is up, and all is on the hazard.”

END

READER’S COMMENT to Das’ Independent article

Reader’s user name: SayNoToRacism

Labour’s new economics – not so new May 22, 2016

Over 1000 people packed into a London college to take part in a day of analysis of the state of the British economy.  And hundreds had been turned away.  This was a conference called by the new left-wing leadership of the opposition Labour party in Britain.  The hardworking and dedicated activists within the Labour party that had backed Jeremy Corbyn, the new leftist leader, had turned out in droves to discuss with due intent what is wrong with capitalism in Britain and what to do about it. It was an unprecedented event: the leadership of the Labour party calling a meeting to discuss economics and economic policy and allowing party members to discuss.

Labour’s finance leader, John McDonnell opened the conference by saying the aim of the various sessions was to see how Labour could “transform capitalism” into delivering a “fairer, democratic sustainable prosperity shared by all”.  We needed to “rewrite the rules” of capitalism to make it work for all.  He argued the British capital was failing to invest for growth and jobs.  We needed to break with the ‘free market’ ideology of the neo-liberal agenda and “reshape the narrative” with “new economics”.

What was this new economics?  Well, I’m afraid it was not new but really a rehash of old Keynesian arguments and policy proposals.  As McDonnell said, the aim was to “transform capitalism” with new rules and state intervention, not to replace it.

The key note speaker at the conference was left Keynesian Cambridge University economist Ha-Joon Chang.  He delivered an entertaining and amusing presentation, the gist of which he had already written in an article for the British liberal Guardian newspaper that week.  Chang presented a compelling argument that the strategy adopted by previous right-wing and Labour governments of weakening manufacturing and industry in favour of finance, property and other unproductive services (in other words, turning Britain into a rentier economy) was a big mistake.

British capitalism was failing to compete in world markets with a record high deficit on trade with the rest of the world – see graph below (all graphs in this post have been researched by me and are not those of any speaker).

And its people had seen no rise in real incomes for eight years since the global financial collapse.  British economic strategists reckon that the UK economy did not need a thriving industrial base and could rely on its financial services – just like Switzerland.  The irony was that Switzerland is actually the most industrialised economy in the world, as measured by manufacturing output per person (see below).

In contrast, British manufacturing has been in fast decline as a share of total output among major capitalist economies.

Chang reckoned Labour should aim to boost industry, R&D and investment, because those sectors can raise productivity for all sectors and incomes.  But he did not expand on how that was to be done in an economic world where banks and hedge funds rule, loans are made for property, while businesses hold back from investment.

In the finance workshop, the poverty of analysis and policy was very evident.  The main speakers were Frances Coppola, who has worked as an economist in many banks and now runs a blog on economics; and Anastasia Nesvetailova, who is a professor at the City of London university on finance and has spoken before at the series of ‘new economics’ meetings run by the Labour party.  Both speakers basically told hundreds before them that the regulation of the banks  would not avoid a future financial crash – indeed by making regulation ‘too tight’, it was strangling the ability of the banks to lend.  A financial transaction tax would not work either in controlling risk-taking by banks, particularly in new finance areas outside regulation.  Breaking up the big banks or separating their speculative operations from basic banking would not work either. Indeed, nothing would work to avoid yet another crash in the future: “we just had to prepare for one”!

So our finance experts had not a clue what to do. Staring them in the face was the obvious answer.  If the big banks are still engaged in risk activities, in greedy laundering and in paying grotesque salaries to their top executives, despite regulation, why not take them into public ownership under democratic control so that banking becomes a public service for the people to help investment and growth? This policy move was never even considered by these banking experts and yet Britain’s own firefighters union have produced an analysis showing why it was the best way forward, which was formally approved by the trade union federation.  I was told that state-owned banks would not work because they are corrupted by politicians – sure, as opposed to privately-owned banks that are as pure as snow.

At least in the session on fiscal and monetary policy, Michael Burke provided a coherent account of how the weak economic recovery in the major economies including the UK was not due to a lack of consumer demand as the Keynesian ‘experts’ keep arguing, but to one major factor: the failure of business to invest. The graph for the UK shows how it was investment that collapsed in the Great Recession not consumption. It was the same story in all the major economies.

The large companies were hoarding cash, small business were just hanging on and governments were cutting back on public sector investment.  Indeed, British capital has the lowest level of investment to GDP of the major capitalist economies.

Weak and even falling investment had lowered growth rates and so held down incomes.  The answer was a new plan for growth based on public investment.

The conclusion of the day’s conference screamed out to me.  The capitalist sector had caused the crash, not the public sector.  But the public sector had to pay with increased debt and a reduction in the role of the state as support for growth and as a safety net for those who lost their jobs, homes and incomes.

So instead of trying to “transform capitalism”, Labour needs to develop a programme to replace capitalism by bringing into public ownership the major banks and business sectors under democratic control to be integrated into a plan for investment in people’s needs not profit.  Instead, Labour’s advisers and experts offered just some old ideas that had been tried and failed before to direct or regulate capitalism to make it work better.  No new economics there.

END OF COMMENT

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