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Reaching that Wile E. Coyote moment

In just about all of the Roadrunner cartoons, the Wile E. Coyote character ends up running off the edge of a cliff and plummeting to earth.  Unlike real life, however, Wile E. Coyote is able to keep going until he looks down.  It is for this reason that observers down the ages have compared the workings of the economy to this cartoon character.  Just like Wile E. Coyote, the economy appears to be able to keep going long after it has run off the cliff.  Only when the high priests of finance in Wall Street, the City of London and the central banks look down and apparently “lose confidence” and panic, does the stock market – which is considered a proxy for the economy – come tumbling down… sometimes in spectacular fashion.

Remarkably, it is only recently, with the work of contrarian economist Steve Keen that the reason why this happens has been brought to light.  And even now, most mainstream economists treat the phenomenon as something akin to witchcraft; believing that recessions are the self-fulfilling result of too many people believing in a recession.  The reason why mainstream economists should rely upon superstition to explain the most important thing we pay them to forecast, will be considered incredible by most non-economists.  This is because non-economists have been misled into believing that economics is primarily about how money works.  As Keen explained:

“It may astonish non-economists to learn that conventionally trained economists ignore the role of credit and private debt in the economy – and frankly, it is astonishing.  But it is the truth.  Even today, only a handful of the most rebellious of mainstream ‘neoclassical’ economists – people like Joe Stiglitz and Paul Krugman – pay any attention to the role of private debt in the economy, and even they do so from the perspective of an economic theory in which money and debt play no intrinsic role.  An economic theory that ignores the role of money and debt in a market economy cannot possibly make sense of the complex, monetary, credit-based economy in which we live.  Yet that is the theory that has dominated economics for the last half-century.”

Keen’s modelling of the economy is based on the way new currency is actually created; as opposed to the ‘magic money tree’ fantasies taught in economics courses and regurgitated by politicians.  Although governments continue to create money – mostly in the form of notes and coins – the majority of the currency we use in the modern economy comes into being when banks make loans.  To some extent, then, rather than the economists/politicians’ fantasy model of the economy – which begins with governments raising taxes (where did the first taxpayers get the money to pay their taxes with?) in order to spend the money that customers and banks borrow and lend – it is more sensible to think of a series of “money circuits.”  There is, of course, a government spending/tax circuit; but it is a tiny fraction of the nominal value of the bank loan/repayment circuit.  Less well known, there is also a central bank/private bank circuit which uses a special kind of currency called “central bank reserves” which banks use to settle accounts with one another.

Changes in the government spending/tax circuit can have an impact on the economy.  However, this circuit accounts for a tiny fraction of the currency in circulation – some put it as low as three percent.  The private banks’ loan/repayment circuit accounts for the vast majority of the currency in the economy; and as a consequence has a far greater impact.  As Keen’s modelling demonstrates, it only takes a slowdown in the rate of bank lending to bring the economy crashing down.

This, though, is only half of the story.  There are two broad reasons why the rate of borrowing might slow.  Most obviously, if the central bank raises interest rates, loans become harder to repay; and businesses and households will be more reluctant to borrow new currency into existence.  Government policies might amplify this, since spending cuts and/or higher taxes will also cause businesses and households to be cautious about new borrowing. 

The second broad reason for the rate of lending to fall is that the value/energy cost of goods and services in the real (non-financial) economy begins to increase.  This is largely hidden within the averages that are used to calculate both incomes and prices.  The average UK wage, for example, is around £28,000 per year; which is still lower in value than it was in 2008.  This figure, though, is distorted because the UK is a highly unequal country in which a small number of godzillionaires at the top cancel out the millions of low paid people at the bottom.  The median UK wage – the point at which there are as many people above as below on the income ladder is just £17,000; significantly lower than the average.  Something similar happens with inflation.  Government statisticians use a “basket of goods” based on average purchasing patterns to calculate inflation.  This, however, disguises the fact that non-discretionary items (such as rent, fuel, utilities and food) have been increasing while discretionary items (like flights, smartphones and digital services) have been falling.  The problem with this is that the majority of us spend most of our incomes on the non-discretionary items whose price has been rising remorselessly; while the items whose prices are falling are almost exclusively consumed by those in the top 20 percent or so of the income scale.

These price differences are connected and relate directly to income inequality.  The reason the economies of the western states barely recovered from the 2008 crash is that the value/energy cost (as opposed to price) of energy and resources has increased.  That is, with each passing year it costs us more energy and resources to produce the energy and resources required to grow the economy.  But since the real value of the majority of workers’ wages has fallen over the same period, purchasing power has fallen.  As a consequence, the proportion of wages that must be spent on non-discretionary items has increased while spending on discretionary items has slumped.

The economic consequence for the retailers and manufacturers of non-discretionary goods and services has been a loss of the marginal sales needed to remain profitable.  In previous recessions, the route out of this situation was through increased productivity.  As Phil Mullan at Spiked explains:

“Remember growth in productivity is crucial because for the past 250 years it is what has enabled living standards to rise. Productivity is more than a boring statistic. In indicating the amount produced by each person, it underpins how much people are paid…

“Economists tell us, and history shows us, that increasing productivity is primarily a function of business investment in innovation and in new technologies. Whether you’re making things or delivering services, using better equipment is what makes us more productive. So the goal of industrial policy is not controversial: it is to enable businesses to invest more in innovation.”

Mullan goes on to expound the Austrian School view that what we actually need is the wholesale destruction of the majority of “zombie” businesses that are only just getting by with almost no productivity gains in order to clear the way for a new generation of super-productive innovators supported by government research and development and infrastructure spending – a kind of Green New Deal without the green stuff.

Economists, though, are simply wrong.  It is not technology which increases productivity, but rather what technology leverages.  All “productivity” means is the relative difference between what goes in and what comes out of a production process.  As such, improved productivity simply means either or both getting more out for the same input or getting the same out for less input.  The classic example of this is Adam Smith’s pin manufacture which contrasts the old arrangement in which individual craftsmen made individual pins with the industrial arrangement in which each of the workers on a production line carried out a discrete sub-task in the manufacture of many more pins.  Famously, in the years before the 1929 crash, Henry Ford’s use of production lines brought the price of cars – particularly the Model T – down to the point that ordinary workers could afford them; ushering in the age of mass consumption.  Scientific Management became the order of the day, as corporations sought to streamline their manufacturing processes in order to maximise their returns; a process that spread to the wider world after World War Two.

What the economists overlooked was the driving force behind this change.  The technology was obvious enough; but it was really the energy – largely generated from burning coal and later oil – which powered the machinery that created the productivity gains.  And therein is the answer to what today’s economists refer to as the “productivity puzzle.”  For the best part of the 250 years noted by Mullan, we have had access to abundant and cheap fossil fuels.  Between 1800 and 1950, this allowed the industrialisation of the western economies.  The switch from coal to oil – particularly in Western Europe and Japan – ushered in a two-decade boom – 1953 to 1973 – which doubled the production and trade of the 150 years that preceded it; and paved the way for the global economy which is beginning to disintegrate today.

The year 1973 marks the point when things began to go wrong; although superficial analyses try to blame Brexit.  As Mullan notes:

“The biggest productivity fall of the past five years was unsurprisingly attributed to the default explanation for everything these days: Brexit uncertainties. This buried the much more significant point the ONS reiterated: the current slowdown in productivity growth was noticeable at least 15 years ago.

“The productivity problem therefore not only long precedes the Brexit discussions. It also long precedes the 2008 financial crisis. Longer-term studies actually reveal that the decline in productivity growth, not just in Britain but across mature industrialised countries, has been pretty relentless since the 1970s.”

It is not just that the artificial OPEC oil shock was engineered in 1973.  The more important problem was that energy use per capita across the western economies began to fall at the same time; as the energy cost of producing energy began to increase.  Energy-saving technologies have been deployed since then in an attempt to lower the input costs of various processes.  For example, the aircraft industry has dispensed with fast – and fuel guzzling – engines in favour of much slower but more fuel-efficient engines.  Unfortunately, energy-saving has the same diminishing returns as everything else which afflicts the modern economy.  All of the cheap and easy gains were made in the 1970s and 1980s.  Today’s energy-saving technologies save but a tiny amount of fuel and come at a huge cost.

Whatever one might think about Mullan’s analysis and prescriptions, one cannot disagree with his description of the loss of productivity that is undermining the western economies.  This, however, raises another uncomfortable question: if productivity gains are no longer possible, what will businesses do instead?  The answer to this is to be found in the development of what the media refer to as the “gig economy.”  As Patrick Collinson at the Guardian points out:

“Academic economists have, in recent years, been puzzling over Britain’s dreadful labour productivity record. They obviously don’t get out much. Where once petrol stations invested in car wash machinery, now it’s a gang of labourers with mops in hand. Where people once walked into a KFC or McDonald’s and ordered, now a low-paid worker delivers it instead.

“These are jobs that can only ever generate minimal added value, and will always be low wage.

“Neither will they ever be net contributors to the tax base of the country. Yet, sadly, they are behind much of our so-called ‘jobs miracle’ and what passes for economic expansion in Britain.”

While there is a relatively small group of high-paid professionals such as accountants, lawyers and architects, who make a good living out of the gig economy; for the most part it is made up of the victims of corporate efforts to circumvent minimum wage and employment protection legislation.  This process is aided and abetted by punitive state social security systems which oblige people to work for less than the legal minimum.  The consequence for the broader economy is that “demand” – in the economic sense of people wanting and able to pay for goods and services – is crashing across the global economy as the mass of workers can no longer afford to consume in the quantities needed by corporations.  Across the global economy this manifests in bankruptcies, layoffs , plummeting demand for commodities like steel, copper and aluminium, a crash in sales of plant and machinery, and a collapse in the rail and road transport which moves it all around.

With economies across the globe edging ever closer to a technical recession – and with the key manufacturing sector in freefall; this looks a lot like the moment when the economy – like Wile E. Coyote – has stepped off the edge of the cliff.  All that remains to be seen is how long it takes for the slowdown to transfer from the real economy to the casino financial economy.  This is not, though, going to be the result of bankers and speculators making the Wile E. Coyote mistake of looking down and losing confidence.  Rather, it will be a consequence of the process modelled by Keen. 

As the real economy slows and wages continue to stagnate, there is decreasing demand for business loans.  Cuts in interest rates can help to some degree; as can tax cuts and increased government spending.  But starting from an already low base, these can do little more than ward off recession for a while longer.  Moreover, if real world demand continues to slump, even a negative interest rate is unlikely to prompt companies to borrow to invest.  Sooner or later, the rate of bank lending will slow sufficiently to push us into recession.  The danger, though, is to mistake inevitability for imminence.  With hindsight, all previous recessions can be seen to have been preceded by several years of warning signs.  There is no reason to believe the next one will be any different.  Just like in the cartoons, this economy can keep going long after any impartial observer can see that it is suspended in mid-air.  Come crashing down it most certainly will; but don’t underestimate the ability of central banks and governments to keep it suspended in thin air for a couple more years – particularly with a US presidential election just 12 months away.

As you made it to the end…

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