Discussing the Scale of the Global Economic Crisis

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Economic theory tries to deal with a limited number of factors and the mechanisms by which they interact. The main factors are population, food, energy, property and manufactures, all of which are physical realities capable of being counted. They are the beans which bean counters count with. There are four mechanisms of exchange, money, barter, markets and allocation. These are the mechanisms by which the beans are exchanged.

Different economists have put emphasis on different factors. David Ricardo, the classical economist of the nineteenth century, was a banker who gave special attention to money; Thomas Malthus, another founder of nineteenth century theoretical economics, paid particular attention to population. Indeed he is the founder of population studies. Karl Marx, the founder of socialist theory, paid attention to manufactures, and to population, seen particularly as labour. The leading twentieth century economists, such as Maynard Keynes, Irving Fisher and Milton Friedman, have been derivatives of the Ricardian or monetarist school, though Keynes was a rebel against classical Ricardian orthodoxy.

Unfortunately, it is impossible to think of all these factors simultaneously. Perhaps there will be a time in the future when some super-computer will be able to calculate the interreaction of the global economy holistically. We are still far away from that day. At present, the limitation of the human intelligence means that we can only concentrate effectively on one of these factors at a time. The selection of any one of these factors or interreactions for study draws attention away from other, equally important factors. One can be both a Ricardian or a Malthusian, but one cannot concentrate on both aspects of economic analysis simultaneously without a loss of focus.

However, one can simplify economics by using the different physical factors as a checklist to detect signs of difficulty. That does make economics the gloomy science. At present, the world is suffering from a crisis of overpopulation, with the human population stretching the food supply beyond its limits. Population is continuing to grow, although there is already an inadequate food supply for six billion people and growing famine in Africa. It is possible that the twenty first century will replace the nineteenth as the century of famine.

Food is very closely linked to energy. Food production is dependent on the oil industry, in cultivation, in transport and in protection against pests. The food price has followed the oil price, to the point at which millions of people cannot afford a minimum food supply. That is already a catastrophe, and the trends are unfavourable. There is also a significant shortage of water.

Markets have flagged up food and energy as danger areas for the world economy, by raising their prices. Property and manufactures are secondary to food and energy, in that their prices can change without immediately affecting the price of food and energy. In fact, there has been a worldwide fall in housing prices, particularly notable in Britain and the United States, at a time of steep increases in the food and oil prices. The price of manufactures has been held down by the growth of low cost Asian manufactures.

There is much discussion of the scale of the global economic crisis. Some people expect it to cause a crisis comparable to the Great Slump a wiping out of capital values, a liquidation of global debt. We cannot yet be sure, but we can see that the main factors of global economic development are all in difficulty. On the one hand there is oil at $130 a barrel – on the other, there are banks writing off billions of dollars of assets.

I do not see any basis for economic analysis which would not throw up really alarming signals. These adjustments of the fundamental factors in any analysis put huge pressures on every Government. In the 1930s most Governments were destroyed by the slump. In Britain, Labour lost office in 1931; in Germany Hitler came to power in 1933, as did Franklin Roosevelt. I fear that process will be repeated, even if only by democratic defeats. The storm of the world is still rising.

Lord William Rees-Mogg
for The Daily Reckoning Australia

William Rees-Mogg
Leading political editor William Rees-Mogg is former editor-in-chief for The Times and a member of the House of Lords. He has been credited with accurately forecasting glasnost and the fall of the Berlin Wall – as well as the 1987 crash. His political commentary appears in The Times every Monday. His financial insights can only be found in the Fleet Street Letter, the UK's longest-running investment newsletter.
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  1. Why there will be a Great Slump and debt liquidation

    Three factors are underpinning the soon-coming Second Great Depression. They are: hegemonic and technological transitions and debt. The last factor is the concern of this post.

    The one thing I find frustrating with people like Alan Greenspan, Ben Bernanke, Milton Freedman, Paul Krugman, Robert Samuelson and others is there neglect of their heritage in understanding financial principles.

    If they understood the principles underpinning the Biblical “Year of release” and the “Jubilee Year” they would understand that debt cannot go on compounding forever and that there are severe consequences for debt-financed asset bubbles.

    We don’t need a gold standard as the underpinning of the financial system but a system where by short and long term debt is contracted and paid off over fixed terms.

    “At the end of every seven years you shall grant a release of debts And this is the form of the release: Every creditor who has lent anything to his neighbour shall release it…” (Deuteronomy 15:1-2, NKJV).

    “And you shall count…seven times seven years…forty-nine years. Then you shall cause the trumpet of the Jubilee to sound … throughout all your land. For the fiftieth year shall be holy, a time to proclaim liberty throughout the land to all enslaved debtors, and a time for cancelling of all public and private debts. It shall be a year when all the family estates sold to others shall be returned to the original owners or their heirs” (Leviticus 25:8-10, NKJV/Living Bible).

    “…if the land is sold or bought during the preceding forty-nine years, a fair price shall be arrived at by counting the number of years until the Jubilee. If the Jubilee is many years away, the price will be high; if few years, the price will be low; for what you are really doing is selling the number of crops the new owner will get from the land before it is returned to you” (Leviticus 25:14-16, Living Bible).

    (The present ad hoc system has it back to front with ‘unfair’ high prices at the end of the cycle and ‘unfair’ low prices at the beginning).

    The late Peter Martin, writing in the Financial Times in 2002, appreciated this ‘debt’ system:

    “At the heart of economic activity lies a magical relationship between the operating activities of a business and its capital structure.

    “This relationship – between the real activities of production, investment and service delivery, on the one hand, and the financial structure that supports and amplifies it – has been for so long an implicit part of human life that we take it for granted.

    “True, we recognise the amplifying power of the financial side of the partnership by rewarding its participants more lavishly than those who perform the operational roles. But in general, we see the two aspects of the company as straightforwardly complementary and otherwise give the relationship little thought.

    “Now and then, however, there are moments that reveal the importance of this relationship. We are living through one of them now.

    “In the past week, company after company has made announcements that seemed to have only the most tenuous connection with reality. Corporate restructuring announcements or bankruptcy proceedings demonstrate a yawning gulf between a company’s underlying business realities, the values inscribed in its balance sheet, and the formal commitments to shareholders, creditors and other stakeholder.

    “Obligations with little in common … prove to be economically unsustainable. Reality has to be redefined, obligations dropped.

    “This adjustment of the relationship of the capital structure to underlying operating activities is in some cases a wrenching process, with a complete reassignment of rights and potentially drastic changes in the day-to-day business company. In other cases it is less disruptive, acting through adjustment of future expectations about evolution of profits, cashflows and dividends rather than any one-off change to their absolute level.

    “Capital markets can take most of these smooth adjustments in their stride: their role is precisely to handle day to day calibrations of expectations so that we scarcely notice them. But superimposed on this smoothing process is the bigger disruptive adjustments that flares up in periods like the present.

    “We should think of these adjustment periods as the lineal descendant of the biblical concept of the Sabbath year – the seven-year cycle, described in Deuteronomy, which releases debtors, Hebrews slaves and the victims of foreclosure from their obligations. The original biblical text stresses the operating appropriateness of a seven-year cycle as a means of ensuring continued fertility for the land. But the scripture also makes clear that contractual relationships need to be reset. These presumably include the primitive financial relationships that provided leverage for the operating cycle.

    “A super-cycle of seven times seven years was also described in Leviticus. How this larger jubilee differed from the seven-year cycle is unclear. But there was more sophistication at work than simply cancellation of debts or other contracts. In particular, there seems to be evidence of a resetting of contracts around some normalised terms, based on fair returns for time expired.

    “The implication is that the passage of time and the distortions of the capital market cycle was likely to have caused all obligations to drift upwards towards unrealistic onerous levels. Resetting them to a lower, standardised level was therefore appropriate. A protective clause also requires equitable treatment in the immediate per-jubilee phase, so that the benefits of contractual release are not pre-empted by harsh treatment.

    “… whether they were practical guidelines or merely a theological aspiration they offer a glimpse of an underlying truth. This casts light not merely on the relationship between operations and financial structure that governs stable economic activity, but on a third, invisible element: dream, vision, animal spirits.

    “It is the presence of the expansionary dream that allows financial innovation to build on current or promised operating returns. Returns are no longer restricted by productivity growth, but are as limitless as financial imagination can devise.

    “Entrepreneurs and investors vie with one another to bid up this opportunity. Obligations are heedlessly assumed, since there will be enough potential profitability – say, enough potential subscribers for mid-week football matches in the outer fringes of the Football League – to swamp any risk.

    “It did not take the biblical seven years, let alone seven times seven, for the particular set of obligations to prove unsustainable. A similar brevity applies to many other of the contractual relationships now being restructured. In many cases, the ink is not yet dry on the documents with which today’s bankrupt companies assumed their now impossible obligations.

    “Managers, investors, financial intermediaries, policymakers we can all learn from this experience. The task is a triple one. First, in daily operations ensure that estimates of true underlying returns are realistic, something that demands common sense rather than elaborate technique…

    “Second, dreams must balance humility and ambition…

    “Third, ensure that financial structures support this present reality and future vision, rather than distorting it…” (Peter Martin, Remember the Sabbath day, ft.com, April 8, 2002).

    William Rees-Moggs wrote that “In Britain, Labour lost office in 1931; in Germany Hitler came to power in 1933, as did Franklin Roosevelt. I fear that process will be repeated, even if only by democratic defeats. The storm of the world is still rising.”

    As mentioned in other posts Future Watch compares the Crash of 1873, the ‘Great’ Depression of the Nineteenth Century and WW1 and the Crash of 1929, the Great Depression of the Twentieth Century and WW3 as the lens to view the future Stockmarket crash, the ‘Greater’ Depression of the Twenty-first Century and WW3.

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