Wednesday 22 April 2009

The Truth About The Economy and Economy About The Truth

Today, we should find out the truth about the state of the British economy. However, as we have learned before both Government and State officials can be economical with the truth itself. Indeed, some of that was witnessed yesterday. Earlier in the day, the IMF came out with a statement that the cost for the British Bank Bail-outs would total some £200 billion or around 13% of GDP. But, on Newsnight, Paul Mason ‘exclusively’ revealed that the IMF had, in fact, retracted the statement along with the corresponding graphs on its website. See: Newsnight . During the day, the British Treasury had said that the IMF’s figures were wrong. Of course, in the words of Mandy Rice-Davies, “they would say that wouldn’t they?” Given the Budget today, they especially would say that, because it would be a very big stick with which the Tories could beat the Government over the head, on a day when its expected that the Government will both announce around £1 billion in stimulus for the housing market, and is also expected to engage in a bit of good old Labour, Fabian-style income re-distribution by increasing taxes on those earning over £100,000 a year, and giving a boost to benefits, and people on low incomes! According to Paul Mason, the IMF admitted they had made a mistake, and that what they should have said was that the figure would be in the range of 6 to 13% of GDP, which on the basis of the lower figure would give a total closer to the Government estimate of £100 billion.

In his presentation, Paul also dealt with the figures out, yesterday, on inflation, which showed that on the RPI index prices had actually fallen by 0.4%, whilst on the CPI index prices remained above the inflation target at 2.9%. See: Inflation . Much as I appreciate Paul’s insight into the economy, I have to disagree with his comments, though, in relation to the drop in the RPI number, which he described as deflation. I think that this is wrong, and a look at the graph at the above link shows why its wrong. The graph shows the RPI literally dropping off a cliff, from the end of 2008. The reason is almost entirely due to a statistical fluke, it is down to the fact that the RPI includes the costs of buying houses including mortgage repayments. As interest rates were slashed towards the end of last year to deal with the credit crunch, mortgage interest payments were slashed along with it, massively reducing that component of the index. However, a look at the CPI index, which gives an indication to what is happening to the underlying prices and costs of actually produced goods and services shows a different picture. On the one hand 2008 saw an above trend growth in the index, as the liquidity already pumped into the system went to monetise increasing costs resulting from the rapid rise in the oil price when it rose to $147 a barrel, and began to feed through into wages and other costs. It also reflects the increasing costs due to a falling pound raising import costs. However, although, the CPI index has also fallen sharply at the end of last year as the credit crunch struck, it appears to have then bottomed out in the early part of this year, with that sharp decline being arrested. If you draw an imaginary trend line on the graph, you will, in fact, see that even at its current level it remains on a slightly rising upward trajectory. Of course, future months may see it drop below that trend line, but we will have to see. Even so many economists remain confused that it has remained so high. I don’t think its really so unusual.

In Vol III of Capital, Marx gives a good account of a crisis caused by a deflation. His account could be a good description of what has happened with the Credit Crunch, other than, I think for one thing. Marx says,

“The Bank Act of 1844 divides the Bank of England into an issue department and a banking department. The former receives securities — principally government obligations — amounting to 14 million, and the entire metal hoard, of which not more than one-quarter is to consist of silver, and issues notes to the full amount of the total. In so far as these notes are not in the hands of the public, they are held in the banking department and, together with the small amount of coin required for daily use (about one million), constitute its ever ready reserve. The issue department gives the public gold for notes and notes for gold; the remaining transactions with the public are carried on by the banking department. Private banks in England and Wales authorised in 1844 to issue their own notes retained this privilege, but their note issue was fixed; if one of these banks ceases to issue its own notes, the Bank of England can increase its unbacked notes by two-thirds of the quota thus made available; in this way its issue was increased by 1892 from £14 to £16½ million (to be exact, £16,450,000).

Thus, for every five pounds in gold which leave the bank treasury, a five-pound note returns to the issue department and is destroyed; for every five sovereigns going into the treasury a new five-pound note comes into circulation. In this manner, Overstone's ideal paper circulation, which strictly follows the laws of metallic circulation, is carried out in practice, and by this means, according to the advocates of the Currency Theory, crises are made impossible for all time.
But in reality the separation of the Bank into two independent departments deprived its management of the possibility of freely utilising its entire available means at critical times, so that situations could arise in which the banking department might be on the verge of bankruptcy while the issue department still had intact several millions in gold and, in addition, its entire 14 million in securities. And this could take place so much more easily since there is a period in almost every crisis when heavy exports of gold take place, which must be covered in the main by the metal reserve of the bank. But for every five pounds in gold, which then go abroad, the domestic circulation is deprived of a five-pound note, so that the quantity of circulating medium is reduced precisely at a time when the largest quantity is most needed. The Bank Act of 1844 thus directly induces the entire commercial world forthwith to hoard a reserve fund of bank-notes at the outbreak of a crisis; in other words, to accelerate and intensify the crisis. By such artificial intensification of demand for money accommodation, that is, for means of payment at the decisive moment, and the simultaneous restriction of the supply the Bank Act drives the rate of interest to a hitherto unknown height during a crisis. Hence, instead of eliminating crises, the Act, on the contrary, intensifies them to a point where either the entire industrial world must go to pieces, or else the Bank Act. Both on October 25, 1847, and on November 12, 1857, the crisis reached such a point; the government then lifted the restriction for the Bank in issuing notes by suspending the Act of 1844, and this sufficed in both cases to overcome the crisis. In 1847, the assurance that bank-notes would again be issued for first-class securities sufficed to bring to light the £4 to £5 million of hoarded notes and put them back into circulation; in 1857, the issue of notes exceeding the legal amount reached almost one million, but this lasted only for a very short time.”


Marx – Capital Vol 3 Chapter 34 .

Its useful to read the whole of Marx’s description of these crises here to understand what is going on today. What Marx describes here, is essentially what happened with the Credit Crunch with the exception that nowadays it is private banks who, through the Credit Multiplier, are the main creators of currency and credit in the economy, and not the Bank of England. There is a difference between an inflation and a deflation. An inflation arising from an increase in the supply of money and credit takes around two years to materialise. The reason for that is that it takes time for that increase to feed its way into the system, and into the psyche and behaviour of people. But, a deflation such as that described by Marx can be fairly instantaneous, and the reason is that the sudden cessation of credit availability, the sudden hoarding of cash is more immediate, more apparent, and thereby not only simply cuts off sharp the availability of the medium of exchange bringing exchange itself to a halt, but also has a more immediate effect on people’s psyche, as businesses find that suddenly their cash flow is hit and so on.

Yet, as the CPI figures show, despite, the severity of the Credit Crunch, despite the worst financial crisis in history that has not really happened on the scale you would expect. Economic activity has certainly been severely hit, output HAS contracted sharply on a quarterly basis in the last two quarters, but the Economy has NOT gone into the kind of crisis Marx describes above, despite the severity and global nature of the financial crisis. In fact, economists have consistently been surprised by the fact that Retail Sales figures in the last few months have been remarkably resilient. Why? What is the truth about the economy?

Part of the truth is, of course, that unlike the situation Marx describes above where it took time for the Bank to scrap the 1844 Bank Act and issue currency, Central Banks this time, have from the beginning, been issuing lots of new money in one way or another. The problem, however, has been until recently that the Banks and other financial institutions that act as the transmission belt of that money into the economy, simply haven’t been lending at a sufficient rate. Governments, have also been engaging in some pretty spectacular traditional Keynesian demand management though huge fiscal stimulus packages. However, although Governments can have a pretty immediate effect in that regard as they are in every Capitalist economy the biggest single employer, and account for nearly 50% of all economic activity, its unlikely that much of that fiscal stimulus has yet found its way into economies, because it takes at least several months to draw up programmes and begin to spend money, only tax reductions are likely to have had any noticeable effects in the last few months.

So, how come that spending has not completely collapsed, and how come, therefore, there has been no real deflation, or huge economic meltdown – UK unemployment figures out this morning, for instance showed that the claimant count had risen by only 75,000 compared to predictions of around 100,000, and the rate has still only risen to the highest level since 1997, which hardly sticks in the memory as a year of economic crisis and mass unemployment!

The real reason I think is down to the nature of the modern working class, and the misunderstanding of it, by the many economists as well as by the Left.

I have argued in the past that there is a failure to recognise that there is a wide disparity within the working class – and, therefore, of the majority of consumers – based both on age, and geography. Given that most of the Left and most economists, in Britain, but this is probably true of most economies, tend to be concentrated in London, a distorted view arises of real conditions. The left, is particularly prone to this, because there has always been a tendency to focus on the worst possible view, and on the most disadvantaged in society, because of understandably wanting to paint to the various vicissitudes of Capitalism. But, even in Marx’s day that permanent reserve army of labour that constituted the really deprived section of society only constituted a small minority of the population. Its absolute numbers today, as Marx predicted, is undoubtedly larger, but it its proportion of the total population is likely to be no greater, and its proportion of the working class actually smaller than it was in Marx’s day, due to the absolute increase in the size of the working class itself. This permanent reserve, or what modern sociologists have termed an underclass is likely to constitute no more than around 6% of the population.

The other division is the geographical division. I have said before that the fact that house prices, and, therefore, housing costs in and around London are about four times what they are in most other parts of the country is a hugely distorting effect. It is no wonder that even people in relatively well-paid jobs in those areas find it difficult to find a sufficient deposit for a house, and that when they do, a large portion of their income is then taken up in mortgage repayments. The consequence then for the ability to save, or the propensity to run up further debt in the form of credit card or loan debt, at high interest rates is obvious. But, although a large number of people DO live in London, and its environs, that should NOT be taken as giving anything like an accurate picture of the rest of Britain and its economy in general. Those costs, and the effect on the aforementioned underclass are likely to be more noticeable in London than elsewhere, but it should also be taken into account that although this section of the population is likely to be most affected in absolute terms by any economic crisis – a recent report showed for instance that the main rise in joblessness has been for young people from relatively deprived backgrounds or areas – in relative terms the effect may not be so great, precisely because if you begin with no job, you can’t lose it, and to a certain degree increases in costs are covered by increases in benefits.

In the rest of the country, again, the effects of the crisis depend upon location. In areas like my own in North Staffordshire, where, although two of the main industries coal and steel, were destroyed by the Tories in the 1980’s, a large proportion of the people continued to rely on the third – Ceramics – the effect has been more marked, because the large job losses in that industry have had a similarly marked knock-on effect to all the industries that rely on it, and those that rely on the spending of its workers, in other parts of the country where industry and the local economy has been more diversified over the last 20-30 years the effects have not been so great, because that accelerator and multiplier effect into the local economy has not been so pronounced. Even, in this area, the changes over the last ten to twenty years have had an effect, because the single largest employer now is I think the NHS, with Local Government coming close behind, both employing tens of thousands of people, and neither of those have been shedding huge numbers of jobs or cutting wages. Indeed, given the Government’s anti-cyclical policies they have probably been increasing.

But, there is another division I have referred to previously and that is the division based on age. A report I saw a year or so ago, stated that in Britain by 2012, a third of the population would be dollar millionaires, or in other words would have had at the exchange rate then, a net worth of half a million pounds. To be clear what that means its not somebody who has a half million pounds house, but a mortgage for £390,000, its they actually own outright the half million pound house, or else own a £250,000 house with another £250,000 of savings etc. Now, a third of the population means we are not talking just about Capitalists here! In fact, as I’ve written elsewhere, given the concentration of wealth that has taken place in developed economies the real Capitalists, the people who own and control the majority of productive assets, probably only constitute one tenth of one percent of the population. A full one per cent of the population may own a significant proportion of the total productive wealth, but outside that you are really talking about middle class people with a reasonable amount of savings and investments, and to get to that figure of a third, you are including quite a number of working-class people too, who have managed to save, own their house etc.

Another report that came out last week showed that only 13% of people in Britain had NO savings at all, and that the average amount of savings for the rest was around £20,000. Obviously, averages can hide wide variations as I am suggesting here, but given the existence of various Tax free savings schemes over the last 20 years, its not stretching the imagination to see that older workers during that period could easily have put away their yearly allowance, and over that period accumulated around £60,000. Indeed, I know that most of the ordinary working people I worked with over that period were doing precisely that. And, as I’ve said before, people who bought houses in the 1960’s or 70’s, and then saw the Capital cost of those houses inflated away are now sitting on houses worth between 30 and 50 times what they paid, whilst most COULD, and many DID, simply paid off their mortgages as wages rose way above what they were when they first took it out, or else saw their mortgage payments fall to an insignificant proportion of their income, and either way the consequence was to enable the kind of saving set out above.

Finally, because a large number of people are and have been employed by the Government, there are a large number of older people who are drawing pension incomes of a not inconsiderable amount. In the 14 years I worked at my local Council I saw many people, especially during the 90’s when staffing levels were being reduced, encouraged to take early retirement on a voluntary redundancy basis, and who not only picked up around £20,000 redundancy pay, but if they’d got their full service in (or 33 years plus the added years) also walked away with an average pension of probably around £10,000 a year, and a lump sum of £30,000. Many then got a job working part-time at B&Q, or other such places. Lots of the people I meet down at the local Sports Centre are like that, or else people who retired at 65 with a works pension, people ranging from Miners, to postmen, to pottery workers to production workers at the local armaments factory. There are undoubtedly many, many pensioners who live in quite poverty stricken conditions, where they have not had permanent employment for most of their life, where they have had very poorly paid employment and no works pension, but there are many who are not.

Given that the people in this older age bracket now form a much larger proportion of the population now than in previous decades – and this is true in the US and other developed economies – this is not an inconsiderable factor. In fact, in the last year I’ve been buying things rather than cutting back, because, of the ability to pick things up cheaper. If it wasn’t for the fact that I had to change my car in 2007, I’d probably be taking advantage of current conditions to buy a new car now.

To put it bluntly, if you live in London, and are facing the huge costs of housing etc. then even a good wage probably isn’t enough to live on, facing losing employment must be a nightmare. But, if you already own your house, which many older people in other parts of the country do, and have been able to save money over the last few decades, and especially if you have a reasonable pension income the current crisis isn’t going to affect you too much, in fact, falling prices could benefit you. As a comparison I feel I have a fairly comfortable lifestyle, but I never spend more than around £12,000 a year, so anything above that means I can still save money.

This I think is the main exception to the crisis described by Marx, and explains why retail sales have not completely collapsed. Although, we have this picture of everyone in the country being massively in debt, and so on that is not an accurate picture, as the fact about only 13% of people having no savings indicates. What we have is undoubtedly a significant proportion of people probably in younger age groups who have significant amounts of debt. We also have what appears to be a large amount of credit card debt at any one time, because people pay for everything by card, but many people also at the end of that month pay off the total balance to avoid any charges. In fact, as I suggested a while ago another reason retail sales COULD have been resilient is that if people use any increased income – from tax reductions, reductions in monthly mortgage repayments etc – to clear any credit card or other loan debt they have, then the high debt charges – typically between 20-30% p.a. – on that debt disappears, so that the large amounts that currently went not to finance actual purchase of goods and services, but simply went to bolster bank profits, now becomes available for actual spending!

That is the final component in relation to the consumer. The huge mortgage commitments that people took on during the early part of this decade were a massive drain on potential spending power. The cuts in those mortgage payments have been an immediate and far greater stimulus than anything the Government has done so far. One bloke interviewed a couple of weeks ago, spoke of his monthly mortgage bill going down from over £900 a month to just £300 a month, giving him another £7.500 a year to spend. The average saving seems probably to have been around £200-£300 a month, which provided you remain in work – and the vast majority of people have and will – means a considerable boost to people’s spending power.

There is one final component in relation to the economy as a whole. Although the credit crunch and restriction on lending to businesses has undoubtedly badly affected some businesses, there are also other businesses who have lots of cash. I wasn’t at all surprised to see that TESCO’s profits went to over £1 billion a month in the last year. No matter what time of day, or day of the week I go to my local TESCO there is always about 100 cars on the car park at least. Some businesses over the last decade, like some consumers have built up large cash balances. Last weekend Oracle in the US bought up Sun Microsystems from under the nose of IBM, paying over $7 billion. In fact, many such deals are forecast as cash rich businesses pick up others going cheap. To the extent that they use cash for the purchase rather than the issue of shares such deals themselves act to put cash and spending power into the economy.

For all these reasons, the economy although it has taken an understandably large hit from the worst financial crisis in history has not collapsed. Provided no further financial calamity comes out of the cupboard, the signs that the credit crunch is easing and that credit is flowing again will act to ensure that the economic effects are short lived if severe during that period. The governor of the Bank of China has today said that he is optimistic that China will beat the 8% growth target for this year, and for the world’s third largest economy 8% growth will have a considerable knock-on effect for China’s major trading partners in Asia, which will itself have a knock-on effect for the rest of the global economy.

That underlying trend rate of growth in the CPI, is, I think, telling us something significant. It is saying the underlying factors remain in place to prevent this crisis from extending for too long. It is also saying that for those reasons, the huge increase in liquidity pumped into the global economy will have the other effect described by Marx in that Chapter above, it will mean in perhaps 18 months time a huge rise in inflation.

2 comments:

Anonymous said...

This is a good post. The left desperately needs to do some depth analysis of local and sectoral figures (the former inevitably means comrades in the localities looking at local authority information; the latter outlined e.g in the labour force statistics) in order to get a real concrete understanding of the economy and the impact of the 'credit crunch'. What we have produced instead is commentary based on theory, or analysis based on movements of aggregate GDP, profits, (etc) figures.

Mike Macnair

Boffy said...

Mike,

Thanks for your comments. Its good to hear from you. Necessarily my comments were in part subjective, but I don't think the views expressed based on my experiences of the ordinary workers I speak to every day are untypical for many parts of the country. There will, of course, be other parts of the country where large scale deprivation has persisted, but some of those places that used to be charactrerised that by that 2 or 3 decades ago, are no longer themselves the same places.

I think that your idea about getting comrades to look at local stats, as well as getting some national stats is a good idea. Its the kind of thing we need in order to really refresh theory and ensure its based in reality. There should be enough people on the left based in academia in one form or another to accomplish such a task.