Wednesday, January 28, 2009

Confessions of a Financial Merchantilist

The Gord's most recent speech has talked about the dangers of financial merchantilism. For those who don't know what this means, it basically means that governments are encouraging their banks to lend to domestic customers over and above foreign customers. I've got to say that I completely disagree with him on this point, I find the idea of financial merchantilism very appealing. I prefer, for example, that Icelandic banks should take deposits from Icelandic savers and lend to Icelandic customers over and above the idea that Icelandic banks should take deposits from British savers in order to purchase American financial instruments.

I would go further and argue that the increase in international lending in recent years has damaged the functioning of the market by removing some of the normal self correcting signals.
As an example, imagine a country with a level of savings decides to go on a borrowing based spending binge, the effect of this will be to lower savings as money normally put aside for savings is instead put towards debt repayment. Since bank lending depends on savings a decline in savings will act as a signal to banks to reduce their lending.

If instead, the country's banks are able to obtain money from another source (say another country), they can continue to lend regardless of savings levels and any market signal on debt will kick in far later and the consequences will be far more severe (as we are witnessing at the moment).

Debt is not limited by any availability of natural resources, it doesn't come in different colours and one country can not make better debt than another. In fact, as I've pointed out in the past, locational mismatch often means that foreign debt is almost always worse than domestic debt. There are very few reasons (in my opinion at least) to really justify the current scale of international lending1, so a move towards a financial merchantilism is fine by me.

1. I'll add the caveat that at the moment since a number of countries (UK very much included) are dependent on international lending that going cold turkey would be a bad idea, but long term I think it's preferable.

Sunday, January 25, 2009

A Glass of Wine in the Face..

Luke Akehurst has written one of his let's have a go at Compass pieces for Progress, he's taken a look at Compass' excellent How To Live in the 21st Century website picked a few ideas and suggested that they are completely ridiculous. Thing is, one of them was mine.

I wrote a piece and an accompanying blog post, advocating restrictions on currency convertability and I stand by it. I believe that unrestricted international capital flows have been a major factor in the current financial crisis. I believe that a look at currency convertability is something that should be seriously considered. The IMF has for too long been run in the interests of the financial community of rich nations and at a time when reform of the international financial institutions is seriously being considered, the fund's attitude to exchange controls is in serious need of consideration.

The basis of the policy I propose is taken from two papers by Ilene Grabel who is Professor of International Economics and Director, MA in Global Finance, Trade and Economic Integration at the University of Denver these are "Averting Crisis: Asessing measures to manage financial integration in emerging economies." and "Trip Wires and speed bumps: Managing financial risks and reducing the potential for financial crises in developing economies". And while I take a bit of license in applying policies intending for the developing world to developed economies I believe that the currenct crisis proves that concerns over capital flows apply equally to developed economies.

I believe that my policy proposal has a fairly sound basis, and I really don't like the suggestion that this proposal is not "Politics for Adults". So Luke, I'm calling you out, I demand you either apologise to me and make a note on your post accordingly or you provide suitable intellectual justification for why you believe that this policy idea deserves such a comprehensive rubbishing.

Friday, January 23, 2009

In Defence of the Database State

Henry Porter has asked "Can you argue the case for the database state?", I thought I'd give it a go.

Let us start by establishing what we mean by “The Database State”. Technically, a database is simply a collection of records grouped together for a specific purpose, it needn’t contain personal details, it could contain, for example details of where certain items of stock are located within a warehouse. The databases for concern are the ones containing personal information, these are used in any organisation where there is a need to know the identity of the customer (for example banking, where an account needs to belong to someone).

In this rather broad context, it’s impossible not to have a database state. Elections, benefits, pensions and taxes all depend on the various databases used to administer them. It is not possible to have a database-free state, we can only decide on its limits.

To determine extent of the database state we need to look at it in a number of ways, as well as the information the state holds on a citizen there are also considerations on how many people have access to that information and how easily accessible that information is. Government plans for data sharing mean that although no new information is held on a citizen, that information is available to a greater number of people.

The danger of the database state is that information held could be put to dangerous use, there is a need to consider both minor abuses by individuals with access to this information and larger scale abuses by a government (including future governments1), when the database state is strengthened in whatever way, it is my belief that there is a need to balance the practical benefits against the potential dangers of abuse.

For example, I support ID cards because I do not believe that the information contained in the national identity register could be used by an individual or a future government to harm someone2. On the other hand, I oppose the new communications database because I believe there is a clear case for this one being abused.

So, to conclude, I accept the database state with the caveat that it’s expansion is scrutinised and permitted only where there is a clear benefit and minimal danger.

1. There is a limited extent to which I’ll accept the “future governments” argument because I feel that if a government wants to go full on authoritarian then we have seriously let our democracy go to the wall. I'll accept though that a govenment may indulge in more subtle meddling for political advantage.
2. I’m not sure of how much information will be contained in the ID card’s audit trail, I’m assuming that it will be kept to a minimum.

Tuesday, January 20, 2009

Before the Day is Up

I feel I should provide a hearty "Hail to the Chief" and applaud the new President of the United States of America, Barack Hussein Obama. Let us hope he can bring in a new and better era for all of us.

Alternative Currencies Deserve a Fair Hearing

George Monbiot has earned Derek Draper's zero of the day over on Labourlist and I have to say that what he is proposing really doesn't deserve to be rubbished in the way it has. George's ideas relate to alternative currencies, in particular local scrips with demurrage (negative interest).

Alternative currencies are not uncommon things and pop up in the strangest of places, often they will even develop a real world value. Consider for example World of Warcraft gold which has ended up with it's own mini black market.

Demurrage is not such a crazy idea either, it's simply the application of a conditional effect to a currency in order to elicit a particular behavoir. THe effect it has in this case is similar to inflation, encouraging spending and investment over saving. While economists will agree that hyperinflation is undesirable studies of inflation in various countries have shown that moderate levels of inflation (up to around 40%) have had little adverse effect on economic growth. Korea, for example experienced some of it's highest growth in the same years it had high inflation.

To sum up, there is nothing especially mad or crazy about George's idea, the problem with alternative currencies though is that most people read aboout the Worgl experiment and expect that they can apply a similar model. This ignores a lot of thought on the shape of the modern economy. It is I think safe to assume that Worgl at the time of the experiment was was a fairly isolated town in the Alps, so much of it's economy was likely to based around activity in the local area. This meant that persuading producers and consumers to accept the scrip was relatively easy since the vast majority of goods were produced locally by other people who had been persuaded to accept the scrip.

In the modern economy far less of what we consume is produced locally, this makes the task of persuading businesses in a particular area to adopt an alternative currency incredibly difficult, in a lot of cases the only real local component of the price is the local labour at the retailer. This means that in a lot of cases getting such a scheme to work would be incredibly difficult.

It should though, not be ruled out altogether, there is still potential for the application of alternative currencies at the national level. An alternative currency scheme could be applied in a complementary way in an area with a good level of interdependence between local businesses.

A "Bad" Website

It appears that shortly after opening it's doors Labour List was in trouble due to the purchase of a number of Structured Comment Vehicles (SCV's) and Traffic Swaps it had purchased from Tory blogosphere. It turns out that these complex blogging devices contained not the top rate intelligent comment but a toxic stew of pointless abusive comment.

The solution, has been the creation of a "Bad" website, this one contains an unrestricted comment policy allowing it to handle large volumes of toxic comment while freeing up Labourlist for actual sensible debate.

Wednesday, January 14, 2009

Let's talk about Government Debt

The Tories have been talking about "Gordon Brown's Debt", but as far as I can see, the fiscal deficit is not the problem. Consider two great debts: one is the public debt, the debt held by our government; the other is the private debt, the debt held by businesses and private citizens. Lets say that the public debt is £500 billion and the private debt is £1,500 billion.

Let's now say that the government chooses to make a cash injection into the economy through borrowing of £100 billion. This will likely move through the economy generating activity as it goes, but it will eventually end up in the hands of people who will choose to save it. Assuming that the most effective way to save is to pay of debts we will be left with a situation where the public debt is now £600 billion and the private debt is now £1,400 billion.

The point I'd like to make from this is that when talking about "Gordon Brown's Debt" it's worth considering where the money actually ends up. In the example above we have a closed economy where the burden of public debt will be offset by an increase in private wealth. Of course, we live in an open economy where money can move in and out so the real problem lies in the money leaving the economy, which it does through our purchase of imported goods.

The root cause of all this is ultimately not our prolifigate government, it's the simple fact that for the past 25 years the country has imported more than it's exported. In some ways this is understandable, other governments, particularly Germany, Japan, South Korea, Taiwan and China have actively pursued export promoting policies while we didn't. A lot of it though, can be traced back to Thatcher's Conservative government and the decline of British manufacturing under that government.

I have a real problem with the perception that is common among Conservatives and has found it's way into the public conciousness that Thatcher somehow "sorted out" the economy. Despite the boost from the economy that came from producing vast quantities of oil and gas from the North Sea, we _still_ imported more than we exported. Thats a very different story to the tales of wealth creation they like to tell us about. I should probably also add that Labour have failed on this score..

Moving on, what I think we've had in the economy for the past 25 years is a slow build up of debt, private and public due to the continuing trade deficit. The ultimate solution lies not in fiscal stimuli or a balanced budget but in strengthening our exports. "Gordon Brown's debt" is neither here nor there.

Tuesday, January 13, 2009

Considering Japan

Currently on my reading list is a book called Japan's Great Stagnation, I've been reading it in a piecemeal fashion so I'm still only a little way into it, but it throws up a good number of insights. I think a lot of people looking at Japan as a case against fiscal stimulus ought to reconsider their view somewhat.

First, it's worth considering the Keiretsu banking system, this system means that industrial corporations are part of a business grouping headed by a large bank, for example Mitsubishi bank is a major shareholder in Mitsubishi motors and Mitsubishi electronics (not all groupings share names in this way).

This advantage relationship means that the banks close relationship to their businesses means that finance is more readily available, the downsides are that it can lead to banks continuing to provide finance when a better move would have been to pull the plug. The other problem is that the banks shareholdings mean that they are heavily exposed to stock market falls.

And on that subject, it's worth considering the Nikkei 225's high point of 38915.87 points on December 29, 1989, it's also worth considering the Nikkei's most recent peak around 18,000 in 2006 and it's current level of 8,400. Add to this the fact that at the height of the stock boom we had a property boom of such magnitude that 100 year mortgages were a reality. Japanese property prices have fallen pretty consistently for the last 19 years.

What I'd like to illustrate here is the sheer size of the stock and property booms and size of the subsequent collapse. In relative terms the boom was far larger than the recent US and UK asset price booms.

Next it's worth looking at the demographics, it's worth noting that Japanese population growth has been slow due to a low birth rate and low levels of inward migration. The last 20 years have seen a growth in the retired population and a shrinking of the working age population (I think it's around 10% but don't have any figures to hand). These factors are worth considering when looking at GDP statistics especially given the boost inward migration gives to an economy.

Bringing it all together we've had a country that had to have it's banks bailed out in a major way as a result of being highly exposed to major falls in asset prices that have still not recovered. Compounding this it's also had a shrinking working population and a growing retired population to support. Considering how much the odds were stacked against Japan it's modest growth record (which looks a lot better if you consider it in terms of GDP per capita) interupted by a modest recession look like a pretty good achivement.

While Japan still has problems, it's massive public debt and it's current recession among them I think it is wrong to consider it a basket case or reject out of hand the action it took deal with it's problems, it certainly doesn't make a good case against the idea of a fiscal stimulus. As a final note, I'd point out that it's the country that made this, which is ace.

PS: I would also point out that it's massive debt was only possible due to the large savings by it's population. Looking at it this way the interest repayment on the national debt could be considered to be paying it's citizens pensions.

Monday, January 12, 2009

Supply Side Economics, State Style

With apologies to Tom for yet another economics post.

I caught today's Today Programme just before 9 where we had Geoffrey Wood suggesting that the government shouldn't invest in green collar jobs because there was no demand for it. I'm amazed how many supposedly intelligent people with extensive qualifications in the field of economics make this kind argument. In my opinion it's an incredibly flawed argument.

First, there's the historical argument. Did the Wright brothers, on designing a plane use the existing demand for planes as a basis for creating theirs? Whenever new inventions and innovations come about because a decision is made to take a leap in an attempt to be one step ahead of the market. What we have in the government's plan for green collar jobs is an educated guess on likely future demand.

Second, there's this idea called supply side economics, which owe's quite a lot to Say's Law. Say's law argues that supply does in fact create it's own demand, if no one buys a good, the price will fall, eventually to a point where someone will buy it. I'm not a supply sider, but I do think that demand is a flexible thing that will (within limits) adapt to the production of new goods.

I believe that these new green collar jobs can and will be created by the government and that they are sustainable for the future. Personally I think the government should do this through the creation of new state owned enterprises that will research develop and produce new green technology as well as taking a stake in existing green technology manufacturers. There are several key areas where the government could make a start, with the potential of creating some very prosperous future industries.

Tuesday, January 06, 2009

All a Case of Timing

In my view, Yvette Cooper is spot on in describing the Tories current plans as economic madness, cuts in public spending combined and incentives to save are very bad ideas at this point. Tom Freeman has similar thoughts here.

The main reason for this is that as a recession takes hold, there is a natural tendancy towards higher savings because people are insecure about their future and save in order to protect themselves from the loss of income that might come with losing their job. This does appear to be exactly what's happening (albeit slowly) at the moment, the household savings ratio rose from -1.1% in Q1 of 2008 to 1.8% in Q3 of 2008.

The problem with an increase in savings is that it is matched by a decrease in spending and unfortunately our jobs depend on people continuing to spend, an economy needs consumers as well as producers and there is no magic force that will keep buying our goods if we stop our spending. Public spending cuts will reduce the level of spending our jobs depend on, saving incentives will reduce it further (as I write I notice Chris Dillow disagrees on the saving point reckoning the diference will be near zero), and all this will make the current economic downturn more severe.

The Tories seem to be opting for this puritanical DEBT = BAD approach and while there is a moral to that story, the time it was appropriate was a few years ago when everyone was loading up on debt like there was no tomorrow. Right now, we need to bear in mind the lessons from previous recessions and try to do what we can for demand, saving the lessons about debt for when the economy's back on an even keel.

Monday, January 05, 2009


The Shadow Cabinet webchat is absolutely fantastic. Shame, it's just a little too wide to fit in my blog.

Hats off to Labour's online team.

Sunday, January 04, 2009

The Rise of Capital Market Protectionism

A new one to me is talk of "capital market protectionism", and how forcing our banks to prioritise domestic lending will limit their ability to invest in developing nations. I wonder about this, because I'm highly skeptical of the benefits of banks lending to developing nations. My belief is that developing nations should as much as possible limit their exposure to foreign loans.

A huge danger of foreign loans is something called "locational mismatch" it works as follows:
  • Let's say a firm in Nation A borrows $1 million US dollars and that it uses for investment, it borrows at 8% interest so the monthly payment is around $7,718.
  • Now lets assume that inlation in Nation A causes the currency to depreciate by 50%
  • The result is that the firm is now saddled with debt that will be more expensive to service.

Another danger is that of "maturity mismatch", this occurs when a long term project is being financed on short term debt, if the foreign financing dries up the project could end up being abandoned. Funilly enough, this is exactly what could potentially happen given the change

As much as possible, governments of developing nations should encourage their nations firms to seek domestic lending this means developing a banking system that is responive to the needs of domestic businesses as well as encouraging saving. Developing nations should certainly act to control (directly or through incentives) the level of foreign debt available for it's firms, the only really good use for foreign loans is the purchase of resources not available domestically.

In terms of the potential crisis that could result from a shortage of future foriegn loans, it should be looked upon as an opportunity for developing nations to reduce foreign loan obligations, as much possible, foreign loans should be abandoned in favour of domestic loans.

The talk of protectionism in this sense is strange and to me, since the whole thing is the result the banks' own incompetence. The banks engaged in foreign lending for their own gain rather than some altruistic motive, now that they are forced to prioritise owing to to overstretching themselves it seems more than a little rich that they are attempting to use their supposed commitment to overseas development as a way of avoiding their domestic responsibilities.

NOTE: Much of what is written here owes itself to ideas in Reclaiming Development, An Alternative Economic Policy Manual by Ha-Joon Chang (for it is he) and Ilene Grabel. It's an excellent book and well worth a read.