The Paradox of Unthrift Waiting for another – doubtless very different – Keynes

The cornerstone of John Maynard Keynes’ General Theory of Employment, Interest and Money is the rejection of one of the pillars of classical economics, and indeed of virtue itself classically understood. That pillar is saving. In that classical world, saving is a fundamentally important action, crucial to economic survival and growth. From it flows the wherewithal to outlast economic downturns – “saving for a rainy day” – and from it flows capital which is then available for investment, either by the saver or by someone else, to whom the saver either lends or extends, in the form of venture capital. This was orthodoxy, not only for economists, but for everyone living during the age of scarcity, prior to the Industrial Revolution.

Keynes turned this economic orthodoxy on its head, when he popularized the notion of the paradox of thrift. In this understanding, saving actually is harmful to the economy because it withdraws money from circulation that otherwise would go toward consumption. In other words, saving breaks the link between production and consumption which is basic to the circular flow of the economy. Speaking of the individual saver, Keynes wrote, “For although the amount of his own saving is unlikely to have any significant influence on his own income, the reactions of the amount of his consumption on the incomes of others makes it impossible for all individuals simultaneously to save any given sums. Every such attempt to save more by reducing consumption will so affect incomes that the attempt necessarily defeats itself” (General Theory, p. 84).

Keynes wrote during the time of the Great Depression, when economists (and everyone else) were knocking their heads trying to explain the utter collapse of economies around the world. The conviction of many was that classical economics had not predicted the collapse and could not explain it. They came to these conclusions: At bottom, the problem was a collapse in demand; this was caused by, among other things, saving; demand needed to be restored in order for supply, and thus labor, to be restored. So everyone followed Keynes’ advice and turned to government to make up the shortfall through deficit spending.

What was missing in Keynes’ analysis and indeed in the solutions put forward to deal with the Great Depression was an understanding of the drastic change that had taken place in the economy as a whole which had been wrought by the Industrial Revolution. It was a change pointed out, on a different level, by José Ortega y Gasset in his book, The Revolt of the Masses, published in 1930.[1]

Hitherto the economy had run in terms of the circular flow of production and consumption at the level of the household. These two had to be in basic alignment, with the balance tipping in favor of production, or the household would not survive. Mr. Micawber put it succinctly in Charles Dickens’ novel David Copperfield: “Annual income twenty pounds, annual expenditure nineteen and six, result happiness. Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.”

But the Industrial Revolution brought in its train the fabulous capacity to produce, far beyond anything previously imaginable. This production in turn generated wealth for the masses beyond anything that had gone before, which Mr. Ortega y Gasset brings into clear relief. But it also upset the balance of production and consumption, of the circular flow, by enabling the divorce of production from consumption: rather than being producers first, people became consumers first, and all generations since then have been characterized, not by what role they play in production, but by the fact that they are all consumers.

This consumption without regard to production has been advancing ever since the late 19th century, and it has done so through the political process and universal suffrage. Whatever else it did, the Great Depression, and indeed the Second World War, generated an exponential increase in the number and volume of programs and entitlements enabling precisely consumption without regard to production.

The Industrial Revolution did not create this divorce, but it did facilitate it, by virtue of the exponential increase in productivity it engendered.

Keynes took advantage of this possibility by 1) blaming saving, thus classical economics, for the divorce, 2) rather than restoring this balance, working on the basis of it, and 3) proposing an alternative: demand-side economics, which is deficit spending so as to facilitate consumption and in this manner generate production.

So the Keynesian Revolution hijacked the Industrial Revolution, in doing so solidifying the divorce. But the idea that demand can create supply is only an illusion made possible by the great productivity enabled by the Industrial Revolution. For that capacity to produce, seemingly as if by magic, does not nullify the fact that individual and household production still precedes consumption and enables it. All the factory systems and automation and whatever else is involved in the modern production process does not change a simple reality: it is still aggregates of networked households that do the production, and consume the results of the production. Supply still creates its own demand.[2]

Which is why we are waiting for a new – doubtless very different – Keynes. The divorce between production and consumption has to be resolved; the two need to be brought in balance again, because the alternative is nothing other than ever-increasing debt. For where does the vaunted Keynesian multiplier-inducing pump priming come from, other than deficit spending, i.e., government indebtedness? Mountains of it. And by the same token, the global-supply-chain-structured world economy[3] has broken the circular flow of national economies and turned the world into regions of production and consumption, whereby the link between the two is consciously severed, for the gain of those occupying the nexuses of the transnational framework, in the process generating massive trade deficits, all of which are “financed” by – that’s right – more indebtedness.

All Keynes did was acknowledge the reality of what was already transpiring but had yet to receive any theoretical justification from economists. Our – doubtless very different – St. Benedict will need to provide an economics that recognizes this reality and instead shows how to redress the imbalance wrought by politics and indeed by changed social mores. That will not be easy, for it will require the complete overhaul of our system of values. But who was St. Benedict, other than someone who enabled the conservation and transmission of civilization itself? Nothing less is needed.

(for more, see also The Problem of Saving)


[1] For this and the following, see the previous article.

[2] This will continue to hold true even in the new age of automation ahead of us, in which robotics will play the leading role – Blade Runner notwithstanding.

[3] Paraphrasing Rousseau, I would say that “Man was born free but everywhere is in global supply chains.”

Immigration, Migration, and Imbalances

The current fracas with regard to immigration through the southern border of the United States will die down in time, and another issue will replace it in the headlines, in breaking news announcements, in round-table discussions. There will not be a resolution any time soon. But what is important is to understand the underlying issues involved. The context is what we need to get a better idea of how to judge necessarily ephemeral events.

The first thing to understand is that at bottom, the motivation for these people movements is economic. For this reason, we can start our analysis by eliminating the category of refugees seeking asylum. The latter is not a function of economics but of justice and compassion. While this is important, it is dwarfed by the scale of economics-inspired movement.

We also need to distinguish immigration and migration. In the sense I intend, immigration concerns people going to the country of destination with the mindset of assimilating into that country. For example, hitherto when immigrants moved to the United States, they moved with the intention of becoming Americans, of leaving their home countries behind and entering into the civic compact that has defined the United States from its inception. Migration, on the other hand, is no so much concerned with assimilation, but rather with the maintenance of the original culture and religion in the midst of the new environment – the establishment of enclaves within a foreign culture, that while engaged, is not entirely received, and indeed is held at arm’s length. In this sense, migration is a form of colonialism. And indeed, contemporary migrations are looked upon, approvingly or otherwise, as a form of retribution for the centuries of colonial relations the West imposed upon the rest of the world: these foreign peoples are now returning the favor, colonizing, and extracting wealth from, the host nations.

In the current climate, and in this analysis, it is migration with which we are concerned.

Some economic principles to guide the discussion

Migration, then, is an aspect of a global confluence of factors mainly economic in character.

Certain basic economic concepts have to be grasped in order to get a proper view of this phenomenon.

First: the economy, whether viewed locally, nationally, or globally, is a circular flow of the production and consumption of goods and services. This is a reflection of Say’s Law: supply creates its own demand. Say’s Law, which was most effectively employed in the work of Joseph Schumpeter, from whom the phrase “circular flow” comes, helps us understand how economies function.

The circular flow of goods and services concerns is the so-called real economy.

Second: not only is there a circular flow of goods and services, there is also a circular flow of payment, credit and debt, which is generated together with the other circular flow. It is both the result of that flow, and affects that flow. This is the so-called financial economy.

The two impinge on each other and determine each other. They cannot be viewed in isolation but as two parts of the same coin. The trouble with much of modern economics is that it does not do that, but treats them in abstract separation.

These circular flows are firstly local, comprising a local economy. A larger economy is a composite of smaller economies, and so comprises a confluence of circular flows. For this reason the economy, especially in other languages like French, is also called the conjuncture. The broader economy is a conjuncture of smaller economies operating more or less in sync with each other.

The component sub-economies do not move in lockstep. Rather, they develop at varying paces, some experiencing boom periods, others bust periods, others more or less stagnating.

What happens, then, is that factors of production flow towards areas of greater productivity: that is where the jobs are, that is, where capital receives a better return.

Borders and exchange rates

Within a political unit, these flows can occur unhindered. Between political units, they are obstructed by borders. These borders are the product of law. Laws set up obstructions to the crossing of boundaries. Furthermore, currencies, which are the product of law, form hidden barriers. Because they fluctuate, they make it more difficult to judge relative values, such as wages, keeping investors and workers from making the move, especially if the move looks to be from a more valuable to a less valuable currency. But beyond all of this, language and culture form boundaries, so that even in the absence of legal or monetary hindrances, people are hindered from moving because of the difficulty in adapting to foreign conditions.

So how do adjustments occur between economies separated by boundaries? By adjustments in the exchange rate of the countries’ currencies, so that areas with expanding economic activity see their currencies appreciate, while those with relatively contracting activity see their currencies depreciate. This is reflected in the current account, which is the sum of a country’s economic activity as far as production of goods and services is concerned, as it relates to other countries. The current account is in surplus when exports exceed imports, and vice versa. And a current account surplus should result in an appreciating currency.

In a perfect world, this mechanism would proceed unhindered, and the balance between nations would be maintained, with current account surpluses and deficits continually issuing forth into currency shifts that automatically lead to their reversals. Outperforming countries would have more money to buy foreign goods and services, and underperforming countries would have relatively cheaper goods and services to offer. This would result in a reversal of flows, with the more expensive countries importing more (and producing less) and the less expensive countries exporting more (and consuming less). Wages would increase in step with the currency, allowing them to import more. This is not a static condition. Currency exchange rates would continue to shift, balancing flows through the fluctuations and reversals of economic conditions over time.

Short-circuiting the feedback mechanism

But here is where problems arise. Particular interests are favored at any particular time, on both sides of the equation. On the side of the exporting country, there is the interest of the export industry, while on the side of the importing country there is the interest of consumers. Or at least, consumers can be led to believe that it is in their interest to have cheap goods available, although there is a hidden cost to this, which we will discuss shortly.

This is the situation in our current regime of globalism. Cheap-production countries are looking to lock themselves into exchange-rate and regulatory conditions favorable to their continued exports, even though such a regime is unfavorable to their own domestic economies. In those countries, domestic consumers face high prices on imports and production geared to foreign markets; workers see their wages artificially suppressed, rather than automatically rising vis-à-vis foreign competitors, as they would if currency exchange rates moved in step.

The gainers in such a situation are mainly multinational corporations which have relocated to low-wage countries and use their former home markets as dumping grounds for cheaper production. Other gainers are governments in the exporting countries, which book revenues from those corporations and their exports. Controlling elites on both sides of the equation benefit financially and politically.

The result in the importing countries is cheaper imports, but likewise a drain of production capacity, leading to an economy heavy on service-sector jobs.

Is such an economy – one lacking in production capacity – sustainable? It would seem that, given the demands and requirements of modern welfare states and the generation of revenues they require, that such an economy is not sustainable – for ultimately it is production capacity that generates wealth, while services only redistribute pre-existing wealth. Not to mention the utterly redistributionist nature of entitlement and benefit payments, which generate no wealth whatsoever, and in fact entail a form of friction which erodes wealth.

The stubborn expansion of imbalances

In the event, such a regime generates what have come to be known as imbalances. And a lot of effort is expended to counter those imbalances without resolving them. For to resolve them would lead to favored parties – e.g., multinational corporations, exporting countries – losing their lucrative advantages.

One of the important consequences is reflected in money and banking. The regime of fixed or pegged exchange rates is realized by keeping currency exchange from taking place. Normally, cross-border trade is paralleled by currency exchange, which leads to shifts in exchange rates. But to keep those exchange rates stable, currency exchange has to be headed off at the pass, as it were. This is accomplished through what is known as “sterilization.” Central banks act to keep foreign currency earnings from being released into the domestic economy. This holds down purchasing power and so eases pressure on the domestic currency to appreciate against the foreign currency. But this also leads to bloat in the currency of the importing country. Under our current regime, in which the US dollar serves as the reserve currency for international trade – and in which the US, not coincidentally, serves as the “consumer of last resort”—this has led to the buildup of massive amounts of liquidity which circulate aimlessly on financial markets without touching ground in real markets. This leads to bubbles in markets that traditionally serve as havens for excess liquidity, such as real estate markets and stock markets. Such asset “bubbles,” when they burst, lead to massive failures in the banking system, as occurred in 2008–2009.

Migration as a rectification of imbalances

This is one way in which imbalances are generated, and how they, by hook or by crook, get resolved. But capital flows comprise only one of the factors that resolve cross-border imbalances. The other mobile factor of production – labor – will likewise be drawn by the magnetic attraction of richer countries, especially where 1) those economies are lopsided toward service jobs, which cannot be exported and therefore draw low-wage labor to them rather than going to where low-wage labor is, like manufacturing capacity can; and 2) those economies maintain more or less lavish welfare and benefit regimes which ipso facto exert an attraction on citizens of less prosperous countries.

Therefore, in a world of fixed or pegged exchange rates – or especially, in the case of the European Union, a single currency – imbalances are rectified globally in the same way they are internally within a domestic economy. For the effect of the current globalist regime is to turn the entire world economy into a single domestic economy.

It would seem that this is a driving force behind current policy decisions being taken by Western nations, both in North America and in Europe. In the United States, border control lapsed and the government introduced a range of measures to accommodate inward migration, rather than making an attempt to stifle it. This is a tacit acknowledgement that a regime of floating exchange rates, the counterpart of nations able exert to effective sovereignty, has been set aside for all practical purposes, and that the great dream of cosmopolitan liberals everywhere is at hand: a global regime of universal jurisdiction, of a police rather than a military force, of a global welfare state in which ostensibly universal human rights move from the category of “ostensible” to “actual,” and the entire globe is harnessed to a redistributionist regime in which equal rights for all becomes a reality, regardless of cost.

In the meantime, what this regime of more-or-less fixed exchange rates and open borders spells is mass migration. For able-bodied labor will move if it can move, and given the technical transportational possibilities that increasingly have become available to low-wage populations everywhere, this movement will only accelerate. This is even more the case where populations are stuck not only in low-wage situations but in crime-ridden or even war-ridden, dysfunctional countries. Muslim populations in particular seem to be caught inordinately in such situations. Not surprisingly, Muslim populations are on the move.

The problem with this solution

But this points up the profound danger involved in these movements, and the misgivings they give rise to among “receiving” populations. For we are not dealing here with interchangeable parts; we are dealing with human beings, with cultures, mores, religions, in addition to whatever wealth or lack of it, health or lack of it, they may already have. Add to this the migration-orientation as opposed to immigration-orientation of these peoples, and the problem becomes all too apparent.

With migration, nationhood itself becomes problematic; instead of these groups being encouraged to assimilate, they become treated as victims of nationalistic jingoism, and encouraged to become integral parts of the grievance coalition. Patriotism really does come to be seen as the last refuge of the scoundrel, at least for the idealist. Cosmopolitanism becomes de rigueur.

But that cosmopolitanism is only a façade covering over deep divisions. For example, to what degree is Islam compatible with liberal democracy? If Muslims ever were to become a majority, would they maintain Western liberal institutions, or would they impose the institutions peculiar to Islamic countries, such as Sharia law? These are questions that not only are interesting academic exercises, but which practice will answer unequivocally, sooner or later, and of which real people will feel the effects.

Another such question: to what degree can countries like the United States sustain influxes of low-wage labor for service jobs that already are under pressure from unemployed or underemployed citizens? How can revenues be generated to counter the massive amount of pressure being put on the health, education, and welfare systems these countries have built up over the years, especially given their aging populations? Is it not a form of collective suicide to allow these migrations to take place in the hope that the gravy train will continue to flow? For looked at purely in terms of economics, these flows look to be unsustainable.

The end game?

Perhaps that is what our contemporary global elites are after. The very destabilization of nations, the undermining of national sovereignty, only plays into the hands of those desiring to establish a global regime to replace, or at least gain dominance over, sovereign nations. Nationhood itself is at stake. Politicians seem to have placed the dream of universal jurisdiction and the realization of every human being’s inalienable rights to food, accommodation, livelihood, education, health care, and the rest of it, above the exigencies of national survival. Apparently, they will pick up the pieces left in the aftermath of conclusive national failure.

Indeed, this would seem to be end game of national leaders favoring and preferring foreign interests to those of their own nations (e.g., Barack Obama, Angela Merkel). They seem to be auditioning for leadership in the regime which is yet to come, a regime to supplement or even replace our current framework of internationalist institutions such as the United Nations. Will it ever come to that? Yet another of those questions that practice will answer. But it is looking increasingly likely.

But there is an alternative. The venerable tradition of national sovereignty, of laws and currencies which are the expression of that sovereignty, of national populations that determine their own destinies rather than having them determined by unaccountable elites at transnational levels – the infrastructure for this is still there. And the top priority to this end, quite simply, is floating exchange rates and maintenance of the institutions protective of national sovereignty. This is not rocket science. It is a simple choice. Nationhood, or globalism?

Border-Adjustment Sleight of Hand? Sense and Nonsense on the Border Adjustment Tax

The trickle of articles discussing the proposed Border Adjustment Tax (BAT) has turned into a veritable flood. Not surprisingly, the lion’s share of these articles oppose the idea of border adjustment. It would be tedious to run through them all; suffice it to say that the primary argument is that such a tax would raise the price of consumer goods.

That of course is true. But that would not be such a bad thing. For, what is the point of cheap consumer goods if the purchasing power required to buy those goods has been shipped overseas, in the form of productive labor, otherwise known as jobs?

Is this not the Achilles’ Heel of the current structure of the division of labor? We have divided up the world into rich consumption-oriented regions and poor production-oriented regions, and have allocated production capacity accordingly. The problem with this arrangement is, it has divorced production from consumption: production does not finance consumption, as it should in a healthy economy.

What should happen in such an arrangement is that the low-wage, producer countries should be seeing a steady accretion in purchasing power, reflected both in higher wages and appreciating exchange rates, which would serve to bring trade relations into balance by allowing them to consume more and so import more. The rich consuming countries would constitute the flip side of this: they would produce more and so export more.

That would be a healthy arrangement for international trade. But the current system does not allow for that. It keeps low-wage producer countries at the low-wage end, and obstructs their consumption; conversely it keeps rich consumer countries consuming at the same levels, whether through asset-bubble-financed consumption (which led to the housing crisis of 2007-2008) or simply by lavish wealth redistribution schemes, which in effect redistribute wealth from the future to the present, because they are financed in increasing degree by deficit spending, otherwise known as debt.

So the gap between production and consumption is being bridged by indebtedness. Which is one of the reasons why the world has generated such a massive debt overhang. And no matter how much one hears politicians crow about “the crisis being over” and “the future looks bright,” the debt overhang only gets more overhangy: In 2016 global debt continued its unsustainably onward and upward course.

We owe it to ourselves? Let’s not kid ourselves. Borrowing is not a shuffling of money from one drawer to another, or, as the Dutch say, “broekzak-vestzak” (pants pocket-shirt pocket). No, borrowing is receiving money in exchange for a promise to pay at some future date. In other words, it is not that we owe it to ourselves; rather, we owe it to the future – to future generations, who are on the hook for what we, collectively, borrow in the present.

The idea behind all sound borrowing is that it goes toward investment, not consumption. (Borrowing for consumption can only be permitted if sufficient reliable future income stands over against it – hence, a form of cash flow management.) Borrowing should be done in order to finance future, reliable, income – a return on investment.

Our present global trading system fosters irresponsible borrowing – borrowing for consumption without heed to the capacity to repay. In fact, it is built upon such borrowing. Which explains its unsustainability. Global indebtedness continues to burgeon, as we just pointed out. And fueling this indebtedness is the production/consumption divorce, which is reflected in trade imbalances. These imbalances are simply measures of indebtedness, for all trade deficits are “financed.” Which is another way of saying, paid for by debt rather than by a reciprocal performance.

We have gone over this many times in previous posts. The funny thing is, you won’t hear a word about it in the discussions regarding the BAT. At least, not on the part of its opponents. For them, all that matters is that it raises prices on consumer goods.

As far as popular treatments go, one of the most adept criticisms of BAT was published on April 16 in the Wall Street Journal: “The Border-Adjustment Sleight of Hand,” by Veronique de Rugy and Daniel J. Mitchell.

For starters, de Rugy and Mitchell go after one of the main arguments pushed by the pro-BAT forces, that the tax will cause the dollar’s exchange rate to rise, and so neutralize the effect on imports. Hence, any rise in prices of consumer goods will be wiped out by the rise in the dollar’s exchange rate, which has the effect of lowering prices of imported goods. De Rugy and Mitchell throw cold water on this notion. The data, they say, argue against any such compensating effect taking place, especially in the short term.

I thank the authors for making this argument. Because if the BAT has no effect on trade relations, then – to paraphrase Flannery O’Connor – “to h/*& with it.” What is needed is precisely an arrangement that will do something about trade imbalances, and if the BAT won’t, then let’s get something that will.

But de Rugy and Mitchell go on to argue that the BAT will not do anything to affect trade relations anyway. They do so by pointing to the effect Value-Added Tax (VAT), another kind of border-adjusted tax, has had on trade. In their view, VAT has done nothing to skew trade relations one way or the other.

Here’s the nub of their argument:

The claim is that VATs give foreign companies an advantage. Say a German company exports a product to the U.S. It doesn’t pay the American corporate income tax, and it receives a rebate on its German VAT payments. But an American company exporting to Germany has to pay both—it’s subject to the U.S. corporate income tax and then pays the German VAT on the product when it is sold.

Sounds horribly unfair, right? Don’t be fooled. Like magicians, those making this argument are distracting the unwary, hoping that nobody will notice the trick.

Here’s the real story: What matters from a competitive perspective is whether the playing field is level—and it is. When the German company sells to customers in the U.S., it is subject to the German corporate income tax. The competing American firm selling domestically pays the U.S. corporate income tax. Neither is hit with a VAT. In other words, a level playing field.

What if an American company sells to a customer in Germany? The U.S. government imposes the corporate income tax and the German government imposes a VAT. But guess what? The German competitor selling domestically is hit by the German corporate income tax and the German VAT. That’s another level playing field. This explains why economists, on the right and left, repeatedly have debunked the idea that countries use VATs to boost their exports.

While this argument sounds convincing, it overlooks some essential information. In fact, it focuses on one effect only and totally overlooks another. So it’s not sleight of hand that’s the problem, it’s short-sightedness. Granted, in this example there is a level playing field in America, and an equally level playing field in Germany. But that’s the problem – there are two playing fields. On the American playing field, you have no VAT, but on the German one, you do. The question is not so much whether individual German products are advantaged or disadvantaged vis-à-vis their American counterparts, but whether Germany is shifting its entire playing field to the advantage of producers – both German and American – and disadvantage of consumers – both German and American. And that is what’s happening. Germany, and other countries that employ VAT, have made it more difficult to consume in their countries. Therefore, they end up overproducing, and shipping their excess production to foreign countries, mainly the United States. It is this that leads to the trade imbalances we have been harping on and will continue to harp on.

Here is an overview of US trade imbalances with key trading partners in 2014, taken from the Wikipedia article, “List of the largest trading partners of the United States.” Firstly, notice that the overall US trade balance is in deficit by a $734 billion. That’s an additional $734 billion in debt, rung up in just one year. Add that to the federal deficit and you really do have a twin-deficits problem.

But notice also that all the major bilateral trade deficits are with countries that have a VAT.

Rank Country/District Exports Imports Total Trade Trade Balance
World 1,454,624 2,188,940 3,643,564 -734,316
1  China 115,775 462,813 578,588 -347,038
 European Union[3] 270,325 416,666 686,991 -146,340
4  Japan 63,264 132,202 195,466 -68,938
5  Germany 49,362 114,227 163,589 -64,865
3  Mexico 230,959 294,151 525,110 -63,192
15  Ireland 9,556 45,504 55,060 -35,948
16  Vietnam 10,151 42,109 52,260 -31,958
11  Italy 16,754 45,210 61,964 -28,456
6  South Korea 42,266 69,932 112,198 -27,666
18  Malaysia 11,867 36,687 48,554 -24,820
9  India 21,689 45,998 67,687 -24,309
21  Thailand 10,573 29,493 40,066 -18,920
8  France 30,941 46,765 77,706 -15,824
12   Switzerland 22,701 36,374 59,075 -13,673
10  Taiwan 26,045 39,313 65,358 -13,268
27  Indonesia 6,037 19,203 25,240 -13,166
2  Canada 266,827 278,067 544,894 -11,240

Is that coincidence? We think not. Of course, VAT is not the only factor involved in trade deficits. There is also the infamous currency manipulation, as well as factors such as forced savings. I have gone over these in previous posts, and the reader would do well to apprise him- or herself of them.

The fact of the matter is, the BAT – or something like it – is direly needed to offset these ongoing trade deficits. Of course, there will be a price to pay, in the form of higher prices for consumer goods. That is why representatives of industries ranging from retail sales to the Koch Brothers to “big oil” oppose it. But higher prices for consumer goods will of  necessity reduce consumption vis-à-vis production and help bring that relationship more in line with trading partners, thus helping rebalance trade. Granted, it would be better if those other countries would eliminate their border-adjusted tax regimes, but that is not in the offing. Something has to be done, and this is better than nothing.

 

The Shape of Things to Come?

The fledgling Trump administration has been greeted by an explosion of resistance on the part of the Left. The Democratic Party has shown its antipathy in various ways. For one thing, many Democratic members of Congress declined to attend the inauguration. For another, Senate Democrats have delayed the appointments of President Trump’s cabinet appointees, even though they cannot block them. On his first day of office, President Obama had seven cabinet appointments approved by the Senate; President Trump had two.

These are pinpricks. Something much more substantial, if not in terms of government processes, then at least in terms of imagery, was the Women’s March on Washington, conducted on the day after the inauguration. I must say, I had a hard time discerning what exactly this protest was about. At first glance, given the various forms of costume worn by many of the participants along with the rather graphic and potty-mouthed language flaunted by various speakers, the event was difficult to take seriously. It would seem that there was a message there for President Trump, in response to the notorious recording of his words expressive of sexual harassment. But that particular message already loses its force when one recalls that President Bill Clinton was credibly accused of multiple instances of, not words, but actual acts of sexual harassment, and that these very same forces of feminism not only did not protest his presidency, but defended it.

Indeed, there was something more substantial at stake in this protest. It will form a battleground throughout the time of the Trump administration. I speak of abortion rights. This march was a down payment on the pressure that will be brought to bear when Supreme Court nominations take front and center, as they will before long. For all intents and purposes, feminism is abortion rights; the rest is window dressing.

Be that as it may, in all of the splash coverage provided by the news media, not only of this event but also of such irrelevancies as crowd size at, and viewership of, the inauguration, some monumental events have been taking place that have not received nearly the same coverage. Perhaps this is a good thing, for if they received the attention they deserve, events like the Women’s March on Washington would fade into the background, in favor of a strategy geared more closely to actually regaining the influence that has been lost in hitherto key constituencies.

Allow me to elucidate. On Monday President Trump met with various union representatives. Now we all know that for ages, unions have supported the Democratic Party. But after this meeting, the union leadership expressed sentiments that completely confound this traditional arrangement. It seems that Donald Trump is serious about conducting business in an entirely new way, outside the traditional constraints and folkways that have governed Washington for lo these many years.

Consider the statement made by Sean McGarvey, president of North America’s Building Trades Unions and, among other things, a contributor to the Huffington Post:

We just had probably the most incredible meeting of our careers with the president and the vice president and senior staff, when the president laid out his plans about how he’s gonna handle trade, how he’s gonna invest in our infrastructure and how he’s gonna level the playing field for construction workers and all Americans across this country. And then took the time to take everyone into the Oval Office and show ’em the seat of power in the world… The respect that the president of the United States just showed us — and when he shows it to us, he shows it to three million of our members in the United States — was nothing short of incredible, and we will work with him and his administration to help him implement his plans on infrastructure, trade, and energy policy so that we really do put America back to work in the middle-class jobs that our members and all Americans are demanding.

Other union leaders’ comments echoed this sentiment. When the president announced to them that he was terminating the United States’ participation in the Trans-Pacific Partnership (TPP), they applauded. One leader even spoke favorably of President Trump’s controversial inaugural address, saying that it was “a great middle-class address… It hit home both for the people that have been hurting… it was a great moment for working men and women.”

This is stupefying. What it portends, if President Trump and the Republicans in Congress follow through on their promises and implement job-friendly policies, is a massive shift in the political landscape, as the mainly white working class abandons the Democratic Party and lines up with the Republicans. But such has been in the offing for some time; it only took someone with the, shall we say, chutzpah of Donald Trump to actual make this happen.

The focus of progressivism generally, and the Democratic Party in particular, is no longer with the class struggle, which was their original raison d’etre. The focus has shifted to identity politics with its potpourri of multiculturalism and various aggrieved groups, minority or otherwise, the attention of which is directed not so much to economic class than to the criteria of diversity and an understanding of human rights wherein government-funded consumption takes the place of the right to work.

We have documented the symbiotic relationship between neoliberal capitalism and this multiculturalist identity politics in previous posts, particularly this one. What needs to be realized is that this new coalition is incompatible with the old one, the one in which the working class formed the core constituency. In fact, this new coalition is demonizing the old working class, while the president the workers helped to elect is routinely referred to as a “fascist dictator,” perhaps because of the old-school working-class-oriented policies he is enacting. After all, they are so very industrial. You know, sooty.

The question for the new progressive coalition is, having kicked the working class to the side, what is the game plan now? Is it going to be these showy, frothy marches? If so, it reminds me of the following scene from the movie Rango:

Trumponomics and the Great Rebalancing

Donald Trump’s election victory on November 8th is now a fact. Reactions to it have not been lacking, of course. On the economic front, they have ranged from the cautiously optimistic to predictions of utter doom. For their part, the financial markets went from downturn to upturn in short order (as chronicled here by Jerry Bowyer). But the financial markets, disconnected as they are from the real economy, are not very good arbiters of broader economic trends. What is important is the concrete policy decisions the Trump administration is going to make with regard to trade.

This is not to diminish the importance of other measures, such as tax policy. These will play an important albeit subordinate role in the kind of economic performance the country and the world will experience in the coming years. But the key issue – and significantly, one of the key issues addressed in Trump’s campaign – is trade. In terms of economic importance, nothing else comes close. To paraphrase Alfred North Whitehead, contemporary economic policy consists of a series of footnotes to trade policy.

For those who have been following this blog, such a statement should come as no surprise. Allow me to reiterate the main points:

  1. The global economy is so structured as to be systemically imbalanced. Certain countries run persistent, sizeable trade deficits; certain others run the mirror image of persistent, sizeable surpluses.
  2. Far from being innocuous, these imbalances are unsustainable, and leave a trail of carnage in their wake. They are unsustainable because they are financed, not by Palley’s “virtuous circle of growth” characterized by the circular flow of production and consumption, but by indebtedness. The trail of carnage is the hollowed-out production capacity in rich countries combined with sweatshop production in low-wage countries.
  3. The benefits of this system accrue to transnational elites: first, transnational corporations which profit from “buying low and selling high” within this made-to-order framework, then the politicians, media entities, and academics who serve to justify the framework, mainly by deflecting attention from its true nature and toward the ersatz quest for “justice” as embodied in identity politics, which locks subjugated populations permanently into this exploitative framework.

Great profits are being made within this arrangement, the flip side of the great losses (the ever-burgeoning global debt burden) the tab for which will be picked up by future generations (hello Millenials!). It stands to reason that anyone threatening to upset this particular apple cart will incur the ire of the entire range of vested interests, popularly known as “The Establishment” and more scientifically as the Transnational Capitalist Class.

The gravy train must keep flowing, and the uneasiness bordering on panic bordering on hysteria evidencing itself in much of the post-election news reporting has its roots precisely in the realization that (to use yet another of these analogies) the punch bowl is about to be taken away.

Now then, if these trade deficits are as important as I am claiming they are, what can be done about them? Obviously, this will be easier said than done: not only will there be the implacable resistance of special interests, there will be the entire set of problems that is involved in what has come to be known as “The Great Rebalancing.” For what is required is that entire national economies be reordered to restore the “virtuous circle of growth” and break some seriously settled habits.

On the export side, there are two major forms of imbalance that need to be addressed: the Asian Tiger model and the German model. Let’s take these one at a time.

The Asian Tiger model was pioneered by Japan and took flight during the 1970s upon the breakup of the Bretton Woods arrangement. Ultimately it is based on the artificial suppression of the currency’s exchange rate in order to ensure export sales. The export industry in combination with government controls the economy. They structure the economy in order to benefit the export industry at the expense of domestic industry and trade. In particular, the banking system is subjugated and forced to perform certain functions, such as paying below-market interest rates on both savings (thus penalizing households) and loans (thus benefiting business).

One result of this model is that it keeps money earned from exports (which earnings are denominated in dollars) from re-entering the ordinary market (a process called sterilization), as this would cause the currency to appreciate. Rather than being repatriated to the producers, much of those dollar earnings are kept in dollars, held by the country’s central bank, and invested in US government debt (Treasury bills and bonds). In this manner, earnings are taken out of the ordinary market and kept on the financial markets, leading to asset bubbles. This money can return to the ordinary market and so fund consumption, but not by the original earners spending it (which would reinstate the virtuous circle); rather, it is borrowers, who are given access to this liquidity, and in this manner are allowed to fund consumption in an unsustainable manner. This was one of the factors behind the boom-bust of the first decade of the 21st century.

The German model differs from the Asian Tiger model because it does not depend on obtaining competitive advantage via manipulation of exchange rates or by sterilizing foreign earnings. Rather, it achieves this through fiscal policy, mainly through measures to suppress consumption. Wages are held down in the interest of competitiveness, and consumption is discouraged by means of a consumption tax (VAT). The result is the same: the producers, whether they produce for domestic or foreign consumption, are kept from spending their own earnings. These earnings are simply foregone. This benefits the export sector by improving terms of trade, but it does not benefit the country, because those foregone earnings could have gone to generate and sustain the domestic economy, thus reducing the country’s dependence upon the vicissitudes of export markets.

What these methods have in common is the suppression of consumption. It is perhaps no coincidence that the countries engaging in these practices have long traditions of frugality and asceticism. This is not the place to enter into a discussion regarding the relation of religion and morality to economic growth, although I do reserve the right to do so at some point in the future. I only raise the point to indicate something that cannot be mere coincidence. And indeed, the countries on the other end of the trade relation – the net consumers – have gotten a name for being spendthrift and lazy, incapable of competing. The reality, as we hope to explore another time, is more complicated.

So, in order to achieve this “great rebalancing,” essentially two things have to happen – countries need to reorient their fiscal and monetary policies to, in the case of the producing countries, promote domestic consumption, and in the case of consuming countries, promote domestic production. In the latter case, a reworking of venerable “import replacement” policies is in order. A focus on the domestic economy is required which will restore the virtuous circle of growth and break the cycle of unsustainable debt financing.

What kind of policies would the Trump administration need to pursue in order to further this proposed state of affairs?

First of all, one thing needs to be made clear. All the saber rattling on the part of countries in Europe and Asia with regard to a trade war, such as China’s threat to buy Airbus aircraft rather than Boeing aircraft, are nothing more than that. As with the dire warnings surrounding Brexit earlier, the countries doing the threatening are, in point of fact, in no position at all to threaten. They are running trade surpluses with the US or the UK, as the case may be, which means that they selling more to those countries than they are buying from them. This means that they need those countries’ markets, and if they cannot sell to them, they will be left with surplus production and nowhere to offload it. Hence, these countries know as well as anyone that saber rattling is useless at best and counterproductive at worst.

What about US threats of (to cut to the chase) a 45% tariff on imported goods from China? This would be the least desirable method of achieving some sort of rebalancing. Leaving aside the corruption involved in business lobbying for protected status (as noted in 1931 – another period of protectionist agitation – by James Harvey Rogers), such a tariff would dislocate whole industries and so undermine economic growth in the short to medium term. In the longer term, a tariff might lead to a functioning economy in the US, as domestic industry restored itself to some level of its former glory, but it would damage China severely, without providing any mitigating mechanism to enable it to begin producing for the domestic economy on a sustainable basis.

There are far better and more mutually agreeable ways to engage the great rebalancing than punitive tariffs. Firstly, and Mr. Trump is absolutely right on this, currency manipulation has to be stopped. While China may not be engaging in this at the moment, it most certainly was for a long period in the late 1990s and up until the crash of 2008, leading to its mountain of dollar reserves. In this regard, Trump is closing the gate after the horse has bolted, at least respecting China, but the entire system of sterilization and amassing of dollar reserves has to be put an end to.

Then there are the domestic policies that structurally suppress consumption. These have to be reversed. In the case of China, household consumption in 2010 declined to an “astonishing” (Michael Pettis’s word) 34% of GDP, astonishing in view of the fact that for most countries this figure is at 60-70%. Behind this low level of domestic consumption are policies promoting forced savings and what Michael Pettis refers to as “financial repression,” wherein banks operate to transfer savings from households to business and government at below-market rates. The German method utilizing wage restraint and consumption tax must also be reversed.

The Trump administration must insist on these common-sense changes in domestic policies on the part of its trade partners, because they are not mere matters of domestic concern: they affect trading partners as well. Pettis shows this in ch. 6 of his book The Great Rebalancing. Using the case of Germany vis-à-vis Spain, he outlines how domestic policies in Germany affect Spain’s economic prospects, and how both countries need to make coordinated adjustments to ensure a transition to a balanced economy. The same has to be done on a global scale.

On the domestic front, changes to the tax regime regarding business, bringing it more in line with other countries’ corporate tax rates, will be of some help, as will various initiatives to reconstruct and bring jobs back to the inner cities, and the various infrastructure projects. But these will be of little use if the main issue, international trade and its discontents, is not addressed comprehensively and thoroughly. Otherwise, the opportunity presented when the US electorate dodged the bullet of a Clinton presidency, which would have sealed the deal for the transnational corporate class, will have proved to be only a bump in the road to Elysium.

On the Road to Elysium When fiction approaches fact

The 2013 movie Elysium depicts a dystopian future of unremitting, jarring poverty juxtaposed with serene, detached wealth. Literally detached: wealth resides in a lavishly equipped, lebensraum-furnished space station, high above an impoverished, exhausted Earth. The planet is only useful as a source of provision and maintenance for the space station; its fruits have been extracted and depleted, while the population is mainly left to its own devices, an excess labor force without the capacity to sustain a decent standard of living, the only purpose of which is to serve the elite floating high above.

It is a haunting image, as it should be. And, admittedly, an extreme one. But it resonates – because in this day and age, the gap between rich and poor has been steadily widening, bringing the Elysium scenario within the realm of the plausible. The purpose of this article is to explore how this has come about.

For starters, the problem with the world system as currently configured is that it divorces consumption from production – a recipe for disaster. For consumption needs to be funded, and there are only two ways to do that. Either produce, or borrow. The modern world has chosen – or, our betters have chosen – for the latter.

In the ideal economy, production and consumption are in a circular flow; supply creates its own demand. Production is in equilibrium with consumption, and pays for consumption. There are neither gluts nor shortfalls.

Of course, this is unrealistic. No economy is a closed loop like this. First, as discussed in the accompanying course as well as in this article, the so-called “problem of saving” makes its appearance, and complicates matters. This leads to two markets, not one – the ordinary market of production and consumption, and the financial market of credit and debt. This two-market framework is a natural outgrowth of the money economy. There is no ultimate disconnect between production and consumption here: the monies that flow into the financial market eventually flow back to the ordinary market in one way or another, closing the production-consumption loop.

But in the modern world system the circular flow of production and consumption is purposely disrupted. This is the heart of what is wrong with the world economy today. It is the issue that urgently needs to be addressed, because it is producing a time bomb that eventually must go off, with unforeseen and unfathomable results.

The disruption of production and consumption is primarily visible in the balance of trade. Nowadays, trade relations are characterized by sustained, sizeable imbalances. The inevitable byproduct of these imbalances, and what makes these imbalances so lethal, is debt. In a previous article, I wrote: “Trade imbalances have to be ‘financed’: in other words, they are paid for by debt. When trade imbalances are incurred, the countries running trade surpluses are also exporting capital: this is called a capital deficit. What they are doing is exporting demand, by exporting excess savings. To put it bluntly: they are extending the credit to the consuming countries that these countries require to buy their production.”

These countries are exporting demand. What does this mean? It means they are seeking to sell production, not to their own, domestic consumers, but to foreign ones. They are disrupting the circular flow. In a normal situation, they would not be exporting demand; domestic demand would match supply; they would be buying what they sell. Of course there are always surpluses and deficits, because no economy is entirely closed. But the sustained effort, the policy decision, to “export demand,” which means to shift consumption abroad, would not exist.

How do they do this? By suppressing domestic consumption. In other words, domestic producers are not being allowed to enjoy the fruits of their labor. The demand they otherwise would generate is being taken from them. Normally this would result in overproduction, a glut of goods and services, and prices would adjust accordingly, falling, bringing the unbalanced situation into equilibrium. But through various manipulations outlined here (under the rubric of currency manipulation), domestic production is put out of joint with domestic consumption, the producers are robbed of a portion of their earnings, and the shortfall is made up for by foreign consumption, which picks up the slack.

Why do they do this? Why engage in a conspiracy against the domestic economy in order to promote exports? Back in the late 1800s, the British economist John Hobson already had an answer. For him, British imperialism was a net loss, costing the country far more than it provided in terms of income or revenue. Not only was it prohibitively expensive, but it disadvantaged a broad swathe of domestic producers. Why engage in it then? His conclusion was that it provided an advantage to various vested interests – particular interests, as opposed to the common good – which in turn were able to influence policy in their favor. In other words, imperialism and colonialism subordinated the national interest to particular interests.

The same thing is happening today. Certain countries are pushing exports, generating massive trade surpluses year after year; while certain other countries are living beyond their means, running the mirror image of trade deficits, year after year. The usual mantra we then hear is that the exporting countries are virtuous, disciplined, hard-working, while the importing countries are lazy, decadent, improvident – but it would be more accurate to characterize each as victims of a regime, which exploits both ends of the trade equation.

The transnational capitalist class (TCC – of which more here), composed of various manifestations of “Davos Man,” is the ultimate beneficiary. By engaging in this debt-funded, imbalance-riddled economic system, it is able to funnel the surplus value generated by forced savings into its own pockets, while allowing various debt mechanisms to provide for the indispensable consumption that enables this gravy train to keep going.

In other words, a significant portion of the ever-burgeoning global debt burden is simply the flip side of an equally significant sum of profits disappearing straight into the pockets of our modern-day benefactors, the global corporate elite, along with their cronies, facilitators, and enablers in their various support roles in government, politics, academia, the entertainment industry, and the news media. The tab will be paid by future generations, when those various debt instruments come due. Après nous, le déluge.

This is the source of the widening gap between rich and poor worldwide. This is the road to Elysium.

How is this debt-funded consumption sustained? Let the reader understand: this is the key to the modern political scene. This arrangement, this racket, runs through a political system revolving around identity politics. This is what makes the gimcrack mechanism go. Identity politics, as I outline here, serves to defuse and divert opposition to the global capitalist regime. It deflects leftist agitation away from its home base, the class struggle, toward the safe – for hegemonic capitalism – alternative of identity politics. In fact, it serves as a key brick in the edifice of this hegemonic capitalism, for identity politics dovetails precisely with the culture-ideology of consumerism that locks peoples and nations into their economic roles within the system.

It turns out that identity politics provides the justification, under the guise of “human rights,” for never-ending deficit spending on entitlements. In other words, not only does it foster the ideology of consumerism, it also provides the legitimation for debt-financed consumption, which is the key to maintaining the gravy train of profits into the pockets of Davos Man.

In this age, respect for human rights is considered the sine qua non of civilized society. But what are human rights really? An understanding of their origin sheds light on their conflicted character. They came along during the “Age of Enlightenment” of the 18th century, to take the place of religion as the source of law. As I wrote back in 1995:

Religion was relegated to the privacy of one’s own conscience. It was therefore also removed from any influence on public life. What replaced it, in early liberalism, was a focus on property rights; when that produced alienation, the focus shifted to collective property redistribution. These are modernism’s first principles, and they are Epicurean, materialist, consumerist. Both foci, property and redistribution, have at their core the consumerist individual. It is consumption – appetite – which this society worships. Human rights mean that each individual has the inalienable right to satisfy those appetites. To deny one such a right is to violate one’s integrity as a human being. When a conflict of appetites arises, or when appetite conflicts with a real right (such as with abortion), the strongest (i.e., the one with the best legal representation or the most effective propaganda machine) wins.

Hence, consumerism is not simply a function of households spending beyond their means. It is also a function of entitlements, as currently defined and implemented by welfare states. In his scathing indictment of rights-as-entitlements, P.J. O’Rourke was not far from the mark: “Freedom is not … entitlement. An entitlement is what people on welfare get, and how free are they? It’s not an endlessly expanding list of rights — the ‘right’ to education, the ‘right’ to health care, the ‘right’ to food and housing. That’s not freedom, that’s dependency. Those aren’t rights, those are the rations of slavery — hay and a barn for human cattle.” If this sounds harsh and unfair, think about it. These are the rations of a peculiar form of slavery – to an unseen hegemonic power holding the nations in its sway. We are satisfied to eat the crumbs falling from the table of the TCC.

Government-financed “discretionary spending” keeps the boat floating, even when jobs are scarce and salaries are stagnant, and households have maxed out their credit cards. The economies of the consumer countries have for years had their production capacity hollowed out as with numbing regularity jobs have been shipped overseas. This has had the inevitable effect of producing a structural shortfall in purchasing power. This shortfall was first made up for with the real estate bubble of the early 2000s, but since the crash, it has been maintained by massive deficit spending on the part of the Obama administration.

How the pie is divided up, and who gets a seat at the table, now turns out to be a crucial factor behind the identity politics agenda. The government now plays the role of benefactor to various disadvantaged groups, which are encouraged to develop and maintain an identity precisely as disadvantaged groups, in order to form a consumption-based coalition to 1) maintain the power of the ruling elite (in other words, deflect and coopt the class struggle), and 2) maintain demand for below-market global production, thus keeping the gravy train going.

In the current US political constellation, African-Americans are perhaps the key members to be mollified in terms of this “coalition management.” African-Americans have been whipped up into a frenzy of anti-authoritarianism (mainly against the police, but also against the white majority generally) which seemed a bit odd to those of us who thought that the worst aspects of racism were behind us, but who now have almost been led to believe that racism has never been worse. The plot thickens when one realizes that groups like the Ford Foundation and George Soros’s Open Society Foundation have contributed tens, if not hundreds, of millions to the major front group for this movement, Black Lives Matter. Knowing what we now know, it would appear that this is yet another effort to shunt a disgruntled voting bloc away from dangerous activity (such as voting for a presidential candidate who wishes to confront the system as presently constructed, rather than maintain it) and back into the safe confines of identity politics, in which factions vie with each other for favors, rather than with the central power for justice.

The timing of the emergence of the Black Lives Matter movement lends credence to the notion that this agitation has been part of a strategy of coalition management. The death of Trayvon Martin in 2012 can be seen as a watershed in this emergence, for it was soon after that the #BlackLivesMatter hashtag first made its appearance. But it wasn’t until the death of Michael Brown in Ferguson, Missouri, in August 2014 that things became heated. This was followed by the incidents involving Freddie Gray in Baltimore and Eric Garner in New York. By now this has generated an all-out attack on policing specifically and the allegedly racist character of white society generally, with incidents of attacks on both becoming a drearily repeating spectacle.

What is curious about this, again, is the timing. For the so-called “new wave” of immigration began at roughly the same time. Reports of this “new wave” began trickling in in 2013. This new wave of immigrants, bolstered by a massive influx of children (itself spurred by Deferred Action for Childhood Arrivals, President Obama’s 2012 initiative to provide illegal immigrant minors), produced a surge in numbers of new immigrants, both legal and illegal, in 2014 and 2015.

In terms of coalition management, this influx creates problems. The two groups, illegal or unauthorized immigrants and African-Americans, compete for the same jobs and the same benefits from government. That the administration and the Democratic Party is promoting and indeed sponsoring the wave of immigration has the potential to not sit well with existing coalition members like African-Americans, or the working class generally. Therefore, it would seem entirely plausible that, to deflect attention from this conflict, the African-American community has been stoked with allegations of rampant racism, making use of every plausible such incident to reinforce a general narrative that the enemy is not a competing coalition member, viz., immigrants, but the Other, those outside the Democrat coalition, or in other words, whites, conservatives, the police, Christians. This is a matter of speculation; perhaps Wikileaks emails will shed more light on the decision-making process.

Regardless, this is what coalition management  in the age of identity politics looks like.

There is one more aspect that deserves highlighting, and it is connected with the need to maintain consumption levels in Western countries. The phenomenon of mass migration, encompassing both immigration and the influx of Middle Eastern refugees, runs contrary to the national interest of the target countries, and the widespread opposition to the scale with which it is being conducted has fed massive unrest against the ruling class. What is being missed in all of this is that these newly imported populations constitute fresh sources of consumption, regardless of whether employment and thus purchasing power is available for them or not. For in the age of human rights and the welfare state, consumption will be maintained, whether by production or, as we have learned, simply by mortgaging the future through deficit spending to maintain entitlements. All of these migrants can consume much more of that below-market production if they are ensconced in the rich Western countries than if they remained in their countries of origin. In this manner the gravy train keeps chugging along.

This is how we have embarked on the road to Elysium. Debt-funded consumption is combined with structurally low-wage, low-regulation, environmentally-unfriendly production. It is a massive engagement in transactions of decline which unchecked will lead to a situation in which the Elysium of science fiction will increasingly approach reality.

Prospects for the European Economy

We can conduct a similar analysis of the European economy as we did for the US economy.

We will restrict our discussion to the Euro Area, the countries which share a common currency, the euro. The euro creates a unique, separate trading bloc, the internal dynamics of which need to be understood both to assess the performance of the individual member countries, and to assess their place in the world economy.

Within the larger scheme of the globalist production and consumption network, the Euro Area plays a unique role. It functions neither as a supply region nor a demand region. The Euro Area’s role vis-à-vis the rest of the world is that of a demand region for raw materials/energy, and a supply region for manufactured products.[1]

Up until 2012, it ran a roughly even balance of trade with the rest of the world, as can be seen from the following graph. Euro Area Balance of Trade

Hence, in the run-up to the credit crisis of 2008, the Euro Area did not run a sizeable trade deficit, as one might expect given its status as a region full of First World “rich” countries.

But this is not to say that it was not afflicted by similar problems of trade imbalances. The difference is that these imbalances manifested themselves within the currency area. In this sense, the Euro Area acted as mini-world economy, manifesting similar consumer/producer relations. Here as well the divorce between production and consumption reared its head.

If we break down the figures for separate countries, this becomes clear. In the following graph, we see development of the current accounts of eight key Euro Area countries.[2]

C:\Users\Ruben\AppData\Local\Microsoft\Windows\INetCacheContent.Word\Export (1).png

Prior to 2001 and the advent of the euro, the current accounts of these countries ran closely together. France and Italy, for example, usually ran current account surpluses, while Germany ran current account deficits. But all of this changed with the advent of the euro. From that point we see wide discrepancies between the various current accounts. Germany and the Netherlands begin running significant surpluses, while countries like Spain, Italy, and Greece begin running significant deficits.

We can glean from this that the Euro Area itself became divided into supply regions and demand regions. Supply regions run trade surpluses; demand regions run deficits. The major net suppliers were Germany and the Netherlands. The major net demanders were Spain, Greece, and Portugal.

We can also glean from this that consumption was paid for, not by reciprocal production, but by debt. As we have learned by now from previous posts, trade imbalances have to be “financed”: in other words, they are paid for by debt. When trade imbalances are incurred, the countries running trade surpluses are also exporting capital: this is called a capital deficit. What they are doing is exporting demand, by exporting excess savings. To put it bluntly: they are extending the credit to the consuming countries that these countries require to buy their production.

Such an arrangement was made palatable by the euro. The euro was to be the panacea for all economic ills. Participation in the euro was to automatically bring participation in prosperity. And in the early years of the euro project, that surely seemed to be the case. Funds flowed freely from North to South, fueling a boom across these countries, especially in the period 2005-2007, as the following graph indicates.

euro area gdp growth splits

Source: World Economic Outlook Database, April 2016

But this growth was fueled by the debt implicit in the current account imbalances shown in the previous graph. Capital exports (i.e., credit from the exporting to the importing countries) were fueling consumption. The assumption was that the euro constituted surety for this indebtedness. The debtor/consumer countries being locked into the arrangement, they would not be able to devalue their currencies to reduce the value of that debt. And so it was safe to furnish the credit that would pay for the southern countries’ consumption.

Spain was at the epicenter of this debt/consumption nexus. We can get an idea of this by juxtaposing external debt with the balance of trade, as pictured in the following graph. Spain Total External Debt

External debt exploded from €600 billion in 2002 to €1.6 trillion in 2008, while the trade deficit deteriorated from $4 billion/month in 2001 to $10 billion/month in 2008.

This debt binge, as in the US, took the form of a housing bubble. “The only way [Spain] was able to grow for many years prior to the crisis was with a surge in domestic credit that expanded the nontradable goods sector – real estate and consumption, for the most part, with surging real estate itself fueling further borrowing and consumption.”[3]

But it was not only Spain that in this manner paid the piper. Other countries as well participated in this spending binge, as the following graphs indicate:

Portugal Total Gross External Debt Greece Gross External Debt

Greece is of course the poster child for the, in retrospect, exorbitant and entirely irresponsible spending spree that characterized the pre-crash period, and which was gladly financed by the exporting countries of the North. The only problem with this method, as we saw with the world economy, is that it is unsustainable. At some point, the punch bowl is taken away, and whoever is left holding the bag is also left holding a slew of “odious debt.”[4]

In the aftermath of the credit crisis, the Euro Area has had to adjust to the collapse in consumer demand, just as has the United States. In one respect the two have followed similar paths: government deficit spending has served to fill the gap. The following graph shows how government debt has grown in the US and in the Euro Area. Euro Area Government Debt to GDP

The trajectories are quite similar, although the magnitudes differ somewhat: the US’s ratio of debt to GDP has burgeoned to over 100%, while that of the Euro Area now exceeds 90%.

This is one way the Euro Area has compensated for the drop in demand. Another is by resorting to exchange rate depreciation. This has improved the terms of trade for Euro Area exports and thus helped improve economic growth. Euro Dollar Exchange Rate - EUR/USD

The trend line refers to the exchange rate of the euro vis-à-vis the dollar, and clearly indicates a downward trend, which has the effect of making Euro Area exports more attractive. Because of this, the surplus on the Euro Area balance of trade has steadily widened. The Euro Area is thus attempting to export its way out of its present difficulties. But we now know where such a strategy leads: to dependence upon foreign demand, which itself is funded by capital exports.

We should make mention of one other attempt to boost demand: quantitative easing. Here as well, the Euro Area has followed the lead of the US, force-feeding the central banks’ balance sheets with bonds, which has the effect of flushing the money market with liquidity.

The following graph shows the extent of the operation. Here again, the trend lines are similar although the magnitudes differ somewhat: the Federal Reserve System now has about $4.5 trillion on its balance sheet, while the Euro System has about €3.4 trillion (about $3.8 trillion at current exchange rates). Euro Area Central Bank Balance Sheet

This together with deficit spending was to bolster economic growth. Nevertheless, that growth has remained fairly anemic: Euro Area GDP Annual Growth Rate

The fact of the matter is, neither of these strategies for fomenting growth are sustainable.

Quantitative easing is only a temporary panacea; at some point those bonds are either returned to the market or become due. In both cases, this removes liquidity from the money market.

The attempt to export one’s way to growth is likewise a dead end, as every country that has tried it has eventually discovered, to its cost. This is why Japan is moribund and why China is heading in that direction. Export-led economies need import-led economies to absorb their production; if those import-led economies for whatever reason stop importing and stop demanding, the export-led economies are left high and dry with essentially superfluous production capacity. On top of that, the trade imbalances that are required for this model require the continual buildup of debt, a similarly unsustainable course of action.

This is the reason why economists like Michael Pettis keep urging these export-led economies to rebalance away from dependence on exports towards a more balanced model based first and foremost on domestic demand. This would restore Palley’s “virtuous circle of growth” and the link between production and consumption, having the one pay for the other in the circular flow of the properly functioning economy.

What stands in the way of this? Recall Pettis’s explanation (in this post) of the techniques by which export-led economies generate excess capital with which to fund trade surpluses. They do so by implementing various policies that in effect force their own citizens to “save” rather than spend. Pettis’s list includes:

  • consumption taxes such as VAT, which reduce by the amount of the tax, the amount consumers may consume;
  • tariffs, which artificially increase the price of imported consumer goods, thus in essence forming another consumption tax;
  • financial repression, in which the state runs the banking system and rigs it in favor of commercial borrowers and against consumers, so that consumers have less money to spend on consumption.

In the European situation, it is VAT which jumps out on this list. VAT constitutes an enormous hindrance to consumption spending. The result is to ease pressure on exchange rates and so foment export performance, but at the expense of domestic consumers.

In his book The Great Rebalancing, Pettis points out another method by which Europe’s economic engine, Germany, has been able to generate the massive trade surpluses it has in recent years, especially in the light of its trade deficits in the 1990s. This came about through wage repression. German workers have agreed to have wage growth restrained in order to promote the greater good, which in this case is the German export machine. Pettis’s explanation merits quotation in extenso:

After German reunification in the early 1990s, Germany faced the problem of very high domestic unemployment. It resolved this by putting into place a number of policies, agreed on by trade unions, businesses, and the government, aimed at constraining wages and consumption and expanding production in order to regain competitiveness and generate jobs. Although these policies may have made sense for Germany and the world in the 1990s, … the creation of the euro introduced a new set of currency and monetary rigidities that would change the impact of these policies both within Germany and abroad.

Specifically, as wage growth was constrained in Germany by relatively tight monetary policy in the German context, it was left unconstrained in peripheral Europe because monetary policy there was, paradoxically, too loose given underlying conditions of rapid growth and rising prices. These policies resulted in an increasingly undervalued euro for Germany relative to the rest of Europe, low wages for its level of productivity, high consumption and income taxes, and expensive infrastructure funded by these taxes.

In that case it is not surprising that German GDP growth exceeded the growth in German household income, because households were effectively forced to subsidize employment growth, and this subsidy reduced disposable household income and consumption relative to total production….

The high German savings rate, in other words, had very little to do with whether Germans were ethnically or culturally programmed to save— contrary to the prevailing cultural stereotype. It was largely the consequence of policies aimed at generating rapid employment growth by restraining German consumption in order to subsidize German manufacturing— usually at the expense of manufacturers elsewhere in Europe and the world.[5]

The upshot of all of this is, Europe is as wedded to the system of neo-mercantilist trade imbalances as is the rest of the world. It is here that change needs to come, but no policy proposals are in the offing that even bring this problem set to the table, much less propose solutions to it.

Notes
  1. “[The] Euro Area runs regular trade surpluses primarily due to its high export of manufactured goods such as machinery and vehicles. [The] Euro area is a net importer of energy and raw materials. Germany, Italy, France and Netherlands account for the largest share of total trade. Main trading partners are the United Kingdom (12 percent of total exports and 10 percent of imports) and the United States (13 percent of exports and 6 percent of imports)” (TradingEconomics.com).
  2. As we outlined in the previous post, the current account is similar to the balance of trade and provides the same sort of indications.
  3. Michael Pettis, The Great Rebalancing: Trade, Conflict, and the Perilous Road Ahead for the World Economy (Princeton: Princeton University Press, 2014), p. 4/29 of ch. 6 (ebook version).
  4. Jason Manolopoulos, Greece’s ‘Odious’ Debt: The Looting of the Hellenic Republic by the Euro, the Political Elite and the Investment Community (London and New York: Anthem Press, 2011).
  5. The Great Rebalancing, ch. 6, pp. 10-12/19.

Prospects for the US Economy

THE WORLD ECONOMY IN RÉSUMÉ

In the previous post we outlined the structural condition of the world economy, and in particular the structural flaws it contains.

The main flaw is the divorce between production and consumption.

Prior to the establishment of this new macroeconomic structure, supply and demand were roughly in balance in the domestic economy.

We can see this by taking a look at the balance of trade of the United States between 1950 and 1980. In that period, the US economy was the major trading partner for the rest of the world – not to mention that the dollar was then, as it is now, the currency in which world trade is conducted – so that its trade data can serve as a useful proxy for the development of the broader world economy.

United States Balance of Trade

During most of this period, the US balance of trade was roughly in balance. Only towards the end of the period did it begin displaying the sharp divergences that would characterize the period since then, albeit here the magnitude of the imbalances is still very small. As we shall see, they have since taken on major proportions.

During this earlier period, some countries did indeed display trade imbalances. Where this was the case, it was the byproduct of colonialist relationships, such as with “banana republics” the role of which was to produce bananas; the same was true of sugar or rubber or oil. These commodities were produced for export, and the economies depending upon such exports were thus at the mercy of the whims of the world market.[1]

So this lack of balance between supply and demand was an exception to the rule. But since the establishment of the new macroeconomic order, that balance in domestic economies has been rudely disrupted by a new way of linking production and consumption.

In the new structure, the world has been parceled out into various supply and demand regions. Low-wage, developing countries have been designated as supply regions. They are used as sources of raw materials and production. The rich, developed countries have been designated as giant piggy banks. They have been allocated the role of consuming this production.

All of this is orchestrated from the top by the global corporate elite, which uses politicians, the media, the entertainment industry, and academia to further this “bread and circuses” New World Order of universal colonialism. The world is, indeed, their oyster.

This new order no longer balances production and consumption in a symbiotic circular flow within domestic economies. Instead, massive trade imbalances are created, each of which has to be financed. This means that it is debt, not production, that is paying for consumption. The system mortgages the future in favor of the present.

The magnitude of the new order’s collective trade imbalance, and thus dependence on debt, is indicated in the following graph:

The graph shows the current account balance for the world, the advanced economies, and developing economies over the period 1980-2016. The current account balance is a bit different from the balance of trade, as it includes income payments and transfer payments between countries. But these latter are relatively negligible as compared with trade in goods and services. So the two measures are roughly comparable.

What the graph shows is that the changes in the world economy in evidence since the late 1970s accelerated towards the end of the 1990s. Developing countries began generating an enormous collective current account surplus, in line with their role as the world’s producers; while advanced economies developed an enormous current account deficit. This persisted until 2010. With the credit crisis (actually the “debt-funding” crisis) the situation has since reversed somewhat: debt financing has since become hard to come by.

The upshot is that current account (and trade) imbalances became the norm for the world economy during this period, and since these imbalances had to be financed, they have left behind a mountain of debt that at some point will have to be paid off.

Within this framework, the United States has occupied the central role; it is the “consumer of last resort.”

The question now is, has anything changed with regard to the functioning of the US economy to indicate that it has broken with this structurally flawed global economic mechanism? Our conclusion in the previous post was very summary; we opined, with Palley, that stagnation was the direction the economy was headed, given the lack of any sign of a break with this failed model. Let’s look in more detail at the developments in the US economy since the crash.

WHAT THE STIMULUS DID TO PROMOTE ECONOMIC RECOVERY

Prior to the 2008 credit crisis, the US financed its consumption-oriented trade deficit via the housing bubble. This unsustainable method led to the crash. Since then, the US has turned to various schemes, in order to continue to finance this consumption.

The main such policy has been a return to good old-fashioned Keynesian deficit spending. Barack Obama justified this policy back in 2009:

Economists on both the left and the right agree that the last thing a government should do in the middle of a recession is to cut back on spending. You see, when this recession began, many families sat around the kitchen table and tried to figure out where they could cut back. And so have many businesses. And this is a completely reasonable and understandable reaction. But if everybody — if everybody — if every family in America, if every business in America cuts back all at once, then no one is spending any money, which means there are no customers, which means there are more layoffs, which means the economy gets even worse. That’s why the government has to step in and temporarily boost spending in order to stimulate demand.

That speech blames the banks for the crisis, while explaining also why the banks needed to be propped up and bailed out. Only a politician could argue both of these in the same speech and be applauded for it.

The problem with this kind of thinking, as we stressed in the previous post and shall further elaborate below, is that it does nothing to address the underlying structural economic framework that had the crash as its inevitable consequence.

The stimulus came in the form of the American Recovery and Reinvestment Act of 2009. Predictably, the ARRA did not lead to economic recovery. How could it, when it did not even begin to address the underlying problem of debt-financed consumption? The only change was that the government was taking on the debt, rather than consumers directly.

The ARRA set a precedent for deficit spending which has continued, albeit in more muted form, since then. The US has been running record budget deficits in every year since, as can be seen from the following graph:

As can be seen here, the Obama administration has been running deficits that dwarf those even of the George W. Bush administration, which used to take the prize for this dubious distinction.

This has led to a near-doubling of government debt as a percentage of GDP during the Obama administration’s term of office:

United States Government Debt to GDP

All of this deficit spending might be considered beneficial in the long term if it went to funding investment as opposed to consumption – in other words, if it went to addressing the structural flaw of the divorce between production and consumption. Was it being used to finance investment in productive capacity, so as to restore the “virtuous circle?” Borrowing to finance investment is borrowing to finance growth; borrowing to finance consumption, on the other hand, is simply selling the future out to the present.

This is the criterion. So then, what kind of spending has the federal government been engaging in? In the main, it is consumption as opposed to investment spending, as the following pie chart suggests:

Data is for the 2015 federal budget. Source: Politifact.com

Items such as Health (Medicare and Medicaid) and Social Security are not investment but consumption. Other items on the list can be viewed as partly one and partly the other. In particular, social welfare payments and salaries to civil servants/military personnel qualify as consumption.

Therefore, much of this spending is money distributed to citizens to fund consumption. Which means that much of the federal deficit and federal debt goes toward consumption spending. The same holds true for state and local levels of government.

In other words, most of the burgeoning deficit and debt have gone toward picking up the slack left by the bursting of the housing bubble.

This means that Keynesian deficit spending has not been addressing not economic recovery or restoration, but simply maintaining the status quo that gave us the housing bubble in the first place!

Structurally, nothing has changed.

This is evident from an examination of the US trade deficit during the course of the first 16 years of the 21st century, thus both prior to the crash and posterior to it.

The deficit peaked during the artificial boom years prior to the crash. But – and this is the point – since then, although the magnitude of the deficit has decreased, it is still running at nearly $500 billion per annum.

The thing to understand about the trade deficit is that it, too, has to be financed. In other words, the trade deficit has as its flip side, increased debt. How much of that debt ultimately is owed by the federal government, through its deficit spending agenda, is difficult to say. But what we can say it is this: the trade deficit continues unabated, while government deficit spending has grown enormously. The conclusion can be drawn, then, that government spending has picked up at least part of the slack left by the bursting of the housing bubble.

In other words, the structural flaws of the world economy as outlined in the previous post have not been addressed; only different means have been found to keep the system going as it is currently structured, precisely without addressing its structural flaws, because to do so would harm the interests that are profiting from the current arrangement.

WILL FUTURE ECONOMIC POLICY ADDRESS THE STRUCTURAL ISSUE?

The question remains, is there any prospect of this issue being addressed? As we saw in the previous post, Palley had no confidence that it would be with the Obama administration, and his prediction proved to be correct. But what now? With the 2016 elections we are facing a changing of the guard. Can the candidates’ positions shed any light on this?

One thing is for sure, the latest trade deal, known as the Trans-Pacific Partnership (TPP), is on both candidates’ bad list. This despite the fact that President Obama is continuing to push the deal, attempting to get the appropriate legislation passed by Congress before his term of office expires. Clinton’s opposition does appear to have been forced by both Sanders’ and Trump’s vociferous opposition, and many expect a Clinton administration to include among its priorities the passage of this bill, perhaps with minor modifications.

In a nutshell, the problem with this bill is that it sets up further machinery to arrange trade, not in the interests of the particular countries involved, nor to restore the virtuous circle of domestic economies, but to maintain and perpetuate the production/consumption divorce.

What more might we expect from a Clinton administration? Conveniently, we have a major address on economic policy to work with, given by Hillary Clinton on August 11th. Its key proposal is a renewed stimulus plan that ostensibly will provide the greatest investment in “good-paying jobs” since World War II: “We will put Americans to work, building and modernizing our roads, our bridges, our tunnels, our railways, our ports, our airports. We are way overdue for this, my friends. We are living off the investments that were made by our parents’ and grandparents’ generations.”

The problem here, of course, is that this is precisely what Obama promised. ARRA was supposed to provide a major boost to employment, while also renovating the country’s infrastructure. But as the Wall Street Journal put it in a post-mortem (Obama’s Stimulus, Five Years Later),

The federal government poured billions into the government and education sectors, where unemployment was low, but spent only about 10% on promised infrastructure, though the unemployment rate in construction was running in double digits. And some of the individual projects funded by the law were truly appalling. $783,000 was spent on a study of why young people consume malt liquor and marijuana. $92,000 went to the Army Corps of Engineers for costumes for mascots like Bobber the Water Safety Dog. $219,000 funded a study of college “hookups.”

In the main, the money went not to infrastructure, nor even to productive investment generally, but to the maintenance of existing favored activities in “the government and education sectors,” – thus, essentially, as favors to groups largely supportive of Democratic Party politics.

Will it be any different this time around? In terms of dollar amount, Obama’s stimulus dwarfed Hillary’s $275 billion. Donald Trump has also proposed spending on infrastructure. As The Atlantic points out, “Trump, a builder by blood, has pledged to double that figure, at least. He has called for spending up to $1 trillion on new roads, bridges, broadband, and more.”

If that were all that was to it, then we wouldn’t have much to look forward to as far as structural change is concerned. But Trump has made other proposals as well, which are well worth delving into. We defer that analysis to a later date.


 

  1. For an example of the vulnerability of such export-dependent economies, see Jane Jacobs, Cities and the Wealth of Nations (New York: Simon & Schuster, 1984), ch. 4, “Supply Regions,” which uses the example of Uruguay as a country that was totally dependent upon the cattle industry for exports (meat, leather), which got rich from this trade, but which went into steep decline after that trade collapsed in the 1950s.

The Economic Consequences of the Release (i.e., Brexit)

Much has been written on the recent decision by the UK to leave the European Union. Much of it is emotion-driven. But that is no way to assess such an important turn of events. The actual significance is, in significant degree, economic in nature. This calls for an economic analysis, to which we now turn.

The Organisation for Economic Co-operation and Development’s (OECD) Report published in April 2016, entitled The Economic Consequences of Brexit: A Taxing Decision[1], provides a competent summary of the disadvantages that might follow upon a British departure from the EU. We will use it as a reference for interaction.

Initial objections

The initial objections the Report registers are based on circumstantial evidence.

This holds for “Since EU membership in 1973, UK living standards have risen more than in peers” and “A multipolar world implies that the UK is economically stronger as an EU member, and in turn contributes to the EU strength.” (both on p. 9). Despite the graphs, such arguments, are, at best, suggestive rather than demonstrative. The same holds true for the objection that “Uncertainty has already begun to have a negative impact on the economy” (p. 10).

Exchange rates and the balance of trade

The Report then claims that “Uncertainty about Brexit has led to capital outflows and a weaker exchange rate” (p. 12). For a country running a perennial trade deficit, this is anything but objectionable. The graph below shows the development of the UK’s balance of trade since joining the EU (then the European Economic Community) in 1973.UK balance of trade

 

This shows a downward trend, and since the late 1990s, a persistent trade deficit. As such, a decline in the pound’s exchange rate will only help matters, by encouraging exports and discouraging imports.

This leads directly to the next objection, which is a weighty one. “Trade would be hit when the UK formally exits the EU.” If this is the case, it would be dire indeed. Let’s examine the substance.

“The EU remains the main trade partner of the UK and the financial sector benefits from direct access to the Single Market, which has strengthened the comparative advantage of the City” (p. 14). Absolutely true. And by way of elucidation: “Exports to EU countries account for about 12% of UK GDP and about 45% of total UK exports, and for imports the EU is even a more important partner.” This was already implied in the trade deficit data we looked at above.

The graphs below shows the breakdown. The first shows, by percentage, the UK’s export destinations, the second shows the UK’s imports by country of origin (source: The Observatory of Economic Complexity [http://atlas.media.mit.edu]).

UK exports

UK imports

The data is from 2014. As can be seen visually, Europe accounts for the lion’s share of both imports and exports.

The Report includes the following graph on page 15, showing the trade and current account situation between the UK and the EU:

UK current account2

Now then, all of this indicates mutual dependence. Even more than that, though, it indicates that the EU is more dependent upon the UK as a source of income than the other way around, given the fact that the UK runs a trade deficit with the EU. The EU has every reason to maintain existing trade relations with the UK. It would be to the EU’s disadvantage not to do so.

Renegotiating trade deals

The Report goes on to claim that “Negotiating a new trade agreement with the EU is likely to be complex” (p. 16). The various possibilities are laid out in a table, which we reproduce here:

brexit arrangementsThe claim is that negotiations will be complex and that the UK will be on the outside looking in, with the very real possibility of being relegated to “Most Favored Nation” status, in which trade with the EU will be “subject to the EU’s common external tariff.”

For one thing, negotiations need not be complex at all. The website Lawyers for Britain has put together comprehensive, detailed research papers on this issue, of which we gratefully make use. On Brexit and International Trade Treaties, it summarizes the issue both for the UK and for trading partners generally, with the following points (emphasis added to highlight key issues):

  • “Because of the EU customs union and ‘common commercial policy’, the UK is not able to negotiate its own trade agreements with non-member countries — we can only do so as part of the EU. The UK will be able to participate in new trade agreements with non-member countries from the day after exit.  The process of negotiating new trade deals can be started during the 2-year notice period leading up to Brexit, with a view to bringing them into force on or soon after the date of exit.
  • “The EU has existing free trade agreements which currently apply to the UK as an EU member.  Most of these EU agreements are with micro-States or developing countries and only a small number represent significant export markets for the UK.  Both the EU and the member states (including the UK) are parties to these agreements. The UK could simply continue to apply the substantive terms of these agreements on a reciprocal basis after exit unless the counterparty State were actively to object. We can see no rational reason why the counterparty States would object to this course since that would subject their existing export trade into the UK market, which is currently tariff free, to new tariffs. There will be no need for complicated renegotiation of these existing agreements as was misleadingly claimed by pro-Remain propaganda.
  • “The UK was a founder member of EFTA but withdrew when we joined the EEC in 1973.  We could apply to re-join with effect from the day after Brexit. There is no reason why the four current EFTA countries would not welcome us back, given that the UK is one of EFTA’s largest export markets.  EFTA membership would allow us to continue uninterrupted free trade relations with the four EFTA countries, and also to participate in EFTA’s promotion of free trade deals with non-member countries around the world.
  • “The EU is seriously encumbered in trying to negotiate trade agreements by the large number of vociferous protectionist special interests within its borders.  After Brexit, the UK would be able to negotiate new trade deals unencumbered by these special interests much faster than the EU, and with a higher priority for faciliting access to markets for our own export industries including services.
  • “It is completely untrue that you need to be a member of a large bloc like the EU in order to strike trade deals.  The actual record of the EU compared to that (for example) of the EFTA countries demonstrates the direct opposite.
  • “The baseline of our trade relationship with the remaining EU states would be governed by WTO rules which provide for non-discrimination in tariffs, and outlaw discriminatory non-tariff measures. From this baseline, and as the remaining EU’s largest single export market,  we would be in a strong position to negotiate a mutually beneficial deal providing for the continued free flow of goods and services in both directions.  We explain what such a deal would look like in a later post, Brexit – doing a deal with the EU.”

All of this indicates that it will require no herculean effort for the UK to reestablish itself as an independent trading partner, neither vis-à-vis the EU, nor the world at large. After all, the other countries of the world are not members of the EU, and they are surviving. And it bears repeating that for the EU to impose a tariff on UK imports would make no sense at all, because the same kind of tariff would be imposed reciprocally on exports to the UK: all $420 billion of them (from all of Europe, 2014).

All in all, it would be in the EU’s best interest to simply maintain existing trade relations, as they are eminently in its interest.

Other near-term effects

Further near-term effects discussed in the Report, such as a putative “reduction in UK trade openness,” “imposition of tighter controls on inward migration,” leading to “a large negative shock to the UK economy, which would spillover to other European countries” (all p. 21), are either mere surmises or could serve to argue the exact opposite.

The argument that a decline in the exchange rate would have deleterious effects on the UK economy is an example of an argument that could just as well be used to argue the opposite. As discussed above, a decline in the exchange rate would bolster UK exports and inhibit imports, which would benefit the UK and disadvantage the EU. In other words, the neo-mercantilist export policy of the EU countries like German and the Netherlands would be brought more in line with equity.

Long-term effect on trade

The Report goes on to discuss possible long-term effects.

The first one discussed is the trade situation. “The UK is the most attractive destination for FDI in the EU, partly owing to access to the EU internal market” (p. 24). Foreign direct investment would be restricted by withdrawal from this internal market. But again, as noted above, access to the single market is unlikely to be restricted, as the EU derives more advantage from it than the UK. Furthermore, the major inhibitor to direct investment is currency risk. But it’s not like the UK is withdrawing from the euro; it is only rearranging its relation with the EU, with the relation between the pound and the euro (a free float) not changing at all.

Effect of reduced immigration

Secondly, “Immigrants, particularly from EU countries, have boosted GDP growth significantly in the UK” (p. 26). Apparently, immigrants are more productive than native-born Britons. This is obviously a contentious statement; whether it proves anything is another question. Then there is this contention: “Immigrants from the EU make a positive contribution to the public finances, despite relying on the UK welfare system, which is also the case of UK migrants elsewhere in the EU” (p. 27). This is another statement difficult to rhyme with realities. Even if immigrants are all net contributors in terms of social welfare revenues and payouts, the jobs they take, leave other labor market participants without jobs and thus, at least in part, adds to the social welfare rolls (unemployment and other forms of social assistance). In addition, “immigrants from new EU countries have comparatively lower wages…” (p. 27), which means they depress wages, which may be beneficial to employers, but not to employees, and additionally reduce consumption.

The claim is made that reduced immigration would lead to reduced skills, and “A loss of skills would reduce technical progress.” That may be true in the short term, but where there is demand for skills, there will be training and education to enable workers to acquire those skills, and there is no inherent reason why native-born Britons could not be trained up. It is in fact a curious prejudice and form of reverse discrimination to believe otherwise.

The upshot

As a result of these putative disadvantages, the claim is made for a “central scenario” in which “UK GDP is more than 5% below the baseline by 2030.” Just the opposite is at least as likely.

Objections in favor of withdrawal can also be made, of course, but the Report neglects to mention those. One is the fact that the UK is the second-largest net contributor to the EU’s budget, after Germany. Another is that the UK bears a major part of the costs of the EU’s common defense. Yet another is the costs of an inherently cumbersome and inefficient, far-off, relatively unaccountable bureaucracy regulating so much of the economic life of the nation.

But the biggest problem with the EU is tangential to this particular debate. It has to do with the single currency, the euro, in which the UK, of course, is not a participant. The euro forms a massive net drag on the world economy, and the debt overhang to which it has contributed, by having encouraged irresponsible, indeed unconscionable, North-South lending, is an toxic inheritance that not only stifles current economic growth, but also forms a burden that future generations will be hard-pressed to alleviate.

That, however, is stuff for another discussion. For now, it is enough to re-emphasize that, in line with the position outlined here (with an assist here), it is nations, not empires, that create wealth. And that should be kept uppermost in everyone’s mind.


 

  1. Kierzenkowski,R., et al.  (2016), “The Economic Consequences of Brexit: A Taxing Decision”, OECD Economic Policy Papers, No. 16, OECD Publishing, Paris.

The Mystery of Capital in Context

Given the rancorous debate unleashed by the UK electorate’s decision to depart the European Union – in particular, regarding the damage to the UK economy that independence might bring – it seems wise to re-examine the foundations of economic prosperity and its relationship to political and legal factors. I do so by examining Hernando de Soto’s seminal book, The Mystery of Capital, which goes to the heart of the relationship between political framework, legal framework, and economic development.


The “mystery of capital” is the intriguing title of one of the most important books of the new millennium. Written by the Peruvian economist Hernando de Soto, it breaks with the tradition of dealing with capitalism as a system established of, by, and for the rich, by looking at it from the bottom up: from the lowest levels of society. De Soto finds capitalism even at that level, albeit in a stage of dormancy, as it were. His treatise is intended to help us understand that capitalism is nothing esoteric – despite its being a “mystery” – but rather something down to earth, active in the lowest levels of society, and only waiting for a proper legal and political framework to become an equitable system, in the service of all, not just the well-to-do.

De Soto first made a name for himself with his path-breaking work in Peru, which culminated in the best-selling book The Other Path. In order to show an alternative route to a better society, De Soto developed a unique investigative method. At the time – the 1980s – the better society was being promised by radical revolutionary groups. In Peru, such a group was El Sendero Luminoso, the “Shining Path” – the path to the enlightened society, the workers’ paradise. Officially, this was the Communist Party of Peru, and throughout the 1980s it engaged in violent revolution. De Soto proposed El Otro Sendero, the “other path,” which would render the revolution irrelevant by integrating the real-world economies of the poor within an all-embracing economic framework that left no one out.

What De Soto and his colleagues at the Institute for Liberty and Democracy had discovered was that, at the poorest and most basic levels of society, a vibrant economy was already in existence. It functioned in spite of, rather than because of, the formal institutional and legal structures provided by the state. For in Third-World countries such as Peru, there was not one economy but two: the formal economy, the economy of the wealthy and middle class, connected with the rest of the world; and the informal economy, the economy of the poor, the “off the books” economy, comprising the residual and peripheral denizens who happened to make up the vast majority of the nation. Essentially, the legal and political institutions functioned within and for the benefit of the formal economy, while the informal economy ran on its own, ignored and neglected by the powers that be, kept by the phalanx of rules and regulations from ever graduating from the shadows into the sunlight of the economy proper.

De Soto’s book highlighted this situation and the potential that it held, if it could be harnessed, both for the benefit of the poor and for the nation as a whole. Mainly, the regime of bloated regulation and official corruption needed to be exchanged for the rule of law, specifically the institutions of property and contract. If this would occur, the chains would come off of the poor and they could become full-fledged participants in a functional rather than dysfunctional social order.

De Soto’s second book, The Mystery of Capital, is the culmination of the work done in the wake of, and building on the foundations laid in, The Other Path. It is the product of the transfer of the method pioneered in Peru into many other Third World countries facing similar problems. De Soto took his show on the road, making the Institute for Liberty and Democracy into a globally active entity.

Unlike The Other Path, however, The Mystery of Capital is more than an exposition of the findings of investigative field work. In fact, it transcends the empirical method altogether: it sets forth a philosophical outworking that is both result and foundation of those empirical findings.

In making this leap from practice to theory, De Soto had penned a most important book on the subject. He was enabled to do this precisely because of the empirical basis: the book went beyond economic theory to the real world in which economic practice is embedded, a world that economic theory studiously ignores; it takes into account the real-world framework within which economies function.

The recognition of the two-tiered economy led De Soto to perceive the crucial importance of the legal system. For in his findings, it was the legal system that made the difference between the two economies. This led him to explore virtually virgin territory: the relationship between the legal system and the economy has been largely ignored, except for certain specialty (and rather idiosyncratic) disciplines such as institutional economics, “new” institutional economics, and law and economics. While these latter disciplines have not been entirely fruitless, they have not helped to rework economic theory the way that De Soto had done in his book.

De Soto’s reworking of economic theory starts from a rather crucial distinction that is well known to legal philosophers, the distinction between possession and property. This is a staple of the Western legal tradition (both civil and common). Essentially, the difference between possession and property is physical versus mental – possession is physical holding, while property is an entitlement that stays in force regardless of whether the owner is in physical possession or not. And this distinction depends on a functioning legal order that enforces its arrangements. With possession, enforcement is essentially left to the possessor; with property, it is maintained by a separate entity charged with law enforcement, and hence is not dependent upon the physical strength of the owner in order to enforce possession.

With property arrangements, then, the relations of people and things are elevated to a higher plane than arrangements of pure possession. And they provide for higher-order exploitation of resources than simple possession does. For one thing, property rights can be split up and farmed out any number of ways. For another, property allows for encumbrance in credit contracts, whereby the property item serves as collateral. Without changing its physical status, the encumbered asset engenders a new set of economic advantages. The owner can borrow money against it; and, as Steuart showed back in the 18th century and Schumpeter in the 20th, this is essentially the way in which, in the modern world, money comes into being. At least, in a banking- as opposed to a coinage- or scrip-based system. Credit and debt are the source of money issue. As any bank balance sheet will show you, all money issued has as its counterpart an encumbered economic asset.

In his book, De Soto never explicitly refers to the legal doctrine of possession vis-à-vis property, but despite that, it underlies his entire exposition. He argues that it is the legal system that enables possessions to become property, thus assets, and assets to become capital – resources capable of generating new productivity and income. “Like electrical energy, capital will not be generated if the single key facility that produces and fixes it is not in place. Just as a lake needs a hydroelectric plant to produce usable energy, assets need a formal property system to produce significant surplus value. Without formal property to extract their economic potential and convert it into a form that can be easily transported and controlled, the assets of developing and former communist countries are like water in a lake high in the Andes – an untapped stock of potential energy.”[1]

De Soto’s argument is crucially important – as far as it goes. But it runs into problems when he goes further and highlights a single aspect of the legal system, to which he attributes excessive importance. This in turn causes him to lose sight of other aspects, and indeed, the bigger picture.

De Soto emphasizes the role of record-keeping as the determining factor in creating a cognitive layer overlaying the physical layer of tangible things. Records, titles, data storage and retrieval, allow the things that otherwise exist in isolation to be integrated together into a collective mind map, by which they become a synergistic whole that is greater than the sum of the parts. For De Soto, this is the crucial element of a system of property rights, which enables it to generate productive economic assets – capital.

But this is to overplay his hand. It is not so much record-keeping within a framework of law, but the framework of law itself that is the important thing. The key is the establishment of common law: a law that is valid across the board across the entire territory, which holds for everyone and which establishes at its core, property rights and freedom of contract, uniformly and equally enforced. Historically, this kind of common law was established early on in England, where the king’s writ came to run everywhere. Which is why England became the common-law country par excellence.[2]

Such an establishment of common law, in turn, depends upon the consolidation of sovereignty.

Sovereignty is the power by which the rule of law is established. It is the prerequisite of a functioning legal order. Sovereignty is the power to establish and confirm shared, social value. It does this through legislation and adjudication, establishing laws as standards by which the social order is ruled – the rule of law. These, then, are values, which are universally valid and binding.[3]

But there is more to the establishment of value than this. Valuation has, of course, an economic dimension as well as a juridical one. But does the legal system generate economic value? Yes it does, through the utilization of property and contract. And here we have the intangible, mental, symbolic dimension of the economy that De Soto intuits, but does not quite elucidate, given his focus on record-keeping. Property and contract generate value by the process of credit and debt. When property is harnessed as collateral in a credit contract, it is valued; and this valuation is expressed in the issuance of a monetary equivalent. A deposit is established at the bank, in the equivalent of the loan. Borrowing a metaphor from the days of minting coinage, Steuart called this the “melting down” of property into “symbolical” money. Hence, the regime of property and contract participate in the process of valuation in a very critical way. And out of this valuation comes capitalization – capital.

Now then, the context of this valuation and process issuing forth ultimately in that mysterious entity, capital, is a common legal order, the product of a consolidated and viable locus of sovereignty. Sovereignty, then, enables this whole process of capitalization to take place. What is the locus of sovereignty? Following the German Calvinist statesman and political philosopher, Johannes Althusius, we can answer unambiguously, the nation.[4]

The Industrial Revolution, the “take-off,” as W.W. Rostow put it, did not come about in a vacuum. It came about in nations in which sovereignty had been consolidated; and those nations in which sovereignty had not been consolidated, did not experience it. Nationhood and sovereignty go together. Like a lens out of focus, sovereignty is weak where it does not shine through the prism of nationhood. And, where sovereignty is weak, there also a domestic economy does not materialize; as a result, conditions are rife for an exploitative, colonial or neo-colonial framework. Wallerstein’s center-periphery framework then looms large. None of that is necessary for economic growth: in fact, it only benefits particular interests, at the expense of broad-based, populace-elevating economic growth.

So then, it is sovereignty refracted through nation-states that has enabled the genesis of the capital which De Soto seeks to demystify. Summarizing this state of affairs, I wrote: “Through the institutions of property and contract, credit and debt, the asset base in man (human capital) and through man (tangible and intangible property) becomes capitalized, generating a money supply which, when properly maintained, is the faithful representation of that asset base, no more and no less. The nations of the world have no need of a Wizard of Oz to grant them prosperity. It is in their hands to do so, if they would only recognize it.”[5] That is the mystery of capital explained. In its fullness, only nations can bring it off. Neither inchoate peoples, nor empires, ever have, or ever will.


[1] Hernando De Soto, The Mystery of Capital: Why Capitalism Triumphs in the West and Fails Everywhere Else (New York: Basic Books, 2000), p. 48.

[2] For more on this point see my book Common Law & Natural Rights (Aalten: WordBridge, 2009), pp. 68ff.

[3] For more on this point see my book Common-Law Conservatism: An Exercise in Paradigm-Shifting (Aalten: WordBridge, 2007), ch. 1.

[4] For more on this point see this previous post.

[5] Follow the Money, p. 190.