More Money More Problems/More Problems More Money

"B.I.G said it first More Money More Problems,
the way I see it; More Problems More Money"

Below: The US debt clock in NY, September 15, 2009

If the above statement is true or not something that is worth discussing. Most agree, however, that too much debt leads to major problems.

To qoute Göran Persson: "He who is in debt is not free" (Den som är satt i skuld är icke fri)

I found this very interesting website www.usdebtclock.org, where you can follow the U.S. debt in real time. It also contains information on other important economic factors, for example GDP composition, tax revenues, defense spending, unemployment, oil imports, the budget deficit and how much money the government has spent on stimulus and bailouts.

The numbers are enormous, but it if you take minute to look them over is is easy to get a grip of how things are connected and very easy to see that revenues do not cover expenses.

What surprises you is the speed at which all numbers constantly increase. While I was writing this short post for example (about 20 minutes), spending on defense (including the wars in Iraq and Afghanistan) increased with about $ 15 000 000 (!!!) I guess More Problems does mean More Money after all.

Now, where is the swedish debt clock? It would be really interesting to see something similar for the swedish economy.

You can find the swedish debt on www.riksgalden.se, and a UK debt clock can be found at www.debtbombshell.com

Australia: www.debtclock.com.au
Germany: www.steuerzahler.de/

Let the dollar circulate

"Unemployment on the rise, rent being paid late,
please, let the dollar circulate"

No, Young Jeezy is not qouting Keynes. He is however saying the same things many economists are.


In The Economist from November 5th there is a very interesting article from their Buttonwood column that covers the financial markets. It also ties in with my previous remarks on the crisis. In addition, the author behind the column writes interesting, smaller posts in her/his blog.

There the author writes repeatedly that governments may have saved the financial markets but they have done a worse job with the real economy. Stimulus packages and the takeover of banks probably rescued the financial markets, but it has not got the engine of our economy, consumption and investment, going again. What looks like a recovery by many companies is the result of downsizing, cost reduction and higher efficiency, not increased sales. The latest round of quarterly reports in Sweden looked better than expected, but there may be a good idea to see what lies behind the results. There is a limit to how much you can cut costs and pressure your workers. Sooner or later the turnover has to increase, otherwise we will see increased losses again.

In the previous post I wrote that people do not consume more despite the stimulus package and lower interest rates. The multiplier effect that governments and central banks are looking for has largely been absent. Some people told me that retail sales in Sweden have been persistent. So may be, but Sweden is a very export-dependent country, and exports fell by 17.2% in September compared to 2008 and the trade surplus was 44.4% (!) lower than September 2008.

Does this mean that the propensity to consume (c1) has fallen in John Maynard Keynes demand function C = c1 + c0(Y-T)? I think so. If that is the case it means that incentives to increase income (Y) or tax relieves to reduce T do not have the desired effect. The Economist writes that many believe this is due to people’s fear for future budget deficits that sooner or later must lead to higher taxes in the future (exactly what is happening in Spain right now). This phenomenon is also called Ricardian equivalence. John Maynard Keynes believed that higher public spending was the way out of a crisis when there was no normal demand. Ricardian equivalence contradicts this and says that the more increased public spending affects state finances, the less effect it will have. This might be interesting to keep in mind when you look at the U.S. TARP of 700 billion since they also have a national debt of 12 trillion dollars.

For Ricardian equivalence to be valid though, it requires that people are rational and have all the information needed. So are people rational? I discussed my previous post with a friend during dinner last week. My friend’s response to what I wrote concerning everybody not being affected by the crisis was:
"But, everybody knows that!"

I would say: No, everybody does not. Some are not informed, and some do not care and simply relies on what is said by politicians and the media. If people are not quite as rational as many theories imply, Ricardian equivalence does not apply in the same way, i.e. its impact on the economy is not the same. For those responsible for the public finances it does however, of course, hold. Either they raise taxes now to pay for spending today, or they borrow to pay for spending today and raise taxes later to pay off the debt. The question is how does this affect consumption today? Since people are irrational a tax increase today has greater negative effect on consumption than to raise debt, which does mean higher costs for future generations. A large cost today simply feels worse than an even larger cost in the future.

That is unfortunately how we are. For even if we feel solidarity with our next generations, it seems like the solidarity usually ends at the grandchildren. It is perhaps not surprising that we do not feel as much solidarity with family members that we will never see in life than those who are close to us. I do think however, it is one of humanity's biggest problems. It makes it extremely difficult for all policies and measures that could improve the lives of all people in the future but which currently affect us negatively, to get approved. Politicians who have such ambitions cannot exercise them because they know that they will not be either elected or re-elected. Projects with enormous potential in the future do not get funding. Companies will not invest in products, which can make a huge difference for the world if it does not pay back tomorrow.

Back to the Ricardian equivalence. There must be however a limit to how much a state can get into debt before the people start to react the same way as to a sharp tax increase. The Economist writes that this may depend on the size of the ratio of debt to GDP. I think this sounds very logical. Even a person without the slightest interest in economics will understand that 12 trillion dollar is an extremely large sum that someone (the people) at some point have to start paying back.

So, is Keynes correct that increased public spending is the best option even if it increases the debt burden in the future? Since people are not rational, it seems that way, especially in times of crisis. People believe that the state is helping them and do not think about the fact that it is actually themselves or probably their children or grandchildren who are footing the bill later. There must however be a limit on how big to the debt can become before people start seeing it as a threat. The mountains of debt that some countries have accumulated are likely to be a problem in the future. The U.S. and UK also fund some parts of the debt by QE. They therefore increase the debt by simply printing new money and buying treasury bills, at the same time also keeping interest rates low. Countries with large government debt tend otherwise to be punished with high interest rates. The question is, what will happen to these countries after the crisis is over, that is, when the real economy starts to recover?

A milli, a milli, a milli, a milli

"A million here, a million there"

Maybe Lil' Wayne was predicting the future in June 2008 three months before Lehman Brothers filed for bankruptcy? Probably not. But at least it would have been another way of looking at the crisis.

We live in times of crisis, the worst crisis since the Great Depression in the 30's. It is this information we have become accustomed to during the last twelve months. The information has often come from the media, but it has also been the contents of a wide array of statements from all of chairmen of central banks and chairmen of various institutions to prime ministers and presidents. Lately though, it seems like the wind has turned, and then turned again. Not so long ago it seemed like the crisis was over but in the very recent past, it seems that the risk exists that the crisis will be protracted. Even Reinfeldt had some good points about the risk of a protracted crisis recently in his speech at the opening of the European Developement Days in Stockholm.

What may be worth considering is that even though the world may be in a Depression-like crisis, such statements can be made considerably more nuanced. Everybody is not living through a crisis and many still have a long way to go before they get out of it.

In some parts of the world, people always live in a "recession". It's really that which is and always has been our world's real problem. It's easy to find the current situation a bit ironic when it is only when the prosperous part of the world are losing huge sums of capital that forces are joined, politically and economically, to fight for a common cause. Unfortunately, this is an entirely different discussion.

However, there are those, including this myself, who fortunately still has never experienced a recession. There are even those who gain from it. Those with investments in the Swedish stock market has seen its assets grow by up to 50% since March, may well be that many of them also saw assets decline by much more than that, if they did not, for once, do right selling in panic after Lehman Brothers was allowed to go bankrupt in September 2008. Althogh with today's interest rates dividend yield on a stock is still significantly higher than the interest on a bank account, so perhaps it is not surprising that the stock market has rocketed without any fundamental change?

In the real economy however, things look different. Unemployment in the United States is the highest in 26 years and here, where I currently find myself, in Spain, 80 367 persons lost their job in September and it does not seem like October will offer any happier statistics. An unemployment rate of over 20% is no longer an unthinkable scenario. Adding to this there is a large deficit in the public finances which has now forced the decision on tax increases in the midst of the crisis.

As I mentioned earlier are, however, the point is that not too long ago we learned that the crisis was over. It was reported that key indicators pointed in the right direction, which was immediately interpreted as the end of the crisis. The problem is that the economy right now is on steroids so it would be rather strange if the economy did not show signs of some form of recovery. All the billions of various currencies that have been pumped into the economies in terms of stimulus and support packages and the QE (quantative easing) that the U.S. and Britain have been engaged in, ought to have some sort of effect on the financial system and perhaps it is just that which we have seen recently. QE is very briefly a way for a central bank to stimulate the economy with interest rates near or at zero. This is done through the purchase of securities with short maturity, for example, domestic debt and corporate bonds. These are paid for by the central bank by simply creating money from nothing. In this way the central bank increases the monetary base (M0) and through the money multiplier wishes to increase the amount of money in the economy. The idea is that the banks, thereby will increase its lending business and companies in turn their investments. However, this requires that banks and businesses use the money for lending and investment and do not keep them as security. The effect is otherwise very small and the risk is that there is too much money in the economy if conditions get better, which can lead to high inflation. Britain went right into its sixth quarter of declining GDP, so the question is if that is not exactly what is happening and how much effect QE really have right now and for how long it can continue.

I believe a lot depends on the expectations that exist about the economy. World leaders have perhaps unwillingly been contraproductive by using all these doomsday prophesies since the beginning of the crisis. The extremely low federal funds rate, highly concessional loans to banks and QE are all intended to stimulate the economy, which it has also done to a certain extent. What however, has not happened, and that is the big problem, is that it has not stimulated any real demand from businesses and individuals in the way that would usually be the case. For although people now have much lower interest costs and maybe even borrow more, (it may seem bizarre, but with today's interest rates many people probably have too few or small loans) they do not consume more. Business investment has in turn almost completely stalled. It is here the doomsday prophesies come into play and here I would like to support what I said earlier that not all are in a recession and a bit more nuanced statements are needed. The people who actually has gotten better off during the crisis do not spend their money, which is what normally tends to happen. It is precisely this which would be best for the economy, if all of us who are not affected by the crisis just continued as usual, and maybe even took the opportunity to exploit that we actually have gotten better off. Then why don't we? Why are the purchases of cars, white goods and other similar goods postponed? I believe that ordinary people's expectations have been strongly influenced by all these doomsday sermons during the financial crisis. A decade of continuous growth and low inflation has led to a very great confidence in central banks and therefore we believe them even when they say that the world as we know it, is collapsing. As many probably know, it is precisely people's expectations which largely govern today's global economy. Negative expectations may force a devaluation, make interest rates shoot through the roof and lead to uncontrolled inflation. Positive expectations on the other hand can lead to increased consumption, increased investment and increased lending. The last one ironically being precisely what caused the crisis.

The central banks of course know this. Perhaps therefore they hope that we will believe Ben Bernanke when he says that the crisis is over and begin to consume as before? Otherwise, there may be a risk that the crisis will be long and drawn out? It is possible that the financial crisis is over and that the financial system is saved. Although, I doubt strongly that the crisis in the real economy is over.

This however, is not to say that everyone is in a crisis. Australia, for example, has already raised its interest rates again, and they were never particularly low. Again, everybody is not in a crisis and with a bit more nuanced and flexible statements from the people who actually enjoys great trust, perhaps all these measures in the economy would have a greater impact and those actually affected by the crisis could recover faster.