Category Archives: Economic History

This Time it is Different

I have mentioned in previous posts the work of Ken Rogoff and Carmen Reinhart – co-authors of “This Time is Different” – 2009. Below is a summary from Amazon

Throughout history, rich and poor countries alike have been lending, borrowing, crashing–and recovering–their way through an extraordinary range of financial crises. Each time, the experts have chimed, “this time is different”–claiming that the old rules of valuation no longer apply and that the new situation bears little similarity to past disasters. With this breakthrough study, leading economists Carmen Reinhart and Kenneth Rogoff definitively prove them wrong.

However the rise of the coronavirus and the impact it is having on the global economy is not the same as previous recessions/ depressions in history. Ken Rogoff found it hard to think of a historical parallel and came up with the Spanish flu epidemic which killed millions of people worldwide. Rogoff talks to Paul Solmon of PBS about the impact of the coronavirus.

The Ancient Art of Economic Forecasting – 2019 Coronavirus?

I came across this piece from a colleague on economic forecasting. The article below appeared in the Sydney Metropolitan Press in the late 1920’s. Although economic cycles don’t run to an exact time period the graph below would indicate that this model is not too far out of kilter.

  • The top line = years in which panics have occurred and will happen again
  • The middle line = years of good times, high prices and the time to sell stocks
  • The bottom line = years of hard times, low prices and good times to buy stocks

The past panic century of dates are 1911, 1927, 1945, 1965, 1981, 1999, 2019. Except for 1981, these were all pretty good years to sell stocks – The Big Picture blog. 2016 suggests the top of the present cycle with 2019 being a year of panic.

“The Ancient Art of Economic Forecasting” – Sydney Metropolitan Press 1920’s

The graph below professes to forecast the future trend of Australian business conditions, was first brought under the notice of the public in 1872. It was prepared by a Mr Tritch, whose origin and activities are shrouded in mystery.

  • The top line shows years in which panics have occurred, and will occur again. Their cycles are 16, 18 and 20 years.
  • The centre line shows the years of good times and high prices; the cycles are 8, 9 and 10 years.
  • The bottom line shows the years of depressions and low prices; the cycles are 9, 7 and 11 years.

The panic which occurred in 1893 is shown in 1891. Nevertheless, that year witnessed the beginning of the depression. 1915, just after the war started was a year of depreciation, and 1919, the year following the cessation of hostilities, was a period charcterised by good times.

As this chart was published in 1872, it is interesting to note the forecast of the panic in 2019 – coronavirus? It will be seen that there has been a general upward trend since 1926 with the panic occurring in 1927 after the high is reached. The bottom of the depression is reached at the end of 1930 and the upward trend begins in 1931.”

Brexit and ‘Yes Minister’?

In light of what has been happening regarding Brexit here is a very amusing clip from the BBC series “Yes Minister” in which Sir Humphrey and Jim Hacker discuss Brussels and the notion of the UK trying to pretend that they are European. Also discusses why other European nations joined the common market in the first place.

I am off to the beach and out of internet range – will be back around 6th January. Merry Christmas and a Happy New Year.

AS Economics Revision – Transition Economies

Covered this topic today with my AS Economics revision class. What have been the formidable challenges facing eastern European countries (command) embracing capitalism? Here are some thoughts as well as an informative video from the IMF:

  • In planned some goods are provided free but not in a market economy
  • Corruption – widespread in communist countries in eastern Europe – Oligarchs
  • Inflation ↑ – privatised firms began to charge prices that reflected high costs
  • Lack of entrepreneurial experience
  • Rising unemployment as owners of businesses try to make them more efficient.
  • Labour relations – Poor as workers are in a new environment – Job security?
  • Consumer sovereignty – some industries decline/expand
  • Resources – surplus and shortage
  • Self-Interest – fewer merit goods and more demerit goods
  • Time Gap before framework of government controls can be developed
  • Expansion of industry – potentially for greater externalities
  • Old/disabled – vulnerable with the change of government role
  • Welfare system – limited support for unemployed etc. will take time to develop
  • Provision of public services – disruption to police and other public services
  • Moral Hazard – the state insure workers against risks of losing their job

Democracy and Capitalism – are they compatible?

Although there have been arguments that democracy and capitalism are incompatible no advanced capitalist democracy has been relegated out of high-income countries or reverted into a totalitarian state. It seems that in advanced economies democracy and capitalism seem to promote each other. However the next few years will test this theory as inequality starts to threatens the foundations of democracy.

Economist have given their views as to why capitalist democracies might fail. The oldest worry is that the masses will vote to take possession of the wealthy and without secure property rights there can be no capitalism. Here are the thoughts of some economists:

However what explains why democracy and capitalism have co-existed for so long? Iversen and Soskice in their book “Democracy and Prosperity’ see capitalism and democracy as potentially mutually supporting, with three stabilising pillars.

  1. Strong government – constraining the power of large firms and labour unions, and ensures competitive markets. Weaker countries find it harder to resist the short-term expediency of securing power by protecting monopolies.
    a sizeable middle class, forming a political bloc that shares in the prosperity created by a capitalist economy.
  2. large firms that are not mobile – they cannot break their connections with local skilled networks where business plans and frontier technologies require the know-how developed and dispersed.
  3. Immobile companies give governments a degree of sovereignty which they use to boost the middle class. The middle classes dictate to feeling confident about the economy but a sharp slowdown in growth in real median incomes, could strengthen the appeal of movements that threaten to disturb the status quo. Governments, too, are becoming less responsive to middle-class priorities. America’s is too dysfunctional, and Britain’s too distracted by Brexit, to focus on improving education, infrastructure and the competitiveness of markets.

Conclusion

Demographic change might also take a toll: older and whiter generations may not much care whether a would-be middle class that does not look like them has opportunities to advance or not. Then, too, the authors may have underestimated the corrosive effect of inequality. Threatening to leave is not the only way the rich can wield power. They control mass media, fund think-tanks and spend on or become political candidates. Proud democracies may well survive this period of turmoil. But it would be a mistake to assume survival is foreordained.

Source: The Economist – Economic stress and demographic change are weakening a symbiotic relationship. Jun 13th 2019

World Economic Centre of Gravity – 2018

Danny Quah of the London School of Economics (LSE) wrote a paper in 2011 describing the dynamics of the global economy’s centre of gravity. By economic centre of gravity he refers to the average location of the planet’s economic activity measured by GDP generated across nearly 700 identifiable locations on the Earth’s surface.

The graphic below from The Economist shows an updated WECG. In 1AD China and India were the world’s largest economies. European industrialisation and America’s rise drew the economic centre of gravity into the Atlantic. However Japan’s economic boom made it the second largest economy in teh world pulling the centre north. As China has regained economic leadership, the centre is now retracing its footsteps towards the east. Extrapolating growth in the 700 locations is projected by 2025 to locate between India and China.

It is interesting to note how the WECG seems to move horizontally so does this suggest that the north-south divide will remain invariant? In looking at the actual data in Quah’s research, it shows that latitude declines from 66 degrees North to 44 degrees North by 2049. This might seem to imply that the south, like the east, is actually gaining considerable relative economic strength. Policy formulation for the entire global economy, and global governance more generally, will no longer be the domain of the last century’s rich countries but instead will require more inclusive engagement of the east. Many global policy questions will remain the same, e.g. promoting growth in the world economy, but others might change in character, e.g. appropriate political and military intervention. If you are interested in Quah’s paper you can download it by clicking here.

Sources:

The Global Economy’s Shifting Centre of Gravity by Danny Quah. 2011

The Economist – The Chinese Century – October 27th 2018

10 years after GFC – what we’ve learnt

Thanks to colleague Paul Chapman for this article from Mercer ‘Health Wealth Career’. Its looks at the 10 lessons learnt from the GFC and 3 thoughts from what we might expect in the future.

Lesson 1 – Credit cycles are inevitable. As long banks are driven by growth and profit margins their decision-making inevitably leads to greater risk and poorer quality. The growth from 2005-2008 was generated by leverage.

Lesson 2 – The financial system is based on confidence, not numbers. Once confidence in the banking system takes a hit investors start to pull their money out – Northern Rock in the UK.

Lesson 3 – Managing and controlling risk is a nearly impossible task. Managing risk was very difficult with the complexity of the financial instruments – alphabet soup of CDO, CDS, MBS etc. A lot of decisions here were driven by algorithms which even banks couldn’t control at the time. Models include ‘unkown unkowns’

Lesson 4 – Don’t Panic. Politicians learnt from previous crashes not to panic and provided emergency funding for banks, extraordinary cuts in interest rates and the injection of massive amounts of liquidity into the system. The “person on the street” may well not have been aware how close the financial system came to widespread collapse

Lesson 5 – Some banks are too big to be allowed to fail. This principle was established explicitly as a reaction to the crisis. The pure capitalist system rewards risk but failure can lead to bankruptcy and liquidation. The banks had the best of both worlds – reward was privatised with profits but failure was socialised with bailouts from the government. Therefore risk was encouraged.

Lesson 6 – Emergency and extraordinary policies work! The rapid move to record low policy interest rates, the injection into the banking system of huge amounts of liquidity and the start of the massive program of asset purchases (quantitative easing or “QE”) were effective at avoiding a deep recession — so, on that basis, the policymakers got it right.

Lesson 7: If massive amounts of liquidity are pumped into the financial system, asset prices will surely rise (even when the action is in the essentially good cause of staving off systemic collapse). They must rise, because the liquidity has to go somewhere, and that somewhere inevitably means some sort of asset.

Lesson 8: If short-term rates are kept at extraordinarily low levels for a long period of time, yields on other assets will eventually fall in sympathy — Yields across asset classes have fallen generally, particularly bond yields. Negative real rates (that is, short-term rates below the rate of inflation) are one of the mechanisms by which the mountain of debt resulting from the GFC is eroded, as the interest accumulated is more than offset by inflation reducing the real value of the debt.

Lesson 9: Extraordinary and untried policies have unexpected outcomes. Against almost all expectations, these extraordinary monetary policies have not proved to be inflationary, or at least not inflationary in terms of consumer prices. But they have been inflationary in terms of asset prices.

Lesson 10: The behavior of securities markets does not conform to expectations. Excess liquidity and persistent low rates have boosted market levels but have also generally suppressed market volatility in a way that was not widely expected.

The Future

Are we entering a period similar to the pre-crash period of 2007/2008? There are undoubtedly some likenesses. Debt levels in the private sector are increasing, and the quality of debt is falling; public-sector debt levels remain very high. Thus, there is arguably a material risk in terms of debt levels.

Thought 1: The next crisis will undoubtedly be different from the last – they always are. The world is changing rapidly in many ways (look at climate change, technology and the “#MeToo” movement as just three examples). You only have to read “This Time is Different” by Ken Rogoff and Carmen Rheinhart to appreciate this.

Thought 2: Don’t depend on regulators preventing future crises. Regulators and other decision makers are like generals, very good at fighting the last war (or crisis) — in this case, forcing bank balance sheets to be materially strengthened or building more-diverse credit portfolios — but they are usually much less effective at anticipating and mitigating the efforts of the next.

Thought 3: The outlook for monetary policy is unknown. The monetary policy tools used during the financial crisis worked to stave off a deep recession. But we don’t really know how they might work in the future. Record low interest rates with little or no inflation has rendered monetary policy ineffective – a classic liquidity trap.

Source: Mercer – September 2018 – 10 Years after the GFC – 10 lessons

Questions about the next recession.

Ryan Avent of ‘The Economist’ considers how the next recession might happen — he asks the following questions:

  1. When will the next recession be?
  2. Where will it begin?
  3. Is the world prepared for a recession?
  4. What are the obstacles?
  5. What should governments do?

Very good viewing for macro policies – Unit 4 and 5 of the CIE A2 Economics course.

With the downturn in an economy, cutting interest rates has been the favoured policy of central banks. But the use of quantitative easing (QE) might mean the end of conventional monetary policy with rates already at record low levels – by pushing rates into negative territory they are actually encouraging a deflationary environment, stronger currencies and slower growth. The graph below shows a liquidity trap. Increases or decreases in the supply of money at an interest rate of X do not affect interest rates, as all wealth-holders believe interest rates have reached the floor. All increases in money supply are simply taken up in idle balances. Since interest rates do not alter, the level of expenditure in the economy is not affected. Hence, monetary policy in this situation is ineffective.

Liquidity Trap