Forum Post: Global Economic Crisis

BASIC STEPS  Increase Wages  Control Lending  Allow Interest Rates to Rise  Balance Asset Values and Wages

CLEAR ADVANTAGES  Politically popular (consider the grief and unrest the current measures are causing)  Counter Intuitive but Logical and Correct (Compare with the measures taken to end the 1930’s depression)

The idea is for all the governments of the countries affected by the crisis to allow/encourage or even force wages and salaries to rise. It is crucial that this would have to be a deliberate Global Process. Thinking unilaterally it makes total nonsense but the one thing which we can all agree on is that we have a Global Problem so we need to think of unified Global Action. This provides the opportunity for lateral thinking. I know it sounds like a crazy left wing plan but consider the following.

1. The core problem behind the current crisis is that market values for crucial assets have exceeded their “sustainable value”. Meaning the value of the assets is not supported by the income they can generate (other than by trading the assets themselves). This has lead to excessive borrowing against those assets enabling people and governments to live beyond their means. There are other issues such as dodgy lending practices and financial instruments, but the fundamental correction required is in the value of the assets and the debt which is backed by the assets. Either the assets come down (eroding the equity supporting mortgages and loans and causing the widespread failure and grief which we are currently witnessing) or incomes can come up. This would restore the ability of consumers, property owners, share holders etc to pay for their debt and businesses to generate income and dividends to provide a satisfactory return on share prices. Because tax revenue would increase it would also enable governments to repay their debt without introducing such austere measures as to kill off the economies that sustain them.
2. Trying to stimulate economies by lowering interest rates is actually encouraging the problem in “1” to persist. Think of the economy as being divided into two ends: Asset values at one end and the means by which those asset values are supported (the income of the average income earner) at the other. Lowering interest rates is supporting the wrong end of the economy (the asset end for which values are already too high). It’s the income end which needs supporting. Also lowering interest rates clearly has limited effect as demonstrated by the UK and US because at even minimal interest rates things are not really turning around.
3. Low interest rates drive deposits away from banks making it difficult for them to provide the loans necessary to support business and investment and generally making troubled banks less viable. In fact under my plan interest rates would have to be raised and other controls on lending would have to be tightened to avoid another cycle of asset inflation. This would restore banks’ liquidity and viability. My plan would greatly reduce the government support required by the banks because many non-viable loans would become viable.
4. Increasing incomes will increase tax income (other things remaining equal) which will reduce governments’ fiscal deficits resulting from all the stimuli (this one included) being used to retain or create jobs. All the government loans to banks etc would be able to be paid back faster.
5. The alternative for the future is an economic malaise like the one Japan has been in for over 20 years.

Notes and observations

1. The idea of forcing wages to rises is a “one off” measure. I know it goes against the principles of free market economics but it is clear that serious adjustment is necessary in the short term and at least some fine tuning in the long term.
2. A basic observation is that, left to their own devices free markets naturally boom and bust. It has happened time and again. What amazes me is that: a. Economists have not found a solution to this and in fact free market economics accepts it. “Recession is to economics what hell is to religion”. To many good, unfortunate citizens recession IS hell and leads to misery and death. It is a fundamental failure of pure free market economics which makes it unacceptable in a civilised society. b. Governments permit it to happen. Basically once a market has boomed beyond the “sustainable level”, further “growth” in the market essetially turns the assets into chain letters. Basically the market just goes on trading up until it runs out of confidence or “takers” and the “bubble bursts”. Sounds just like a chain letter to me! I thought this type of trading was illegal? Maybe you could even construct a legal case against the Stock Exchange and others around this.
3. Consider a market like an aeroplane which we all know needs appropriate controls all properly designed and tuned to work properly so that the aeroplane can be flown smoothly and safely in the desired direction and at an appropriate height and level. In the case of markets we clearly either don’t have the appropriate controls or we don’t know how to use them. It’s almost as though we’re trying to fly the aeroplane backwards. Thank God economists and politicians don’t design aeroplanes!
4. I personally believe we need further controls on lending. I hate controls and rules because they encourage delinquency. However I suggest lending against assets should be limited by the income available from the asset (other than income achieved by trading the asset itself, of course). I know this would have all sorts of implications such as restricting the trade in gold, bonds etc, but when you think it through, maybe that’s not such a bad thing. We definitely need to encourage productive investment rather than hoarding investment and such a control would have that effect. I also realize that all sorts of auditing and policing would be necessary (most of it would be automatically achieved by the bank’s computer system). Anyway auditing and enforcement is necessary for the controls we have now.
5. As interest rates are increased to rein in lending, the opposite actually happens if markets are rampant. More money is attracted to banks so they have more to lend. So long as the “growth” in the markets is fast enough the high interest rates don’t matter to the “investor” and the banks become more reckless because their loans are always supported by the rising value of the markets and they enjoy huge profits etc etc. High bank liquidity and reckless lending were prominent phenomena during the last months before our current troubles.
6. Markets can actually rise with almost no influence from interest rates or money supply. Consider the following hypothetical situation: You have a “market” consisting of 100 investors who own 100 properties between them each property worth $10,000. “007” can agree to buy the property of “99” for $11,000 without borrowing, finding or earning a cent provided another investor will buy his property for $11,000. All the investors can do the same deal between themselves and no money needs to enter the system (apart from bridging loans which act as the “lubricant”). These trades can go on and on until the values are out of reach of anyone outside the system. This is, of cause, a grossly simplified model but it highlights one of the factors which renders interest rates and monetary policy ineffective and in fact inappropriate in times of inflamed markets.
7. Inflation: We seem to have an obsession with it ever since we discovered monetary policy and the OCR. What we seem to have forgotten is the reason we need to control inflation. Inflation is bad not just because its damned inefficient having to adjust for it all the time but because of the distortions it causes in the economy. We need to be like Einstein and focus on relativity, not just inflation for its own sake. What has happened lately is that inflation has been reasonably (though not rigorously enough) controlled but we have allowed relativity to sneak through the cracks. We’ve forgotten the key objective of what we set out to achieve by controlling inflation in the first place (to avoid distortion). However, having reminded ourselves which is the objective and which is the tool we can use the tool to restore relativity to the economy. I.e. introduce an appropriate degree of inflation at the correct end of the economy (wages) to restore relativity between incomes and asset values. This is the crux of my suggestion. One of the key distortions inflation causes is that erodes the value of savings. Hello! Savings are the other end of debt are they not? So eroding the value of savings erodes the value of debt. Right? Isn’t the value of debt the problem? Have we not found a solution, then?
8. In future governments and economists clearly need to pay more attention to balance in the economy rather than just focusing on GDP, inflation and exchange rates. There is a key relationship that must be established between the value of assets (and this needs to be split primarily into hoarding assets and productive assets) labour and other resources. There are clearly other relationships that must be in balance such as the cost of welfare versus GDP and the division between rich and poor. Developed economies prosper when the relativity between key elements of the economy and society are in balance. Excessive imbalance leads to failure, wastage, unemployment and unrest. Developing economies are a different case but almost without exception their growth and development is based on the deployment of cheap labour both educated and skilled and unskilled (as well as the exploitation of available natural resources). This has been so since the start of the industrial revolution