Knowing and Making

Martin Wolf has an intriguing proposal to " end the land cycle " - by which he means: make sure that any future rise in the value of land goes to society rather than the individual landowner. This argument has three parts. First, he makes a moral case that increases in land value are largely a function of external effects - increasing population density and infrastructure investments - and therefore why should the current occupier of the land capture all the benefits? Second, a practical case that the current system has stymied productive new development - because it's easier and cheaper for landowners to get a return by reducing the competitive supply of new housing (through the planning system) than by investing in new infrastructure which benefits everyone. Third, the current system of land ownership through debt is one big casino: buyers borrow money in order to put a bet on the Ponzi game continuing. When it does not, the losses are shoved onto two groups of peop...

I heard an astonishing fact yesterday at the LJDM seminar . Or is it a fact? I'd be grateful for confirmation. Apparently, if you move into a new bed in a British prison, you become responsible for the debts of the person who was there before you. The opportunities this offers for abuse or gaming of the system are immense. If you know you're going to be moving out, you have every incentive to run up a huge debt before you leave. Is there a credit checking system? Gambling is rife in prisons and this system allows you to borrow, gamble in the hope of winning big; and if you don't, stick some other poor sap with the losses. In fact, now that I put it that way...it reminds me of something similar in another world . There must be more to this. Who is doing the lending in this system? What about the sucker who moves into the bed? Do prison officers influence who gets which bed? What are the amounts at stake - is the debt 20 cigarettes, £3 or £3000? What is £3 in prison w...

The Economist has a Global Public Debt Clock on their site now, along similar lines to the American and Irish debt clocks but monitoring the total public debt of the whole world. But lots of people are concerned by the buildup of private, consumer and corporate, debt as well as debt incurred by governments. So, inspired by previous conversations with Nick Rowe , I decided to extend it to show the net total of ALL debt in the world - public and private. The clock will automatically update to the correct figures in real time. Here it is - enjoy:

Scott Sumner has published a couple of good articles about the difficulty of understanding supply and demand, and Robert Peston's posting today may be an excellent illustration of that. Robert says: Here's the great and resonant unknown of the moment. Is the credit contraction a reflection of less demand from you, me and millions of others? Or are the banks rationing much more than they had been doing? The answer is - probably - a bit of both. But does that make any sense? Well, it could - but is it plausible that demand for loans just happens to fall at the same time as the banks tighten their standards? And why would the banks "ration" credit anyway? Professor Sumner might give a simpler explanation. Occam's razor, as you know, says that the simplest explanation is usually the best. So can we identify a single cause of this phenomenon? Yes we can. Imagine that there is a stable market for credit in 2007. Then just one thing happens: the supply curve for loans ...

Robert Peston writes an entertaining, slightly scary, story about BT's pension liabilities . But is this anything to worry about? Not really. He makes a few points that sound striking, but under closer examination are utterly unsurprising. ...in an economic sense, BT's current and future pensioners own this totemic business. True, but any business is "owned" both by its creditors and its shareholders. The creditors always have to be paid off first before the shareholders have clear title to the company's assets. And in most large, old companies, pensioners are among the biggest creditors. Look at General Motors, which has just handed over a majority stake in itself to its pensioners (via their union, the UAW). To put this £8bn chasm in its pension-scheme into an appropriate context, the entire market value of the company is less than £10bn. Also true, but meaningless. The pension deficit - like any other debt that BT has - is already factored into its market value...

Any of these links could have made a blog posting of its own, but instead why not help yourself to a high-density nutritious snack selection of random commentary? During the first lecture of Paul Krugman's London visit last month he commented that the economy might be "stabilising". The stockmarket leapt a hundred points (giving rise to much hilarity on the second and third evenings). This perceptive writer points out a similar occasion in 1929 when someone "of no great note" called Roger Babson made a comment that the market was due to crash. At which point it duly crashed - for the next twenty-five years. Now a little later in the Robbins lectures Paul Krugman reviewed a history of not the 1929 but the 1873 depression - and how the economy recovered from that, in the absence of the modern era's gifts of Keynesian stimulus and World War II. Nothing to do with the earlier comments...except for one little thing... An interesting behavioural marketing tactic ...

The relative economic strength of the last eight years has for me contained one abiding mystery: why isn't there more business investment? Paul Krugman's current lecture series emphasises the contribution of a housing boom (exacerbated by cheap secured home loans); there's a consensus that debt-financed consumer spending has been the other driver of growth. Worldwide saving has fallen and, with it, investment. And yet, as Martin Wolf points out today , returns on physical capital have been excellent - above 13% for several years. So why aren't more people investing? A shallow answer is that consumers are focused on the short term and prefer the instant gratification of consumption to the long-term returns of investment. But this isn't really a question for consumers. The mystery is why savers have accepted miserable returns on consumer, mortgage and government debt instead of earning more that twice as much money by investing. You might think that there are few vali...

Robert Peston, famous among his blog commenters as the BBC's banking editor (with a sideline in other businesses) has come up with his most creative definition yet of a "business" - the UK government . He points out, in a surprisingly sanguine article, that UK government debt has been put on negative watch by Standard and Poor's. As he says, it's not that big a deal - I suppose the surprise is that it didn't happen earlier. As the UK is likely to be one of the world's top ten debtors in the next few years, with about £1 trillion of public debt (still less than Citigroup or RBS, incidentally, and much lower than the Japanese, US or Italian governments), it is only natural that people would keep an eye on the figures. S&P have said that the downgrade might happen if the next government does not come up with a credible plan to put the debt on a long-term downward trend. Seems fair - and everyone expects the next Chancellor, whoever it might be, to do exac...

An intriguing post from Robert Peston raising the spectre of the Treasury failing to sell all the bonds it wanted to sell yesterday. Is this, as he implies, plain bad news for the government because their funding is getting more expensive? Or is it good news for private lenders - implying that investors are fed up with their "flight to quality" and are now considering private sector investments instead? The answer is dependent on two further questions: is investors' money switching to foreign investments, UK private lending or UK equities? are investors actually running out of money to invest - the infamous savings trap, where people in aggregate try to increase their savings but fail to do so, because the attempt to save reduces total income in the economy and available savings are reduced too? Hopefully we can find out. How could we figure it out? by looking at total UK savings this month - this is not an exact science but we should hopefully be able to see if the tren...

Robert Peston's column today got me thinking on a tangent. If the state incurs liabilities (let's say while rescuing banks), there are a few ways it can pay them off. One is by selling assets that it acquires along with the liabilities. For example, if it acquires a 70% stake in Royal Bank of Scotland, it can sell it into the private sector for (let's say) £20 billion. This might offset some or all of the liabilities it has covered. Another is by increasing taxes. In one sense, this is exactly the same as selling assets: it takes money from the private sector into the public sector. The difference is in the distribution. When selling assets, the money comes from those people who choose to buy the assets. When taxing, the money can come from whoever you like. A third is by walking away. After all, the state's liabilities are unenforceable except by the state itself. Thus the state can simply ignore its liabilities (as Argentina did a few years ago, and most developed ec...

HBOS today announces losses of about 6% on its total corporate loan book, according to Robert Peston (ignore the 47% figure that he also gives - that is only generated by cherrypicking the scope of the statistic to get the most serious-looking number). Can a bank charge a sufficient additional premium on its interest rates to cover this size of loss? It's unlikely. Small businesses regularly pay a spread of 6-10% over base (I've heard from some bank managers that they are charging up to 15% to some) but most loans are to much larger companies which have been able to get much better terms in the past. So, if a bank can't charge enough money to cover its costs, should it stop providing the service? Strict microeconomic logic says yes: the service is not viable in the marketplace at the current price, so its price should go up and the volume of loans provided should be much lower. But this is a classic example of market failure due to uncompensated externalities. Most discuss...

Continuing the discussion of a few days ago , Nick Rowe joins in correcting Niall Ferguson 's "average debt" logic. Maybe we should give the guy a break - he is only a historian, not an economist. No doubt whenever a historian writes a book about the history of [X], they get brickbats from all the practitioners of [X]. But then that's the price of intellectual engagement. The comments on Nick's post set me thinking about better ways to measure the total impact of debt in the economy. One commenter (Patrick) reminded me of the issue of debt maturity mismatch, which seems to have been a major contributor to of the current financial crisis (aside from the effect on the real economy). Here's the response I posted there: It sounds attractive that there would be some meaningful measure that at least partly captures the way in which debt influences the economy. We could certainly build models where a large amount of gross debt has almost no effect at all (e.g. A owes...

Another article (this time by Niall Ferguson, of whom more later) on the too-much-debt theory. The subtitle is: "Governments cling to the delusion that a crisis of excess debt can be solved by creating more debt". Well, this isn't a crisis of excess debt. To the extent that credit problems are responsible for the recession, it is a reduction  in the availability of credit that has triggered it. Ferguson may think that companies and individuals owe too much. But who do they owe it to? Er, other companies and individuals! He doesn't present much evidence for the "too much" theory, except an assertion: The Western world is suffering a crisis of excessive indebtedness. Governments, corporations and households are groaning under unprecedented debt burdens. Average household debt has reached 141% of disposable income in the United States and 177% in Britain. Worst of all are the banks. Some of the best-known names in American and European finance have liabilities...

Warren Meyer at Coyote makes a familiar argument against the stimulus : At the end of the day, businesses and individuals have a felt need to deleverage.  That is going to cause a recession, end of story.  The Congress’s and Obama Administration’s obsession with short-circuiting this sensible desire to reduce debt is not only counter-productive, it is offensive.  Banks are sensibly trying to strengthen their balance sheets, but the government wants to stop them. Individuals are trying to cut back on spending, reduce debt, and save more.  Again, the government wants to stop them, by going to debt and spending for them if consumers won’t do it on their own. This sounds intuitively sensible, but is it correct? As often is the case, a simple model sheds some light on the argument (retrospective note: the model is simple, but the analysis turned out longer than expected. I still think it's worth reading). Imagine a very small economy with just two people in it. A is a baker and B is a b...

Just as we have been discussing levels of debt, Robert Peston informs us that the UK government will be guaranteeing billions of pounds more of corporate and consumer lending, starting tomorrow. This is somewhere between the US government's guarantees of Citigroup and Bank of America's debts, and a giant credit default swap (CDS). Quite clever, in that respect. CDSs were a good business for lots of insurance companies for a long time, and now that the worst of the losses have probably been written off by banks already, they could be a good business again. CDSs do, I believe, increase economic efficiency by aggregating a portfolio of risks and allowing capital to flow to the most productive destination without being hampered by the " one bottle of poison " problem. The state is by far the best provider of these services, because there is no counterparty risk, and because control is correlated with a positive return. That is, because the government has the ability to d...

While the amount of net debt across the world is always zero , the amount of gross debt is not. And gross debt has reduced substantially in the last year as firms and consumers are deleveraging. An interesting post from Steve Waldman at Interfluidity praises this trend. I'm not convinced by his conclusion but he does contribute something rarely visible in economics commentary - a good philosophical understanding of what debt is. "Credit, also known as debt, is one of several arrangements by which a party with the power to command resources but lacking aptitude or interest in managing a productive enterprise delegates wealth to another party who is capable of creating value but unable to command sufficient resources." I would put it slightly more generally: Debt is a promise to give resources to another party in the future . On this view, the gross amount of debt in the world is a representation of the number of promises we have made to each other. A promise is a restrict...

" The crisis is caused by excessive debt " " You can't borrow your way to prosperity " (video) " We need a recession to clean up the rot " " We have borrowed prosperity from our grandchildren - transferring consumption through time" Economic illiteracy , all of it. We can only consume today what we can produce today. Was your iPod made in a factory built in 2016? Monetary transfers (i.e. debt) cannot create new goods or services. You cannot transfer consumption from the future. But it is a common fallacy to think you can. There are three kernels of truth in this viewpoint, and some of them give us a clue to the real answer: Individuals can transfer consumption from the future to the present by borrowing money from other individuals. But there is an entry on the other side of this ledger - the lender is transferring their own consumption from present to future. The net effect on the whole system is nil. Countries can do the same - if America...