Thursday, Feb 26, 2009
Was there insufficient base money?
Cynicus Economicus: No explanation of policy from BoE
The article points out that, unusually, there is a somewhat unsatisfactory veil of secrecy concerning the BoE proposals, in that normally information would be published, whereas the public are currently expected to obtain their information solely from the minutes of the meeting. Although I disagree with some of his assumptions, I like the real world analogies he presents. I have one of my own which explains the current recession which I shall post in a comment. Essentially I blame the expansion of the state sector.
Posted by stillthinking @ 01:30 PM (616 views) Add Comment
13 Comments
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1. stillthinking said...
Ok. Here is the analogy why we are bound to suffer from an economic collapse, which is different from a recession.
Imagine there are a 100 people all of whom work, each creating a 2 single units of work per year (this indivisibility is a key part), which they are more than happy to consume. So each persons consumption is 2 units per year.
Further, imagine that they consume each others production. If you like, rather than being the independant economic units of rural China, they are the inter-related production units of a developed economy.
Let us say that in fact, they only really require 1 unit per year for sustenance, and they, as a group decide that they would like the provision of non-productive services, such as committees for social improvements, whatever. The key part is that these social services do not actually make anything, provide a service yes, make something no.
Initially, they move 20 people into provision of services, leaving them with 80 producers. And this is arranged by a tax. So far so good, they still make 80x2=160 units a year. So instead of consuming 2 units per year they consume 1.6, but they are happy with that because they consider the services worthwhile.
Now the indivisibility of this is, as mentioned, important, as these units if you like represent -expensive- items. So in fact, every three years they can consume 3 units, because -partial consumption is not possible-.
Anyway, time goes on, they like the services and decide to devote more resources. Accordingly, 50 people start to provide services leaving 50 producers. So now 50x2=100 they can consume 1 unit per year. All is fairly divided.
However, they decide to move over a critical level for provision of services, which they usually vote for, in this case 60%. So now 60 people provide services, and 40 people work in production.
This critical point suddenly moves them into a situation where not only the service producer, but -even the producer is unable to afford their own production-. Considering the producer, although capable of producing 2 units a year, even the consumption of a single unit is unaffordable. The same is true for the service provider.
At this point their society must break. Even though there is demand, there isn't the capacity to pay. So the situation is that demand is perversely crushed by affordability. Their after tax pay isn't sufficient to purchase a single unit, and fundamentally, it is the -indivisibility- of that unit which collapses demand.
That is the end of the analogy which actually isn't so great. What I am trying to say is that for many goods they are indivisible, such as a new car. I can't partially buy a car. Further, as Ford(of car fame) realised, the workers at the production plant -must- be capable of buying a car, if they are not, then there is absolutely no demand, because there -cannot be- partial consumption.
I don't feel that it is a coincidence, in other words, that the first collapses within the economy are on expensive items. Now, it is very trite to say that consumption of these has collapsed because they are the most expensive. But, I feel that it is not the expense as such, rather -the indivisibility of such purchases.-
As most know, real after tax wages have not grown since 1997, but the expansion of the state has been quite dramatic. For the UK, we have passed an invisible line that chokes valid demand of expensive items. As the production of these items ceases, the reduced employment in time trickles down and affects production of goods that would be otherwise unaffected. This is the nature of the downward spiral.
2. paul said...
I commented in CE's blog over there.
This is also why the application of Keynesian thinking in a deflationary environment is pointless.
CE is kind of on the money with his analysis - this whole QE thing has ruffled him, and I think it should ruffle all of us. The case for it is unproven, its effects are untested and what's most worrying is that the methods are completely unseen.
3. stillthinking said...
Its not really a comment on what he is saying. I just needed an article to attach to as a sounding board.
4. str 2007 said...
stillthinking
I agree we may have gone past the critical mass situation.
However to pick up on a couple of points - you can buy part of a car as such. You can lease it so your only overhead is the cost of finance and depreciation. Only slightly more than buying it outright and not tying up the capital. (In fact for some over the last year or 2 leasing will have been the cheaper option as depreciation id probably higher than was predicted).
Also I fully agree that house prices are way to high, but could we have entered a new environment where by interest rates stay low and they vary them by a 1/4 or even an 1/8 of a point which would have the same effect as when we only had half as much borrowed 5-10 years ago.
My point being that adjustments in society can and have been made to make allowances for overcooking the service/production ratio.
It puts us on a knife edge as there is no where left to go except printing money (hang on a minute !).
So that's it we've arrived then - last chance saloon with the numbers being manipulated even harder than the banks were doing - God help us.
Anyway you can see where I'm coming from.
5. refusetobuy said...
@stillthinking
You can partially buy a car. You buy it over a number of years (although it costs more). All you need is a loan.
....
ah.
6. stillthinking said...
I meant affordability. Anybody involved in leasing must ultimately cover the costs of the purchase, and borrowing won't get you round the ability to pay. For example, I don't think people lease large flat screens for 6 months of the year and do without the rest of the time, I think they just don't buy them. I take your point that people can hire a car in an emergency, but really that is only a fraction of the car requirement compared with ownership.
A concrete case (! ..), a Ford Ka is 8,000 pounds. However, you have to pay tax on your income first, and then tax on the car purchase, and aside from that your disposable income is eaten up by secondary taxes(which I will ignore). So if your basic rate of tax is 30% and the VAT is 15% then you are blocked from the real purchase price of £4760.
That is a pretty big demand blocker, and what is worse, your inability to buy something that you actually want, leaves Ford Ka employees unemployed, exascerbating the effect. Taxes are kind of a lot in the UK for what we get, but there is a line in the sand where we just collapse ourselves and printing money won't change that.
I make the point because I was very much used to thinking that our problem is excessive savings, and people hoarding money, and a collapse in demand because of a preference to save. BUT, now I am starting to think, hold on, there IS a lot of demand in the UK, just that wealth is spread around so thinly it ends up being useless for any purchases.
Or imagine a kid with a penny pocket money a week, but the cheapest sweet is 10p. That kid is desperate for sweets! He doesn't want to save at all. He just has to because 1p doesn't buy anything. His demand is collapsed into saving, which he doesn't want!
7. letthemfall said...
stillthinking
Your fable implicitly values production over services, whereas I would say the two go hand-in-hand - and too much of one and too little of the other reduces overall wealth as most would conceive it. The argument about indivisibility is interesting because it says something about complexity in a modern economy: as others have said, there are ways to buy "part" of a unit because of services like car clubs, hirers, etc.
Isn't the problem really one in which a section of the population has offered up its units to another, which, having promised their units in return at some point in the future, are not coming up with the goods, so to speak? And everyone became convinced that a certain unit was somehow worth 2 units, then 3... and so on.
8. str 2007 said...
stillthinking
I can see what your getting at but the car analogy I fear will always fail because there are so many ways of buying part of a car whether it be leasing, loans or buying a KA instead of a Golf GTI or second hand instead of new.
The sweet analogy gets closer (although I don't think you can get penny chews anymore).
My example is if I can have a plot of land in a good area for the price the French have to pay for one ie 30,000 Euros then I will release all of my money into the economy to build a house which will employ a couple of people for a year building it for me.
So yes your point is correct to the extent that while I consider housing overpriced then I'm not going to buy.
If I owned and had a big mortgage I'd be taking full advantage of th low interest rates and staying put.
So currently we're all stuck. (as I see it).
9. 51ck-6-51x said...
Who needs to buy a car every year? There is an optimal mix of producers and services and the free market should find it. In the generic case, though, isn't that what the utility called banking is for? One could save up for a car, or one could take out a loan.
10. 51ck-6-51x said...
Regarding the article - I'm in the camp that China hold all the cards, if they decide they must be rid of this paper (mainly Gilts & T-Bills), that will initiate a massive sell off. However, I'm not sure they will, I think they will realise that the addict is still an addict, it's just he has robbed all the houses on the estate, and that, therefore, they must appear to wait patiently whilst strengthening their position for the future, which means keeping the paper even as it devalues.
11. letthemfall said...
I can't see that wealth is spread around too thinly. Quite the opposite.
12. stillthinking said...
OK. I think the sweet analogy is better as well. Except I want to change the pocket money to 5p -after tax for "services"-, the kid would get the full 10p otherwise. The price of the sweet stays at 10p.
13. goweresque said...
For any society to function effectively economically, you need a sizeable proportion of the population to be involved in genuine wealth creation - that is taking raw materials and refining them, and creating goods from those refined products. Which are sold at home and abroad. While some wealth is added by service providers (especially if they sell their services abroad) they require a level of wealth in the economy that only basic production can provide in the first place. We cannot all make a living being lawyers/accountants/consultants. Or taking each others washing.
What that proportion is, as a % of GDP, I do not know. But I'm pretty sure we passed it going in the wrong direction some time ago.