Monday, January 11, 2010

It is essential to distinguish between the position of the government and the position of the countr

Financial problems are easily solvable, provided recession is conquered

From the article: There are two key things to look at – the country's net external assets and the current account of the balance of payments." UK: net external liabilities 7pc of GDP. (Ireland, Greece and Spain 55pc, 70pc and 75pc respectively). 30pc of the UK's government bond market is foreign-owned (US: 60pc) UK's current account position: 1% of GDP (Greece: 11% Spain: 5%)

Posted by flashman @ 10:24 AM (2428 views)
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34 thoughts on “It is essential to distinguish between the position of the government and the position of the countr

  • I have occasionally tried to explain the difference between a financial crisis and an economic crisis. Perhaps this article will go some way to persuading some of you that there is a difference?

    I have always acknowledged that the UK is in a parlous state but I have also emphasised the importance of looking beyond our debt. Our real economy and our ‘assets’ are just as important. This website is more or less in the prediction game and any good ‘predictor’ should free himself from emotion and take a balanced view of the facts. People on this site frequently complain about media bias but the bias expressed on this site is sometimes a bit fanatical

    The recent discussions on the subject of ratings agency gradings are a case in point. The PIMCO (and others) comments re the UK’s possible downgrade from AAA status were posted and debated. It would have taken some analytical integrity to acknowledge that they all said words to the effect that: “the UK will be downgraded IF a plan is not put in place to reduce debt”. To the best of my knowledge, every comment on this site ignored the ‘IF’. The ratings agencies are well aware that the Tories will take a sharp axe to government spending and it will not have escaped their notice that the Labour party are now also boasting of their cost cutting credentials. The ratings agencies are also aware that we have the benefit of an historically unique situation, where the majority of the public, are supportive of cuts.

    PIMCO and friends buy bonds and it is their job to talk up the yield on these bonds. Surely someone realised this?

    I’m sure that some of you will wilfully read this post as an expression of bullishness (btw, the bulls versus bears argument is a bit of a red herring that does not properly reflect the reality of market behaviour). To that end, please allow me to state my position…

    House prices will definitely fall because they cannot possibly escape the gravitational pull of unemployment and higher interest rates and taxation. Contrary to popular belief, the government is almost powerless to prevent a surge in repossessions. An economic recovery will take place that will be horribly anaemic. The economy will limp forward for another 3 to 5 years until the debt situation is improved and unemployment is reduced to below 2 million. I have no interest in talking about the stock market.

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  • fallingbuzzard says:

    I agree with you in general terms but I think the IF is a very big if. Pimco have looked at recent times when the UK had to cut public spending and noticed that it can’t actually manage to do it if history is anything to go by. Even the Iron Lady, notorious for making cuts and a hard line, didnt get it done. Hence the problem of a credible plan with any potential incoming government, all will have zero credibility.

    I also reflect on my own experience buying and selling companies. Virtually always there is a cost reduction plan set out for the next 5 years. If buying, we would always discount the plans by upwards of 50% no matter how credible they were because its not easy to make reductions in real life but very easy on paper. When you’re selling, its all achievable of course!

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  • cat and canary says:

    flash, understand what you’re arguing. My doubt is the ability of (whichever) government to impose sufficient cuts, because of levels of personal debt.

    I have a pure-hunch that our political masters wont have the leadership to force the cuts, and will only act when ‘forced’ by one or more agencies?

    Not sure if the majority of the public are that willing to accept the size of the cuts. Interesting balanced article on…
    http://www.ipsos-mori.com/researchpublications/researcharchive/poll.aspx?oItemId=2473

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  • Hello fallingbuzzard. The PIMCO thing is a bit of a side issue to the post (my fault) but I noticed Gordon Brown was recently boasting (words to the effect) that it would not be hard to make painless cuts because he had doubled public spending in a short space of time. Cost cutting is sometimes little more than an idle boast but in the case of the UK, most believe that there is easy meat to be carved off, without nicking the bone.

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  • C&C: Do you remember the Clinton advisor who said: ” I used to think that if there was reincarnation, I wanted to come back as the president or the pope or as a .400 baseball hitter. But now I would like to come back as the bond market. You can intimidate everybody”?
    (Clinton wanted to increase his budget but the bond market caused a rethink)

    It may be semantics but the bond markets, rather than the ratings agencies will impose spending cuts if necessary. The yields that will have to be paid out if we do not make the cuts will be the real driving force. The government will find cuts to be less financially painful than paying excessive yields. What I am getting at is that it doesn’t matter what the government wants to do….they have to make the cuts

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  • First he compares the UK with the PIGS of southern Europe (or the PIIGS of southern and Northern Europe), i.e. some of the worst performers.

    Then he slips in that the “crisis is primarily financial rather than economic”. Where does that come from?

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  • icarus: It all boils down to the profile of a countries financial problems. The UK does indeed have severe financial problems but they are not the same as the problems facing the “PIG” countries. The finacial problem versus economic problem conundrum can be defined by how limited a country is by its current account/ net asset position. If a country has a very poor current account/net asset position then it is unable to economically perform. Realistically these countries face years of deflation to restore their competitive edge and they are quite simply incapable of growth in the short and medium term. The nature of the UK’s financial position (we have a much better current account/ net asset position) is such that it does not necessarily prevent our economy from growing. It cannot be argued that we don’t have a severe financial problem but fortunately it is possible that the economy will provide a short and medium term path out of our finacial problem.

    I have often sensed peoples frustration at the dichotomy between a country as fucced as ours continuing to predict economic growth. This article goes some way to explaining how that is possible. Our debt and our economy are interrelated but the later is capable of alleviating the former rather than the former inevitably crushing the later.

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  • mountain goat says:

    Flashman – Thanks for the posts making a distinction between the government’s financial position and the country’s economic position. Can they be clearly separated though, especially now that we seem to be going into a fresh trend of nationalization and economic socialism?

    I winced at your comments “this site thinks …” because I take the position that the ONLY thing most of us agree on is that house prices will fall. There is a steady drone of views on the UK going bankrupt, UK doesn’t produce anything anymore, hyper-inflation round the corner, conspiracies etc which one eventually gives up challenging because some people never seem to change their mind. Doesn’t mean I agree with them though. People probably think the same of me ranting on about debt deflation.

    I think you are right that we are not on a high-risk bankruptcy list. Most sensible commentators don’t put the UK there (for example
    http://ftalphaville.ft.com/blog/2009/12/15/112756/the-worlds-riskiest-sovereign-borrower-2009/, and
    http://ftalphaville.ft.com/blog/2010/01/04/119336/sovereign-debt-crises-2010-an-rbs-sapling/). But a down grade from AAA is probably inevitable in the years ahead given the electorate’s entitlement expectations, long-term losses to industry, rising unemployment, aging population, on-going need to support the banking industry as the world wide recession drags on and debt go bad etc etc. Doesn’t mean we become a banana republic over-night, but we and many others get a diminishing slice of the pie as the third world gets an increasing share.

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  • stillthinking says:

    You seem to be saying we will have a harsh but fundamentally limited duration recession as opposed to a spiral of decline. Personally I think the UK looks more like a spiral of decline, of course I don’t know, but I am sure we will know by the end of the exciting year of 2010.
    I was looking at mish’s site today (for the US), and he commented that there will be high youth unemployment, which will lead to a lower rate of household formation. This is true for the UK.
    Government deficit spending has been and probably will be extraordinary, when this is withdrawn the UK will have a severe dose of cold turkey and employment levels will drop. 100 billion less spending is a huge sum. This is the yearly wages of 4 million [email protected] a year, let alone secondary spending, but that is what is required over 5 years to halve the deficit.
    I feel that the rosier estimates going forward depend on underestimating the mind blowing level of debt support the UK currently has. In context, Japan has sprayed money around on infrastructure for over two decades to reach their current level of debt, ~220% of gdp or whatever, we are over half-way there in just 2 years !
    The government forced the equivalent of a decade of Japanese debt spending into the country in -2- years !, and all they managed to do was moderate a brutal level of decline.
    2.5 million unemployed (find a job) and 4 million running on debt (change jobs) need to find some sustainable employment over the next 5 years. I just don’t see this happening. Debt has masked the real level of sustainable employment in the UK, and when the debt stops, we will see the real level of unemployment.

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  • flashman – but he didn’t support the ‘financial rather than economic crisis’ line. Not sure how the economy is going to alleviate the debt (your last para.).

    The core of the problem of this ECONOMIC crisis is debt. The major component of debt isn’t gov’t but private debt (households, businesses, financial sector). Hourly earnings peaked in the 1970s and debt has tended to finance consumption for long periods since then.. The result of this debt (see Japan) is short business cycles within overall stagnation. Not a V or a W-shaped recovery but a wwww non-recovery. That’s why some are calling it a balance sheet recession (as distinct from an inventory cycle recession, which is more easily handled) involving debt reduction, deleveraging, asset liquidation and increased savings. Debt-service payments rose relative to income and the bubbles went into reverse. There’s no increase in credit activity because would-be borrowers are too indebted. It’s difficult to get the economy going without debt restucturing or writedowns – for mortgages, the financial, corporate and commercial realestate sectors.

    There’s an ersatz recovery based on government support for prices of assets on bank balance sheets (more support for banks on the false premise that strengthening their reserve positions will lead to increased lending), which has fuelled stockmarkets.. But, in the absence of writedowns (or radical debt restructuring or debt forgiveness) only government stimulus is keeping economies afloat. There’s too little final effective demand from the private sector (which can be disguised for a while by the likes of China’s bridges to nowhere infrastructural expenditure, creating a chain of temporary demand). If governments withdraw stimulus – as they may under political prssure to reduce deficits – then we are back to Roosevelt in 1937 or Japan in1997, where stimulus withdrawal led to a second major dip.

    Bottom line – the debt crisis IS the economic crisis.

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  • stillthinking says:

    Put it another way, the only way the UK can achieve growth going forward is to cut back to the core healthy sustainable economy, and then let that grow. We haven’t done even one thing yet. Even the sickest diseased leaves are still on the plant, -nothing- at all has been done. We have run up this debt for nothing.

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  • I take Flashman’s point with regard to the net balance of the UK’s financial position.

    However, which countries are the ones that owe the UK? Is there not a chance that our net position would not be quite so rosy if countries that have borrowed from UK plc. begin to default?

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  • Flashman,

    I agree with the article in the sense that economic growth will be required to reduce our deficit but I cannot see where this growth will come from in the short term.

    The tax take from the City has fallen as a consequence of the credit crunch and I don’t expect it to rise to 2007 levels again in a hurry. Our industrial base is a bit run down and that cannot be built up quickly either – particularly in an environment in which finance for business is difficult.

    Last year, I recall you talking about companies gearing up and excitement at new opportunities … What sort of economic growth do you expect us to achieve in the next decade? I think we should be building up our industrial capacity but that won’t be easy when we have to compete with cheaper labour abroad.

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  • “unemployment and higher interest rates and taxation. Contrary to popular belief, the government is almost powerless to prevent a surge in repossessions. An economic recovery will take place that will be horribly anaemic. The economy will limp forward for another 3 to 5 years until the debt situation is improved and unemployment is reduced to below 2 million”

    I’m just impressed that you’ve managed to call that a recovery. I guess technically it would be, though I expect it wouldn’t feel that way.

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  • Mountain goat: “as the world wide recession drags on and debt go bad etc etc. Doesn’t mean we become a banana republic over-night, but we and many others get a diminishing slice of the pie as the third world gets an increasing share.

    Thanks for your reply. There is no way the recession will ‘drag on’. Recessions always end and I see no reason why this one will be any different. The latest data suggests that it has already finished

    There is no reason why the Western slice of the pie will diminish because “the third worlds gets an increasing share”. It doesn’t really work like that because a higher velocity of trade tends to benefit everyone. In other words, the whole pie gets bigger when there is growth. The third world will undoubtedly get richer but that does not mean that we will get poorer. First world corporations and businesses are pretty well globally imbedded

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  • hello quiet guy: We have a surprisingly diverse economy. It is not accurate to portray the UK as having just a finance sector and a run down manufacturing sector. Any google search will turn up pie charts and statistics showing the diversity or our economy. For example, we are a global powerhouse in oil, minerals and mining. Growth anywhere in the world will greatly benefit these industries. There are also exciting opportunities coming up in infrastructure, energy and renewables. The reduced pound has already benefited many businesses but this will take six months to filter through to reported figures. My overseas customers are very happy that my bills have been effectively reduced so much, by the reduction in value of the pound. My small example will be repeated all over the country

    We did no lose more than a few % points of our GDP in the recession. If a Martian read our blogs and mainstream press you would think that we had lost 60% of it. I am stuck in traffic everywhere I go. This traffic represents real activity in action. For whatever reason we are already technically out of recession. When the props are removed we will probably stagger a bit but all recessions end sooner or later with or without help

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  • stillthinking: “Put it another way, the only way the UK can achieve growth going forward is to cut back to the core healthy sustainable economy, and then let that grow”

    Why?

    Not all businesses and industries are coupled to the debt that exists in this country. Many businesses have adequate sources of capital and well-developed overseas market penetration. They can grow regardless of what troubles Gordon Brown. The UK is not one large organic mass tied to the government’s mother ship.

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  • icarus: “but he didn’t support the ‘financial rather than economic crisis’ line. Not sure how the economy is going to alleviate the debt”

    In the article he says: “The significance of the current account is not only that it affects the country’s net asset position. It also reflects its competitiveness and thereby its ability to grow its way out of financial difficulties”.

    “Bottom line – the debt crisis IS the economic crisis”

    See my comments @ 16

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  • Icarus: Sorry I meant see my comments @ 17

    Just in case I wasn’t clear @ 18, the author is saying that our net external assets and current account positions are not nearly as bad as some other countries and we are able, therefore, to promote/allow the economic growth that will alleviate our debt problem. The PIGS/PIIGS cannot do this and will therefore have to endure years of deflation and belt tightening misery. The Irish and the Spanish can’t really have thought that they were our economic equals? This is what you get when you try to play catch up in half a generation.

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  • flashman – my point is that it’s private debt that’s the stumbling block. It’s much bigger than government debt. There’s massive private deleveraging and resulting unemployment. This is a worldwide problem, so trading our way out is difficult to say the least. Bootle’s basing his argument on government debt is a red herring. In the absence of growing current account surpluses the government’s deficit is simply the obverse of private saving – if the private sector is to repair its balance sheet by spending less than its income the government has to spend more than its tax take or risk further recession.

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  • stillthinking says:

    Put it like this, when we measure debt to gdp, we are actually measuring debt, which is fixed, against gdp which might and probably will change. The very act itself of fiscal tightening is going to reduce gdp. One of the complaints about qe from early on was that once started, its impossible to know when you pass an invisible line of unsustainable debt. Government debt currently sustains our “gdp”. The longer the delay in reducing the debt, the harsher the debt reduction must be.
    So, when fiscal tightening occurs, we will find that our still increasing debt is in a comparison against a shrinking gdp i.e. our true debt is much higher relative to the productive capability of the economy. The suggestion that there are many companies which have penetrated foreign markets and which can grow irrespective of the UKs economy, is very similar to saying, companies disconnected from the UK will do alright. I am sure they will. But there are presumably some companies in the UK which are connected to the UK?! If a town was firing on all cylinders then it could support 100 pubs and those pubs would be part of a sustainable economy. I see the UK as an unsuccessful town still running 100 pubs. They -could- be part of a sustainable economy, but they aren’t. The town is poor and labour is disorganised, money is diverted into cr*p debt based projects, and the town can only support 50 pubs. But you could argue, the town can support a hundred so maintain some debt to get back the level of healthy again. I don’t think we can maintain the level of healthy because 2007 wasn’t healthy, it was just the height of personal and corporate debt. Irrespective of what -could- be OK, we need to collapse down to a 50 pub scenario and hope that the organic growth inherent in capitalist economies gets us back up to firing on all cylinders 100 pub status.
    None of which has happened. There isn’t one single thing the government has done to get the economy back to a high sustainable level of production, just debt debt debt and more debt.
    When they stop or are stopped we will find out our real situation is much bleaker, and our collective debts much higher. At that point of course, the money which is currently “borrowed” will look liable to monetisation, and yet more muddying of the waters for anybody fool enough to set up a company here, rather than just waiting for houses to bottom.

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  • mountain goat says:

    Flashman – “It doesn’t really work like that because a higher velocity of trade tends to benefit everyone.” I must concede that in the past world economic growth has benefited us too but considering the chart below means drawing straight lines from the past are probably going to be wrong. Clearly human growth is unsustainable, but perhaps this will only change centuries from now, and you will be shown to be right for now.


    http://www.321energy.com/editorials/chefurka/chefurka01.gif

    In terms of slices of the pie. We have benefited so much of late from a strong economy and currency. For example we have nurses and doctors working here because they earn more than in their home countries. As these countries prosper they will be able to hold onto their skilled people better. Now they spend a lot of money educating their doctors only for us to benefit from this. A weak pound helps our industries but turns off these other unique benefits we have had of late. And developing nations will be able to afford better food. These resources are not infinite, and so will cost more to us, even if the earth’s climate manages to stay as stable as it has been over the past few centuries. So for me I view this as near our peak. Record debt levels and asset price bubbles are a symptom of this unsustainable growth and peaking process. I am grateful to have lived now but will be surprised if our children will enjoy the same quality of life we have had.

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  • icarus: On that we can agree. Too much private debt will always be a stumbling block. I guess I think it is surmountable and you perhaps think it isn’t?

    It does help though, that our government is able to be more accommodative than that of the PIIGS

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  • 22. mountain goat said…”Clearly human growth is unsustainable,”

    Apologies for off topic, but I heard an analogy the other day which put unsustainable human exponential growth into perspective.

    Assume a particular bacteria growing in a petri dish will divide and double it’s number every minute. Assume that when the bacteria fills the petri dish then the agar growing medium will be used up and all the bacteria will die. Assume that this particular bacteria is intelligent and will notice when the petri dish becomes half full and will therefore be able to forsee it’s own destruction and take steps at that time to conserve it’s food supply/resources

    The question is this :- If it would take a full day for for the bacteria to completely fill the petri dish, how long would the bacteria have to take steps to avoid it’s imminent destruction? Answer = just 1 minute.

    Yeah I know there are flaws in the analogy, but you get the drift.

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  • flashman 23. A lot depends on the nature of government deficit spending. It’s propping up asset values rather than funding job-creating activities that generate goods, services, necessary infrastructure etc.

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  • tenyearstogetmymoneyback says:

    By far the most interesting figure in the article is ……. UK: net external liabilities 7pc of GDP.

    Several people commented on Personal / Private debt. What would be very interesting would be to see figures
    which showed which also shows personal credit. I work with several people who have completely paid off their
    mortgages. With some of them I really wonder what they spend their money on – Answer they probably don’t.
    On top of all that we (as in the employees where I work) have the money in our pension funds. When you are
    personally paying in £450 a month (and the company even more) it all starts to add up.

    The thing that does appear to have gone completely wrong is that a large proportion of the savers money has
    been lent out as mortgages or personal loans instead of being used for something useful like building some more
    Power Stations or Wind Turbines.

    p.s A final question for everyone. DO you think Fred Goodwin is worried about his personal debt ?
    Unlike a lot of RBS mortgage holders I bet it is the last thing on his mind.

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  • mountain goat @ 22: I generally stay away from population explosion discussions. I suspect that that the subject demands many years of study and is therefore beyond the scope of simplistic guesswork. Even an expert would have to admit that they really haven’t a clue what the world’s population will be in 100 years time. Too many variables and unknowns.

    “I am grateful to have lived now but will be surprised if our children will enjoy the same quality of life we have had.”

    You cannot possibly know what the future holds that far out, so it makes no sense to be determinedly pessimistic. I think it is perfectly reasonable for you to be pessimistic about our immediate situation but an honest professor of Futurology (if there was such a thing?) would undoubtedly tell you that he hasn’t got a clue what will happen long term …so why choose to believe in the worst possible outcome?

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  • If the past is any predictor of the future a level of pessimsim is always warranted. Historically horrendous things tend to happen with alarming frequency. Not that the past is much of a predictor of the future.

    I like stillthinking’s comment @21. I’d add that personal debt is the problem, that, and the state debt and liabilties we are adding to sustain the asset values that became so hopelessly detached from the income that theoretically supports them.

    There are usually reasons to be cheerful, and I’m sure in time there will be, but optimism for now seems no more well founded than it was in 2006.

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  • “why choose to believe in the worst possible outcome?”
    Hope for the best, prepare for the worst.

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  • @stillthinking, a question – “The very act itself of fiscal tightening is going to reduce gdp.”
    The fiscal tightening would be to pay off debt at the same time as the gdp shrinks, maintaining the ratio – no?

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  • bellwether:

    “Historically horrendous things tend to happen with alarming frequency”

    So do good things and indifferent things. We can therefore conclude that something will frequently happen in the future. Like you say, the past is not much of a guide

    “but optimism for now seems no more well founded than it was in 2006”

    It didn’t seem particularly well founded in 2008 but 2009 was nevertheless a cracking year .

    “I’d add that personal debt is the problem, that, and the state debt and liabilties we are adding to sustain the asset values that became so hopelessly detached from the income that theoretically supports them.”

    The statement above sees things through the narrow prism of asset values and debt. Large tracts of the economy will continue to function no matter what happens (or does not happen to asset values). Not everything is coupled.

    bellwether, does the ‘pat’ nature of all the colourful debt descriptions used here and elsewhere ever make you suspicious? I say this because I am confident that the mechanisms that operate economies and markets are far too complex to be defined in such narrow and simplistic terms. Debt is very important but not everyone or everything is affected by it. Like I say, not everything is coupled.

    I would go so far as to say that there are many opportunities that arise from the indebtedness of people and companies. For example, I have recently bought some assets from indebted entities. I am in the process of putting them to work in a far more vigorous fashion than managed by the previous (indebted) owners. Not everyone is in debt, so assets can and will tend to go to entities with more energy and capital. It is late so I am rambling but I am trying to show you a mechanism whereby debt could even be a source of growth (i’m not saying it will).

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  • mountain goat says:

    Flashman Sorry it seems we have come back to the bull-bear discussion. We were talking about the world economy and our slice of the pie. That plot I posted leads to all sorts of reactions but I merely wanted to point out that extrapolating from the past will not work forever when human populations are on an exponential trajectory. What has been normal throughout our lifetimes is this exponential trajectory. I don’t expect the worst, I just expect what is normal to me not to remain as the norm. Excessive optimism can lead to denial of reality and wishful thinking. Excessive pessimism to worse problems still. One needs to be aware of both optimism and pessimism because they can interfere with sound judgment. I don’t know the future but it seems reasonable to me that despite technological advances that 6.7 billion people alive today can’t live at our standard of living. But these people do aspire to our standard of living so it also seems reasonable that we must have a smaller slice of the pie, even if the population stopped growing.

    p.doff thanks for the analogy. As I was saying the exponential plot gets you thinking in all sorts of ways, although my point was limited to that exponential growth is not sustainable so the past is not always a good indicator, rather than exponential growth always leads to disaster. In biology there are many cases of exponential growth in populations which eventually lead to sustainable populations once the niche is fully exploited. As a species that is our next challenge perhaps, whereas up till now we have just surged because we could.

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  • mountain goat: You may have misunderstood me. I am neither optimistic, nor pessimistic. I really don’t worry about the economy, let alone the population growth curve. I actually had no reaction to your chart because if I am honest, I can’t be bothered to think about it. I am sure that some people would say that it is important to consider these important matters but I am genuinely more worried about Owen Hargreaves’ knee. I don’t wish to cause you offense but you might do well to recognise the fact that ‘wider’ society would most certainly describe you as a pessimist. Didn’t someone famous once say that he felt like cutting his wrists after reading HPC for a few minutes? There is no harm in you being a pessimist and I respect your right think anything you want. Each to his own and all that.

    I often think that the many war generations would be quite contemptuous of the breast beating that goes on about our debt and supposedly parlous state. I’m also sure that the real depression generation would be astonished by the comparisons that people glibly bandy about whilst shopping for a new i phone.

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  • Flash I am still at work so here is a response.

    The debt view may, or may not be off pat on this site, but it is not even recognised much when it comes to the mainstream. That said a fair point.

    I also incidentally think your optimism is one of the few things that spark any sort of decent discussion here so I’m all for it. Can’t be bothered to add much more for now.

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