Good News

Today David Cameron gave a strong hint that the GDP figures to be released tomorrow will be “good news”. As Jonathan Portes quickly pointed out, someone in the know even hinting at the figures before they are released is illegal. David surely knows this and it is a sign of the pressure he is under over the economy that he has blurted this out today.

When the GDP figures are bad the government says things along the lines of, “Things are worse than we thought, this is even more of a reason to pursue austerity!” And when they are good tomorrow they’ll say, “Austerity is working!” So whatever is going on they’ll say austerity is the right policy because they’re in too deep now to say anything else. But will these “good news” figures really mean a good economy?

GDP figures are always quoted relative to the previous quarter. The previous quarter was an absolute disaster so doing well in comparison to that is not necessarily good news. As I wrote three months ago:

We will almost certainly do better in Q3 – it is virtually impossible for us to repeat a quarter that bad. And when we get a recovery in Q3, the government will be saying it is advocation of their policy.

Q3 being better than Q2 isn’t that important. If the economy had been in free fall it would be important but the economy hasn’t been in free fall, it has been in depression and as I’ve mentioned on here before, the results in an individual quarter don’t tell us much at all. The important thing is not whether Q3 was better than Q2 – it is the longer-term trend, i.e. how much longer we have to wait until the economy returns to a healthy level?

Whatever the numbers are tomorrow it will certainly not represent an advocation of austerity – the expiry date on that fallacy is long passed and, in a depression longer than The Great Depression of the 1930s, it would be fairly ridiculous to claim it had worked.

The question we should be asking now is not, “When will the economy be bigger than it was in the second quarter of 2012?” A much better question would be, “When will the economy be bigger than it was at the start of 2008?”

And I promise you this much – that ain’t going to happen tomorrow.




Really quick post. I saw a lot of government ministers today giving themselves massive pats on the back because of our brilliant unemployment figures. Down 50,000 they say!

That may be the case but we need to put this into perspective. This is the graph from today’s ONS report and the bit circled in red is the bit they are all getting over-excited about:

UK unemployment (source ONS)

UK unemployment (source ONS)

While any decrease in the rate of unemployment is good, this is way too slow, especially considering that many of the extra jobs seem to be coming from people moving from previous full-time employed to now part-time employed.

It really does take an incumbent government to think that graph looks like anything other than a disaster.

I’m not going to be popping the champagne just yet.


It’s the Economy, Stupid.

Today I listened to David Cameron’s Conservative Party Conference speech on the wireless. Below is a transcript of what he said about the economy and (roughly) what I said back at the radio.

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David Cameron: To help our people rise, then – number one – we need an economy that creates good jobs. We need businesses, of every size, in every type of industry, in every part of the country – investing and taking people on.

RedEaredRabbit: Sounds good.

DC: There are some basic things they need to do that. Low interest rates so they can afford to take out a loan. And confidence that it’s worth investing – because the customers will be there, whether at home or abroad. Getting the deficit down is essential for both.

RER: No it isn’t. Throughout the last few years when we have had a large deficit and interest rates have been the lowest in living memory. I would also argue that confidence in the economy comes from people seeing sustained economic growth and job creation, neither of which we have.

DC: That’s why our deficit reduction plan is not an alternative to a growth plan: it’s the very foundation of our growth plan.

RER: I realise it’s the foundation of your growth plan but two and a half years in it has yielded precisely no growth. That doesn’t suggest it’s a particularly good growth plan.

DC: Now I know you are asking whether the plan is working.

RER: No I’m not. I know the answer to that.

DC: And here’s the truth: the damage was worse than we thought, and it’s taking longer than we hoped…yes it’s worse than we thought, yes it’s taking longer, but we are making progress. Thanks to the grit and resolve of George Osborne, we have cut a quarter off the deficit in the past two years.

RER: I’m confused. In 2010 you said that if we didn’t cut spending the deficit would, by this time, only have reduced by 25%. You said this would be disastrously slow so you needed to cut spending to do it much faster. You’ve cut the deficit by the amount you said would be disastrous but have additionally killed the economy in the process. Is that good now?

DC: That’s helped to keep interest rates at record low levels, keeping mortgages low. Leaving more money in your pockets. Giving businesses more confidence to invest.

RER: I’ll take these one by one.

  • Interest rates are low because the economy is screwed
  • If you think people have more money in their pockets you are even more out of touch than I thought
  • Businesses are not investing. I have no idea where you got that idea from.

DC: Now, the Labour politicians who got us into the mess say they have a different way out of it. They call it Plan B and it goes like this: “We should stop worrying about deficit reduction, borrow more money and spend it to boost the economy.”

RER: Ah, those bastards are using “macroeconomics”. I think though, you’re giving them a bit too much credit by suggesting they invented it.

DC: Right now, while we’ve got a deficit, the people we’re borrowing money from believe that we’ll pay it back – because we’ve set out a tough plan to cut spending and live within our means. That’s why our interest rates are among the lowest in the world…

RER: They believe we’ll pay it back because we are a large developed economy whose debt is in its own currency. We have never been at any risk of default. See my previous point on interest rates.

DC: If we did what Labour want, and watered down our plans, the risk is that the people we borrow money from would start to question our ability and resolve to pay off our debts. Some may actually refuse to lend us that money.

RER: No they wouldn’t. People are queuing up to lend us money. In an era where banks are risky and Eurozone economies borrowed in a currency they can’t control the UK has been and will always be a safe bet.

DC: That would hurt the economy and hit people hard.

RER: So your plan is to cut out the middle-man and do this yourself?

DC: If you have a mortgage of £100,000, just a 1 per cent interest rate rise would mean an extra thousand pounds to pay each year.

RER: I don’t know if you’ve looked at mortgage rates offered by banks recently. They bear no relation at all to the rate at which the UK government can borrow.

DC: Labour’s plan to borrow more is actually a massive gamble with our economy and our future.

RER: Whereas at least with you we know we’re fucked.

DC: And it would squander the sacrifices we’ve already made.

RER: You have sacrificed jobs and growth. Wouldn’t squandering those disasters be quite good?

DC: We’re here because they spent too much and borrowed too much.

RER: No, the banks caused the crisis, it had nothing to do with government borrowing at all.

DC: How can the answer be more spending and more borrowing?

RER: Are you familiar with the book, “Economics for Dummies”?

DC: I honestly think Labour haven’t learned a single thing.

RER: As opposed to your “learning” government who has blindly pursued an economic policy that has continually delivered the opposite of what they said it would?

DC: When they were in office, their answer was always borrow more money.

RER: Actually their borrowing level in 2007 on the eve of the crisis was almost exactly the same as their borrowing level they took on in 1997 and was fairly flat throughout. The numbers are not hard to find.

DC: Now they’re out of office it’s borrow more money.

RER: Ha, those fools! Pursuing their “macroeconomics” again!

DC: I sometimes wonder if they know anything about the real economy at all.

RER: If only they could know all that you do because you’re really good at it.

DC: Did you hear what Ed Miliband said last week about taxes?

RER: No? Did he think it was the plural of taxi?

DC: He described a tax cut as the government writing people a cheque.

RER: Oh.. he got it right. That’s not nearly as funny.

DC: Ed… Let me explain to you how it works.

RER: Time to dispel the macroeconomics witchcraft.

DC: When people earn money, it’s their money. Not the government’s money: their money. Then, the government takes some of it away in tax. So, if we cut taxes, we’re not giving them money – we’re taking less of it away. OK?

RER: Ah.. you’re not giving them money, you’re taking less of it away. Got it. Ed probably hadn’t realised he could make tax-cuts for rich people sound that nice when he said it.

DC: And while we’re on that – who suffers when the wealthy businessman goes off to live in Geneva?

RER: His new neighbours?

DC: Not him – he’s paying about half the tax he would do here…

RER: Well I for one have stopped feeling sorry for the poor and the unemployed now. That rich businessman is clearly the victim. Also, did you know that women are allowed to be successful business people now?

DC: …it’s those who want to work who suffer because the jobs aren’t being created here.

RER: Oh, I see! The jobs aren’t being created here because the rich aren’t rich enough. And all the time I thought it was because of that depression you created.

DC: We promised that those with the broadest shoulders would bear the biggest burden and with us, the rich will pay a greater share of tax in every year of this Parliament than in any one of the thirteen years under Labour.

RER: Yes, but I don’t think cutting the poor’s tax burden by making them all unemployed was what they had in mind.

DC: We remember who busted our banks, who smothered our businesses

RER: Yes, the banks busted themselves, which led to an economic disaster that smothered our businesses.

DC: …who wracked up our debts, who wrecked our economy…

RER: Really glad you’re finally going to have a go at the banks.

DC: …who ruined our reputation, who risked our future…

RER: You tell those banks, David!

DC:…who did this?

RER: I seem to recall it was something to do with the banks.

DC: Labour did this.

RER: Damn. I honestly thought you were going to get something right then.


The Blame in Spain

As you are no doubt aware, the Eurozone is going through a bit of a tough time at the moment. While the economy in Germany has remained resilient throughout the crisis, many other Euro members have not been as lucky. Take Spain for example. Here’s how Spanish unemployment compares with German unemployment during the crisis:

Spanish and German Unemployment Rates (Source IMF)

Spanish and German Unemployment Rates (Source IMF)

Yes, it’s awful but we all know how this happened, right? The Spanish government borrowed far beyond its means during the good years, running up huge debts and when the economic crisis hit they couldn’t afford to pay it off. How do we know this? Well, Angela Merkel told us. Anyway, it’s easy enough to prove – the IMF database has everything we need. So let’s grab the data and see how terribly irresponsible Spanish government borrowing was during the good years of the Euro:

Spanish and German Debt:GDP Ratio (Source IMF)

Spanish and German Debt:GDP Ratio (Source IMF)

Oh. So if Spain was doing the precise opposite of plunging itself deeper into debt, what exactly is going on?

At the moment Spain is a deeply ill patient and Germany is her self-appointed doctor. Not only has Germany (as we’ve just seen) misdiagnosed the cause of the problem but they have also prescribed austerity as the cure.

I’ve talked before about the fallacy of attempting to solve a depression with austerity and we need not go through those details again to know why it is a fallacy. What I do want to think about though, is why Germany has been so quick to misdiagnose the cause of Spain’s problems and for four years has chosen not to look at the numbers in the graph above.

There is a theory about this but to understand it we first need to travel back in time to the 28th of June 1919.

On that day in history, Germany and The Allies marked the end of war by signing The Treaty of Versailles. The treaty, amongst other things, laid out the reparations that Germany would have to pay The Allies in compensation.

At the time that the treaty was signed the British economist John Maynard Keynes described the reparations not as a compensation but as a “deliberate impoverishment”, and went on to predict (rather chillingly) that they would lead initially to mass poverty and then on to vengeance and another war.

When the reparations began, Germany soon didn’t have enough Marks to buy the foreign currency needed to make the repayments so they printed more Marks. Each time they did this the value of the Mark decreased, so that the next time they went to the printing press, they had to print more Marks than last time. Inflation turned into hyperinflation and the value of the Mark fell off a cliff and then kept going in spectacular fashion.

At the end of The First World War, one US dollar was worth about nine Marks. By the end of 1923, one US dollar was worth 4.2 trillion Marks. Inflation was so high that prices were doubling every two days. Saving money was a pointless exercise, so people spent it as soon as it was in their hands. Workers were paid hourly so they could hand the money to their families to go out and spend immediately while they could still get something for it. If someone went to the pub intending on having a couple of beers, they would buy their two beers on entry for fear that otherwise the second would be more expensive by the time that they came to order it. To help to put this into perspective, here’s a fifty billion mark postage stamp.

A 50 Billion Mark Postage Stamp (Milliarden means Billion)

A 50 Billion Mark Postage Stamp (Milliarden means Billion)

Living through such a period is almost unimaginable for us and it is little wonder that the current generation in Germany have such an inherent fear of inflation. A leader who would even give a hint of allowing some of it would immediately become deeply unpopular.

So how, you may ask, does this have any bearing at all on the current crisis in the Eurozone? Sadly, the solution that is needed, inconvenient as it may be, is German inflation.

During the good years of the Euro, Spain’s economy did well. Adoption of the single currency led to huge capital inflows from German banks to Spanish banks. The German banks’ perceived risk of lending lots to Spanish banks (and the Spanish banks’ perceived risk of borrowing lots from German banks) reduced significantly (and erroneously) once they were all using the same currency. The German banks thought that since they were both on the same currency now, lending to Spain was like lending to Germany. The Spanish banks eagerly accepted the German loans and invested them in the Spanish housing bubble (they didn’t call it a bubble at the time). As more and more money passed from Germany to Spain the bubble grew, Spanish wages increased and Spanish prices increased.

This is how relative Spanish and German prices changed throughout this period:

German and Spanish Price Inflation (Source IMF)

German and Spanish Price Inflation (Source IMF)

And this is how relative Spanish and German labour costs changed throughout this period:

German and Spanish Unit Labour Costs (Source OECD)

German and Spanish Unit Labour Costs (Source OECD)

As you can see, during this time the cost of Spanish workers became much higher relative to their trading partners in the north. When the financial crisis hit and demand dropped off, this left Spain with a deeply uncompetitive economy. Production of goods and services for export to Germany, France and other economies in the north is simply too expensive now.

This is the primary problem that needs to be solved in order for Spain to recover and you might note, it has nothing to do with government spending.

So now we understand the problem, what’s the solution? Well, one solution would be Spanish deflation but deflating your way to competitiveness is extremely difficult because it means everyone taking pay cuts and people don’t really like taking pay cuts. The Spanish government could start by cutting the wages of all public sector employees (and deal with the riots) but how do you convince the private sector to do the same? Also, Spanish deflation effectively increases their debt burden*, which means it’s pretty unworkable in any case.

There is another option – inflation in Spain (and Italy, Portugal, Ireland**) that is low relative to the Eurozone as a whole. The Eurozone economy is dominated by Germany so essentially this means German inflation. We’re not in any way talking hyperinflation but something like inflation of 1% in Spain and say 5% or 6% in Germany would start moving things back toward competitiveness.

With the horrors of 1920s hyperinflation still ingrained in German minds, Angela Merkel will have no easy task in pushing such a policy through and her current policy of blaming the problem on Spanish government spending in the good years and prescribing austerity as the cure has certainly helped to maintain her popularity with German voters.

Sadly though, Angela Merkel being popular won’t be enough to save the Euro.


*Although Spain’s debt wasn’t high during the good years it is high now due to their economy collapsing. It’s important to understand the the high debt was caused by the crisis rather than the other way around.

** You might have noticed I didn’t mention Greece. They actually did borrow beyond their means for a sustained period and relative deflation is not sufficient to save them. From what I can see they are pretty much done for.