BORIS DEBIC: Welcome
everybody.
I am extremely pleased to
welcome today Mark Blyth.
Mark Blyth will share with us
his insights into austerity as
it takes shape in the
European Union.
Let me read a little bit
from his biography.
Mark Blyth is a faculty fellow
at the Watson Institute,
professor international
political economy in Brown's
political science department,
and director of the
university's Undergraduate
Programs in Development
Studies and International
Relations.
He's also the author of "Great
Transformations--
Economic Ideas and Institutional
Change in the
20th Century."
He's the editor of the
"Routledge Handbook of
International Political
Economy," co-editor of a
volume on constructivist theory
on political economy
titled "Constructing the
International Economy," and
he's working also on a new
book that questions the
political and economic
sustainability of liberal
democracies, called "The
End of the Liberal
World." That's dramatic.
Blyth is a member of the
Warwick Commission on
International Financial
Reform.
He is a member of the editorial
board of the "Review
of International Political
Economy." And his articles
have appeared in journals such
as "The American Political
Science Review," "Perspectives
in Politics," "Comparative
Politics," and "World Politics."
He has a Ph.D. in
political science from Columbia
University, and
taught at Johns Hopkins
University from 1997 to 2009.
Please give a hand
to Mark Blyth.
MARK BLYTH: Thank you.
Cheers.
Is this mic on?
Yes?
Can you hear me?
Hello?
Right.
So I have a Scottish accent.
There's surprise number one.
And those slides started to
change themselves, which is
surprise number two.
OK, how am I going
to start this?
Why did I write this book?
I wrote this book for the
following reason--
I got really, really pissed off
with people with lots of
money telling people who don't
have any money they need to
pay shit back.
That's basically it.
I grew up on the butt end of
the British welfare state.
I'm an orphan, and I was
raised by my paternal
grandmother.
So I am the greatest living
example of inter-generational
social mobility you're ever
going to see, because I'm a
freaking Ivy League professor.
So I went from there to there.
How did I do that?
Because of this thing that gets
blamed called the welfare
state, that bloated,
paternalist, out of control,
incentivizing, demotivating
piece of crap called the
welfare state.
Now, why is this a completely
bullshit story?
Well, that's not, but why does
it turn into a bullshit story?
It turns into a bullshit story
for the following reason--
back in 2000, the number one
concern of financial markets
globally was there wasn't going
to be enough federal
debt, because we had balanced
the budget.
Seriously, the number one
concern was there wouldn't be
enough T-bills.
So fast-forward 13 years, ah,
we're all freaking out.
Now, in between, a couple
interesting things happened.
So you have a balanced budget,
which basically means over
time, as the economy
grows, your debt
stock is going to shrink.
And that's why people had
a problem with it.
So you're going through a
period of rapid growth.
This was the tech boom period,
all this sort of stuff.
And then there's 9/11.
So there's a little dip in the
economy and a guy called
Greenspan comes along and says,
let's cut interest rates
and essentially do asset
protection for everybody who
has bought assets by giving them
more or less free money.
So then we decide on top
of that we're going to
have two tax cuts.
Why?
Because we just need
more money.
Screw it.
We're just going to do it.
Let's have some tax cuts.
No corresponding way of paying
it off, or whatever, we'll
just take the tax cuts.
And then we'll decide to fight
two wars of choice for dubious
political reasons without
raising any taxes.
That'll be a good one.
So by the time you get
to 2006, there's
61% debt to GDP already.
I don't remember anybody in
Congress, particularly
Republicans, jumping up and down
about the crazy level of
federal debt in 2006.
And then in 2007 and
2008, there's a
run on the repo markets.
Basically, the hidden story of
the financial crisis that
nobody really talks about-- it's
actually quite simple--
is that because there was a
shortage of T-bills, because,
in fact, many of them were in
China, because they keep
buying a lot of them, we started
to use AAA mortgage
products as collateral for short
term financial deals in
the repo markets.
As the housing crisis happened,
those bonds that
made up those instruments
fell from AAA to B to C.
At that time, that meant that
if you were a heavily
leveraged financial
organization-- a Bear Sterns,
for example--
and you were using these things
as pledges and as repo
collateral, as they fell in
value, you had to use more and
more of them to borrow the
same amount of money.
Unfortunately, you couldn't do
that, because there's a fixed
stock of the assets.
And they're hugely levered.
This meant a 3% return against
their asset base, rendered
them effectively insolvent.
Once everybody figured this
out, you shout fire in a
crowded theater, everybody
freaks out,
heads for the exits.
You get a liquidity crunch.
You've got a financial crisis.
We decided to bail out the
system rather than let it
fail, because it was
too big to fail.
The costs of doing so were
basically a 30% drop in tax
revenue across the OECD
countries, because the
financial sector had become so
big, particularly in the
United States and the United
Kingdom, that it was
generating huge amounts
of taxes.
At the same time, the economy
slows down as the liquidity
crunch hits the real economy
and affects lending and
borrowing and spending.
Consumer expenditures trend
down, as do consumer
expectations, as do investment
expectations.
You get caught in a slump.
Once you get caught in a slump,
automatic transfers in
the economy mean that benefits
go up at the same time as tax
revenues go down.
So you're going to have
a bigger deficit.
As you have a bigger deficit,
you multiply that over time,
you issue more debt, you go from
61% to 100% debt to GDP.
That's why we're here.
There was no orgy of
public spending.
It's a lie.
I take Amtrak every day.
I would've noticed an orgy
of public spending.
If there was an orgy on public
spending, it was on asset
protection and income protection
for the people who
had made out with the most for
the past 30 years when we
bailed out those assets.
That's actually what happened.
Now, here's the inequity of the
[INAUDIBLE] in this whole
thing-- why is it that social
security, which isn't even
part of federal budget
calculations on the deficit,
which, by the way, has a $2.3
trillion surplus, that has to
be cut so we can pay back the
debt accrued by bailing out
some of the richest people
in our society and
ensuring their assets?
Does anybody else think that's
total horse shit?
Because I really do, and that's
why I wrote this book.
Now, here's the weird thing.
We're actually not in
that much of a mess.
It's been a sticky recovery.
It's been a technological shock
to a lot of service jobs
that we didn't expect,
et cetera.
But nonetheless, we haven't
been cutting them.
Because of that, the federal
deficit's projected to be
around 3% next year--
even with a margin of error
in the projection, say 4%.
Britain has its own currency,
like us, and has been cutting,
been doing austerity.
Having done that, it's now
looking at 7%, totally
[INAUDIBLE]
growth, and a possible
triple-dip recession.
Europe has been cutting like
there's no tomorrow.
They've got the leaches on
the corpse and they're
opening up the veins.
Greece has lost 30% of
GDP in four years.
The German army didn't manage
that between '41 and '45.
That's how much damage has
been done by this.
So the question is
the following--
why is it that Europe,
particularly the European
Union, the part that we think of
as the most kind of, if you
will, welfare-statish-friendly
transer, et cetera, suddenly
became this huge doomsday
device for this enormous
experiment on austerity, which
so far has cost around 30% of
GDP in the periphery and has
generated 25 million extra
unemployed in comparison
to the United States?
Seems like something
to investigate.
So, there's a standard picture
of Europe in terms of its
fiscal balances.
As you can see, the United
States around here, 2012.
By the way, always look at the
net figure, because if you
look at the gross figure,
that assumes
that nobody pays taxes.
And given that we all just wrote
checks just a little
while ago, that would tell you
that you really shouldn't look
at that one.
It also it seems the country
has no assets.
And if that's the case, why do
we have the National Security
Investment Act to stop
people buying assets?
So obviously, look
at the net one.
So you look at the net
one, where are you?
Well, basically, everybody's
kind of in the
mire, more or less.
So what brought about
this fine mess?
Age check in the room.
Anybody who's giggling now
is over the age of 40.
On the left, we have Laurel and
Hardy, and on the right,
we have Angela Merkel
and Sarkozy.
There we go.
I put that in purely for comedic
values, just to make
sure everyone is paying
attention.
And actually, they did bring
about this fine mess, so that
is a serious point.
So what's the story here?
Well, there's an
official story.
It's what I call story one,
and this is the sort of
vaguely sophisticated version
that you get if you read
things like "The Economist,"
"The Financial Times," et
cetera, et cetera.
And I'm going to tell you why
it's total crap, because it's
not really true at all.
So there's story one
and story two.
So here's the official
story, story one.
You do this by looking
at this.
This is interest rate
convergence over
10 year bond spreads.
So if you go back in the day
before there was this thing
called the Euro, when everybody
had their own
currency, if you were buying a
bit of Greece on 10 years,
there's a 25% risk premium
you're getting paid for
holding that.
That means that basically
there's a one in four chance
they're going to default.
Why would you price that in?
Well, because they haven't run
a budget surplus in 50 years.
Because they've been taking
turns to steal the state and
using other people's rents and
revenues to do it since they
basically ended the Civil War,
so why would you not price
this at 25%?
Then have a look at the French,
the Italians, the rest
of the Mediterranean, it's
strained around 15%.
This whole [INAUDIBLE]
in here, over 10%.
That's a lot.
You're getting paid a lot for
just holding a 10 year debt.
Now, that reflects the real
price of the bond, the real
risk of default that's
in the bond.
Now, the official story
goes like this--
around 1991 there was this
wonderful treaty called the
Maastricht Treaty.
Well, that's '86.
'91 is the Monetary Treaty.
And we decided that we're going
to build this monetary
union in Europe.
And what did that mean?
It meant basically that you're
going to have this German bank
called the Bundesbank
generalized
across the whole area.
All the people that currently
have inflation and exchange
rate risk and default risk no
longer will have it because
we're going to take away
their printing presses.
And once we've locked up all
the printing presses in the
one time deal and given them
to a guy in Frankfurt, and
he's the only one who can
print the money, well,
basically doesn't that mean that
Greece becomes Germany?
Doesn't that mean that Italy
becomes Germany?
Because after all, they
can't inflate
their way out of trouble.
So you get rid of that risk.
You can't devalue your way,
which is a backdoor way of
solving the same problem.
All you can either do is
deflate-- austerity--
which is politically
unpalatable, or you basically
sort your economy out and
everybody kind of becomes
German, and that's
the great plan.
And you can see how this
is represented
in this risk premium.
There's where the
Euro comes in.
And then there's a 7 and 1/2
year period where basically
all of these countries-- think
about how diverse this is--
everyone from Belgium to Italy
to Greece to Spain to Portugal
have basically got exactly
the same default risks.
Now, that's kind of odd if you
think about it for more than
two minutes.
So what's behind this?
Well, the story goes
like this.
Basically, what's undermining
this-- if you go back to the
end here and you see where the
spreads go up right, why does
it all start to go wrong?
Well, if you have a look here,
your current account and
balances, exports and imports.
And you'll find that what
you've got here is most
countries in the Euro, the major
countries, are basically
running deficits all
the way through.
And the only one that starts
to run a surplus here is
Germany, which picks up just
as the Euro comes in and
becomes the export powerhouse.
Now, when you control for the
size of the German economy
relative to everybody else, what
you begin to realize is
that their surplus is
the counterpart
everybody else's deficit.
In other words, somebody has
to buy all those BMWs.
And if you're buying all those
BMWs, you're not making your
own [INAUDIBLE]
and selling them back
to the Germans.
So you start to get these
current account imbalances.
But that begs the question--
where did all these guys in the
south get the money to buy
the BMWs in the first place?
Well, that's your story about
lax public finances.
This is these countries that
are spending too much.
So look, it's the PIGS--
Ireland, Spain, Greece,
Portugal.
The Netherlands we'll put
in a bracket, right?
But basically, look--
a huge amount.
That's 10% year on year annual
growth of government
expenditure.
They are spending like drunken
sailors, there's no doubt
about this.
Now, what made this possible?
As I said before, this is the
ECB, being Deutschbank Uber
Alles, taking inflation
and devaluation
risk off the table.
And also, the Maastricht
criteria for Euro gives
credible rules against sovereign
misbehavior.
You can have a 60% debt
load, 3% deficit,
and variable inflation.
And as I said, the yields
converge, and the countries
over-borrow.
As we saw in those last three
slides, they're basically
spending too much money.
But then what does that do
to your competitiveness?
Well, it's going to obviously
hit your competitiveness.
If you're spending that much
money and you've got a huge
trade imbalance, you've got to
be basically awarding yourself
way above productivity
wage increases.
And look at what you've got.
Ireland, Spain, Italy, Greece,
Cyprus, Malta, Portugal.
The PIGS again.
And look at these massive labor
cost changes over the
last 7 year period.
You're awarding yourself
pay increase you
can not hope to cash.
So this is all a very convincing
story, right?
And what made this possible?
Well, of course, what made it
possible is cheap debt.
Because as those yields
converge, look what's happening.
Portugal is borrowing.
Spain is borrowing.
Greece is borrowing.
Ireland is borrowing.
Look who's actually
in surplus.
The Germans and the
Netherlands.
So their savings are financing
their consumption.
So these countries have
massively over-borrowed.
With the take-home being the
southern countries have
borrowed too much.
Now, have a look at this
network diagram.
It's kind of interesting,
because there's a question
mark there for a reason.
There's Portugal.
Relative sizely economy
123 billion euros.
Spain, 345.
Italy, very big-- nearly
half a trillion.
But pretty much all of their
bonds are domestically held.
60% are long-term domestic.
The ones that are 10-year
rollover escalate by 10%.
Look at this.
Look who's popped up here, with
a trillion dollars of
crap assets lying on their
balance sheet.
It's the Brits, the world's
largest financial entrepot.
And look who's up here.
It's those prudential Germans,
who save a lot and tell
everyone to upgrade
their scales.
They've got half a trillion
of debt going on.
So what do you mean the southern
countries have
borrowed too much?
There's a rather large problem
with this story.
You can't have over borrowing
with over lending.
This is actually a Citibank
advertisement.
Some of you who are over the age
of 16 may remember this.
The largest ever advertising
campaign for a finance company
in the world was Citi's
campaign, "live richly," from
2003 to 2006.
It didn't invite you
to save up money.
It didn't invite you
to be prudential.
It said live richly.
It didn't even say be rich.
You kind of have to have rich
before you spend it unless
you've just got a giant
line of credit.
So let's run that story again.
Here's the greatest moral hazard
trade in human history.
Remember the whole story I told
you about the ECB and
credibility and all
the rest of it?
Here's why it's complete
horse shit.
Because what actually
happened was this--
I'm a large European bank.
I know that I've got a sovereign
behind me that, if I
become really big, I'll become
too big to fail.
Which basically gives me a
license for doing whatever the
hell I want because then
it will all be bailed.
It gives me a funding cost
advantage, and it means that
basically I can lever up well
beyond human reason with
pretty much no consequences.
And the more powerful I become,
the bigger threat I am
to that sovereign.
And eventually, if the sh-- hits
the fan, well, you know,
I'll get bailed out.
It's totally fine.
So imagine I know there's this
thing called the Euro coming
in, and you're all other
European banks, and you know
that you could earn a nice
little bit of coupon buying
this Greek bond at 25%.
There aren't that many
of them-- it's a
thinly traded market.
But if you can get it,
if you lose, fine.
But the upside's great--
25%.
Now, what happens if everybody
really believes this Euro
story and everybody starts
to converge down?
Well, I'm going to make
less and less money on
those bonds over time.
So a quick bit of math
up in your head.
How would you make even more
money on a declining spread?
You've go to use volume, you've
got to use leverage.
So what you do is you basically
get the balance
sheet of your bank and you cram
it with as much periphery
debt as you possibly can.
You take all your nice, safe
German, Dutch bonds and you
throw them out.
And you pile on as much Greek
debt and as much Portuguese
debt and as much French
debt as you can.
And you turbo charge that,
running operating leverage of
around 40 to 1, which means your
equity cushion is less
than 3% percent of your
asset footprint.
You make Lehman Brothers look
like a prudentially run
organization.
And you do this because you've
got a guarantee.
The guarantee is the state.
The state will come
and rescue you.
You get in trouble,
you're fine.
Except there's a slight
flaw in the plan.
What happens when the
Euro comes in?
You have to give up your
printing press.
So that means your state can't
bail you out anymore.
Well, that's even better.
Because then I become
a systemic risk.
I'm not just a risk to France,
I become a risk to the entire
European banking system.
Score!
I've got the ECB
over a bottle.
I can do whatever I want because
they're going to have
to bail me.
Except it's run by Jurgen Stark
and a bunch of Germans.
And they're not going
to bail you.
So when the shit hits the fan,
you've got a really, really
big problem.
Which is where we are now.
Core banks get stuffed with
periphery debts gone bad, a
result of over landing.
Foreign banks consolidated
claims on Greece, Ireland,
Italy, Portugal, and Spain in
2011, last time they published
any reliable figures.
French banks have over 33% of
GDP equivalent on their
balance sheets in periphery
assets that aren't coming back
anytime soon.
Add in the Spanish real estate
loans they've got on there--
run.
And you have a SocGen account.
Netherlands, one bank,
ING, 211% of GDP
is its asset footprint.
Leverage ratio is
over 40 to 1.
That alone is 30%
of Dutch GDP.
They don't have a printing
press anymore.
Are you beginning to
see the problem?
The result is assets held by
banks in Germany, France, and
the UK are about double the
annual GDP of the entire EU.
Here's the too big
to fail USA.
Top six bank assets,
61% of GDP.
Any one of them fails, even
allowing for systemic
interconnections, you're going
to take out 10% of US GDP.
That's about $1.4 trillion,
$1.5 trillion.
That's a lot, but when you've
got your own currency, you've
got the global reserve asset,
we can deal with that.
We can bail it.
We've done it.
That's what we did.
It cost of a $3 trillion
all told, that's it.
We're now in recovery mode.
At least the Brits have
their own currency.
There's British GDP.
That's the size of
their banks.
You should be very,
very afraid now.
Now let's have a look
at this one.
Here's France.
BNP Paribas, Agricole,
Generale.
These three banks alone are
taking you up to 250% of GDP,
and they don't have a printing
press, and they're seriously
impaired with bad assets.
And now here's the kicker.
You know that ECB?
It's a fake central bank.
It's really a currency board.
Because what it does is it says,
we're not doing bond
buying, we're not mutualizing
debt, you have to look after
the problem yourself.
So when you have a
financial crisis,
you've got four exists.
You can either inflate--
whoops, you don't have
a printing press.
You can devalue--
whoops, don't have your
own currency.
Or you can do austerity.
You can squeeze and hope you
stabilize public finances, add
liquidity, keep the can kicking
down the road-- this
is LTROs, all the loans that
have been given to the banks.
But at the end of the day,
you cannot do a Bernanke.
So what's a Bernanke?
A Bernanke is when you go into
the banking system and you
grab the shitty assets on their
books and you put them
on the Federal Reserve's
balance sheet.
And you call them things like
Maiden Lane 2, and the
Termloan Auction Facility 3,
and a bunch of completely
opaque nonsense that nobody will
ever understand unless
they spend time looking
into this.
Congress, who basically don't
understand anything, are
completely oblivious to
what's going on--
you then flush the entire
system out with as much
liquidity as you can, and you
allow them to recapitalize as
they de-lever.
Which is why the operational
leverage of the American banks
is now about 50 to 1 rather than
30 to 1 at the height of
the crisis.
They've rebuilt, they've
recapitalized, they've cleaned
their balance sheet.
As the economy recovers,
you know all those
assets that you bought?
Guess what?
Those houses in Glendale one day
will have value again, and
you sell them back
to the banks.
It's not a money pump.
It's an asset swap
with liquidity.
The ECB can't do that.
It is constitutionally and
intellectually incapable of
making that move.
Consequently, what the markets
were pricing is as yields were
spiking was the possibility
of a breakup of the Euro.
Because if any one of those
banks goes down, it doesn't
stop at Spain.
It doesn't stop at France.
It goes all the way back
to the German banks.
If that goes bad, it's game
over for the core European
banks, which is why we really
have austerity policies.
It's about stopping a bank run
around the bond market.
This is why you've got to keep
the Greeks in at all costs.
Because if you're a bank, and
you've got 2% of your assets
in Greek debt--
say you're exposed to
Greece heavily.
How are you going to
get rid of that?
Well, you can't.
You can sell it on the hedge
funds basically at 20% on the
face value.
Or you can hope it
doesn't go bad.
But imagine you wake up one day,
and you think, this is
going to go bad.
You want to sell it, so
you sell it first.
The minute all those contracts
hit the floor, what
happens to the price?
Everybody else dumps theirs
and they go to the floor.
You've now made a 2% loss
to your portfolio.
How do you balance it back?
You sell the next asset class
before it goes down.
Hi, Portugal, how are
you this morning?
So you dump Portugal.
And as those prices go to
zero, what do you do?
You look around and you go,
shit, what have I got left?
Let's dump the Irish, then.
So you throw the Irish on the
floor, prices go to zero.
You've now knocked 11% of
Euro-zone GDP and probably
about 12% of your portfolio.
You do that on the lending
portfolio of a highly levered
bank, what's going to happen to
its share price once people
figure out?
So you're going to have a huge
panic that's caused by a
sovereign bank run, right the
way through a currency union,
something that is supposed to
be theoretically impossible.
That's what this has
always been about.
That's why you keep
the Greeks in.
That's why you're willing
to destroy 30% of GDP.
Because this is about saving
Societe Generale, and it is
about saving Deutsch Bank from
their own over borrowing and
over lending mistakes.
Consequences.
You can't solve a banking
problem with budget cuts.
You can cut Greek's public
spending to Neolithic levels.
It's not going to make a damn
bit of difference to SocGen's
balance sheet.
You can't run a gold standard
in a democracy.
We tried this in the 1920s.
It really didn't work too well--
ended up with a few
political parties that
were kind of nasty.
You can't solve a solvency
problem with a liquidity
instrument.
But God bless Mario,
he's been trying.
You just add enough liquidity
and hope the problem goes away
by saying, I'll do whatever
it takes.
That's what he said six months
ago, the yields came down.
Since then, he's actually done
nothing, and yet the yields
have gone down, proving one
thing-- it's about the
credibility of bank policy.
It's not about cutting
the budget.
The markets aren't craving an
extra 30,000 civil servants
being thrown out of
work in Greece.
They're worried about the
Euro breaking up.
So once you give a credible
guarantee, you do a
Bernanke-lite, all of the market
pressures are relieved.
That was what was lacking
the whole time.
And the most important one is
you can't all cut at once and
expect to grow.
Why not?
Because in order to save,
you need to have income
from which to save.
So if everybody simultaneously
cutting,
nobody's generating income.
So imagine the economy with an
80% debt to GDP ratio, and
turn it into a simple fraction
of four over five.
Now imagine that 40% of
the five is government
expenditure.
You want to cut in half.
You're really going to credibly
commit to cut the budget.
So you just turn that
into four over four.
On a constant stock a debt, your
debt to GDP ratio just
went from 0.8 to 1.
Every single country that's
undergone an austerity program
now has more debt than
when they started.
Any country the hasn't cut,
including the United States,
now has proportionately less.
The evidence is in.
And the tragedy is it was
all avoidable, and
we knew this already.
So why did anybody, especially
in Europe, ever think this was
a good idea?
For that, you have to kind of
have to go back in time.
And it's still about
two rival stories.
This time it's not ECB
credibility versus the moral
hazard trade.
It's something far
more spooky.
The first one I like call
liberalism's emetic economics,
emetic being a wonderful word
meaning to throw up.
And what's this all
about throwing up.
You go back to John Locke's
"Treatise on Government." The
fifth chapter is really
fascinating.
John Locke is this guy who's
basically the intellectual
propagandist of a bunch of guys
who want to kill the king
and take all the property
for themselves.
They're called the merchant
classes, and these are the
guys that then set up markets
and land, labor, capital,
private property, throw
people off the land,
all the rest of it.
You ever heard the
word vagabond?
It means a man without
bondage.
Why bondage?
Because basically, you've been
thrown off your land, so you
basically had your status
removed from you.
So basically, the English
Revolution sets up the markets
in private probably,
et cetera.
And then there's a problem,
because the minute you do
this, you recognize that
untrammeled markets lead to
massive income and wealth
inequalities.
Which is great if you happen
to be the guy at the top of
the pile, and not so great
if you're at the bottom.
So unfortunately, then
you need a sate.
Why do you need a state?
To make markets, in
the first place.
The notion that they pop out of
the ground fully formed is
a nice fiction, but
simply not true.
In order to turn serfs into
workers, you actually need
acts of parliament
and legislation.
The state makes these
things happen.
But here's the kicker.
You need to state to police
the inequalities that the
market makes possible.
Because if you don't--
poor Adam Smith on this one--
"for every rich man"-- this is
out of "The Wealth
of Nations"--
"for every rich man, there must
be 500 poor, and that
rich man must sleep always with
the strong arm of the
civil magistrate at his side,
for he is always regarded with
jealousy and envy."
So you need that state to
police the inequality.
But here's the Lockean kicker.
This is why we have the
Second Amendment.
Any state strong enough to
police those inequalities is
strong enough to come
and take your money.
So you've got a dilemma
running into this.
You need this state, you can't
live without it, but at the
same time, you can't live with
it, because you're afraid of
the damn thing.
So how are you going
to do this?
And how are you going
to pay for it?
Because most people don't
want to pay any taxes.
Well, that's where this guy
comes in, David Hume.
He has a wonderful essay on
money and on interest.
He talks about merchants being
the most useful race of men,
because when you give it to
them, even though money's
neutral in the long run, if
you give it to him and his
friends, it goes to the right
places really fast.
So basically, you think of money
in a Keynesian way from
Hume, which is short-term
stimulus is long-run neutral,
but really because
you give it to my
friends rather than losers.
Now, what he comes up
with is the problem
with government debt.
Liberalism loves debt, because,
if you think about
it, it's a free option
for the state.
So you're the state, I'm the
merchant, I've got lots of
inequality in my society--
I'm worried about people
coming and
burning my house down.
So I say to you, you
need to protect me.
And you say, you
need to pay me.
And I say, I don't want
to pay taxes.
You say, ah, I have this thing
called a debt instrument.
It's fabulous.
You go, how does that work?
Well, it works like this.
You give me a better paper,
and I'll give
you a million pounds.
Brilliant.
OK, what happens now?
In 10 years time, I'll give you
the million back, and I'll
pay you interest.
What are you going to say?
So I'll lend you the money you
need to protect me, and then
you'll give me it back and
you'll give me interest.
Fabulous.
It's a free option.
Unlimited upside,
zero downside.
Problem.
Original argument against it.
Crowding out.
In order for this to work,
you're going to offer a rate
of interest higher than the
market would produce.
So everybody goes in
to government debt.
Because of this, as Hume says,
all the gold and silver
necessary for commerce gets
crowded out of the economy,
finds its way into debt
securities, the whole nation
ends up in hock, eventually you
have to sell yourself to
foreigners, and you
end up with a
bankruptcy of the nation.
So easy money and
crowding out.
The downside of debt means that
it's an attractive way of
paying for the state you need
but you don't want, but at the
same time, a terrifying one.
Because at the end of the day,
it's going to result in the
ruin of the nation.
Adam Smith picks
up on this one.
For him, it's all about why we
actually save and invest, why
x equals i in economics
to this day.
Savings equals investment.
Why is this?
Well, for him, it's because
we're all parsimonious Scots,
we're all hardwired to save.
There's a wonderful line where
he says, "where there is
tolerable security, a man would
be perfectly crazy if he
did not employ as investment
all his available capital."
So basically, you take the
money, you invest, it
automatically produces
economic growth.
Well, he also recognizes this
whole thing about inequality
in the state.
My favorite line from
Adam Smith.
"Civil government, insofar
as it is instituted, is
instituted for the defense of
the rich against the poor, or
for those who have property
against those who have none."
That is not Karl Marx.
That is Adam Smith, end of Book
Two of "The Wealth of
Nations," quote, unquote.
Now, he recognizes then that
you're going to have to pay
for this, so he goes
to taxation.
But the forward of "The Wealth
of Nations" starts off with
progressive taxes.
It's totally nuts.
So here, look, see the people
who have got the most stuff?
They have the most
skin in the game.
They should pay the
most taxes.
And then he goes, wait a
minute-- that would mean the
rich would pay the most taxes.
Well, we can't have that.
So then he backs off immediately
and turns around
and argues for exactly
what the Republicans
are arguing to do--
a national consumption tax on
everything except luxuries.
So your yacht is fine,
but your corn flakes
are going to be taxed.
Problem with this.
Well, it never raises
enough revenue.
And he recognizes that.
So he's like, shit, what
am I going to do?
And he goes, I suppose
there has to be debt.
But the problem with debt is
exactly as Hume's pointed out.
Everybody's going to invest
in the debt markets, the
underlying economy is
going to crumble.
Because of that you'll end up
with more debt on a smaller
economy, and eventually the
whole nation gets bankrupted.
So what do you end up with?
Debt perverting parsimony,
therefore savings doesn't lead
to investment doesn't
lead to growth.
All very convincing, and it's
all exactly the same story as
we hear now.
Now, when you hear the same
arguments repeated for 300
years without modification
regardless of any facts in
fact in them, you should
generally be suspicious.
The result is you can't live
with it, can't live without
it, don't want to pay for it.
So I like to call this
liberalism's neuralgia and the
aspirin of austerity.
You reach for it regardless of
if it does you any good.
But it's a 300-year-old trip.
Now, how do we know that these
guys are wrong about this?
Well, basically, at the time
they were writing, Hume
predicted the collapse of the
British economy by, I
think it was, 1780.
And in fact, what happened was
they went from the relatively
low debt levels that they had,
but they were accumulating,
all the way to the highest debt
that they ever had, which
was 240% of GDP at the end
of the Napoleonic Wars.
So never mind 80%,
100%, whatever.
Back in the day, they
had 240% debt to GDP
at the end of 1815.
What happened to the British
economy after 1815 until 1914?
It ran the hold goddamn world
and expanded faster than
anyone ever thought
humanly possible.
Reinhart and Rogoff
95%, my ass.
Now, this creates two liberal
stories that go through the
19th century.
Story one, David Ricardo.
You can't live with it, and you
don't want to pay for it,
and you pretend you
don't need it.
Second one.
This is John Stuart Mill,
handsome fellow.
I know.
Accepting the need for it,
and also accepting the
need to pay for it.
Because if you don't pay for
it, then you get into a
problem, because if you
basically leave the state out
of the equation, you cannot rely
on markets to do anything
except the inequalities that
will undermine markets in the
long-run themselves.
So you get these two very
different versions of
liberalism come out of this.
This one goes to the
Austrian economist.
This one goes to
the Keynesians.
That's basically the way it
splits down the middle.
Now, along came the
Great Depression.
I love this picture.
It's absolutely emblematic.
It's one of my favorite slides
of the Great Depression--
the bread line at the same time
as the, no way like the
American way.
So reality, theory,
facts, whatever.
Now, here's the first one.
I like to call this the emetic
response, American
liquidationism.
This is Joseph Schumpeter.
And by the way, he actually
looked like that.
This is not an exaggeration.
He really did.
And he, in the 1920s, had come
over from Austria and
basically taken up residence
running Harvard's economics
department.
And the basic story was there's
the long run capital
structure of the economy, you
can't really see it, you don't
know what's going on, you
should never intervene.
What happens is that banks,
there are booms and bust
business cycles.
Banks have a problem,
particularly when the bank is
backed by the government.
They produce too much credit,
entrepreneurs get confused
about price signals, they
invest in things they
shouldn't, you end up producing
things you're never
going to need, the credit pump
dries up, and eventually you
have this purging that
needs to happen.
So you binge on credit
and then you purge.
This is version one
of austerity.
Because of this misallocation of
capital because of credit,
you end up with too much in the
wrong type of investment
in the capital structure.
So you basically have the boom,
and then you have to
have the slump, and you have to
go barf and you have to get
it all out and let the clock
reset, and off you go.
Now, the British had a version
of this, which, you know, of
course, the British are a bit
more polite than this, so they
wouldn't be emetic.
So they have the treasury
view, which is a
more austere response.
And it's very similar, but
again, it's these arguments
from the 1700s brought back.
So the basic idea is that free
trade is welfare-enhancing.
Well, the Brits would say that,
because they were 50% of
the global economy at that point
in time, and most of
their free trade was
done with empire.
But putting that to one side,
I'm sure the Indians thought
it was free trade when
they showed up,
and so did the Chinese.
But anyway, 1910 to 1920s, this
is Churchill when he was
Chancellor of the Exchequer,
the finance minister.
He comes out with this
memorandum written by a guy
called Henderson that basically
responds to a guy
called Lloyd George's thing
about, can we do something
about unemployment?
The problem had been this--
Britain's the largest economy
in the world, World War I
spanked 60% of its
national wealth.
They're on the gold standard.
Basically, exchange rate clever
mechanism for the
global economy.
They have a choice.
If they go back on the gold
standard with a high exchange
rate, it protects all the
people who hold sterling
paper, because you're not
devaluing their assets.
If you go back on a low one,
it benefits the domestic
economy because you'll get an
export boost and your domestic
economy will go up.
But all the people holding
sterling paper will freak out
because you've devalued
their assets.
So they'll dump them.
So you've got a run on the
pound and a run on the
exchanges, so you're
screwed either way.
So what did they do?
They went back on a high
exchange rate.
The result?
An instant extra million
unemployed that
lasted for a decade.
So that was one of the lynch
pins in the global economy
that caused the Great
Depression.
So lots of people are
saying, can't we do
anything about this?
Can't we do something
about unemployment?
And along came the memorandum
that says, no-- and there's an
argument called Ricardian
Equivalence--
and spending now is going to be
zero sum against taxes in
the future.
So if you know that, the minute
you do it, it nullifies
its own effects, so
don't even try it.
Second thing, and this is
particularly true on
investment, if government
presumes to do the job of the
private sector, the private
sector will let it do it, but
then it will do it at a cost.
Because it's still not
investing, so it's zero sum
against itself.
And the last one you may
remember from the Obama
stimulus was the lack of
shovel-ready projects.
Remember that language?
It's written in there-- it was
called the lack of suitable
public works.
Now, here's the second story
that comes out of the John
Stuart Mill tradition.
Basically, it's not
about Keynes right
in the general theory.
There's a wonderful line by an
economist called June Robinson.
She says that, "in 1936, Keynes
was writing down what
might cause unemployment while
Herr Hitler was curing it."
There's a certain element
of teaching
birds how to fly here.
And the two critical cases
here were the Germans--
as it says here.
There's a story that basically
it was all sort of like
Catholics in the south that
voted for Germany.
No it's not.
They were industrial workers.
They were miners.
And then here's a guy called
Takahashi Korekiyo, who is the
guy who was the guru for the
Japanese Central Bank's
Abenomics policy at the
moment of massive
monetary and fiscal stimulus.
So this is a guy from '34.
So what actually happens here
is very similar to what's
going on in the Euro-zone.
You have simultaneous
contractions of the five
largest economies
in the world.
Everybody cuts at once.
GDP shrinks, constant stock
of debt goes up.
The British debt to GDP ratio
in 1930 was 170%.
By 1933, despite repeated rounds
of cuts, it was 190%.
It continued to go up.
In Germany, what happened was,
after short-term capital
United States, post the '23
inflation, had made Germany
the most stable and fastest
growing economy in Europe at
that point in time.
There was a swap in the
agreement governing war debts.
The main war debts
got seniority.
The American capital pulled out
to take advantage of the
stock market boom in 1928,
'29 and a federal
interest rate increase.
If you get 7% per sticking it
in a bank, so why would you
put it in Germany?
A lot of capital goes
flying out.
To balance the budget, a guy
called Bruning comes in as the
chancellor, and he starts
hacking away at the budget.
So he issues somewhere in the
region of about 200 emergency
austerity decrees.
At that point in time, there's
a minor party that everyone
had written off.
They got 8% of the vote in
1928, or thereabouts.
By 1930, it was up
to I think 18%.
By 1933, it had 43.3%
of the vote.
It was the only party arguing
against austerity.
I don't think I need to tell
you what they were called.
Japan was even worse.
The brunt of civilian
expenditures, the brunt of
public expenditure cuts
in Japan were
borne by the military.
They were the biggest
item in the budget.
By 1930, the Japanese military
started to assassinate their
financial elite.
It took out two finance
ministers, two prime
ministers, several cabinet-level
appointees, and
half a dozen senior bankers.
You can rack up quite a body
count doing this if you piss
off the military enough.
So the lesson learned on this
was simultaneous contractions,
when everybody else is doing
it, is zero sum against
everybody else, and leads to
really nasty politics.
So Keynes and events
overturn austerity.
What does it show us?
It shows there are fallacies
of composition and
non-scalability in labor
and money markets.
What's true about 2 people or
10 people is simply not true
about 20 million or five
interlinked economies.
There are systemic
non-linearities and difference
that simple cannot
be done by type.
Investment expectations are
not about parsimony.
They're about fear.
And if everybody's fearful for
the future and has myopic,
short run expectations, and we
look to each other for signals
about whether we should be
investing next month or not,
you discount the time series
of the 36 good periods and
heavily weight the three
in the front.
That's why it's hard to get
out of a recession.
The emetic response, you binge
and then you purge, assumes
you're at the bottom.
People start saving again.
You've got [INAUDIBLE]
consumption, austerity, you
start saving.
And the assumption is that
saving is automatically
investment.
But there's a drop there,
because you have to invest in
a recession.
Why would you want to be the
guy who takes the chance to
invest in a recession?
Surely you'd rather be liquid,
so everybody tries to sit on a
liquidity all at once.
But you can't-- in order for
you to be liquid, somebody
else has to be illiquid.
So you end up with
a liquidity trap.
And that's when you get
stuck for 14 years.
That's why the Great Depression
lasted so long.
So because of this, rather than
curtail consumption, the
austerity response, consumption,
to repeat the
obvious, is the sole end
of economic activity.
"General Theory," page 71,
if I remember correctly.
Lessons learned.
It all goes back to
redistribution.
Democracy is asset insurance
for the rich.
Don't skimp on the payments.
That's what was going in
the '20s, and that's
what's going on today.
Redistribution of debt is
reinsurance for democracy, and
austerity is anorexia
for the economy.
That was what was
learned by 1940.
Oh, how we forget.
And why do we forget?
We forget because of Germany,
because Germany is a very
peculiar economy.
It is not a liberal economy.
It is much closer to Japan than
it is to anything else in
Europe or the United States.
It is, in fact, the original
developmental state.
What do I mean by that?
In 1873, there was a huge
stock market bubble in
Germany, and it blew up.
It was called the
Founders Crisis.
And liberal economic ideas of
the type we've been discussing
were completely discredited.
At this point in time, there
was a guy called Liszt who
comes along and says, you know,
the funny thing about
the Brits telling us all the
story about how to get rich,
if they had actually done that
themselves-- you know what
their comparative advantage
was in?
Wool.
They would still be making
blankets for
the people in Flanders.
How come they're running
the world?
How come they have the biggest
navy in the world?
How come they make steel
when they basically
have no iron ore?
What the hell is
that all about?
So he rewrote how you think
about international trade.
And at the same time that he
did this, he, and also the
Bismarck who was running the
place did what was called the
marriage or iron and rye,
bringing together the
industrialists in the south,
the agrarians in the north.
You use the surplus from
agriculture to basically buy
flattened equipment.
You bring it in, you reverse
engineer it, you do it faster,
you do it faster, you build up
German industrial capitalism.
Big firms, big banks,
forced saving, a big
role for the state.
And it's all driven
by exports.
There's your difference.
But when you're exporting and
your sources of demand lie
outside your economy, you don't
have to worry about
internal demand.
The Keynesian story makes no
sense if you're Germany.
Why would you want to stabilize
consumption if
you're export dependent?
Because all you're going to
do is raise your wages and
prices, and your BMW is going
to go from 50,000 to 100,000
real fast, and you're not
going to sell them.
So if you don't rely on domestic
consumption and rely
on external consumption, the
dynamics of your economy are
completely different.
What do you care about
price control?
All this stuff about the
neuralgia of the 1920s and the
inflation experience, this is
a post-war construction.
It's really about
remaining price
competitive in export markets.
So you need a strong,
independent central bank.
What else do you care about?
Very important--
competition.
You want to have competition
over products, so that you
have BMW and Audi competing with
each other so they can
sell more to the Chinese both
because they're competing
against product quality.
You don't get involved in the
Apple, Samsung, buy up patents
and sue each other
in court crap.
You do real competition
to get real value out
at the end of it.
Given that the role of the
state, these Freiburg
liberals-- this is Walter Euken,
one of the guys who,
post-war, reinvigorates
all this stuff.
Because after Nazism is
discredited, they
needed a new thing.
And basically it was about the
economic constitution, where
competition rather than
consumption becomes important,
and sound money and
central bank
independence defines the economy.
Why is this important?
First of all, for 30 years, this
is the entire structure
of the Euro.
If you think about the way the
European Union is set up, it's
Generalized Ordoliberalism,
to give that type of
liberalism its name.
The commission is the important
part, not the
parliament.
The parliament is a talking
shop that very little
representative rights
or power.
Sound money is far more
important than output.
It's all about the European
Central Bank and its policy.
It has one target--
fighting inflation, even if
there's a deflation going on.
Well, what does that reflect?
The need for cost
competitiveness.
What is it that the
commission does?
The commission basically
sets rules.
What are those rules about?
Competitiveness.
What's the largest component
of the administrative
architecture of Brussels?
The Competition Commission.
Rules rather than discretion
at all times.
You can't trust politicians to
run the economy-- they'll run
inflationary cycles, that
will be bad for growth.
Yes, if seen through a
German perspective.
But here's what it misses, a
giant fallacy of composition.
For you to sell your BMW,
somebody else needs to be
buying them.
For somebody to basically be
having an export surplus,
somebody needs to have
an important deficit.
In the aggregate, in theory,
it balances out.
But if you go way back to that
picture I showed of the
current account imbalances,
there's only one company
running a surplus.
And the sum of that surplus is
the sum of that deficit--
they're almost exactly
equivalent.
So what you have here is a
situation whereby when you
generalize the economic
principles and institutions of
one country across the whole of
the EU, which was fine, so
long as the banks were spending
money all over the
place so nobody noticed,
it's fine.
But once that credit bubble
pops, suddenly you all have to
be Germany.
Tell me, how is Greece
and Portugal
going to make an Audi?
And even of they did, who are
they going to sell it to?
Who's going to buy it?
Imagine the Competition
Commission gets its way and
everybody becomes more
competitive, and
they all make exports.
Who's going to buy
all this crap?
The over-tapped American
consumer?
We're already spending
too much already.
So you end up with an economy
and an economic structure, an
economic model for an entire
continent which literally
cannot work.
It makes no sense on a global
level, and yet that's the one
that it's pursuing.
Competitiveness rather
than complementarity.
And also, you then have idiotic
things like debt
breaks, Schuldenbremse.
This says that nobody can
ever have more than
a 5% debt on deficit.
Really?
Because that means everybody has
to run a budget surplus.
How is that going to happen?
That's actually not
arithmetically possible, but
it doesn't stop them writing
rules about it, even if it's
arithmetic nonsense.
This then leads to Italy.
I'm getting there.
This guy was the first Prime
Minister of Italy and head of
the Italian Central
Bank post-war.
He set up the Bocconi School
of Public Finance in Milan.
The Bocconi School was famous
for two things.
Number one, public
choice theory.
Essentially, states are
rent seekers and
they can't be trusted.
Hey, if I grew up in Italy, I
would probably think that
about the state, as
well, but they
generalized it to everybody.
They're also very fond of the
notion of a European Union as
a disciplinary device overriding
local democracy and
reigning in state spending.
The Bocconi School are important
because when
Cambridge--
qua Cambridge, UK-- blew up in
the '70s intellectually and
Cambridge and America had their
lunch in what was called
the Cambridge Capital
controversies, the only
economics department in Europe
that was mathematically
sophisticated enough to play
with the Americans was the
Bocconi School.
And they were hard-wired for
seeing the state as a bad
thing at exactly the time that
liberal economics went in the
same direction, when
it went neoliberal.
Consequence of this--
these guys become an aircraft
carrier for austerity thinking
that goes from Milan to Harvard,
which leads us to
today, the financial crisis.
This is Greenspan's mea culpa.
I think there's a flaw in my
ideology, and it's this big.
And we get to this guy, who's
Alberto Alesina, who, just
like Joseph Schumpeter, is
arguing for emetic economics.
And he, too, is the head
of the Economics
Department of Harvard.
He's the guy who came up with
what's called the expansionary
austerity hypothesis.
It's about debt and time and
consistency, which is actually
that Ricardian equivalence
stuff all again.
And it basically says the
following-- this is the
confidence theory thing.
This is why you cut spending.
So imagine the economy is
falling around your ears, you
don't know if you're going to
have a job tomorrow, your
partner is already unemployed,
you really don't know about
the future, but you really
worry about the debt.
You just lie awake all night
worrying about the
debt, as people do.
So the government credibly
signals that it is going to
massively cut government
expenditure.
And what you do, using your
rational expectations that are
built into your head-- well, you
know the true structural
form of the equation governing
the economy and the value of
the coefficients therein.
Big assumption, but put
that to one side.
You calculate your lifetime
budget and your lifetime
expenditure in relation to the
fact that 20 years from now,
because of these state spending
cuts now, you'll pay
less taxes then.
Thereby, you can retro-dict how
much extra money you've
got now, and everybody goes
to Ikea and buys a couch.
And that cures the recession.
I am not making this shit up.
Take away all the math, that's
what all these papers say.
And what we actually see at
the end of it, you got all
these countries cases
that supposedly
show this in the '80s--
Ireland, Sweden, Denmark, et
cetera-- and in the book I go
through them and show that they
do nothing of the kind.
What actually happens is,
take Canada as the
greatest example of this--
the Loonie takes a 40%
devaluation from '76 to '86.
You're export dependent.
You're a commodity exporter.
Your major trading partner who
takes 75% of your exports is
the United States.
The United States' economy
is nine times the
size of your economy.
You have a 40% devaluation as
the American economy takes off
like a rocket between
'86 and '92.
What do you think is
going to happen to
Canada's budget surplus?
It gets massive.
They cut and then it
led to growth?
No.
They grew and then they cut.
Because that's what
your meant to do.
Austerity date is best done in
the boom, not the slump.
That's what all these
states actually do.
Cutting in a slump produces
a bigger slump.
It's really that simple.
So this is taken up by the
European Central Bank and was
called the Ecofin Brief
and the G20 finance
ministers in 2009.
It's published in
all its glory in
the TCB's 2010 report.
All the arguments from David
Ricardo, et cetera, and John
Stuart and Hume and Smith, I'm
not kidding, are in that book.
I mean, literally, you could
quote them line for line.
It's exactly the structure of
how they did all the bailouts,
and how they did all the stuff
in terms of bailing out
Greece, et cetera.
And there result of this is what
I call the greatest bait
and switch in history.
Because what's actually happened
is all that private
debt that was generated by the
banking system through
over-lending is now on the
public balance sheet.
And to go full circle, all the
way back, that means that
people like me, who have grown
up on the welfare state just
now, have to pay for the
mistakes of systemically
irresponsible bankers.
Because you can't tax them
themselves because they're too
politically powerful.
That's why this is fundamentally
a problem of
politics, and not a problem
of economics.
Is there a way out of this?
People have started to defect.
The IMF has started to go.
The IMF has calculated now that,
what happens when you
cut $1 of public spending
in the periphery?
You lose $1.5 to $1.7 in
spending, which is why you get
this wonderful negative
convexity, where it goes, ah,
which is what's happening
to periphery economies.
You end up with more
debt, not less.
The rebel alliance--
Romania, Estonia, Bulgaria,
Latvia, Lithuania--
they tried to blow
up the debt star.
They failed.
It's been a disaster.
Excelgate, that's Reinhart
and Rogoff's 90%.
There really was nothing
there to start with.
And we have 25% permanent
unemployment in Europe.
That is not politically
sustainable.
So where does it all end?
First one, financial
repression.
You take those banks that are
heavily levered and filled
with government bonds and you
fill them with even more
government bonds.
Then what you do is lower the
payment on it that you get
from it, and you lend
to maturity.
And then what you do is you
run a positive inflation.
Hence, why central banks
are now moving
to inflation targets.
What does that do?
It creates a negative
real interest rate.
That cures your debt far better
than any amount of
cutting, which actually doesn't
work because it's zero
sum against itself.
When did we last do this?
End of World War II.
The liquidation tax accounted
for the equivalent of 40% of
American GDP being paid back in
10 years, and the American
economy boomed at
the same time.
So there's something very,
very important.
That's where this
one's heading.
Who is this bad for?
This is totally bad
for creditors and
really good for debtors.
I just took on the largest
mortgage in human history
because I fully expect
this to happen.
I'm bar-belled.
If the economy recovers, my
asset goes up in value.
If there's an inflationary
cycle, it eats
away half my mortgage.
Screw them--
I've been paying for
their bailouts.
Second one.
Higher taxes.
Carried interest exemption.
Mitt Romney pays 15% tax.
I pay 30%.
You pay 30%.
Do you think that's fair?
I don't think that's fair.
I think that's coming
to an end.
And we're going to shut down
every goddamn tax haven on the
planet, as well.
Because you know how much
is hidden there?
$27 trillion in untaxed
wealth--
estimate--
is sitting in five tax havens.
How many divisions does the
Cayman Islands have?
None.
Let's go get it.
It's so much easier than
slashing the fire brigade.
And the last one, if you think
about this as payback for the
bailouts who started it all,
is Hippocratic economics.
First do no harm.
The United States was
meant to die.
We had spent too much.
We were the profligate.
We were all going to die.
Remember all those articles
about, oh, it's coming, the
great end, the great crash,
the whole lot?
We've de-levered, we've cleaned
up the balance sheets
of the financial sector, we're
lending again, we've got
positive growth.
In three years' time-- we
actually have stabilized the
debt already.
In three years, we'll be
effectively reducing it.
The Brits are in for a
decade of recession.
Ireland has a lost generation
because they bailed their
banks and they did austerity.
Periphery Europe is stuck with
25% permanent unemployment.
This doesn't work.
It is a human disaster.
But most of all,
it's politics.
Because it's always
about one thing.
Somebody got all the benefits,
then they cost all the costs,
now they want somebody to pay
for the costs while they keep
all the benefits.
That's what this is
really all about.
Thank you.
[APPLAUSE]
MARK BLYTH: Went on a bit
longer than anticipated,
despite talking faster
than JFK on speed.
Sorry about that.
AUDIENCE: Much as I'd like to
take out a huge mortgage and
buy stuff, there's something
of a bubble
going on around here.
Any other suggestions for how
to take advantage of this?
MARK BLYTH: Well, as
I switch onto my
financial adviser mode.
How do you make money in
a positive inflationary
environment?
It's not easy, but it's
not impossible.
If you have a look at companies
that did really,
really well in the 1980s, late
'70s, early '80s, they tended
to be sort of conglomerate
trusts.
So they owned a little
bit of everything.
That's like the Abu Dhabi
Investment Corporation, whose
unofficial slogan is, we own
half a percent of everything
that isn't nailed down
on the entire planet.
And the idea behind it is that
you don't know where the
upside is coming from.
So what you should be is
maximally diversify.
It's like an index fund.
So basically, anything at
all that is internally
diversified, so buying cut
shares in companies that have
that type of structure is
probably the best way of
bar-belling yourself
against them.
But ultimately, you know,
investing in debt markets is
probably a bad idea right
at this point.
But it's still sort of-- at the
end of the day, about this
paranoia that inflations
lead to
hyperinflations, it's total crap.
When I went through the book and
did the research on this,
I wanted to--
I'm married to--
background information--
I'm married into a
bunch of Germans.
Well, I'm only married to one,
but the whole family comes
with them, right?
And my [GERMAN], as I like to
call him, my father-in-law,
[GERMAN], he's a
classic German.
He's like 71 years old, he's
retired, and he still saves.
What the?
You'll die--
what are you doing?
Why?
He's totally hardwired for
saving, and he's totally
paranoid about inflation.
So I went and read a lot about
the German hyperinflation.
And it was deliberate government
policy to stuff the
French over reparations.
I mean, they did it quite
deliberately.
And the weird about it was after
they did it, it ended in
eight months.
And the entire economy was
stabilized within 12.
And then it grew
for five years.
And then what actually happened
was austerity,
through the economy of a cliff,
and that's when the
Nazis came to power.
So we have this story about the
least degree of inflation
leads to some kind of infinity
curve hyper-convexity where,
boom, off it goes.
And it's simply not true.
Post-war Europe ran positive
rates of inflation with
positive real rates of growth
all the way through the
postwar period until
about 1980.
So the inflation
panic is there.
AUDIENCE: So I've heard Krugman
and others bring up
Japan as an example to support
these kind of arguments.
Can you just talk a bit about
how they're able to run a high
debt for so long and things
don't seem to--
MARK BLYTH: Sure, sure.
Absolutely.
I actually think these guys
are wrong about Japan.
I think what goes on in Japan is
actually deeply structural.
There is a wonderful book by
guy called Sven Steinmo,
called "The Evolution of the
Modern State." And he has a
chapter on Japan.
And if you ever wanted to read,
I think, the definitive
story on Japan, this is it.
He spent two years there on an
Abe fellowship and had access
to all the people.
Well, it was two books.
It was Richard Koo's "Holy Grail
of Macroeconomics." So
basically what happens is Japan
goes through a balance
sheet recession.
What's a balance sheet
recession?
Basically, your companies are
de-levering but don't want to
tell anyone because
if they do, there
will be a run on them.
And everybody's complicit
together because they've all
over borrowed.
So basically, you have this
kind of slow bleeding that
goes on as it's sort of
monetized by the central bank,
and it ends up in debt.
So you're not growing.
And that's sort of the obvious
part of the story.
The less obvious part of the
story goes like this.
Go back to 1986.
There's a thing called
the Plaza Accord.
The Plaza Accord was when the
United States turns around to
its two major trading partners,
Japan and then West
Germany, and said, our exchange
rate is too high.
People are buying dollars, we're
doing well just now.
And it's killing our exports.
You guys are wiping us out.
Remember the whole paranoia
about Japan that went on?
They were going to take over
the world, all that.
You ever see the film, "Rising
Sun," Michael Crichton?
Possibly the most racist film
ever made in human history,
but put that to one side.
So Japan's going to take
everything over, blah, blah,
blah, the rest of it.
And then, of course, what
actually happens is they do
the exchange rate thing, the
United States exchange rate
goes down, the German one and
the Japanese one goes up.
Now, the Japanese economy is
entirely export dependent.
It's sort of like Germany
on steroids.
So what they do is they move the
plant and equipment from
the Japanese home islands out
to the second tier tigers.
So you start to get investment
in Vietnam, Malaysia, all
these places, and they move
the entire thing with the
supplier networks,
the whole lot.
Well, the way that the Japanese
welfare state was
constructed, it was all
in-house to the firm.
It was meant to be cradle
to grave, but the firm
took care of you.
Well, the firm has just broken
the social contract.
So how did people protect
themselves?
They wanted another asset they
could have that would have a
positive upside, that would
retain its value, and they
could sell it in their
retirement.
What did they buy en masse?
Real estate.
So you get a giant real
estate bubble.
The real estate bubble gets so
out of control that it popped
and the banking system
can't support it.
That collapses and that
starts the recession.
But the important part is
the sociological story.
You've got a cultural and
generational shift.
Because you've got a very old
population who are now 45
years old, facing unemployment,
with a very,
very narrow safety net
for the first time.
So what do they do when the
government gives them money to
spend to stimulate
the economy?
They stick it under
the mattress.
It doesn't go anywhere.
It gets hoarded.
So the savings rate goes up.
And where do they
put the savings?
In the post office account
and in the bank account.
And what do the bank and the
post office do with it?
They buy government bonds.
So that's why you end
up with this massive
extension in debt.
Now, the thing is, the Japanese
propensity to consume
is really, really low,
particularly the higher up the
demographic you get.
So 80-year-olds are not just
buying bonds and then
liquidating them in retirement,
they're actually
keeping them whole and handing
them onto the next generation.
So you've got an
inter-generational debt
transfer going on.
So the story that basically it's
just a monetary policy
story in, you know, Japan,
I think that's wrong.
I think there's actually a
deeply structural problem
that's going on there, and it
goes all the way back to the
Plaza Accord.
So that's my short version of
Sven Steinmo's argument, but I
find it quite convincing.
AUDIENCE: How can an individual
state in the EU,
like Ireland or something, try
to fix things for itself with
all the constraints under it?
MARK BLYTH: They can't.
Look, and it's good.
Because you're in the Euro.
So once you're in the
Euro, it's a kind
of a one-time game.
Because the problem was if
you're Argentina and you tie
yourself to the dollar, as they
did back in the day, back
in the late 1990s into 2000, and
then you have the default.
And they had a default because
Argentina is the graveyard of
all bad economic policies
gone wrong, there's
no doubt about that.
But also because their major
trading partner is Brazil.
And basically, the Real had a
40% exchange rate gain, and
basically it screwed up all
their exports and the whole
thing fell down.
Now, because they were just on a
peg, they actually still had
their own domestic currency.
So they could go, to
hell with the peg.
We've still got it.
And then you lock up the banks
and people bang on the doors
and all that sort of stuff.
But you still have
your currency.
Ireland doesn't have
a pound anymore.
I mean, literally, the bits
of paper don't exist.
So if you were going to
get out of the Euro--
just think about the complexity
of this for a second--
you would have to kind
of freeze time.
Everybody freezes, some kind
of government agency with a
time machine would freeze time,
you'd go around, you'd
vacuum up all the bills out of
everybody's wallets, the whole
lot, and you'd stamp them all
and reissue them the new
currency, and then you'd
unfreeze time.
And then you would have
an economic crisis.
So just that alone adds a level
of complexity to it
which makes it just incredibly
difficult.
Bigger countries like France
and Italy can do this.
The Italian economy, North
Italy, is actually globally
competitive, totally solvent,
the whole lot.
The south is a basket case.
It's a bit like the north and
south of the United States.
Shh.
Anyway.
But you get transfers across
the region, that's
what keeps it going.
The problem is Greece has
nothing to export.
It really doesn't.
It has olive oil.
But so does Italy, and they
can make more of it.
Spain makes even more of that.
Do you know when you buy
your EVOO and it says,
Italian olive oil?
It's actually Spanish olives
they've bought and they
brought to Italy and then they
grind them and call it
Italian olive oil.
So that's all zero sum
against itself.
So if you don't have something
to export, then the
devaluation thing that you'll
get won't benefit you because
you don't have anything.
And all you'll do is end up with
hyperinflation because
your imports become so
incredibly expensive.
So Ireland, Greece, Portugal,
they are stuck because they've
got nothing to sell.
That's it.
So they're kind of trapped
in this worst of
all possible worlds.
Ireland is really screwed
for a whole generation.
The debt to GDP figures
you see in Ireland
are a big, fat lie.
Because they basically book
services exports from this
company as exports.
So basically, the profits
from this farm go to
an office in Dublin.
Has anybody ever been to
the office in Dublin?
No?
There's about 25 people
who work there.
And your entire corporate
profits get declared through
them, because you only
pay 12.5% tax.
So that 12.5% gets booked as an
Irish services export and
appears in their balance
of payments.
Well, it's complete paper.
It's nothing.
It's complete garbage.
And they also have all the bad
assets from their banks that
blew up and this thing called
NAMA, which is a super bad
bank, and that's never
coming back.
And that's off balance sheet.
So when you add it all together,
Ireland is actually
worse than Greece.
Shh.
Just don't tell the Irish.
AUDIENCE: Speaking of people,
what do you think about
Iceland, how they dealt
with their financial?
MARK BLYTH: Iceland is a
brilliant example of no good
deed goes unpunished.
So when I started all this off,
I was a member of this
thing called the Warwick
Commission on Financial Form.
And you know, the crisis
happens, and people are like,
it's the shadow banks.
And I'm like, what's
a shadow bank?
I mean, you need to
do a little bit
of catch-up on this.
So at first, I bought
the whole narrative
of too big to fail.
Systemic interconnections, the
rest, the whole lot, blah,
blah, blah, blah.
And by the time I finished the
book, I said, no, I actually
totally don't buy this--
I think we should have
let them fail.
Oh, but what about systemic
risk, all the rest of it?
Well, I know what lost GDP is,
I know how much unemployments
cost, I know all that.
I know the real costs
of not bailing them.
And more to the point, the
banking system, even though
it's de-levered, is actually
more concentrated now than it
was in 2007.
So Citibank is even too
bigger to fail.
And the European system
is that on steroids.
So you've basically given
someone not just a banking
license with a subsidy,
an extortion
racket on the taxpayer.
And that's just, it is
literally criminal.
Best example of this--
UBS.
Fined $1.2 billion a few
months back for doing
terrorism financing and money
laundering with drug dealers.
Now, if you or I did this,
we would be in the jail.
They get a fine.
Why do they get a fine?
Because if you are an investor
in an American or
American-licensed broker/dealer
entity--
a big bank--
and one of your corporate
officers is charged with a
criminal liability, you are
under legal obligation to
withdraw your investments.
So if UBS is actually criminally
charged, or their
senior officers are charged.
And then CalPERS has to
pull the money out.
If CalPERS pulls the money out
along with everybody else,
what happens to that bank?
So what happens to the system?
So you're basically playing
systemic moral hazard as a
business model.
This is screwed up
beyond belief.
So Iceland, to finish
this one, basically
let their banks fail.
Now, a lot of the debt, most
of the debt was externally
held, so the cost of that
went on to others.
But here's the interesting
part of the story.
All of the super geniuses who
were working in the banks
engineering derivatives now
had to get a real job.
So what happened was the
domestic economy, the real
economy, rebounded, because all
these start-ups happened.
Because all these really bright
people went, shit, I
need something else to do.
So they started doing all these
new businesses which
didn't appear before.
They became a huge hub for
online gaming, because you can
stick the servers
in the ground--
and it's bloody cold--
and you've got all the people
with the math skills who can
do the software engineering and
make the whole thing work.
So there were all of these
positive externalities of
actually letting them fail.
Their unemployment level is
now about one point higher
than Germany .
Compare it with Iceland, which
is 14% on the official rate,
and that's with migration
going out.
So the people who did this, the
government that came in
and basically allowed this to
happen, it's been a bit tough.
They actually do things like
pay back the debt and are
fiscally responsible.
So they've just been voted out,
and the people who blew
up the banks in the first place
are now back in power.
No good deed goes unpunished.
AUDIENCE: I don't know if you're
familiar with what
happened in Australia.
I'm from Australia.
But people have largely missed
the financial crisis.
And there are two
stories running.
And I don't know if you know
which one is the--
anyway, they're competing.
One is saying that, well, the
government did spending and
gave people money.
And they spent it.
And that saved the economy.
And the other story running
is that, no,
it's the mining boom.
We just dig everything
up, sell it to
China, China went well.
And it has nothing to do with
what the government did.
Have you got a view on that?
MARK BLYTH: The second one
is completely right.
And the way you can see this is
you can't trade the Chinese
currency easily, because of
capital controls, et cetera.
But what you can do is basically
look at the shadow
markets on the Chinese
currency versus
the Australian dollar.
And they move like this.
And it is because, basically,
Australia
literally is owned by China.
I mean, people say this about
the United States.
Oh, China owns the USA.
And it's like, well look, only
17% of bills are actually
owned by China.
And it's brilliant.
Because for the past 30 years,
we've been giving them bits of
paper that bear 2% net.
And they've been giving
us televisions.
It's a sweet deal.
I don't know why anybody would
ever want to end it.
It's brilliant for us.
The Australian one is the
other way around.
They actually do own your
assets completely.
Because if it wasn't for the
western Australian mining
boom, and just all the
commodities they're sucking
out at the peak of a commodity
cycle, I mean, do you really
think a house in Perth
would cost 2
million Australian dollars?
And it does.
It's totally that.
It's totally the mining boom.
So what that means is either the
commodity cycle peaks or
China slows down, Australia
is in serious trouble.
Now, the price to income
multiples in
Sydney are 13 to 1.
So you need to marry two people
and have family money
in order to get a house.
So it's not 3 times your income,
it's 13 times your
income for a three bedroom flat
in a nice part of Sydney.
That's a colossal housing
bubble, and it's Chinese
liquidity that's pumping it.
If that every goes away, boom.
AUDIENCE: The housing bubble
has never crashed in
Australia, unlike
everywhere else.
MARK BLYTH: Yeah, absolutely.
And you know what?
All bubbles pop.
It is just a question of time.
AUDIENCE: I was hoping you could
talk a little bit about
the BRIC countries, and
especially what Brazil needs
to be doing.
MARK BLYTH: Brazil needs to do
what Brazil's been doing,
which is awesome.
So quite primer on the Brazilian
political economy.
For years and years and years
they had one of the highest
Gini coefficients
in the world.
They were incredibly unequal.
And they had a problem because
wealth being so concentrated
meant that the people who make
effective investment decisions
decided that their own economy
was too risky, because it
would either be run by the
military or run by the
communists or run out of town.
So they would take their money
and they would put it in
Citibank, which is
nice and secure.
And you got a lesser rate of
return, but you don't mind
because you own everything,
anyway.
So that's the way it went on for
years and years, until it
got to a point where basically
you had to spend so much money
on private kidnap insurance and
mining your house against
the people who would try and
kill you, that they did a deal
with a guy called Lula.
Lula u to run the
Worker's Party.
So the guy who ran the Worker's
Party, the lefty guy,
comes in and basically does
exactly as I said on the
bottom of that slide.
Democracy is asset insurance for
the rich-- stop skimping
on the payments.
So did this strategy whereby
they got BNDES, the Brazilian
National Development Bank,
to bank-- their lending
portfolio, by the way,
is twice the size
of the World Bank--
to subsidize domestic
corporations so that they
could multinational.
So you've got companies like
Embraer, the aircraft company,
the big cement company, and
the others, that are now
globally successful
corporations.
Because of that expansion,
bankrolled by the development
bank, what they do is they tax
the companies on their
earnings abroad, bring that
back in, and they set up
something called Bolsa Familia,
which is the welfare
state that Brazil never had.
This has squeezed the income
distribution like this at the
same time as it has gone up,
which enables the Brazilians
to finally build
a middle class.
It empowers the middle class.
And it dis-empowers the
durational land-owning elites.
So what you end up with--
there's a little fixey-do with
domestically high interest
rates to keep these
guys happy.
Well, what you've actually
done is to engineer is to
engineer a kind of new
developmental welfare state,
which has actually been great
for Brazilian growth and has
actually brought down the
Gini coefficient.
Because of this, everybody wants
to buy Brazilian assets,
which is why the Real
is going up.
And they're export-dependent,
so they're freaking out.
So what they've done is they've
put inward capital
controls on inward investment.
And usually, the big fear is
you put your money in, they
put up capital controls, you
can't get it out, it's
expropriation.
They're doing it totally
different.
They're like, you want
to come here?
Dead easy.
Pay a transactions tax
and a deposit.
Because if you're not coming in
for the long term, forget
about sitting here earning
high interest rates just
because you can.
So they're making it difficult
for that money to come in.
But as a growth node in a big
country, it is happening
nonetheless.
So the Real is going up, the
economy is slowing down.
But what they've done over the
past 10 years, I think, is
nothing short of remarkable.
BORIS DEBIC: Thank you, Mark.
[APPLAUSE]
