Monday, 23 January 2012

Debt And Interest Rate Comparison published a graph last Friday showing a comparison of debt to GDP ratios amongst developed economies, quoting the WSJ. I took the liberty to use the data from there and add Iceland to it but also add the long term interest rates that those economies are funding the debt on (OECD figures). The following graph shows the comparison.

Debt to GDP ratios of developed economies. Long term interest rates according to OECD on the top of the bars. See CreditWritedowns for references. Q2 2011 figures.

Note: The government debt ratio for Iceland is "general government" but not federal government. The federal government debt ratio was 111% at end of Q2 2011.

Few points to notice

  • Iceland is, contrary to what it was in year end 2010, not the most indebted economy when it comes to non-financial private debt.
  • The Icelandic interest rates are killing the economy! Blame that on indexation of mortgages in Iceland and the legal obligation of pension funds to get 3.5% real return on their investments.
  • There is a reason why Canada's financial sector is the safest one in the world: the economy is simply not that indebted, with the exception of rather high household debt.
  • South Korea, Spain, Iceland and UK are in serious threat of debt deflation: high private debt and interest rates rather high. South Korea's comparatively low debt ratio helps while UK's low interest rates help on the field. Iceland and Spain are debt deflationary doomed, especially since the local governments cannot do much about it (the Icelandic one because of its own debt levels and Spain's because of pressure from Brussels).
  • Japan is "fine" in the sense that they are at least paying low interest rates on their debt, contrary to all the other countries. 

Tuesday, 17 January 2012

An Orderly Exit From the Eurozone?

It's been rather blatant for the last months and years that some EZ countries aren't in their best economical shape. Greece is probably doing worst and in fact the despair is getting extremely serious as news come from there that parents are leaving their children for the simple fact that they cannot support them and pharmacies' stocks are getting seriously low. It is beyond any discussion that if those kinds of stories are true the management of the crisis is running in the wrong direction.

Austerity in Greece hasn't done anything for its economic shape. Most people, at least outside of Brussels, now accept the fact that Greece has to leave the EZ, devalue the new drachma and get money into the economy instead of "saving itself out of recession".

But the problem is the threat of disordered default on Euro denominated debt and contagion on other EZ economies. Due to this, the ECB and people that are uberfrightened of inflation don't even want to think about Greece's exit from the Euro nor quantitative easing in the form of ECB buying government bonds, in the hope of getting the interest rates back to human levels from heights that not even the Greek gods could pay. The holders of Greek bonds aren't too eager either, many of them on the edge of bankruptcy themselves.

The repetition of history
This has all happened before. In the early 1930s, the "gold bloc" was fighting to maintain gold's status as an international currency. But the UK and US wanted to revive their economies and get long term interest rates down and so, they devalued their currencies in terms of how much gold one sterling / dollar could buy. The gold bloc strengthened their ties but it didn't work simply because the citizens of the gold bloc countries revolted or demanded serious improvements. Czechoslovakia left the gold standard in 1934. Others slowly followed suit.

A major player left the gold bloc in 1936. That was France. She managed to do it with the assistance of UK and US that agreed on defending the French franc from any "unnecessary" movements.

Essentially, this is exactly what Greece needs today. The economy is in shatters, just as the economies of the gold bloc countries in the 1930s, and its only getting worse. Greece has to leave the Euro, nobody in his right mind claims that she can "austeritise" herself out of recession. The only problem is how to perform the exit in a rather calm fashion.

Greece should copy 1936's France. If Greece stays in the gold bloc - the Eurozone - we can forget that the economy of Greece is going to revive itself. In order to stop speculation from going on a rampage, the US Fed and Bank of England, along with central banks of Japan and Switzerland, must assist the ECB on maintaining the interest rate levels of other EZ countries at the low and at the same time keep the currencies in question within reasonable levels of fluctuation.

That way, countries that need to leave the EZ can do it without risking getting hammered by speculation or infecting other economies with speculation flows. Greece would be followed by Italy, Portugal, Spain and Ireland. Their new currencies could, and should, be set on an adjustable peg with the Euro with wide fluctuation bands that would not only be defended by the ECB but the Fed and Bank of England as well. This would be a mini-version of Bretton Woods.

Obviously, I'm not the dreamer to think this will happen, at least not yet. No political leader in Brussels, with any serious powers, is courageous enough to face the situation as it really is and simply tell the truth: some EZ countries must be allowed to exit the EZ with international assistance and the chance of joining the currency zone again in later time if they so wish. But if we continue on this mad path of austerity the only thing that will happen is that social revolts will take power, whether we like it or not.

What is most frightening however is that it took France seven years to exit their gold bloc trap back in 1930s. Hopefully, Greece doesn't have to wait three more years.

Monday, 16 January 2012

The State Of The Economy And Social Revolutions

I believe it was an acquaintance of my girlfriend who said that French society didn't evolve; it mutated, violently, every now and then but in-between the society was calm and "business as usual" carried on.

I suppose this isn't too far away from the truth. And quite frankly, one can easily say this applies to other societies/nations/economies as well. And the most remarkable thing is that it seems like the social unrest takes place only, or at least mainly, after economic hardship, however that hardship came about. Cornered people that have nothing to lose don't just sit by and wait for things to happen.

US colonists revolted against UK because of taxes and demanded tributes to the King ("No taxation without representation"), France's Revolution was amongst other things because of bad harvests (allegedly caused by Laki volcano in Iceland), the Nazis gained power because of the Versailles treaty and the debt-hardship it put on the German people while today the citizens of Latvia, Iceland, Portugal, Spain, Romania, Greece, Italy, US to name just a few have all marched the streets essentially because of debt levels and the economic slowdown they have introduced.

How does the Chinese curse go: "May you live in interesting times!"





Monday, 9 January 2012

Economics And The Icelandic Collapse

Inside Job was recently shown on the Icelandic equivalent of BBC 1. In the wake of it, bloggers and the public either made fun of the economists and bankers behind the whole collapse or continued cursing them to the “debts” of Hell. Frettabladid, a newspaper, published a comic of Tryggvi Thor Herbertsson watching Inside Job but Herbertsson was the co-author of the “Financial Stability In Iceland” report that notoriously changed its name to “Financial Instability In Iceland” on Mishkin’s CV (the red ink text reads “impudent, impertinent, unreasonable, unfair”. The guy behind Herbertsson (basically) asks him what he’s watching).

Others, such as Styrmir Gunnarsson, former editor of Morgunbladid (one of the daily newspapers back home, now edited by David Oddsson, former PM during 1991-2005 and the governor of the Central Bank of Iceland 2005 - 2008), correctly pointed out that one could hardly see who had been deeper in the pockets of bankers, politicians or scholars. Furthermore, no serious discussion had been amongst scholars about whether the economics departments of the universities of Iceland had played any role in the economic collapse of Iceland.

Gunnarsson also writes: "Economists and economics professors, especially at American universities, have repeatedly given all kinds of advices and analysis to financial firms in last years and been rewarded handsomely. One can therefore hardly expect many of them to have given warnings what was going on, although they should have had more chances of understanding it rather than other people." (my italics).

Although Gunnarsson is spot on when he mentions the lack of throughout discussion amongst academic economists about the role of economics teaching behind the collapse, he is not running a home run on this point. Exactly because so many economists, such as Mishkin and Herbertsson, were using neoclassical economics that ignore the role of private debt in the economy, one cannot expect them to understand the problems that were mounting up before the Global Financial Crisis hit.

I mean seriously, can one expect economists that use economics where marginal productivity of capital equals interest rates, marginal productivity of labour equals wages, where one can add single demand curves up to get a downward sloping market demand curve, where people are walking calculators that can calculate in a splinter of a second their utility of all possible choices even from now to eternity, where the economy is repeatedly modelled using a single eternal representative agent, where firms maximise profits by supplying their good into the market until marginal revenues equal marginal costs, where debts and nominal figures are repeatedly or naturally ignored, and so on, to understand that the real economy that we live in is on the brink of collapse? No, no we cannot because all of this is incorrect! Never again may we do the same mistake!

Economics at the University of Iceland
I finished my undergraduate degree (BSc.) from the University of Iceland in May 2008. Parallel to my studies, I worked as a part-time analyst at the research department of Kaupthing Bank in Reykjavik.

Today, I must admit that I feel ashamed not to have noticed the nonsense that I was being fed at the University. But even though I may have noticed something, chances are that it would not have mattered. I remembered that when my fellow students pointed out or asked about something dodgy that was written on the whiteboard, the lecturer normally said that economics were simplification of reality and assumptions had to be made to reach conclusion that could then be applied to the economy. That’s all fair and well. But over simplification and assumptions that do not apply in the real world can be seriously distorting for the conclusion. One should never swallow without questions a conclusion that is reached by using unrealistic assumptions that transform the world we are trying to inform ourselves about into something that can never be thought of being anything else than a shadow of reality, if it manages to be that. Assumptions matter, whatever Milton Friedman said.

After I moved to England in September 2008 I came across economics that I had never imagined existed (thank you!). I drowned myself in financial history, especially because Iceland was shoulder deep in a financial crisis that nearly no one had anticipated – a psychiatrist publicly did it back in 2007 and was immediately made fun at by Icelandic economists that said he didn't understand basic economics, just as they themselves didn't understand basic psychiatry. "Let the economists to the economics and be quiet" they said.

 I was shocked to see how common financial crises were. In the undergrad program back at the University of Iceland none of my lecturers had more than mentioned financial crises. Throughout discussion about how or why they developed didn’t exist.

In April 2010, I sent an email to a prominent blogger who is also the host of a talk show about whatever not – he interviewed my in January 2011 about the bleak future of the Icelandic pension system. The email was a comment I sent to him personally after he had blogged about economics in Iceland and in it I criticised the economics department of University of Iceland for basically being crap. He asked me if he could post the email on his blog and I told him he could if he wanted to, and so he did.

My former teachers weren’t all happy with it. Some of them thanked me for the comment and said that it was well worth discussing within the economics department. Others were straightforward sullen and told me I was unfair and off track.

The words of one them not only surprised me but quite frankly worried me:

“The main purpose of teaching economics [at the University of Iceland] is to provide solid economics knowledge to students that can suffice them as foundations to further studies at good universities outside of Iceland. This we have succeeded at quite well, as you should know yourself.” (I had finished my MSc. and started my PhD at this time at a "good university outside of Iceland").

But seriously, think about this for a second! The “main purpose of teaching economics at the University of Iceland is to provide solid economics knowledge to students that can suffice them as foundations to further studies at good universities outside of Iceland” even though this economics is quite often straightforward mathematically wrong, not applicable in the world we live in and to a large extent responsible for the economical situation in the whole world, from failed privatisation in ex Communist nations in Eastern Europe to underdeveloped economies in Africa all the way to over-indebtedness of developed economies. What a track record! What a splendid economics to teach!

If this is seriously the case, then shame on the economics department of the University of Iceland! How about teaching economics that is not mathematically wrong, more applicable to analysing the workings of the real world and understands the immorality and the financial instability that is an unmistakable part of modern capitalistic economies, no matter if it helps the students into "good universities" abroad or not? How about teaching the economics of the real-world economies but not economics of dreamt-up, non-sensible and non-human economies of neoclassical economics?

If you want to read economics of the real world, you should not attend the economics department of the University of Iceland but start by reading books such as those on this list: Which Books To Read About Economics. Debunking Economics by Steve Keen is a must read, it may well be the only book on economics you have to read in your entire life to know when to stop listening to economists if you feel like they are wasting your time, talking nonsense.

Friday, 6 January 2012

Where Is The Investment Coming From?

Egill Johannsson made a comment on the previous post regarding the questionable return of economic growth in Iceland. I translated - and expanded a bit - the post into Icelandic and posted it on my Icelandic blog site.

Johannsson (I'd naturally just address him with his given name since that's customary in Icelandic but since this is a blog in English I'll obey the formalities) asks where the investment is coming from, i.e. is it coming from private enterprises or from the State. Unfortunately, distinction between private and public investments only dates back to 1997 while one can trace the aggregate investment figures back to 1945.

The first graph - sorry for the Icelandic - is the development of investment as share of GDP in Iceland back to 1945 in case of no segregation but the second shows segregated figures back to 1997.As one can see, the majority of the collapse in investment is in the private sector which one can be tempted to interpret as a  symptom of a balance sheet recession.

Investment as share of GDP back to 1945. Annual aggregate numbers only available. 

Segregated data of investment as % of GDP. Quarterly data back to 1Q 1997.