How We Got to Our Current Economic Problems

A little while ago, Nature (582, 461) ventured an item on our economic problem, and it is of interest to reflect on this. Most economic presentations, especially those that concern politicians, involve microeconomics: what happens to individual, families, businesses, etc. That is natural because that is where the votes lie, and to some extent it is what politicians can control. The main point of the Nature article revolved around macroeconomics, which involves cross-border capital flows, the role and behaviour of central bankers, the role of global financial markets, and the role of the US Federal Reserve, which, despite its grandiose name is actually not a government owned or controlled institution. The owners of the Federal Reserve are effectively members of the plutocratic class that own the economies.

In 1944, Franklin D Roosevelt decided to make some attempt at fixing the macroeconomic situation and he invited qualified experts to set up a useful system to form an international financial system that represented the needs of diverse geographical regions with diverse economies. Of considerable interest, bankers and financiers were barred, as Roosevelt did not trust them to put aside their own interests. FDR understood them very well. The result was the Bretton Woods system, named after where the procedures were devised. This arguably worked well, although I have little doubt it could be criticized.

In 1971 Richard Nixon dismantled that system and replaced it with, er, not much. A special place arose for the US dollar, which, because the US economy was so large that no single transaction would appear on the overall “balance sheet”, this was the only real currency that was considered to be stable. The idea was, if there were anything resembling an idea, let the market rule. A subsidiary idea was (although this was never openly stated) it gave a special position to the Federal Reserve, who could print what they felt like printing. The market is the proper place for fixing the price of things that are traded according to available supply and demand, and each of those is free of external constraints. The concept is, if something is in short supply, the price rises and new suppliers enter the market. However, if a cartel can control supply, say, as with OPEC in the 1970s, price rises get out of hand, but great profits are made by the cartel. Currencies can be open to manipulation. The very rich can withhold to raise the price and sell at huge profits when more is needed to settle other trading. You see a large number of very rich people who got that way by trading currencies, generally through inside knowledge of what is going on in the broader market. However, that trading does not create anything of value; it merely skims from those who do, so such trading is little better than a bunch of parasites who also precipitate the financial crises we seem to have gone through since 1971. Of course, on the other side of the argument, the value of a nation’s currency should not be set by politicians with other agendas, because long-term, only too many suffer.

This market rules system has led to much greater world trade, it has raised the living standards of many, but in the western world it has done this by permitting the very rich to become ridiculously more wealthy while punishing what we can loosely call the working class. Manufacturing has been shipped to the lowest cost labour, and the multinationals from a limited number of countries built manufacturing complexes, often with very little regard to the health of the local population. Pollution occurred at levels that would be totally unacceptable in the countries where the companies have headquarters. I recall driving through Cubatão, which is just inland from Santos in Brazil, one evening in the mid 1980s. One chemical plant was pouring out clouds of white stuff, which I provisionally guessed was phthalic anhydride. The health effects of this sort of pollution on the locals were terrible, there was no excuse for this, but because general safety and pollution control was absent, the product would be cheaper. So the net result was that a surprising amount of manufacturing fled the West to places that did not care, while workers in the West joined the unemployment queues.

Thus fortunes for the very rich increased dramatically, but at the expense of the not so rich, many of whom became the new poor. The real money was made by bankers, and as they grew richer, not by doing traditional banking but by selling financial “products”. After the 2007-2008 crisis, you might think things improved, but no, the world is still flooded with junk bonds, leveraged loans, and huge debt. You might have expected the US Federal Reserve to act responsibly and limit the potential for excess credit, but after 2009, why, no, they allowed the private credit market to expand to $US 9 trillion. Since a certain virus struck, the Federal Reserve has made a massive cash injection, but where has this gone? Largely to bail out what the Nature article calls “Monetary chicanery”. In short, the bankers pass go and again collect 200 billion.The question then is, can markets provide affordable health care, affordable housing, affordable higher education, security in times of crisis? I leave you to find your own answers, but I suspect the answer will often be no. Then there is the question, what will happen to all this created money? So far it is sitting harmlessly on ledgers, but what happens if enough of the rich decide to cash out at the same time? Who saves the poor, and the innocent? This is a system that needs fixing, but where do you find the fixers? Not from those who have the resources to fix it because they are the major beneficiaries.

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The Recent Economy up to Covid-19

In the previous post I noted that Keynesian economics tended to fail because governments overlooked the second half of the prescription: when the going got strong, it was necessary to “pay back” the debt, or at least reduce the money supply. That results in politicians being party poopers, restraining the good times and what politician wants that with an election coming? The net result was with too much money floating around, we had the rather unexpected result of inflation coupled with stagnation/recession. More money would not solve that. Friedman had the answer, perhaps: stop government priming the economy and correct structural deficiencies. That was not followed either – Friedman had no more success than Keynes in getting politicians to behave. What resulted was the likes of Reagan reducing government expenditure, lowering taxes, and maintaining and expanding the government deficit. Then the US Federal Reserve set the tone by reducing the money supply, even though it knew that would send unemployment soaring. They simply did not care. Anything went in the name of “economic efficiency”. 

What was undefined was “efficiency.” To answer that we have to ask what is the purpose of the economy? To the bankers it seems to be to make nice profits for banks, but surely it is more than the keeping of tidy books. For some, it is to maximize wealth, especially for themselves. For some it is to generate the means of enabling people to live in a pleasant place and live alongside nature. For others it is to enable all people to get the best out of life. Under the new economics of Reagan and others, the emphasis was on the “basics”: get the government out of the economy because they don’t know what they are doing, focus on low and stable inflation, let the rich get richer, following which the wealth would trickle down. Except the evidence is, it didn’t.  Then when it became clear that squeezing the money supply, while it might have helped make the books tidier, was generating unemployment that was too great, so central banks switched to using interest rates as their primary tool. Which gets us to where the bankers are now. Interest rates have got to the point where depositing in banks is only good for security, as long as the bank does not go belly up.

What actually happened was that when the corporations noted that the government did not care about employment it fired its workers, thereby saving money on benefits, etc. and moved manufacturing to low wage countries. Basic manufacturing, like clothes, were exported to places like Indonesia or Bangla Desh, and more difficult manufacturing to China. That undoubtedly increased the wealth of the rich, but it sent the workers into low-paying jobs in the service industries. Meanwhile, there was a somewhat unrecognized crisis in the academic community, and in particular the physics community. Funding had dropped and we had a large number of highly educated unemployed. The physicists, in particular, were good at computer modeling, and they got jobs in banks to create new “financial products”. The banks made huge profits until about 2008. The problem with these “products”. which were sliced and diced debt, were based on the assumption that nothing significant could go wrong, but in the US, for political reasons, a huge number of houses were sold to people who had no hope of repaying the mortgages. Oops. 

We have sort of recovered from that, but the legacy is that thanks to COVID 19 the debt levels of so many countries is extraordinarily high, interest rates are ridiculously low they cannot go lower, so there is no incentive to save. Money goes into assets, which merely inflates the price of the assets. Stock at $100 is worth that if you can sell it for that, but at the end of a period of time, you have to look at the overall returns on investment. In a bubble, everyone makes money until the music stops, then the losses are concentrated on the then holders. COVID has forced the nervous investors to cash out and the stock market fell, but it is coming back because of the quantitative easing. So what happens when the quantitative easing stops and the bonds are cashed out?What is clear is that we cannot look to the past for ways to get out of this. We have to try something new, but what? If you look at our leaders, do any of them have a solution to what happens after quantitative easing? Or do they have their heads in the sand and assume that will be for another electoral cycle?

Will Pump-priming the Economy Help Post-Covid?

Because I operated a company that had the primary objective of developing technology for new businesses in the chemical arena, economics interested me. We can all be smart looking back, but what about now? What should we do about the economy during virus times? So what are some options? This will take more than one post, but first, what is the best example in history of getting out of trouble? What tools are available?

In 1936, John Maynard Keynes published “The General Theory of Employment, Interest and Money”, and when he did so, he should have known it worked for getting out of depression because when Adolf Hitler took over in Germany, the economy was in a mess, with horrendous unemployment and terrible wages for most of those actually employed. Hitler promised to fix things, and he did, by implementing the policies that Keynes was later to publish. By 1936 the German unemployment had essentially disappeared and Keynes would know that.  Hitler was to provide the world with horrors, but early on his economic policy was exactly what Germany needed.

Keynes’ approach was essentially that in a depression the state should provide money to prime the economy, and when better times arrived, pay it back. In my opinion, therein lay one flaw: when better times arrive, do politicians want to pay it back? Er, no. Better (at least for re-election chances) to leave it as debt and inflate it away. (Hitler never had the opportunity to pay it back, because he had other interests.) It is usual to say that Keynes’ economics collapsed in the 1970s with persistently high inflation and high unemployment. One could argue that at least part of the inflation was because the governments refused to pay back, and instead kept borrowing. I have no doubt the counter to that will be, look at now – there is no inflation, and governments are borrowing heavily. Maybe.

If following Keynes, does it matter what the money is spent on? In the German example, the money went on infrastructure, and on providing the expansion of industries for making things. There was an unintended consequence after the war: once the West Germans started to run their own economy they had another economic miracle. Thanks to Hitler’s apprentice schemes, there were a large number of highly skilled people required for manufacturing, and they had factories. The allies bombed cities but mainly left the factories alone. German manufacturing reached its highest point of the war in late 1944. As an example, they made ten times more fighters then than around the Battle of Britain. (That they had run out of skilled pilots was a separate issue.) 

Keynesian economics involved high taxes on the wealthy and some claim such tax rates prevent innovation and general expansion. In the US, from 1953 to 1964, the top tax rate was 90%, and it did not drop below 70% until about 1982. This period corresponded to the US being the most developed country in the world. The tax rates did not stifle anything. Of course, there were tax exemptions for money being sent in the desired direction, and that may well be a desirable aspect of taxation policy. The death of Keynesian economics was probably a consequence of Milton Friedman, as much as anything else. The stagflation in the late 1970s convinced politicians they could no longer spend their way out of a recession. An important observation of Friedman was that if policymakers stimulated without tackling the underlying structural deficiencies, they would fail. They did not and fail they did, but that was partly because the politicians had ceased to look at structural deficiencies. Friedman was correct regarding the problem, but that was because in detail Keynes’ obligations were overlooked. No more than half of the Keynes  prescription was implemented generally. So, where does that leave us? Is Keynes applicable now? In my opinion, the current attempts to spend our way out of virus difficulties won’t work because there are further problems that apply, but that is for a later post.

The Hangenberg Extinction

One problem of applying the scientific method to past events is there is seldom enough information to reach a proper conclusion. An obvious example is the mass extinction that we know occurred at the end of the Devonian period, and in particular, something called the Hangenberg event, which is linked to the extrinction of 44% of high-level vertebrate clades and 97% of vertebrate species. Only smaller species survived, namely sharks smaller than a meter in length and general fish less than ten centimeters in length. This is the time when most ammonites and trilobites, which had been successful for such a long time, failed to survive. One family of trilobites survived, only to be extinguished in the Permian extinction, another  of those that wiped out 90% of all species. 

So why did this happen? First, it is most likely the ecosystems had been stressed. The Hangenberg event occurred about 358 My ago, but before that, at about 382 My BP most jawless fish disappeared, while from 372 – 359 My BP there were a series of extinctions or climate changes known as the Kellwasser event (although it was almost certainly a number of events.) So for about 30 million years leading up to the Hangenberg event, there had been severe difficulties for life. At this stage, leaving aside insects and plants that had left the oceans, most life were in marine or freshwater environments and it was this life that appears to have suffered the most. That conclusion, however, may more reflect a relative paucity of land-based fossils. Climate change was almost certainly involved because over this period there was a series of sea level rises while the water became more anoxic. The causes of this are less than clear and there have been a numper of suggestions.

One possibility is an asteroid collision, and while impact craters can be found they cannot be dated sufficiently closely to be associated with any specific event. A more likely effect questions why anoxic? The climate  should have no direct effect on this, although the reverse is possible. The question is really was it the seas only that became anoxic? One possibility is that on land the late Devonian saw a dramatic change in plant life. In the early Devonian, plants had made it to land, but they were small leafy plants like liverworts and mosses. In the late Devonian they developed stems that could move water and nutrients, and suddenly huge plants emerged. One argument is that this caused a flood of nutrients through the weathering of rocks caused by the extensive root systems to flow down into the sea, which caused algal blooms, which led to anoxic conditions. Meanwhile, the huge forests of the Devonian may have reduced carbon dioxide levels, which would lead to glaciation, and the sea level fall in the very late Devonian. However, it does not explain sea level rise earlier. That may have arisen from extensive volcanism that occurred around 372 My ago, which would enhance greehouse warming. You can take your pick from these explanations because even the experts in the field are unsure.

Accordingly, a new theory has just emerged, namely Earth was bombarded by cosmic rays from a nearby supernova (Fields, et al., arXiv:2007.01887v1, 3rd July, 2020). This has the advantage that we can see why it is global. The specific event would be a core-collapse supernova. If this occurred within 33 light years from Earth, it would probably extinguish all life on Earth, but one about twice as far away, 66 light years, would exterminate much life, but not all. The mechanism is in part ozone depletion, but there is the possibility of enhanced nitrogen fixation in the atmosphere, which might lead to algal blooms. One of the good things about such a proposition is it is testable. Such an event would bombard Earth with isotopes that would otherwise be difficult to obtain, and one would be plutonium 244. There is no naturally occurring plutonium on Earth, so if some atoms were found in the fossils or in accompanying rock, that would support the supernova event.

So, is that what happened? My personal view is that is unlikely, and the reason I say that is that most of the damage would be done to life on land, and as I gather, the insects expanded into the Carboniferous period. The seas would be relatively protected because the incoming flux would be protected by the water. The nitrate fixation might cause an algal bloom and while a lot of energy would be required to saturate the world’s oceans, maybe there was sufficient. The finding of plutonium in the associated deposits would be definitive, however. The typical deposits were black shales overlaid by sandstone, and are easy to locate, so if there is plutonium in them, there is the answer. If there is not, does that mean the proposition is wrong? That is more difficult to answer, but the more samples that are examined from widespread sources, the more trouble for the proposition.

My preferred explanation is the ecological one, namely the development of tree ferns, etc. The Devonian extinction was slow, taking 24 million years, and while most marine extinctions occurred during what is called the Hangenberg event, the word event may be misleading. That specific period took 100,000 – 300,000 years, which is plenty of time for an ecological disaster to kill off that which cannot adapt. To put it into perspective, Homo Sapiens has been around for only 30,000 years, and effective for only about 10,000 years. Look at the ecological change. Now, think what will happen if we let climate change get out of control. We are already causing serious extinction of many species, but the loss of habitat if the seas rise will dwarf what we have done so far because our booming population has to eat. We should learn from the late Devonian.