Kay and Wolf – voices of reason at the FT

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Being grey haired is meant to make you old, grumpy, withdrawn and resentful of all around you if you believed the popular press — or at least Grumpy Old Men on BBC2.

It can also let you recount of your wisdom, as John Kay and Martin Wolf are at the FT this morning. John Kay first:

If you ask people in the industry to justify recent financial innovations, they will explain that they allow risks to be managed more effectively. Yet if you asked people in the street whether recent developments in financial markets had made them feel more secure, they would assume you had taken leave of your senses

As his headline outs it, rather well:

Finance spread its own risks but left ours alone

And as he notes:

The principal financial risks faced by individuals are loss of employment, breakdown of relationships and illness.

Quite so. Nice of finance to do that, wasn’t it? And boy are we going to be paying the price by the bucket load. Especially as, as John Kay also notes:

The risks of ordinary life are mainly handled by families and social institutions, and the contribution of markets to handling such risks is generally diminishing.

Now there an argument for progressive taxation if ever I saw one.

Turning to Martin Wolf, discussing the causes of the current collapse in demand in the private sector in so many countries says:

Maybe, the collapse in private spending in the wake of the financial crisis was caused by terror of the fiscal deficits to come. Maybe, the moon is made of green cheese, too.

It’s refreshing to note I am not the only one driven to sarcasm by the madness of those arguing the economically absurd at present.

Wolf, as usual, has serious research to back up his point since, as he notes “There is also next to no sign of crowding out in capital markets.”

First on interest rates:

On Monday, the yield on 10-year government bonds was 1.1 per cent in Japan, 2.6 per cent in Germany, 3 per cent in the US and 3.3 per cent in the UK (see chart). Based on yields on index-linked securities, real interest rates on borrowing by these governments are very low (1.2 per cent, or less, in the US, Germany and UK). Investors are saying that they view the risk of depression and deflation as greater than that of default and inflation.

Again, quite so. Indisputable, really.

And then regarding demand:

Why should it be so easy to fund such huge fiscal deficits even after central banks have stopped their buying of government bonds? In response, here is a calculation that can be derived from the figures for fiscal and current account balances in the latest Economic Outlook from the Organisation for Economic Co-operation and Development: the private sector — households and corporations — of advanced countries is forecast to run an excess of income over spending this year of 7 per cent of gross domestic product. In round numbers, this is $3,000bn. In the US and eurozone, the implied private surplus is about $1,000bn, in each case. In Japan, it is about $500bn. In the UK, it is $200bn.

Focus on the $3,000bn: this is the amount by which the private sectors of the advanced countries are forecast to increase their net claims on governments and foreigners in 2010. That means massive private retrenchment, with corporations particularly frugal at the moment

Put simply: people are choosing not to spend. Emerging economies are also in surplus (mainly China, it has to be said) and so, inevitably, someone has to absorb that cash. Guess who is doing so? Governments are! This is where the finance for deficits is coming from: people are choosing to invest in them. And until there is economic recovery hat’s what they’ll continue to do. And then that recovery happens they’ll pay more tax and the deficit will go away. When will that happen? as Wolf concludes:

My conclusion, then, is that the advanced countries remain highly short of demand.

At the summit of the Group of 20 countries in Canada, leaders pledged to “halve fiscal deficits by 2013 and stabilise or reduce government debt-to-GDP ratios by 2016”. It would make far better sense for governments to focus their efforts on altering the long-term trajectory of spending. They may hope that retrenchment now will spur on private spending. But what is their plan if it turns out that it does not?

As it will not — as Martin Wolf knows.

As I know.

Then government has the duty to use those funds entrusted to it wisely — by expanding the economy, and not crushing it as the ConDems plan.


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