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Don't mention nationalisation

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Stephanie Flanders | 12:08 UK time, Wednesday, 25 February 2009

President Barack ObamaIn his speech to Congress yesterday, President Obama wanted to remind us of his steely resolve. You can see why.

To judge by the polls, voters still hold Mr Obama in high esteem. But when it comes to the economic crisis, steely resolve has not been the message of the administration's first month.

Fixing the US economy and the banking system was always going to be hard. No-one expected the Obama team to wave a magic wand. And, to underscore the point, it has only been one month.

But here's what many find troubling about the record so far. The Obama White House will almost certainly never have more political capital than it has now - more room to think the unthinkable,and do it.

Yet to many economists, the policies that the administration has announced so far are in some respects, the bare minimum. They're what the country will need if everything works. And the White House is having trouble with even those.

Yes, the fiscal stimulus package was large, but no larger than most think the economy will require. To get it, the president had to struggle much more than he would have liked.

He has also given the public the impression that this will be the last stimulus package Congress will have to pass. We'll find out more when he unveils his new budget tomorrow, but that's the implication of the president's pledge last night to halve the deficit by the end of 2012.

To believe there won't be need for any more, you have also to believe that the private sector will be able to take up the baton of growth by the middle of next year, when the bulk of this stimulus will have run its course. To many economists, that sounds optimistic, at best.

As Goldman Sachs analysts have pointed out, the American private sector is moving from a period of historic deficit to one of surplus - from net borrowing of 3.5% of GDP in 2006 to net saving of around 1% of GDP last year.

To judge by the Japan experience, that shift has a long way to run. The same team reckons the private sector could be saving to the tune of 10% of GDP by 2012.

Theoretically, the rest of the world could take up that slack; exports could soar, and the US could start lending all that private saving to the rest of the world. But that's not what you would call the baseline scenario. The much, much more likely outcome is that government borrowing will not only rise to around 10% of GDP this year (as projected) but will also stay in that vicinity for several years.

The only question is whether that happens by choice, through government stimulus, or by default, as a deeper recession takes its toll on the federal budget.

You can see why the President would not want to raise these issues in his address last night. In a world of problems-for-right-now, next year's fiscal stimulus package is one of the few that can wait.

But the same cannot be said of the Financial Stability Plan and fixing America's banks.
The Administration has said it will be resolute in stress testing the banks and acting on the findings.

Nearly everyone agrees that this kind of reckoning will be required to finally rebuild confidence in the nation's financial institutions.

Surprisingly, perhaps, most now also believe that the end conclusion of this exercise ought to be the nationalisation of several important banks. That's because, even to many Republicans, the uneasy middle ground we have now exposes the taxpayer to all of the risk on the banks' balance sheets but none of the potential gains.

But in its extraordinary joint statement on Monday with the major financial regulators and the Fed, the Treasury Department once again re-iterated that "the strong presumption is that banks should remain in private hands".

That is certainly the strong presumption for normal times. Just as nationalisation, in normal times in America, is the policy that dare not speak its name. But these are not normal times. If the Administration dare not speak its name now, many are wondering what else it will not have the courage to do.


  • Comment number 1.

    Could be first post here.....

    Stephanie, I still struggle with economic stimulus being the solution to a problem in part (a large part) caused by too much economic stimulus

    For me there appears to very little difference in what the UK and the US appear to be seeing as a solution – that being the Govs taking the lead and pumping money into the economy.

    Replace Government with Banks and that is pretty much what has been happening over the past 10yrs isn’t it?

    The only material difference is that when a Gov stands back and allows individuals to do the borrowing to inflate the economy it is down to the individual to repay......

    ...... this way the cost is spread amongst the entire nation!

    I know I’m repeating myself but using “Keynesiasm” to solve a problem cause by “Keynesiasm by Proxy” is not a solution

  • Comment number 2.

    While banks are being rescued in the national interest by taxpayer funds the banks are in effect national entities. It would only be a cause for contempt if profits were to remain in the hands of a few private individuals.

    Banks will still have to be run by people who know what they are doing, which politicians do not. So I think in the UK the nationalised banks will end up reporting to some separate entity from the government. I would expect that this entity would also be reporting to the ECB as I expect the ECB will be tasked with implementing EU-wide regulations on financial institutions. I see this as a potentially positive development - a supranational financial infrastructure constrained by the EU with local administrative entities taking on national nuances.

  • Comment number 3.

    I guess what we are looking at is a form of national sclerosis. A country in denial about the financial mess that it is in. And no one, least of all the new President wants to be the bearer of such tidings.

    The trouble was money problems as we can all atest is that you cannot just wish them all away. At some point Americans of all political persuasions will just have to wake up and smell the coffee as they say.

    For a generation not that long removed from a people once held hostage to McCarthyism the idea of nationalising banks and socialising failure is much too horrible a thought to contemplate.

    But if China and a handful of other far eastern central bankers stop buying their country's increasingly dubious paper then the mere matter of nationalising their failed banks will seem like missing a stroll in the park.

    We have the equivalent of the punic wars in the middle east and an inability to do reality at home. The thing about change is that it can actually be a change for the worse.

  • Comment number 4.

    If a government "nationalises" its banks proper, it will assume the liabilities of those banks. Unfortunately, the liabilities are very large and would swamp the state and the tax payer.

    Instead, there is the "bad bank" option. If Bank X puts its toxic assets into a new separate legal company and then floats that new company on the stock exchange, the new company's share price will be very low. The share capital raised by the new company will be small - much less than the book value of the toxic assets, which means that Bank X will have sold its toxic assets to the new company at a huge loss, and will have crystallised all the huge losses immediately, all in one year. This will force Bank X to go crying to the government for yet more bail-out funds to restore its liquidity and cover its losses.

    The only other option is the zombie banks we have now; where the banks haven't succeeded in off-loading their toxic assets on to anyone else. The troubled banks will slowly have to write the bad debts off over the coming years. Sure, the banks will have to cut back on lending, and won't be able to lend to credit risk businesses, but at least the huge losses on toxic bad debts are spread out over many years to come, making them more manageable.

    The tax payer cannot guarantee all the bad debts and losses from toxic assets. Therefore, the only option is zombie banks.

  • Comment number 5.

    More and more people are realising that capitalism doesn't work.

    They know they are being ripped off.

    In years to come the idea that a few can control the means of production (and so dictate our lives) will seem as absurded as slavery.

  • Comment number 6.

    The Obama recovery package will fail. The massive de-leveraging now well underway cannot be stopped.

    The collapse of the 'Originate & Distribute' model will take years of stagnation to work through the system. Much of the growth seen over the last 10-15 years was fuelled by the growth of shadow banking.

    This model has not been shown for the hollow sham it always was - the palming-off of risk by US mortgage shysters onto guillible greedy (ie stupid) foreign banks as well as their own.

    As the current Alt-A mortage collapse in the US (soon in the UK) shows, this financial HUMPTY-DUMPTY, CAN NEVER BE PUT BACK TOGETHER AGAIN.

  • Comment number 7.

    It seems that Obama and the Democrats, like NuLab, have their ideological knickers in a twist over the issue of Nationalisation. It is clear IMO that failing banks should be nationalised and make credit available again; which in turn should help healthier private banks survive.

  • Comment number 8.

    In general I'm against any form of Nationalisation, but in this instance I think it has additional benefits over and above the ‘uneasy middle ground’ you mention.

    It sends a clear signal to those responsible in the future that it is an option for Government and one they are prepared to take. At the moment it seems to the world that if you run a back or are an influential shareholder you can do pretty much what you want, without the ultimate consequence of bankruptcy.

    I know I’ll get some feedback from shareholders, but many of these institutions ARE bankrupt and without huge state aid would fail – your shares are worthless! If this were any other industry it is more than likely they would be allowed to fail....... probably by a bank calling in its loans!!!!

    Once nationalised, back to sustainable, realistic banking and an eventual return to the private sector (which might offset some of the cost)

    The issues in our country are far deeper than just the Banks. A fair Global Economy is idealistic nonsense – at present it seems to be that half the World make goods and save, the other half borrows and buys....

    If we manufacture/produce we back it...... if it’s a service then it’s a luxury and it fends for itself!

  • Comment number 9.

    If they nationalise that stuff, the public debt doubles and the Treasury implodes. That is why they cannot. It has nothing to do with courage. It has everything to do with not wanting interest rates to go to 20%. The strength of their electoral mandate is irrelevant.

    As for the stress test, the desired results will be decided first, and the test engineered to produce them. It will be no surprise if the large insolvent banks get the green light to raid smaller ones for capital, for example. Or if yet another injection of public funding is contrived.

  • Comment number 10.

    #4 MrTweedy wrote:

    "The tax payer cannot guarantee all the bad debts and losses from toxic assets. Therefore, the only option is zombie banks."

    There is another option - liquidation. Is it the answer that dare not speak its name?

  • Comment number 11.

    Actually, I would love it if Stephanie's next article were to be titled "Don't mention liquidation". Seriously, I would like to hear a mainstream figure's take on the pros and cons.

    If you type nationalisation or the American spelling into Goggle Trends, you can see the hype. Unmentionable it isn't. Overexposed, more like.

    So what is the reasoned argument against winding down? That is the real elephant in the room, by the looks of things.

  • Comment number 12.

    Its time a non-USA bank was alllowed to go to the recievers and the receivers start a class action against the USA banks that sold their repackaged sub-prime junk.

    Someone somewhere has to start this particular ball rolling.
    Unless and until this is done and we start washing these financial instruments from the system we will continue on this downward spiral to complete and utter stagnation.

    The time to start this was six months ago and the longer this is shirked the longer the depression will last. The economies of the world do not have the money to continually keep these financial institutions on a drip feed. We need Dialysis, without that by the time it is over we will need a new kidney.

  • Comment number 13.


    "That's because, even to many Republicans, the uneasy middle ground we have now exposes the taxpayer to all of the risk on the banks' balance sheets but none of the potential gains".

    If the State owns part of the ordinary share capital of a bank, the State's losses are limited to the cost of the shares purchased. The State would not be liable for all the bank's losses. The bank's creditors would pay for the bank's losses.

    If the State "takes over" a bank, it would do so in order to guarantee all the bank's losses. "Nationalisation" in this context means the tax payer taking over responsibility for all the losses, guaranteeing that none of the bank's creditors would lose money.

    The troubled banks have more liabilities than assets - more losses will have to be written off in the future, as more assets turn into bad debts. Tax payers cannot afford to cover all these bad debts and shortfalls in asset values; we simply don't have enough money; we can't afford it.

    Therefore, I don't see any alternative to zombie banks, where the tax payer injects only enough capital to keep the banks afloat. The banks then slowly write the bad debts off over the next 10 years. The banks stay alive but only lend conservatively, and only make enough profit to cover the bad debts as they fall over. Hopefully, the banks are able to repay their creditors as they fall due, and don't ask for yet more capital from the taxpayer.

    After 10 years, the bad debts will be fully written off or provided against, and the troubled banks will start to make profits again, leading to the recovery of their share price. The State will then be able to sell its shares and get its money back.

  • Comment number 14.

    Nationalisation has become a political slogan with little of its original meaning.

    There have been expectations which have placed President Obama just one below the Second Coming. Everyone must now wake up to the reality that he is but a man who has to sort out not just one but many serious problems left over for him by the previous incumbent. I wish him luck as do most of the Amercian people.

    The economy is a job I would not wish on anyone. This is the deepest of the deepest muck I have ever seen and we still haven't found the bottom. Since we are still falling, trying to do something has its dangers but what else can you do?

    Yet having said that the degree of collapse is less than it was at the time of the Great Depression. So all this money being poured into the economy is having an affect but it is just not noticeable.

    I am insufficiently equipped to suggest solutions myself but do feel that until we find the floor we will continue to struggle, continue to be uncertain and continue to worry. The time we find a footing will eventually come and then we can begin to recover our confidence.

    I only hope that by then President Obama, who is one of the good guys, has not lost his credibility due to over-blown expectations.

  • Comment number 15.

    No. 10. WerringtonSilent wrote:
    "There is another option - liquidation. Is it the answer that dare not speak its name?"

    Imagine my UK company has X million pounds deposited with a UK commercial bank. If that bank is liquidated, my company would lose all its money. When the bank's assets are sold they will not raise enough cash to repay the bank's creditors. My company, by depositing cash with the bank, is one of the bank's creditors.
    I would then have to liquidate my company and sell the company's assets in order to pay my company's creditors. This domino effect would sweep through the whole economy, taking down many previously healthy businesses along the way.

  • Comment number 16.

    Governments are throwing our money at private sector banks. It is the taxpayers money that is going to keep the bankers in their absurdly elitist plutocratic lifestyle.

    The taxpayer expects the recipients of all this money to pay it back, with interest - eventually. However, at present there is nothing to stop the banks embezzling the taxpayers cash so some form of golden share MUST be implemented to prevent these banks from just stealing the taxpayers' money as they have already done with the depositors' and shareholders' money.

    Call it nationalisation or not, what matters is that the elected governments take reasonable steps to safeguard the taxpayer's pounds or dollars.

    I do however has a very major concern with the whole process and that is that we are trying to re-inflate a busted balloon - I can see that this process may be necessary in the very short term to lessen the risk of immediate collapse, but as the process is exactly the same that caused the problem it is critically important that moves towards the new world of Mr Mainwaring banks is essential as is a return to proper interest rates of 4 to 5 percent - within months.

    (I note the 2.3 Bn GBP taken out by savers from the banking system in January 09 and comment - "you ain't seen 'nufing' yet!" - this in itself is a liquidity squeeze of up to 70 bn GBP - which the taxpayer will have to replace.)

  • Comment number 17.

    The US Government has the unique asset of the Federal Deposit Insurance Corporation when dealing with failing banks. If a bank gets into the FDIC's hands, the strong presumption is that the banking business will be returned to private hands. How and when it is returned is a tactical decision -as it was for the Sedes when they returned their 'nationalised' banks to private ownership.

    It follows that the US Government has little need to talk about 'nationalisation'; the end is one they can achieve by other, well-tried, neans.

  • Comment number 18.

    His passionate speech was from the heart. Here is a statesman determined to rescue America from doom and gloom.Getting the country back on track will be a mammoth task given the economic downturn, the deepening recession,the banking crisis, the number of people out of work and confidence at a very low ebb indeed. President Obama has assumed office at a critical juncture. He has hit the ground running, trying to instil courage and hope where deep sacrifices have to be made. As the recession pinches harder, American citizens will be looking for quick results. Of course Obama is no magician but he has guts, vision, empathy, steely determination, and total honesty to his cherished quest to make America stand tall again. These are laudable objectives!

  • Comment number 19.

    The CEO in the bank I work for has seized on this comment of Obama's; "See, see, they're not going to nationalise us!". Me thinks he doth protest too much. The government has a strong interest in propping up the credibility of the banking sector. That doesn't mean the sector isn't in critical condition, and it doesn't mean things can't get worse.

    I agree that no country should agree to "socialise" the losses incurred by the banks, without also "socialising" the upside.

    I don't agree this means we necessarily need to take on the liabilities of the banks. The country can simply become the dominant shareholder - as has already happened in many cases - and further increase its shareholding if further injections of cash or guarantees are required. However it is a good point because, if we go back to the Lehman Bros collapse, the problem was not taking over the banks shares (in effect they were free for the taking), but injecting extra capital to meet Lehman's debt obligations, and obligations mediated by Lehmans. Without this stop gap guarantee, masses of write-downs and downgrades of debt (mostly of debt derivatives) were forced. This created a cascade of de-leveraging that is yet to work itself out, and the full extent of which is still unknown.

    Socialising upside as well as downside is the equitable (fair) approach but there is a paradox which inhibits the US or the UK from going to far down this equitable road. The mere possibility of nationalisation is enough to send bank shares plummeting. This could accelerate de-leveraging for institutions that hold bank shares. Even increased government shareholding (short of full nationalisation) depresses bank share prices, as the market expects commercial interests will be compromised in favour of government priorities (such as making Thus talking about nationalising one bank can cause a wholesale collapse in the sector. And the government definitely doesn't want to have to take over the entire sector. It knows it doesn't have the skills or the financial resources. Which is worrying, because the governments in both the US and the UK may yet be forced to nationalise their banking industries.

  • Comment number 20.

    There is yet another big issue to be addressed before we can consider banks as (almost) morally sound businesses: the issue of off-shore banking and tax havens and the trillions of dollars, euros, francs and pounds hidden away in Switzerland, Liechtenstein, Bermuda, Cayman Islands and many other similar places.
    Now is the time to recover those looted trillions. Where are the morally upright political leaders that will 'serve the people' and not the looters and their well paid middle men (e.g.banks) Where are the politicians willing to enforce laws to bring those trillions back for a productive use in credit crunched societies?

    Where are the true global leaders with a moral compass that will use this moment of opportunity to finally unmask the
    impunity of those banks who helped to hide away trillions, with no questions asked. Can we expect Gordon to take this decisive step forward, to show global leadership? You could do humanity a great favour Stephanie, if you would call for a worldwide re-patriation of those looted and untaxed trillions.
    Finally, a quote from Joseph Stiglitz, Nobel Laureate (2001)
    in Economics:
    ""You ask why, if there's an important role for a regulated banking system, do you allow a non-regulated banking system to continue? It's in the interest of some of the moneyed interests to allow this to occur. It's not an accident; it could have been shut down at any time. If you said the US, the UK, the major G7 banks will not deal with offshore bank centers that don't comply with G7 banks regulations, these banks could not exist. They only exist because they engage in transactions with standard banks."

    Let's get serious and have a long overdue, real global banking reform, for the benefit
    of the majority of the world population. After all governments are there to serve the people, not the elite?

  • Comment number 21.

    WerringtonSilent: the argument against liquidation is as follows. It's a position you could disagree with, but here is the rationale:

    First, creditors would lose a lot of money. This may include retail depositors (depending on how the liquidation is done and the extent of government guarantees) but it will certainly include a lot of institutional investors. And this means a big hit to personal wealth of people who have put their money in supposedly 'safe' places. Including companies who have their working capital in the bank, or insurers who are keeping a cushion of money to be able to pay out on policies etc.

    Now, this does meet the test of fairness. Creditors who lent their money to the wrong institutions will be punished. They took a risk in return for higher interest; some risks do not pay off.

    But the workings of the economic system would utterly seize up. If companies could not access their working capital, or insurance companies could not get to their reserves to pay out, the economic damage would go far beyond the immediate hit to creditors.

    Therefore, we might decide not to do what is strictly fair or just, in order to pragmatically preserve a working economic system.

    Could a system be designed where we would never have to make this tradeoff? I ask that question in this article:

  • Comment number 22.

    #12 - Not sure about a class action. Caveat emptor and all that. And the banks could rightly just blame it on the ratings agencies, who don't have the money to cover any serious liabilities. Neither do the banks for that matter. And who exactly would the plaintiffs be? The way CDOs were bought and sold, two thirds of the plaintiffs would be bringing a class action against themselves!

    But I would definitely like to see a better debate about "liquidation". I kind of bought the argument about protecting "systemic financial infrastructure". Maybe I shouldn't have. I definitely don't believe we need to be protecting car manufacturers, housebuilders, or anyone else who gets their snout in the trough. How bad would it be, really, if the solvency of every company was tested, and the duff ones went to the wall?

    I'm worried this is a Wizard of Oz sort of question - looking behind the curtain. Because if there *is* a good reason why we can't allow companies to fail, then that means that the whole economy is smoke and mirrors, a self-supporting house of cards. Very worrying.

  • Comment number 23.

    The danger for Obama is probably pretty similar to that for Grodon Brown and many other national leaders.

    Brown is increasingly being seen as giving out slogans rather than delivering any outcomes that make any difference to the man on the street. (For example, I find it quite difficult to find anyone who actually believes there was any benefit to the VAT cut.)

    Increasing numbers of people are becoming increasingly harmed by the consequences and sequels of what is generally perceived to be the result of imprudent bank management, poor regulation, 'yes-men' shareholders and politicians who conveniently looked the other way.

    High numbers of disaffected people increase the risk of civil disorder and of the breakdown of law and order, be that in the US, UK, France, China or wherever.

    Add the number who have lost their jobs (and who will be losing them soon), to those whose houses either have been or will be repossessed, to those who have lost huge amounts as bank (and other) shares tumbled, to those whose pensions have been devastated, to those whose businesses can't get finance and are going (or have gone) to the wall, etc., etc. ... right the way to those who have seen their family's hopes and ambitions smashed to pieces by other people's greed or imprudence, and you get a very high number of people.

    The big question is - can anyone do anything to convince the masses that the situation is reasonably under control or is actually going to get better (or less worse), faster than such people start to take things into their own hands? That is, fast enough to offset the risk that this will all end in riots and looting and arson and the like, if not worse?

    (And, of course, such disorder could have huge impacts upon the economies of various nations or regions).

    Or is this issue another thing that 'nice' people don't mention?

  • Comment number 24.

    I feel sorry for Obama. YES WE CAN is rapidly deflating to "we might be able to but not just yet - maybe next year - or even the year after that"

    In some ways the US is in an even bigger bind (not just in number terms) than the UK. Here we know that we no longer have a big enough manufacturing base to satisfy domestic demand. For the first time the US is slowly coming to terms with the fact that if they do reflate their economy they will suck-in higher levels of imports and that a large proportion of domestic manufacture will be met by foreign controlled companies. Add to that a banking sector that is in an even more perilous state than the UK banks.

    The public attitude to previous recessions has been to say "we'll tighten our belts and work harder". This time it will not matter how hard you try to work. It is only slowly dawning on the average American that this crisis has the potential to be as bad as The Great Depression.

    The big question will be how long China will continue to support the US by buying their Bonds.

  • Comment number 25.

    #15 MrTweedy:

    Deposits would be guaranteed, of course. Other creditors - tough. Share the gain, share the pain. "Zombie banks" are a recipe for stagnation like Japan at best. At worst, what confidence would there be in any bank if insolvent banks were concealed among the herd?

  • Comment number 26.

    I was going to ask what the difference between Nationalisation and State Ownership was, but #13: MrTweedy has already answered it. Thanks.

    It would seem nationalisation would be like getting into bed with some one who had Ebola from the taxpayer's perspective. I cannot see why anyone would want to suggest it. Even those Socialists who believe the government should run everything would be better off starting new state banks rather than taking on the mess that is the current banks!?

  • Comment number 27.

    #10. WerringtonSilent:

    Liquidation would seem to be the option that the smart money takes. E.g. Barclays waited for Lehman Bros to go bust and then bought up the bits they wanted from the receivers. Had Barclays bought Lehman before going bust then presumably they would have taken on Lehman's liabilities too.

    Governments could do similiarly, e.g. if the bank goes bust, then buy the retail/business banking operations to guarantee the deposits of individuals and businesses and then leave the rest.

    I wonder what the cost to the taxpayer would be if we did just guarantee the deposits of UK individuals and businesses and let the banks go bust. It may be high, but at least it would only be once - unlike the current bailout cycles that will likely go on forever until someone in government says enough is enough.

  • Comment number 28.

    Nationalising the banks in the US? Which banks? How could there be any proper system?

    If you walk about central Philly you can see

    Bank of America
    TD Bank North (snapped up Commerce)
    Republic First Bank
    Citizens Bank (RBS)
    National Penn Bank
    Firstrust Bank
    Beneficial Savings Bank
    Royal Bank America
    Conestoga Bank
    Royal Bank Pennsylvania
    Allied Irish Bank
    Wachovia (Bank of America)
    Jefferson Bank
    First Republic Bank

    Just a sample from the neighborhood. All in two square miles of a country the size of Europe.

    Doesn't include the credit unions of course

    Would you include Vanguard?

    Just how many shareholders would lose even more than they already have just from fear of intervention?

  • Comment number 29.

    Its pretty simple but no-one wants to face it. There are far too many people in China (and India and Brazil) for the EU and US consumer to bring out of poverty by selling exports. China exports 6x as much to the US as it imports.

    No-one can win unless China changes course. Anyone who makes anything will be undercut on price. China prefers to bring another 100M ultra poor people from the countryside into the workforce rather than letting those already there get rich enough to buy western products. Its not just manufacturing: anyone who designs anything novel and successful sees it get copied and sold for peanuts : patents and copyright don't apply in China. No point in trying to sell software or entertainment - it just gets copied for free.

    Marketing doesn't matter either when you are selling copied products with someone elses name on them. Without intellectual property law there is no value in all the 'knowledge economy' skills that we work so hard at.

    Not much chance of selling the Chinese banking or insurance when their currency is not convertible. Not much chance of buying Chinese companies and profiting from their low cost base either with rules against foreign ownership.

    The solution is straightforward: the world economy worked fine for the developed world before the BRICS nations emerged and if necesssary it can work just fine without them again. Just apply tariffs large enough to bring high tech manufacturing and knowledge jobs back to the developed nations until China change course and organises its economy so trade is balanced.

  • Comment number 30.

    Liquidation is the better answer under the current system.

    Guarantee deposits for creditors but let the banks fail. It's highly inflationary, but otherwise we are simply propping up zombie banks and rewarding the muppets who caused the problem.

  • Comment number 31.

    Along with nationalisation there is also this:

    More state intervention? For some simply that, but for me this is the ticket out of the economic crisis.

    Someone else in a previous discussion was calling for comments towards a solution to this mess. I think the answer is simple: stop expecting any kind of 'recovery' in the next 5 years. There is no indication whatsoever that there should or could be one. If you think there is, show it. What needs to be done is to start as soon as possible laying the foundations for a sustainable, cost reduced future. This will take a lot of benevolent state intervention, including both state control/regulation of banks, and stimulus that sets the right incentives for the right direction.

  • Comment number 32.

    #30 true-liberal

    with the US it's not just the banks. They have to re-evaluate their whole industrial sector as well.

  • Comment number 33.

    Steph, is it just me but does the photograph you used have just a touch of the Mr Bean about it? :)

  • Comment number 34.

    Economic stimulus packages will not work.

    A useful article to explain why:

  • Comment number 35.

    As The Market Ticker points out, "the failure to step to the microphone and make a strong, concise, and no-wiggle-room statement that we will NOT nationalize banks has led to a loss in the banking index (BKX) of thirty percent over two weeks time. Tim Geithner is directly and personally responsible for that loss of value."

  • Comment number 36.

    Call it 'nationalisation', call it 'receivership', call it 'liquidation'. Whatever you call it, it will have to be done. The toxic assets are ultimately toxic because the assets they are built upon are still massively over-valued. The 'money' has been spent on overcapacity. By way of illustration: thousands of malls, golf courses, to many jets for long-haul, too many second and third cars. All paid for by the money creation machine called credit created by the banks themselves.

    The magic figure is between 25 and 30%.

    Until the world economy grows by an equivalent amount, this toxic overhang cannot be cleared. Unless, of course, you favour massive inflation and take those risks.

    Best bet (if you pardon the expression) is to liquidate the assets by rescueing the viable retail and let the rest go along good old insolvency.

    That would be in the interest of the majority of the citizens of the world. Clean out the wealthy but that's life.

    Recovery would be rapid. Always is when you make a clean slate.

  • Comment number 37.

    @21. inoncom wrote:

    "...the argument against liquidation is as follows.

    First, creditors would lose a lot of money ..."

    Your argument seems based on the fact that someone will loose a lot of money. I would argue that that money has already been lost. The question now is just who's pocket does it come out of.

    At least if the banks were allowed to go bust then it would automatically cancel the bonuses and Sir Fred's big pension!

  • Comment number 38.

    Obama is too weak to do what's needed. His whole campaign revolved around a) not mentioning his colour, and b) not mentioning his policies. It was a subtle campaign but at the end of the day it was almost entirely about Bush's failures, not his own plans.

    Obama has had to make too many deals to get where he is today and unless he has the guts to break some of those deals he will get nothing done. I don't think he has it in him .

  • Comment number 39.

    I am not convinced that any particular route forward gives an outstanding advantage. The straightforward fact is that a huge debt problem has to be digested.

    There are supposed long and short haul options for this and different mechanisms but the fact remains a huge debt has to be digested and it will take time.

    If the imbalance is substantial it will be no surprise if it takes a decade to pull clear. However if a protracted period is needed for the digestion process then several outcomes are likely.

    There will be no leaping of the gap economically. Indebted business has to readjust. As the gap cannot be leaped the propping up of businessess has to be minimal. Public expenditure will have to be cut before the debt is sorted.

    Any politican is in for a rough ride due to the mismatch between public expectation or desire and reality. Realistically reelection will have to occur before the debt is purged.

    Further if the economy is to run at a lower level then focus should occur on what is functioning in this environment, because that is the only way wealth is being generated.

    As the full impact of this process is felt then there will be less not more sympathy for the indebted and big business and government.

  • Comment number 40.

    An interesting take, but analogies can decedipful. The US and Japan have different cunsumer culture. Furthermore Japan public debt is roughly 160% of GDP

  • Comment number 41.

    An interesting take, but analogies can be deceitful. The US and Japan have different consumer culture. Furthermore Japan public debt is roughly 160% of GDP whilst the US is currently roughly 50%, yet no one bats an eyelid about Japan, why?

    I think Obama is playing for time regarding the proper state of the largest US banks. In the meantime the stimulus plan other measures will buy time. A smart move.

  • Comment number 42.

    According to the BBC web - "The British government has spent GBP 81 bn to prop up RBS, HBOS and Lloyds TSB, as well as nationalised Northern Rock and parts of Bradford and Bingley".

    According to today's FT - The British government is now expected to insure GBP 300bn of toxic assets belonging to RBS; plus a further GBP 250 bn of toxic assets belonging to Lloyds Banking Group (which includes HBOS). The government is expected to pay for 90% of any losses arising from this insurance scheme, with the banks bearing only 10% of any losses.

    So, in a bid to get the commercial banks lending again, the British taxpayer will potentially pay out GBP 405 bn in order to protect the GBP 81 bn of bank share capital already purchased by the government.

    405bn + 81bn adds up to approximately 40% of Britain's annual GDP.

    That's a lot of money for us taxpayers to guarantee.
    Let's hope the losses are spread out over many years to come, rather than all crystallising in the next 2 or 3 years.

  • Comment number 43.

    #37 simonmw3 wrote:

    "I would argue that that money has already been lost. The question now is just who's pocket does it come out of."

    I agree. Winding down would place the losses in the pockets of those who willingly assumed investment risk, ie common equity and bondholders. There is nothing wrong with that, it is part of the business. Nationalisation would place losses in the pockets of the taxpayer, who never willingly assumed investment risk, but is being coerced into bearing losses.

    Apart from the morality of the situation, nationalisation would be a short-sighted policy because nothing is gained by protecting private capital from further losses if the taxpayer and the Treasury are ruined and the perpetrators escape justice. There is then no trust, and with the wealth of the common citizenry gone, no foundation for a recovery for a generation. It would be self-defeating.

    I wonder then, why Stephanie implicitly makes the assumption that nationalisation is the answer, and questions the courage of those who fail to embrace it. This article reads as though she has picked a side.

  • Comment number 44.

    How much is enough ?

    Stephanie is bang on the money with the current observation

    To quote
    'Yet to many economists, the policies ... announced so far are ... the bare minimum.
    They're what the country will need if everything works'

    The main question for Governments therefore appears to be turning into

    'How much spend is enough, before a new approach. or a radical re-think is needed ?

    The answer cannot be an infinity of bailout cash.

    As we know Paulson thought that 700 billion was the answer. Darling thought a takeover and a VAT cut would solve all evils.
    Unfortunately not so and thus another couple of quick fixers bite the dust.

    If one added up the macro level totals spent and the totals earmarked by all Governments on Stimuli, Bailouts, Insurances, Handouts and Recovery Packages, etc., the answer may well be greater than the total supposed losses being claimed by the Global Banking Fraternity.

    The trouble is that nobody fully knows the total debts and the total claims. This leaves great scope for creative accounting practices and further amounts to be claimed as being essential to 'whatever it takes to save the Economy'

    Known unknowns perhaps - well it might be a reasonable idea to try to find it out !

    But what can be said is

    a) it is going to take a long time to unwind all this
    b) the regulators and governments won't fully know if they have been duped again or not
    c) the global Public will have to bear the cost

    So, what comes after a thousand trillion?

    Whatever it is, the system is probably going to need a wider calculator window to accomodate what is steadily turning into an ever increasing moving feast of distribution.

    The effectiveness of which is one of those known unknowns.

    Or even
    ' Effectiveness? -Que?

  • Comment number 45.

    The Japan story was a long conversion of private debt to public debt, much the same as what is happening to the UK now. Japan started with total debt at 160% and finished with total debt at 160%. Result? Nothing.

  • Comment number 46.

    The troubled banks' balance sheets are black holes, from which no tax payer can escape.....

  • Comment number 47.

    Martin Weiss writes on the Market Oracle -

    "Let's not waste our breath debating whether the plethora of government actions and programs since 2007 are philosophically right or wrong.

    The fact is, they have failed.

    In addition to the USD152 billion Bush stimulus package in the spring of last year and the USD700 billion Troubled Asset Relief Program (TARP) in the fall, the U.S. government has loaned, invested or committed USD200 billion to nationalize the world's two largest mortgage companies, Fannie Mae and Freddie Mac … over USD42 billion for the Big Three auto manufacturers … USD29 billion for Bear Stearns, USD150 billion for AIG, and USD350 billion for Citigroup … USD300 billion for the Federal Housing Administration Rescue Bill to refinance bad mortgages … USD87 billion to pay back JPMorgan Chase for bad Lehman Brothers trades … USD200 billion in loans to banks under the Federal Reserve's Term Auction Facility (TAF)
    … USD50 billion to support short-term corporate IOUs held by money market mutual funds … USD500 billion to rescue various credit markets … USD620 billion for industrial nations, including the Bank of Canada, Bank of England, Bank of Japan, National Bank of Denmark, European Central Bank, Bank of Norway, Reserve Bank of Australia, Bank of Sweden, and Swiss National Bank … USD120 billion in aid for emerging markets, including the central banks of Brazil, Mexico, South Korea, and Singapore … trillions to guarantee the Federal Deposit Insurance Corporation's new, expanded bank deposit insurance coverage from USD100,000 to USD250,000 … up to USD500 billion in Fed purchases of asset-backed securities … plus trillions more for other sweeping guarantees.

    Grand total: Over USD 9 trillion … and counting!

    The economy was not stimulated;
    The housing bust was not avoided;
    Public confidence was not restored.

    The Obama stimulus package is USD787 billion, five times larger than the Bush package just one year earlier...."

    Martin Weiss concludes -

    "Good luck and God bless!"

  • Comment number 48.

    #43 WerringtonSilent wrote:
    "Nationalisation would place losses in the pockets of the taxpayer, who never willingly assumed investment risk, but is being coerced into bearing losses."

    Indeed! Furthermore, Brown and Co are going to get big publicly funded pensions like Sir Fred. They seem to think that the taxpayer is the gift that just keeps on giving. However, tax receipts are already down and will drop further. They need to wake up and get a full and final solution to the banking problems. The government thinks that they can defer the problems with massive government borrowing. However, this will just raise taxes in future, and they will find all the educated, skilled people leave the country for lower tax countries else where.

    It should not be looked at as a fight to save the banks, but a fight to save the whole country!

  • Comment number 49.

    WRT above few comments, the observation that bailouts and QE and etc cannot work has already been made, and based on sound principles. The govts would have to multiply their QE efforts by a factor of a 100 to get credit flowing.

    The only quick fix is a globally coordinated debt write off. This won't happen of course.

  • Comment number 50.

    This comment was removed because the moderators found it broke the house rules. Explain.

  • Comment number 51.

    Can't help feeling all of these so called stimuli packages are just stalling and lengthening the inevitable.

    Letting the people down gradually month by month year by year to avoid social unrest.

    Our governments know only too well they cannot sort this out because they still don't know what else is out there.

    Keeping the people calm is their priority so we can expect more of these packages not less.

    Where it all ends up eventually is anyone's guess.

  • Comment number 52.

    MrTweedy (#47)

    How many people looked into any of this in early 2007?

    Or ever pay attention to what's unfamiliar?

    "Good Night and Good Luck!"

  • Comment number 53.

    #47 Mr Tweedy

    Thanks for the research conducted by Martin Weiss.
    Much appreciated.

    Weiss might not exactly be an Obama fan, however he certainly doesn't pull his punches does he ?

    'Further, to stimulate its economy, Japan spent $6.3 trillion. Since the U.S. GDP today is 4.6 times larger than Japan's in 1990, to match Japan's spending, our government would have to fork up $29.1 trillion. That's THIRTY-SEVEN times more than the just-passed Obama stimulus package. '

    (if anyone is interested in accessing the full article identified by MrTweedy, a google search is needed for
    Market Oracle Obama Economic Stimulus: Truth and Consquences )

  • Comment number 54.

    If we let the banks go into administration and a portion of depositors assets were lost who would lose most?

    Presumably: China and OPEC who have been lending to the West, presumably the extremely wealthy, older people with savings, companies - including the very large companies like oil companies, large organisations.

    The average taxpayer in their high earning years does not have that much savings: they are still trying to build them up. The people who gain most from the bailout are not the same people who pay most towards it. And because wealth is very unequally distributed it is a case of poorer workers protecting the assets of the rich.

    Most taxpayers might well be better off having 10% of their savings written off when their bank goes into administration than paying higher taxes for years to make sure that people with much more money in their account dont lose anything.

  • Comment number 55.

    There are real and serious technical arguments against nationalization.

    Nationalization would trigger CDS default. Who can tell us, for sure, what the knock-on risks of that would finally amount to as that cascades right through the global financial system again.

    Does anyone know how many other entities would it bring down and in which countries ?

    At this stage in a rescue no-one needs that. There aren't enough personnel in the Fed, Treasury, SEC etc. to operate the regulatory side of things, far less the banks.

    They have not exactly demonstrated much practical understanding of the real way banking operates as it is.

    So many ordinary lending positions are in trouble too, e.g commercial property and any assets that are used as collateral. How much more hedge fund liquidation has to go on ?

    The size of Civil Service you'd need would be huge and the people aren't there who know the business.

    Unless you close the financial system for a few months.........
    - years ?

  • Comment number 56.

    No. 52. JadedJean wrote:
    "How many people looked into any of this in early 2007?"

    The IMF was warning the British government in 2006, and even before, that debt levels and house prices were too high in the UK economy.

    Gordon Brown kept saying it wasn't a problem because interest rates were low and households and businesses could afford to service the debt....

  • Comment number 57.

    Market Oracle is worth reading for views on markets and economics.

    It can be found at

    I tend to go to "Authors Archive" and I look for:
    Nadeem Walayat
    Mike Shedlock
    Martin Weiss is under Money and Markets

    There are plenty of other contributors too. Some if these others try to recommend gold as a store of wealth. The website and articles are free; so it's part funded by those contributors who use it to advertise gold. You can easily ignore these "buy gold" types if you happen to disagree with their point of view; so don't let them put you off the site.

    For my taste, Nadeem Walayat, Mike Shedlock and Martin Weiss always make interesting reading.

  • Comment number 58.

    #54 tom_edinburgh wrote:

    "If we let the banks go into administration and a portion of depositors assets were lost who would lose most?"

    As far as deposits go, no-one. The damage would be limited to the capital structure.

  • Comment number 59.

    You know what? JadedJean is right. We focus too much on the details, ignoring the real issues.

    So what if nationalisation triggers CDS default? Let them default, let the banks collapse, and let all those unspeakably foolish clowns in the banks and government reap the harvest they sowed.

    What even IS a CDS? Some nonsense invented by the same clowns that have screwed everything up? And they want us to care about these damnable things? It seems clear to me that these CDSs and CDOs are nothing more than excuses to print more paper so that these pranksters were able to continue their city binge of free-market females and Columbian powdered novelties at our expense for just a little while longer. Well now it is all at our expense one hundred percent, the only difference being that the free market females and Columbian powdered novelty product line are the only businesses worth being in.

    And then we have the politicians. Pompous prigs who survived on being able to appeal to an increasingly moronic proletariat, who from low to middle class believed that their purposeless automaton jobs in assembly lines and back offices actually had any worth, importance or significance, and measured it all by the size of the flat-screen TV they could afford. Democracy. What a farce. A TV show contest of who can appeal to the most stupid people. And all with the blessing of the United States, a country where the obese and the ignorant are astonished to find that their leader has a different colour and an IQ above 100. Democracy.

    It's no surprise that we're all up the creek.

    I am starting to feel nihilistic towards things. This, this economics discussion, this mainstream economics, these lies from the politicians about potential recovery. It's nothing more than basic propaganda. There is no recovery. It's all completely screwed and anyone with half a brain knows it. They've been struggling trying to save the Western way and Freedom since the early 70's.

    If there wasn't a law against incitement to hatred I'd advocate having these incompetents taken down by force. For now, we'll have to wait and see what this farce called democracy produces..

  • Comment number 60.

    This is a test. How automated are these moderators?

  • Comment number 61.

    What the politicians and mainstream economists may or may not realise is that the recession/depression was capital destruction through over-consumption that occurred during the preceding boom.

    What they plainly DO NOT realise, of course, is that "stimulus packages" or deficit spending - instead of promoting recovery - will result in more consumption and therefore more capital destruction.

    Because some defunct economist told them to do it, that is why they are doing it.

    So, what does one do apart from stocking up on tinned foods now? Pray, I suppose, and hope it works - hardly likely though!

  • Comment number 62.

    FrankSz # 59

    You're getting there, Frank. But try not to confuse democracy with freedom; they are not the same thing.

  • Comment number 63.


    Whilst I sympathise with your view that the fiscal stimulus is just trying to postpone the inevitable - capital destruction, there may be some logic in their approach, at least in theory.

    It could be that with the government sector substituting private sector demand alongside increases in labour productivity a softer landing could ensure.

    This is theory though.
    In practice there doesn't appear to be any big increases in labour productivity to be had.
    Indeed, with the end of cheap oil (in the medium term) labour productivity may go into reverse, causing even more capital destruction for profitability to be restored.

  • Comment number 64.

    No. 63. duvinrouge

    If the government had reserves, which it had saved up from tax receipts in the good times, it could spend them now to replace some of the lost private sector spending.

    However, the government spent all its reserves in this way when it saved the economy after the dot com bust in 2001.

    Also in 2001, the government allowed retail banks to begin borrowing money on the wholesale markets. This flood of cheap money into the UK caused massive inflation of 20% per year. The inflation was in asset prices, which lulled the unwitting into thinking everything was rosy. By contrast, consumer goods were coming down in price, as manufacturing was outsourced to China, India, Malaysia, etc., where wages are only 5% of the wages in the West.

    Borrowing peaked in 2007.
    Manufacturing efficiency peaked in 2007, as everything that could be outsourced had been outsourced.
    At that point, the whole house of cards began to fall apart.

    If the government had kept some money back in reserve, it could now play that money in to the economy to support a soft landing. However, it has no reserves. Indeed even the government has borrowed too much, as it has the unfunded public sector pension liabilities plus the private public finance initiative liabilities. The government indulged in off balance sheet financing.....

    Hence, we've had it.
    We're spent hollow.
    Zombie banks and a zombie economy.
    Too late to do anything about it now....

    Maybe in 10 years' time, things will be a little bit better.

  • Comment number 65.

    The credit crunch has helped me get back on my feet - my car's been repossessed.

    How do you define optimism? - A banker who irons 5 shirts on a Sunday.

    What's the difference between an investment banker and a large pizza? - The pizza can still feed a family of four.

    Laugh? I nearly tried.......

  • Comment number 66.

    I'm off to buy a heap of gold coins, rice and 500 tins of sardines. Do you think I should get an automatic weapon too?

  • Comment number 67.

    duvinrouge # 63, MrTweedy # 64

    In order for recovery to take place, the economic system needs to rebuild its stock of capital. It needs to engage in greater savings over consumption. This will help to restore the supply of credit and put an end to financial failures based on a lack of credit.

    Recovery requires the freedom of wages and prices to fall so that the present reduced supply of capital and credit is capable of supporting the existing or larger structure of production and employment.

    In addition, unsound investments need to be liquidated rapidly. If borrowers cannot meet their obligations to pay interest and capital, then the assets involved need to be sold off and turned over to lenders as soon as possible to end further losses and therefore salvage as much capital from the debacle as quickly as possible.

    However, current government policies are trying to prevent all this from happening.


  • Comment number 68.

    #61 But the stimulus package, or deficit spending, will increase capital if it is spent on infrastructure and importantly on a path towards sustainability and reduced dependency on oil.

  • Comment number 69.

    In a society where a member of the public standing around on the fourth plinth in Trafalgar Square is considered "art", we find ourselves in the biggest economic mess of all time.

    Junk culture for a junk economy.

    You think that anyone with half a brain would consider putting a permanent statue of a Suffragette on the plinth, seeing as the struggle for women's emancipation is probably the most important story of the 20th century.
    A story that is rarely told.

    But what do I know about anything......?

  • Comment number 70.


    The key point to remember is capitalism only produces for a profit.
    If the profit rate is zero or worse it won't bother.
    Hence mass unemployment, house reposessions, etc.

    The argument is what causes the rate of profit to fall.
    Lack of effective demand is the superficial reason.
    If only customers would keep consuming.
    But consumers (ordinary people not the super rich) are up to their eyes in debt.
    Debt that has been lent to them from the banks.
    This bank lending is based upon ficticious capital - not real value.
    Increases in the money supply which is so easy in a fiat monetary regime.
    The Libertarian school regard this as the foundation of the problem.
    Hence the call to return to the gold standard.

    Marxists go further.
    Whilst agreeing that this ficticious capital just postpones the inevitable (and potentially makes the inevitable worse), the real cause lies in the ratio of constant capital to variable capital.
    Which in layman's terms is close to the amount required to replace capital stock (and new capital investment) divided by the wages of productive labour.
    This is what is known as the organic composition of capital.
    As it goes up so the rate of profit goes down.
    The main reason the third quarter of the 20th century didn't see a declining profit rate was due to one of the main offsetting factors - increases in labour productivity.
    The last quarter has seen the other main factor primitive accumulation - Chinese peasant labour incorporated into the capitalist system.

    But finally the capitalist system is waking up to the reality that vast capital amounts need to disappear to restore the organic composition of capital to a level that gives a profit rate that's worthwhile for capitalists.

    Just how much capital has to be devalued is the difficult question to answer.

    But even if capitalism survives this crisis, with fewer peasants to bring in and expensive energy adversely affecting labour productivity, capitalism just offers more of the same.

    Not a pleasing thought for parents and grandparents.

  • Comment number 71.

    5imple5imon # 68

    But the government does not have a pot of money stashed away somewhere.

    Where does that "capital" come from?

  • Comment number 72.

    No. 67. LibertarianKurt

    The flies in the ointment are:

    (i) Our current government is too scared of being unpopular. It sees popularity as the main aim of government, and forgets the real aim is to safeguard the stability of the nation. It aims to dump the complete mess of taxpayer debt and corporate debt and household debt onto the next set of politicians unlucky enough to be elected in 2010

    (ii) If the assets are sold now, to preserve the value of capital as you suggest, it will chrystallise all the bad debts today, and bankrupt the world economy in one day. If all the assets are sold now, all in one go, it would push asset prices through the floor.
    Effectively, you want to tell people to sell their house to the government at today's prices (GBP10), use the proceeds to part pay off their mortgage (GBP13 outstanding), and then the government would reimburse the lender for the shortfall (GBP3) by raising taxes on the people whose house had just been sold. The people who sold the house would be saddled with the tax bill (-GBP3) for the shortfall and then would have to try to buy the house back from the government. The people could only afford a lesser price (GBP7) as the banks are now lending sensibly, which would leave the government with a loss (GBP3), which it would then place back on the people through yet more higher taxation. The people will have the same house but now have an additional GBP6 tax liability which they must repay from their future earnings.

    You can't escape the fact it is either the people's viable earnings which pay for everything or viable private sector business earnings that pay. The chickens always come home to roost. The losses are always underwritten by the viable earnings.

    For me, the only hope is to spread the bad debts out over 10 years, to make them more manageable. It's a case of "cutting the dog's tail off by inches", as it will be less painful. A series of small hand grenades blowing up once a year is better than a large nuclear explosion today followed by nuclear winter. However, the hand grenade to blow off an inch of a dog's tail once a year mixed metaphor would mean a zombie economy for the next 10 years.

  • Comment number 73.

    To clarify my point outlined in #72

    In my example, I forgot to mention that the people who are selling their house will be made redundant in 2011, when the value of their house will only be worth GBP5

    Therefore, LibertarianKurt is arguing that if they sell their house today, when the market price is still GBP7, we will avoid part of the bad debt.

    However, today we do not know that the people will be made redundant in 2011. What we have to realise is the toxic bad debts will keep blowing up unexpectedly over the coming years as the economy contracts. The future bad debts will come from unexpected places.

    The longer it takes for the bad debts to crystallise, the longer the banks and the government have to save up their earnings and tax receipts, to try to accumulate enough savings and reserves to cover the bad debts when they do eventually occur.

  • Comment number 74.

    MrTweedy # 72

    No, I'm not saying that people who can still afford to repay what they borrowed should sell their property.

    What is required is what was explained at # 67 para 3.

    Although the supply of capital has been reduced, there will be still enough savings/real wealth available to buy assets at their now or what will be devalued prices as pointed out in # 67 para 2.

    The government does not need to get involved in this process.

  • Comment number 75.

    My philosophy is the opposite. Get the pain over with now. The sooner we do it, the sooner we can move on. It will last a decade in the best case anyway. Why spread the misery over an even longer period?

  • Comment number 76.

    duvinrouge # 63

    No, there is no logic in their approach. Deficit spending will only result in more loss of capital.

    For example, if we start with the purchase and consumption of a new television set by someone who has not previously produced and sold anything of equivalent monetary value that provided the funds for his now buying the television set. He has simply received the money from the government. In this case, what we have is one television set withdrawn from the capital of the economic system and placed in the hands of a non-producing consumer.

    We can assume, for the sake of argument, that the retailer of the television set will order a replacement set from the wholesaler, and that the wholesaler in turn will order a replacement set from the manufacturer. We can assume further that the manufacturer will now produce a new television set to replace the one that he sells to the wholesaler from his inventory.

    The production of the replacement television set entails a using up of materials and components and part of the useful life of the plant and equipment required. Aspects of such using up of capital goods also take place on the part of the retailer and wholesaler and in the transportation of the television set.

    Very importantly, any new and additional workers who may be employed - precisely the goal of the whole operation - in producing a new television set or in moving a television set through the channels of distribution must be paid wages, which they in turn will consume. The goods these workers receive when they spend their wages represents a further depletion of inventories, on the part of all the retailers with whom they deal. In addition, the various business firms involved have additional profits, or at least diminished losses, as the result of the various additional purchases. This enables their owners to consume more and probably results in the payment of additional taxes, which the government consumes.

    Even whatever depreciation allowances are earned along the way in the various stages of replacing the television set are likely to be consumed. This is because in the context of a recession or depression investors are afraid of losses if they invest in private businesses and thus prefer to invest in short-term treasury securities, such as treasury bills, which they consider to be far safer. But when depreciation allowances are used to purchase treasury securities, they end up financing consumption rather than capital replacement. This is because the Treasury uses the proceeds from the sale of its securities to finance nothing but consumption, either that of the government itself or that of the private individuals to whom the government gives money.

    The point here is that any replacement of a good consumed by a non-producer itself entails very substantial additional consumption of inventories and the useful life of plant and equipment of business firms. The same is obviously true of the replacement of goods that have simply been destroyed, whether by war or by an act of nature.

    No matter how long the process of spending and respending of the funds introduced into the economic system by a stimulus package might continue — no matter how many instances of replacement production there might be following the purchase and consumption of our hypothetical television set or of any other such good — the initial loss of capital need never be made up.

    This is because each act of replacement production is accompanied by corresponding additional consumption. Thus the initial act of consumption - or destruction - of wealth and capital may be followed by 10 or 100 acts of subsequent production, each carried on in order to replace the goods used up before it. But if each of these subsequent acts of production is accompanied by fresh consumption that is equivalent to it, the net effect is still one act of consumption. As a result, the supply of capital is reduced. For what is always present is X instances of production respectively following X+1 instances of consumption.

    As another example; one only has to look at what happened in Japan during the 1990s. In total, the Japanese government spent $6.3 tn on infrastructure for which they have, amongst other things, some marvellous bridges and buildings to admire. However, did this entire "stimulus" have the desired effect of bringing about a lasting recovery? The short answer is no.

    Ah, but - say the great economic minds of today - the Japanese didn't spend the money on the right things and much more than that, the "stimulus" wasn't large enough!

    Well, how much is not enough?

    The problem with the followers of Keynes is that they seem to think that all economic activity starts and ends with consumption. They ignore or, at least, don't care about the role of capital.

  • Comment number 77.

    "Although the supply of capital has been reduced, there will be still enough savings/real wealth available to buy assets at their now or what will be devalued prices as pointed out in # 67 para 2."

    I don't understand this.

  • Comment number 78.

    No. 74. LibertarianKurt

    I'm feeling rather bad tempered today, given the size of taxpayers' exposure to GBP 600bn worth of toxic assets (RBS + Lloyds).
    Please forgive me if I'm not thinking straight in relation to your ideas.

    I think what you are saying is - if prices and wages fell, we could cope with banks restricting the supply of credit. That way we could sidestep the full horror of the toxic debt insurance scheme. We wouldn't need taxpayers to underwrite the bad debts; we'd just inject enough capital to keep the banks alive and we'd be able to cope with the effects of reduced bank lending.

    You feel that to counter the contraction of bank lending, we must allow prices to fall, thereby making the cost of purchasing goods and services more affordable to the consumer. The consumer can then buy the goods without credit.

    In order for prices to fall, wages must fall, to keep businesses profitable.

    However, if wages fall, it will cancel out the effect of the price reductions; consumers still won't have the money to buy the goods without credit. The only way this would work is if the businesses providing the goods and services cut their gross margins; so that wages fall less than the selling price of the goods.

    Others have proposed wage cuts as an alternative to redundancy. This way, skills are maintained in the workforce and are not lost. However, if our wages do fall we won't be able to afford our mortgage repayments, the cost of our utility bills and council tax. This would increase the risk of default, and lead to bad debts being realised faster. To counter this risk, the banks could reduce the interest they charge us on our debts, and extend the repayment period. This would potentially reduce their profits and/or increase their losses; already they are only paying 0.05% interest to their depositors so they can't cut their costs much beyond this. If the banks' losses increase, seeing as the economy is currently over-indebted, then the taxpayer will have to bail them out, which increases the tax burden. An increased tax burden makes it harder for businesses to make a net profit, and for consumers to afford to buy goods.

    Which prices will fall and which will refuse to fall? The 30% reduction in the value of sterling does mean our imported necessities are now more expensive.
    Lack of demand causes output prices to fall until they hit the point where input prices stop them from falling further. At that point a business must hope it can sell enough products at the market price to make a profit. I think we will find that even at the lowest output price, demand will still be low, as consumers do not have savings with which to purchase the big-ticket goods.

    My conclusion:
    (i) Consumers and businesses are not spending because they are over-indebted. They are concentrating on repaying their debts. Savings are also very low, and are not earning much interest. Even if output prices fall by a large amount, demand for goods and services will remain low.
    (ii) The weakness in sterling has caused the output prices of some goods to increase, ie imported inflation.
    (iii) I think that margins are already squeezed to their minimum; therefore to maintain profitability, businesses will have to cut wages or make staff redundant. This just reinforces the negative cycle.

    The deflationary spiral is a nasty thing. It is very hard to escape from it.
    At the moment, it looks impossible to escape its suction.....

  • Comment number 79.

    Debt deflation.

    However I think debt deflation should not have to result in massive job losses in this case. Let me share with you the reason I think why:

    In the last depression, the build-up to it was very rapid.
    This time though we must recognise that the build up began in the early 70s. The pressure for *growth* led to a culture of rampant spending on new products, new services, new acquisitions, etc. The operational side of the business was asked to just get the things implemented, do it yesterday, patch it, make it work, etc

    Inefficiency, wastage and suboptimal design is now ossifying our system. This detritus has been accumulating for 30 years.

    Our main obstacle now is a generation of management and leadership that is brainwashed into the language of growth. Optimism over caution, attitude over aptitude, and so on.

    People from all walks of life should take the approach that their management should either adapt and listen or step out of the way. We can change the way things are done in the workplace and remove this detritus, optimise things, take advantage of new opportunities, and in general cut costs by 50% or more without having to sacrifice sales or large numbers of staff.

  • Comment number 80.

    Once it begins, nothing can escape deflation, not even light.

  • Comment number 81.

    FrankSz # 77

    Apologies for not explaining this fully. It was a hasty response to MrTweedy's post at # 72.

    What I meant was:

    That although the supply of capital has been reduced, there should be still enough available capital (savings/real wealth) in the future to provide loans in order for people to buy those assets (most notably property) at what will be their much lower prices in the future as outlined in # 67 para 2.

    However (and this is the qualifier for the above), this requires an end to financial pretence. There are banks that do not want to see the liquidation of various types of assets that they own, notably, "collateralised debt obligations" (CDOs). These are securities issued against collections of other securities, which in turn were issued against collections of mortgages, an undetermined number of which are in default or likely to go into default. The presumably low prices that such securities would bring in the market would likely serve to reveal the presence of so little capital on the part of many banks that they would be plunged into immediate bankruptcy.

    To avoid that, the banks want to prevent the discovery of the actual value of those securities. At the same time, they want creditors to trust them. Yet before trust can be established, the actual, market value of the banks' assets must be established, even if it serves to bankrupt many of them. The safety of their deposits can be secured without the banks' present owners continuing in that role.

    When these various requirements have been met and the process of financial contraction comes to an end, the profitability of business investment will be restored and recovery will be at hand.

  • Comment number 82.

    MrTweedy # 78

    "However, if wages fall, it will cancel out the effect of the price reductions; consumers still won't have the money to buy the goods without credit."

    Therefore, it means less consumption: Who are the biggest consumers MrTweedy?

  • Comment number 83.

    FrankSz # 66

    Pretty much the same as what I have done. However, buying an automatic weapon might prove problematic; the government banned them all about 12 years ago!

  • Comment number 84.

    No. 82. LibertarianKurt wrote:
    "Therefore, it means less consumption: Who are the biggest consumers MrTweedy?"

    Referring back to your television example, and your comment above, I think you are saying that government is the biggest consumer.

    I agree there is a problem with stimulus packages, in that:
    (i) Govt. levies taxes on the private sector;
    (ii) Some of this tax revenue is then lost to bureaucracy in the process of collection and distribution;
    (iii) Govt gives money back to private sector as a stimulus;
    (iv) Therefore, the government is just moving money from productive parts of the private sector and then giving it as bail-outs to unproductive parts of the private sector, in the hope the unproductive companies will one day come back to life.

    Therefore, Frank and I, and others, have pointed out that a stimulus will only work if the government gives the money to those organisations who will be able to develop new efficiencies/ technologies, which will enable them to pay the loan back to the government with interest, out of the "new" money generated from finding more efficient ways to utilise the planet's resources. However, the chances of new efficiencies being found in the short to medium term are very slim.

    Therefore, it appears we have reached agreement?

    From my viewpoint, it still seems almost impossible to escape the deflationary spiral. The economy has already fallen too fast, and too far, for any government to catch it. Our governments have lost control of the economy. The toxic asset insurance scheme now part-quantifies the depth of the problem - we have GBP 600bn earmarked for RBS and Lloyds(HBoS). HSBC is having to resort to a rights issue, and who can say that Barclays won't need more capital at some point in the future. But this still doesn't take into account the bad debts which will be suffered by other companies outside the banking sector. Outside the finance industry, debtors are slowing down from paying 30 days end of month and moving towards 90 days end of month; more of them will go bust and default as the economy slows.

    Add to this the impossible government borrowing requirements, and their resolve to print money (QE), we have the recipe for economic disaster.

  • Comment number 85.

    The chance to turn this recession around is fast drying up. We should have been digging out the problem derivatives from bank balance sheets everywhere.

    It didn't happen.

    Huge quantities of bailout cash should have fill the voids left behind, and more gargantuan quantities of cash should have been pumped out to consumers. It didn't happen.

    The big banks should have been fundamentally restructured.

    USD dependency should have been reformed. A new central currency, the Global, should have been established from all the world's major currencies.

    There's an eerie silence.

  • Comment number 86.

    No. 85. peterdough wrote:
    "USD dependency should have been reformed. A new central currency, the Global, should have been established from all the world's major currencies."

    I was just reading an article which suggested a single currency for the USA, UK and the EU.

    If all western governments are running huge fiscal deficits, due to low tax revenues but high public spending, the best way to protect one's currency from collapse is to have only one currency....

    Interesting idea.

    Each individual country within the EU still issues its own government bonds. If we have one currency, covering the USA + EU + UK, would we still have individual governments issuing bonds, or would we need a central bank/ treasury setting interest rates and issuing bonds? I imagine we would need a centralised treasury?

  • Comment number 87.


    MrTweedy (#56) "The IMF was warning the British government in 2006, and even before, that debt levels and house prices were too high in the UK economy."

    The problem is that Herrnstein and Murrray were warning about this in 1994, and before that, Herrnstein in the early 70s, Michael Young in his late 50s satirical novel, and Cattell back in the 1930s. Each time, there's been a frighteningly shrill response or desperate efforts to brush it all under the carpet. Yet it is all government data driven.

    Here (updated to make it more glossy), in 2007, the biggest applied R&D education organisation in the world put their muscle behind it, and it was still given the silent. Futile No Child Left Behind and Every Child Matters, ignored Leitch Review here.... coninued mass low skill immigratin

    The problem is this growing divide and polarity. A small, (dwindling) cognitive elite, a disappearing Middle Class, and a burgeoning Underclass. People don't see how the 'predation' really works because they've imbibed a false equalitarianism.


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