mfioretti: debt* + globalization*

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  1. finance should, in an ideal world, be creating debt in order to finance growth of activity in the real economy. Instead, what has happened since the 1970s de-regulation of global finance, has been that finance has, over time, been increasingly financing…finance. That is, it has been financing itself. Indeed, in most of the western world, the growth of financial intermediation as a percentage of gross value added, has over the last two decades outpaced the growth of the real economy. That is until the bubble burst in 2007. Finding ways to redirect finance towards productive activity in the real economy is thus crucial.

    Third, in Italy, the effect of financialization has been made even worse by the presence of entrenched interests and “clientelismo” governing Italy’s economic system. Projects receiving loans are often not judged objectively, with criteria that are based on viable potential returns and the productive nature of an investment. Rather, they are often judged by clientilistic and nepotistic relations – as was made evident with the bank Monte Paschi di Siena (although this is really just the tip of the iceberg). Indeed, lets remember that the term “clientelismo” comes from the Latin clientes which means not modern day clients, but parasites feeding on presents (regalias) from the rich and powerful who, as described by the latin writer Giovenale, every day would visit their patronus for the morning salutatio. Italy’s sick banks are thus both a cause and a symptom of its never ending clientalist culture.

    Fourth, when growth is low—as it has been in Italy for the last two decades where both GDP and productivity have hardly grown at all—the above dynamic by which finance finances itself (or lends based on dodgy criteria in the real economy) becomes even worse. If finance has fewer good opportunities for investment in good companies and good projects in the real economy, then finding those opportunities in the speculative world of finance becomes even more appetizing. Indeed, research conducted in a large EC project on finance and innovation I coordinated some years ago showed that in many countries the problem is often not one of the supply of finance for firms, but the lack of good firms demanding finance. For example, most small medium enterprises that are innovative and productive, DO find the finance that they require. There are simply too few of those types of companies. Why? High growth innovative firms tend to prosper more in countries with dynamic innovation eco-systems, with strong links between science and industry, with high public investment in education and vocational training, high private spending on training programs for workers, strong R&D, and patient strategic long-term finance. When these are lacking growth will not follow – no matter how much emphasis a government puts on reducing red tape, or making labor markets less rigid (e.g. the Jobs Act). And when the real economy does not grow, finance becomes a betting casino.
    http://marianamazzucato.com/2016/08/1...ve-key-points-for-italys-banking-woes
    Tags: , , , , by M. Fioretti (2016-08-11)
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  2. Debt is a key factor in creating an economy that operates using energy.

    A generally overlooked problem of our current system is the fact that we do not receive the benefit of energy products until well after they are used. This is especially the case for energy used to make capital investments, such as buildings, roads, machines, and vehicles. Even education and health care represent energy investments that have benefits long after the investment is made.

    The reason debt (and close substitutes) are needed is because it is necessary to bring forward hoped-for future benefits of energy products to the current period if workers are to be paid. In addition, the use of debt makes it possible to pay for consumer products such as automobiles and houses over a period of years. It also allows factories and other capital goods to be financed over the period they provide their benefits. (See my post Debt: The Key Factor Connecting Energy and the Economy.)

    When debt is used to move forward hoped-for future benefits to the present, oil prices can be higher, as can be the prices of other commodities. In fact, the price of assets in general can be higher. With the higher price of oil, it is possible for businesses to use the hoped-for future benefits of oil to pay current workers. This system works, as long as the price set by this system doesn’t exceed the actual benefit to the economy of the added energy.

    The amount of benefits that oil products provide to the economy is determined by their physical characteristics–for example, how far oil can make a truck move. These benefits can increase a bit over time, with rising efficiency, but in general, physics sets an upper bound to this increase. Thus, the value of oil and other energy products cannot rise without limit.

    Research involving Energy Returned on Energy Investment (EROEI) ratios for fossil fuels is a frequently used approach for evaluating prospective energy substitutes, such as wind turbines and solar panels. Unfortunately, this ratio only tells part of the story. The real problem is declining return on human labor for the system as a whole–that is, falling inflation adjusted wages of non-elite workers. This could also be described as falling EROEI–falling return on human labor. Declining human labor EROEI represents the same problem that fish swimming upstream have, when pursuit of food starts requiring so much energy that further upstream trips are no longer worthwhile.

    If our problem is a shortage of fossil fuels, fossil fuel EROEI analysis is ideal for determining how to best leverage our small remaining fossil fuel supply. For each type of fossil fuel evaluated, the fossil fuel EROEI calculation determines the amount of energy output from a given quantity of fossil fuel inputs. If a decision is made to focus primarily on the energy products with the highest EROEI ratios, then our existing fossil fuel supply can be used as sparingly as possible.

    If our problem isn’t really a shortage of fossil fuels, EROEI is much less helpful. In fact, the EROEI calculation strips out the timing over which the energy return is made, even though this may vary greatly. The delay (and thus needed amount of debt) is likely to be greatest for those energy products where large front-end capital expenditures are r
    https://ourfiniteworld.com/2016/05/12...s-story-what-other-researchers-missed
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  3. who will pay all this debt? The answer is simple – our children and grandchildren will have to pay.

    Debts are always, above all else, a claim on future production, to be paid out of future earnings, either directly or through taxation. And if for some reason governments manage to keep on kicking these debts ever further down the road, as they tend to do, it will still be our children and grandchildren that pay the price, through lower earnings and a generally poorer world, because debts always have to be paid, one way or another. If this wasn’t the case, then we must have found a way to create something out of nothing. A miracle!

    But there’s nothing miraculous about the current situation. It might be the case that banks do in fact create money out of nothing, in the form of credit, but unless that money is backed by real wealth creation in the underlying economy, all that credit creation must devalue the currency, which would normally lead to inflation. I say ‘normally’, because this doesn’t seem to be happening anymore, despite the best efforts of various western (and Japanese) governments, who are more concerned now with the opposite problem: deflation, or falling prices.

    It’s not immediately obvious why price inflation remains subdued, but I think there are two main reasons. Firstly, all this new money hasn’t gone into general circulation, it’s stayed within the financial system, to the benefit of the wealthy, boosting asset prices and inequality.


    The second reason, I think, is to do with the globalization of wages, which are being held down because over half of all real industry now takes place in China and other emerging economies. When we pay less for goods and services, we must expect to earn less ourselves, because ultimately all exchanges in the marketplace represent an exchange of labour.

    We can summarize the global economic problem in one sentence: Not enough people are doing the right kind of work anymore. By this I mean that the real wealth-creating sectors of the economy are employing fewer and fewer workers as a percentage of total population.

    Upon further investigation into the sources of all wealth and what happens to all the money that ends up in the financial system, I worked out that around one third of all economic activity during recent years was fuelled by debt, rather than by real wealth creation, and this has led to a situation now in which around a third of supposed wealth, as represented by money, doesn’t actually exist, because it’s based on credit that is itself a claim on future production.

    This huge claim on future production is bound to make the world a poorer place. For one thing, it means that a great many government promises, and possibly private promises too, will not be kept. By this I mean promises for future pension and welfare payments in particular, because the wealth that supposedly backs these promises doesn’t actually exist.
    http://www.positivemoney.org/2015/02/200-trillion-debt
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  4. The “middle class” is an oft-used but poorly understood category that seems to be defined by who is not included rather than who should be. Indeed, the only people who clearly don’t belong in the middle class are the very poor and the really rich.

    When Americans think of “class,” they seem to divide people into three groups: the poor (lower-class), the really rich (upper-class) and everybody else (middle-class). Given these groupings, the middle class includes both the “near poor” and the “not exactly rich,” like the higher-income families who invest in 529 plans.

    The middle-class (as broadly defined) panicked when the 529 proposal was announced because of the risks it posed to their children’s futures. While the top 1% does not fret about how they will pay for their children’s college education, even parents who earn $150,000 worry because tuition rates have been surging for years, rising faster than incomes and financial aid.

    Anxious parents who earn too much for their children to receive Pell grants and other aid, yet not enough to make lump sum payments, are painfully aware that their progeny must go to college to succeed. They also know that saddling them with several hundred-thousand dollars of debt to do so could cloud their futures.

    A college degree is now a prerequisite to joining the middle class, and college-educated workers earn about twice as much as high-school graduates. And, as Obama noted in his State of the Union, by the end of this decade two-thirds of new job openings in the next five years will require at least some college education, and virtually all jobs will require some type of post-secondary training.
    Soon we’ll all be ‘middle class’

    The Obama Administration appears to have been blindsided by the vociferous opposition to the 529 proposal, which is somewhat understandable since the president was clearly correct in stating that few lower- or middle-income families would be harmed by it. The upper-income parents who objected felt they were being attacked, because they self-identify as being middle-class, not upper-class. And, compared with the top 1% of Americans who earn more than $663,000, they may just be right.

    An expansive definition of the middle class will make it even harder to find politically palatable ways to target its true members, who are increasingly struggling just to make ends meet.

    So even as more people think they’re in the middle class, its actual membership will continue to shrink as long as the income and wealth gaps keep growing. And the amount of money the government is willing to spend on the true middle class will continue to shrink as well.
    https://theconversation.com/the-incre...onversationedu+%28The+Conversation%29
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  5. Beijing's move to bail out Russia, on top of its recent aid for Venezuela and Argentina, signals the death of the post-war Bretton Woods world. It’s also marks the beginning of the end for America's linchpin role in the global economy and Japan's influence in Asia.

    What is China's new Asian Infrastructure Investment Bank if not an ADB killer? If Japan, ADB's main benefactor, won't share the presidency with Asian peers, Beijing will just use its deep pockets to overpower it. Lagarde's and Kim’s shops also are looking at a future in which crisis-wracked governments call Beijing before Washington.

    China stepping up its role as lender of last resort upends an economic development game that's been decades in the making. The IMF, World Bank and ADB are bloated, change-adverse institutions. When Ukraine received a $17 billion IMF-led bailout this year it was about shoring up a geopolitically important economy, not geopolitical blackmail.
    http://www.bloombergview.com/articles...-25/china-steps-in-as-worlds-new-bank
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  6. An essential and enduring insight of Keynes is that what works for a single family in hard times will not work for the global economy. One family whose breadwinner loses a job can and should cut back on spending to make ends meet. But everyone can’t do it at once when there’s generalized weakness because one person’s spending is another’s income. The more people cut back spending to increase their savings, the more the people they used to pay are forced to cut back their own spending, and so on in a downward spiral known as the Paradox of Thrift. Income shrinks so fast that savings fall instead of rise. The result: mass unemployment.


    If Keynes were alive today, he might be warning of a repeat of 1937, when policy mistakes turned a promising recovery into history’s worst double dip. This time, Europe is the danger zone; then it was the U.S. What’s called the Great Depression was really two steep downturns in the U.S. The first ended in 1933. It was followed by four years of output growth averaging more than 9 percent a year, one of the strongest recoveries ever. What aborted the comeback is still debated. Some economists blame President Franklin Roosevelt for signing tax hikes and cuts in New Deal jobs programs. Others blame the Federal Reserve. Dartmouth College economist Douglas Irwin argues that the Roosevelt administration triggered the relapse by buying up gold, removing it from the U.S. monetary base. The move to prevent inflation succeeded all too well, causing deflation. Whatever the cause, Britain and other trading partners were dragged down, and U.S. output plunged and didn’t fully recover until America’s entry into World War II. “We are really at a kind of 1937 moment now,” says MIT’s Temin. “It’s a cautionary history for us.”
    http://www.businessweek.com/articles/...ries-can-fix-the-world-economy#r=read
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  7. On Monday, September 29, the Wall Street Journal (WSJ) published a story called “Why Peak Oil Predictions Haven’t Come True.” The story is written as if there are only two possible outcomes:

    The Peak Oil version of what to expect from oil limits is correct, or
    Diminishing Returns can and are being put off by technological progress–the view of the WSJ.

    It seems to me, though, that a third outcome is not only possible, but is what is actually happening.

    3. Diminishing returns from oil limits are already beginning to hit, but the impacts and the expected shape of the down slope are quite different from those forecast by most Peak Oilers.

    Peak Oilers got at least part of the story right–the fact that we are in fact reaching diminishing returns with respect to oil. For this they should be commended. What they didn’t figure out is, however, is (1) how the energy-economy system really works, and (2) which pieces of the system can be expected to break first. This issue is not really the Peak Oilers fault–it is the result of starting with a very bad model of the economy and not understanding which pieces of that model needed to be fixed.

    We are dealing with a networked economy, one that is self-organized over time. I would represent it as a hollow network, built up of businesses, consumers, and governments.

    This economic system uses energy of various kinds plus resources of many kinds to make goods and services. There are many parts to the system, including laws, taxes, and international trade. The system gradually changes and expands, with new laws replacing old ones, new customers replacing old ones, and new products replacing old ones. Growth in the number of consumers tends to lead to a need for more goods and services of all kinds.

    An important part of the economy is the financial system. It connects one part of the system with another and almost magically signals when shortages are occurring, so that more of a missing product can be made, or substitutes can be developed.

    Debt is part of the system as well. With increasing debt, it is possible to make use of profits that will be earned in the future, or income that will be earned in the future, to fund current investments (such as factories) and current purchases (such as cars, homes, and advanced education). This approach works fine if an economy is growing sufficiently. The additional demand created through the use of debt tends to raise the prices of commodities like oil, metals, and water, giving an economic incentive for companies to extract these items and use them in products they make.

    The economy really can’t shrink to any significant extent, for several reasons:

    With rising population, there is a need for more goods and services. There is also a need for more jobs. A growing networked economy provides increasing numbers of both jobs and goods and services. A shrinking economy leads to lay-offs and fewer goods and services produced. It looks like recession.
    The networked economy automatically deletes obsolete products and re-optimizes to produce the goods needed now. For example, buggy whip manufacturers are pretty rare today. Thus, we can’t quickly go back to using horse and buggy, even if should we want to, if oil becomes scarce. There aren’t enough horses and buggies, and there aren’t enough services for cleaning up horse manure.
    The use of debt for financing depends on ever-rising future output. If the economy does shrink, or even stops growing as quickly as in the past, there tends to be a problem with debt defaults.
    If debt does start shrinking, prices of commodities like oil, gold, and even food tend to drop (similar to the situation we are seeing now). These lower prices discourage investment in creating these commodities. Ultimately, they lead to lower production and job layoffs. If deflation occurs, debt can become very difficult to repay.

    Under what conditions can the economy grow? Clearly adding more people to the economy adds to growth. This can be done by adding more babies who live to maturity. It can also be done by globalization–adding groups of people who had previously only made goods and services for each other in limited quantity. As these groups get connected to the wider economy, their older, simpler ways of doing things tend to be replaced by more productive activities (involving more technology and more use of energy) and greater international trade. Of course, at some point, the number of new people who can be connected to the global economy gets to be pretty small. Growth in the world economy lessens, simply because of lessened ability to add “underdeveloped” countries to the networked economy.

    Diminishing returns are what tend to “mess up” this per capita growth. With diminishing returns, fossil fuels become more expensive to extract. Water often needs to be obtained by desalination, or by much deeper wells. Soil needs more amendments, to be as fertile as in the past. Metal ores contain less and less ore, so more extraneous material needs to be extracted with the metal, and separated out. If population grows as well, there is a need for more agricultural output per acre, leading to a need for more technologically advanced techniques. Working around diminishing returns tends to make many kinds of goods and services more expensive, relative to wages.

    Rising commodity prices would not be a problem, if wages would rise at the same time as the price of goods and services. The problem, though, is that in some sense diminishing returns makes workers less efficient. This happens because of the need to work around problems (such as digging deeper wells and removing more extraneous material from ores). For many years, technological changes may offset the effects of diminishing returns, but at some point, technological gains can no longer keep up. When this happens, instead of wages rising, they tend to stagnate, or even decline.

    What Effects Should We Be Expecting from Diminishing Returns With Respect to Oil Supply?

    There are several expected effects of diminishing returns:

    Rising cost of extraction for oil and for other commodities subject to diminishing returns.
    Stagnating or falling wages of all except the most elite workers.
    Ultra low interest rates to try to make goods more affordable for workers stressed by stagnating wages and high prices.
    Rising governmental debt, in an attempt to stimulate the economy and in order to provide programs for the many workers without good-paying jobs.
    Increasing concern about debt defaults, as the amount of debt outstanding becomes increasingly absurd relative to wages of workers, and as all of the stimulus debt runs its course, in countries such as China.
    A two-way problem with the price of oil. On one side is recession, when oil prices rise to unaffordable levels. Economist James Hamilton has shown that 10 out of 11 post-World War II recession were associated with oil price spikes. He has also shown that there is good reason to expect that the Great Recession was related to the run-up in oil prices prior to 2007. I have written a related paper–Oil Supply Limits and the Continuing Financial Crisis.
    The second problem with the price of oil is the reverse–price of oil too low relative to the cost of extraction, because wages are not high enough to permit workers to afford the full cost of goods made with high-priced oil. This is really a problem with inadequate affordability (called inadequate demand by economists).
    Eventual collapse of whole system.


    Our networked economy cannot shrink; it tends to break instead. Even well-intentioned attempts to reduce oil usage are likely to backfire because they tend to reduce oil prices and have other unintended effects. Furthermore, a use of oil that one person would consider frivolous (such as a vacation in Greece) represents a needed job to another person.

    One of the areas that Peak Oilers tended to miss was the fact that an oil substitute needs to be a perfect substitute–that is, be available in huge quantity, cheaply, without major substitution costs–in order not to adversely affect the economy and in order to permit the slow decline rate suggested by Hubbert’s models. Otherwise, the problems with diminishing returns remain, leading to declining wages and rising costs of making goods and services.

    One temptation for Peak Oilers has been to jump on the academic bandwagon, looking for substitutes for oil. As long as Peak Oilers don’t make too many demands on substitutes–only EROEI comparisons–wind and solar PV look like they have promise. But once a person realizes that our true need is to keep a networked economy growing, it becomes clear that such “solutions” are woefully inadequate. We need a way of overcoming diminishing returns to keep the whole system operating. In other words, we need a way to make wages rise and the price of finished goods fall relative to wages; there is no chance that wind and solar PV are going to do this for us. We have a much more basic problem than “new renewables” can solve. If we can’t figure out a solution, our economy is likely to reach what looks like financial collapse in the near term. Of course, the real reason is diminishing returns from oil, and from other resources as well.
    http://ourfiniteworld.com/2014/10/06/...peak-oil-predictions-havent-come-true
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  8. raising interest rates could implode the monster derivatives scheme. Michael Snyder observes that the biggest banks have written over $400 trillion in interest rate derivatives contracts, betting that interest rates will not shoot up. If they do, it will be the equivalent of an insurance company writing trillions of dollars in life insurance contracts and having all the insureds die at once. The banks would quickly become insolvent. And it will be our deposits that get confiscated to recapitalize them, under the new “bail in” scheme approved by Janet Yellen as one of the Fed’s more promising tools (called “resolution planning” in Fed-speak).

    As Max Keiser observes, “You can’t taper a Ponzi scheme.” You can only turn off the tap and let it collapse, or watch the parasite consume its food source and perish of its own accord.

    Collapse or Metamorphosis?

    The question being hotly debated in the blogosphere is, “What then?” Will economies collapse globally? Will life as we know it be a thing of the past?

    Not likely, argues John Michael Greer in a March 2014 article called “American Delusionalism, or Why History Matters.” If history is any indication, governments will simply, once again, change the rules.

    In fact, the rules of money and banking have changed every 20 or 30 years for the past three centuries, in an ongoing trial-and-error experiment in evolving a financial system, and an ongoing battle over whose interests it will serve. To present that timeline in full will take another article, but in a nutshell we have gone from precious metal coins, to government-issued paper scrip, to privately-issued banknotes, to checkbook money, to gold-backed Federal Reserve Notes, to unbacked Federal Reserve Notes, to the “near money” created by the shadow banking system. Money has evolved from being “stored” in the form of a physical commodity, to paper representations of value, to computer bits storing information about credits and debits.

    The rules have been changed before and can be changed again. Depressions, credit crises and financial collapse are not acts of God but are induced by mechanical flaws or corruption in the financial system. Credit may stop flowing, but the workers, materials and markets are still there. The system just needs a reboot.
    http://ellenbrown.com/2014/07/25/you-...t-taper-a-ponzi-scheme-time-to-reboot
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  9. It is worth stressing, once more, that little of this is dependent on public sector debt. Government debt rose sharply as a direct result of the crash, having remained very stable for the decade or so beforehand. On Cuthbert’s figures it’s now around 105% of GDP: substantial – and certainly more than its historic average – but utterly inconsequential relative to the 1,364% of GDP that are the total liabilities of the UK’s financial sector. This is much larger than the estimate NEF has used in the past. We quite deliberately took a conservative approach to the calculation, following the method used by McKinsey in this 2011 report, since the case for transformation is solid even on these conservative figures. Cuthbert, more ambitiously, includes financial derivatives, the use of which expanded wildly over the 2000s.

    These are (largely) private sector liabilities, held by (largely) private sector institutions – the twist being, of course, the semi-public ownership of two major UK banks. But 2008 revealed that the location of ownership need not matter: in the event of a major crash, it is the whole of society that can be forced to carry the costs of a privately-owned financial system. This is precisely what happened, through the bailouts and the recession.

    So one way to understand the seeming irrationality of austerity is in part, as Cuthbert suggests, not the need to shrink government debt now, on which it has in any case been so far wholly unsuccessful. Rather, it is the need, as far as possible, to clear the decks in the event of a future crash. Bailouts last time came close to bankrupting us; there is no way they could be afforded on this scale the next time round. And “next time round” may, on current evidence, be far sooner than we would wish.
    http://www.neweconomics.org/blog/entry/another-crash-around-the-corner
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  10. With the dollar as the world’s reserve currency, globalization leads to huge US balance of trade deficits and other imbalances.
    Figure 10. US Balance on Current Account, based on data of US Bureau of Economic Analysis. Amounts in 2012$ calculated based on US CPI-Urban of the Bureau of Labor Statistics.

    Figure 10. US Balance on Current Account, based on data of US Bureau of Economic Analysis. Amounts in 2012$ calculated based on US CPI-Urban of the Bureau of Labor Statistics.

    With increased globalization and the rising price of oil since 2002, the US trade deficit has soared (Figure 10). Adding together amounts from Figure 10, the cumulative US deficit for the period 1980 through 2011 is $8.6 trillion. By the end of 2012, the cumulative deficit since 1980 is probably a little over 9 trillion.

    A major reason for the large US trade deficit is the fact that the US dollar is the world’s “reserve currency.” While the mechanism is too complicated to explain here, the result is that the US can run deficits year after year, and the rest of the world will take their surpluses, and use it to buy US debt. With this arrangement, the rest of the world funds the United States’ continued overspending. It is fairly clear the system was not put together with the thought that it would work in a fully globalized world–it simply leads to too great an advantage for the United States relative to other countries. Erik Townsend recently wrote an article called Why Peak Oil Threatens the International Monetary System, in which he talks about the possibility of high oil prices bringing an end to the current arrangement.

    9. Globalization tends to move taxation away from corporations, and onto individual citizens. Corporations have the ability to move to locations where the tax rate is lowest. Individual citizens have much less ability to make such a change. Also, with today’s lack of jobs, each community competes with other communities with respect to how many tax breaks it can give to prospective employers. When we look at the breakdown of US tax receipts (federal, state, and local combined) this is what we find:
    http://ourfiniteworld.com/2013/02/22/...s-why-globalization-is-a-huge-problem
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