Regular programming has been interrupted this week by a surge in interest in macroeconomic theory and peak oil in the NZ blogosphere! Mostly this interest has been catalysed by last Friday’s sustainable economics conference*, which I had hoped to attend. Unfortunately, I had a work thing, and missed it, but my spies reported it went reasonably well.
Attendees Matt Nolan* and Claire Browning* covered the conference . Claire has built on a earlier post* on the prospects of Solid Energy converting Southland lignite to liquid fuel. Over at The Standard, shadowy pseudonymous blogger ‘Marty G’ posted* Jeff Rubin’s ASPO conference speech transcript on oil prices as the major factor of the financial crisis. Followed soon after by a thoughtful piece* (and series beginner) on what is the economy for anyway? Meanwhile, buried in the Monday lunchtime tweetstream, iconoclast financial journalist Bernard Hickey crossed over* into full peaksterdom (/peaknikhood?/ peakerstroika?).
The surge in interest in topics dear to my heart is most welcome. Maximum Power usually follows my programme of wonkish arguments, but this recent interest has spurred me to enter the fray of inter-blog discussion. I offer two points:
First, the question I would have asked conference panelists. I can’t speak about this one, but in my experience conferences of this sort typically focus on how to transition our economy wholesale into ‘sustainability’, which is usually abstractly defined. While the transition is thought of as a journey of a thousand miles, perhaps beginning with a few small steps, except that the road turns out to be pea-soup foggy and nobody really has any directions. My question is supposed to call attention to the scree slope that we seem to have stumbled down:
“Given that we seem to be in the midst of a 1 in 80 year debt deleveraging cycle and that the world’s major energy resource is about to go into terminal decline, what is the risk that New Zealand’s GDP/cap will never recover to 2008 levels? 1%, 5%, 50-50?”
Probably wouldn’t have gone down very well. A question like this however, does focus the mind on the here and now, and an emergency response approach to policy follows from it, rather than the usual bland commitment to the environment.
Second, I disagree with Jeff Rubin’s analysis of the Global Financial Crisis (GFC). Sort of (I disagree with conventional wisdom too.) Rubin is sceptical of subprime mortgages as the ultimate cause of the GFC and instead pins the blame on the rise in oil prices 2002 through 2008. I agree that the subprime mortgages are a sideshow, but I even though I’m blogging on peak oil I think Rubin’s case is too simplistic.
The clearest and most cogent explanation of the GFC I have found is Prof Steve Keen’s (see sidebar). Keen does his economics in a Post-Keynesian framework which has the bulk of money created ‘endogenously’ by private bank lending rather than the fiat money creation of central banks that most economists learn in their textbooks. In this framework, the money supply expands and contracts on borrower sentiment. When people are (over)confident about the future they have no problem taking out a loan, to say, invest in the housing market because house prices always go up, right? Debt piles up, until something bad happens and borrowers get a bit nervous about how much they owe, how much interest they’re paying, and how much they could be paying if interest rates rise. They decide to reverse their previous position! They begin to pay down debt, diverting money that would normally feed consumption to saving. When borrowers all do this together it worsens the economic situation and leads to further uncertainty and further declines in consumption.
(The theorists behind this framework include, Irving Fisher, Hyman Minsky, Basil Moore, Joseph Schumpeter, Keen himself, and some chap called Karl Marx if you want to look them up). Most orthodox economists are not comfortable with this framework, because it breaks a several orthodox doctrines like fiat money creation, rational expectations, and economic equilibrium (which I’ll deal with later).
To track this debt contraction/expansion dynamic Keen measures the total amount of Debt compared to GDP. I’m going to show how NZ figures measure up, but the reader should keep in mind that most advanced economies have similar levels of debt. The following chart shows these figures from the RBNZ for the New Zealand Economy.
Business debt has been deleveraging since the end of 2008, while other private sectors are only just starting to turn in the most recent quarterly figures (July, 2010). Government debt has been expanding at a fair clip but is still lower than recent historical levels. The standout is of course, mortgage debt which has rocketed up to 90% of GDP with only a brief pause at halftime.
Keen also uses an ‘Aggregate Demand’ metric. Aggregate demand is GDP + the change in debt and is supposed to measure demand for goods and services (included in GDP) and assets like houses and equities (not included in GDP). Aggregate Demand is a bit tricky and is used more as a ‘roughly right’ rather than a ‘precisely wrong’ measure. Keen discusses the ins and outs here. The key point is that when debt growth becomes large relative the economy, any slowdown of debt accumulation reflects a change in sentiment that flows through to less demand for goods and services. The New Zealand economy continued to accumulate debt through the financial crisis, but at a slower rate than the early Noughts. Here’s the chart for Aggregate Demand (click to embiggen):
Change in debt figures in this chart are quarter over same quarter year previous year, so the chart still shows a growth in debt (the red line is above the blue line). You can see that aggregate demand has fallen since the start of 2008, propped up by government borrowing (the gap between the red and green lines). When aggregate demand falls and the economy has become dependent on debt-financed spending, then some people lose their jobs. The next chart shows the correlation between debt-financed proportion of aggregate demand and unemployment (inverted):
So how does this relate to oil prices? On the one hand oil expenditures are much smaller than debt-financed expenditures. The next chart shows both in relation to Aggregate Demand:
Oil expenditures come from infoshare’s import data and are summed crude oil and petroleum products figures. I’ve drawn a line from the respective high and low points and use the difference to create the next chart:
The rise in oil prices is not insignificant. At the price peak in 2008 we were sending about 8 billion dollars a year overseas to pay for our oil imports, which is about the size of our dairy exports. We also know that when oil prices go up they often have a larger than expected impact on spending as consumers delay purchases on big-ticket items. However, the slowdown in debt growth (and recent beginnings of a debt contraction) has been substantially greater. What I’m suggesting is that while oil prices have certainly contributed to economic uncertainty, and uncertainty bursts overconfident debt bubble, overconfident bubbles have to burst sometime.
Clearing this debt overhang is going to take a long time. And of course, if anything bad happens in the next 2-5 years, like say, oil extraction rates coming off their current plateau, then we’re in completely different territory.
“Keen does his economics in a Post-Keynesian framework which has the bulk of money created ‘endogenously’ by private bank lending rather than the fiat money creation of central banks that most economists learn in their textbooks”
Hey,
One thing here is that mainstream economics does have an endogenous money supply. The central bank controls the opportunity cost of lending/borrowing for banks by setting the cash rate.
And when it comes to debt, I agree that large scale debt accumulation leads to slower future growth – but there are factors to keep in mind when thinking about the global economy such as:
1) Why did we take on the debt – was there investment that will be productive in the future
2) Someones debt is someone else’s savings – what does this imply for demand from countries that have been saving, and furthermore what does this imply about the future rate of return required.
3) If we took on debt to consume, why? Was it that consumption was very cheap for some reason? Have we seen big productivity improvements in the global economy?
Also, on a fall off in “AD”, even without large scale debt, would have lead to higher unemployment – given “sticky” prices (and co-ordination issues inside the economy). It isn’t just a matter of debt.
Their is not much consensus on all these issues at the moment – I am sure that once the crisis is over, and we are in a completely different part of the cycle, we will get consensus. But this is often the way of things.
Thanks Matt, I’ll discuss your points in a few days.
Interesting ideas! I may try putting together some US numbers.