“An economic crash with untold consequences for the world”

I realise I haven’t been haranguing you about the menace of Keynesian economics for a while so thought I’d remind you of its enduring horrors as there is unanimous agreement that Australia has to get its fiscal house in order. The origins of that disorder are, of course, in the Keynesian policies put in place during the GFC. Just hearing about Kevin Rudd’s 48-hour decision process for the pink batt adventure is a reminder of just how useless, in terms of productivity and real growth, almost all government spending is. A perfect paradigm example. Past the first ten percent, government spending is unproductive whatever other benefits there may or may not be.

As for a recantation from the economics community, not a word. You do have to wonder if they are ever going to get it right. And if they don’t get it right, how policy is ever going to get it right. The latest episode of wrongheaded analysis shows up on the ABC with this story not about Australia but about China. Apparently the problem with the Chinese economy is debt:

In recent times, the boom has been sustained by an explosion in lending by banks and so-called “shadow banks”. If the current scale of lending proves to be unsustainable, could that end the boom and result in China becoming the next country to succumb to the impact of unproductive debt? [my bolding]

Ah, “unproductive debt”! What, pray tell, is that? It is, in fact, exactly what every pre-Keynesian classical economist warned against. It’s spending on non-value-adding forms of production, the usual object of government spending in virtually every one of its forms. There it is, the problem right before their eyes but invisible all the same. Whether one thinks of it in money terms, so that debt is taken on for forms of production which ultimately do not earn sufficient revenue to repay what is owed, or it is thought of it as using up productive resources in ways which do not replace the capital that has gone into that particular form of production, one way or the other the economy is going backwards and not ahead. Keynesian economics is poison but who’s to know? This is what the Chinese did:

The program clearly lays out how the Chinese leadership responded to the prospect of a global financial crisis and possibility of a world-wide depression. The response focused on a spending and investment program carried out on a scale never seen before in human history. Over the past five years, a new skyscraper has been built every five days in China – along with 30 new airports and 26,000 miles of motorways.

Well there was certainly an enormous quantum of resources used up which, incidentally, also happens in highly productive investments. In this case, however, there are the office building, there are the roads, there are the airports, but none of them will generate the revenue to repay their costs. A Keynesian program to the back teeth with predictable results, or at least predictable if you start with Say’s Law. Starting from Keynes it is all a mystery with no explanation. And where do they think it will end up:

Interviewing key players including former American Treasury Secretary Henry Paulson, former Chairman of the Financial Services Authority Lord Adair Turner and Charlene Chu, a leading Chinese banking analyst, reporter Robert Peston reveals how China’s extraordinary spending has left the country with levels of debt that many believe can only result in an economic crash with untold consequences for the world – particularly resource-driven economies like Australia.

If you thought the last five years were bad, apparently the next five will be even worse. Meantime, ending the reign of Keynes and return to classical economic theory would be a start in even understanding what’s going on never mind actually getting our economies untracked.

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40 Responses to “An economic crash with untold consequences for the world”

  1. mundi

    I have never understood why Rudd picked the pink batts. Was it green senators he needed back then?

    The only thing Rudd slightly did right was the $900 Krudd cheques, unfortunately he made the mistake of giving most of them to non tax payers… and made the even bigger mistake of paying for them with debt when the liberal savings ran out.

  2. stackja

    Again if Keynesian economics is the answer. Why do we still have a problem.?

  3. will

    I suspect that cost-benefit analysis (where you get to make up your own numbers) has a role in this, but I am not sure anyone even does that anymore.

  4. Ripper

    Historically there has always been a recession after a large unbanisation of the populace and resulting property boom of the populace.

    http://www.rba.gov.au/publications/rdp/1999/1999-06.html

  5. Myrddin Seren

    Anecdote o’clock ( indulge me – I think it is relevant ).

    I recently caught up with my Chinese-Australian friend – who runs a commodity trading business.

    In discussing the Chinese economy, he illustrated that he had recently caught up with an old school friend who is the chief economist in their home town small Chinese local government area – only about 1.5 million people – a postage stamp compared to the rest.

    First warning bell – his friend is the chief economist in the region. Implying there are subordinate economists. For 1.5 million people ?

    My friend asked Mr Economist how the local government finances were going. Well said Mr Economist.

    Revenues equivalent to $1 bill p.a, expenditures equivalent to $2 bill p.a. (!)

    The difference ? Borrowed ! $1 bill p.a. piling up.

    Is this not a problematic amount to be borrowing ?, asks my friend.

    No problem at all, says Mr Economist – in relative terms their little province/LGA is a model of fiscal rectitude compared to most other regions !!!

    I really want and need to believe China will stabilise and get back on a sound growth track, for professional reasons.

    But pessimist that I am, I cannot hear things like this and fear we are all about to plunge off a cliff. How on earth could all this government debt around the world being palmed off to Tomorrow ever be repaid ? And if it can’t be repaid, are there not an awful lot of people sitting on such worthless IOUs that they will make Confederate bonds look like a safe haven ?

  6. H B Bear

    If the Chinks blow themselves up it is all over. Iron ore back to $20 a tonne dirt.

    Grab some tinned food, a rifle, ya dog and head for the hills.

  7. Myrddin Seren

    Grab some tinned food, a rifle, ya dog and head for the hills.

    And pray the GT Falcon doesn’t blow the supercharger

  8. john constantine

    jon faine,the millionaire socialist,with a government job for life,and a production company that can supply to the government and be taxed at a lower rate—faine uses the abc to tell his audience that tories lie when they say debt is a burden.[lucky he isnt going to rely on his government pension in retirement].

  9. OldOzzie

    An article in zerohedge.com sums up China’s Debt

    How Much Bad Debt Can China Absorb?

    Submitted by Sara Hsu via The Diplomat,

    China is coming under close scrutiny these days, as the leadership scurries to find new sources of economic growth and control its debt. Some analysts have reassured China watchers that the Chinese government can simply write off its bad debt, at least within the major banks, and pass it on to the asset management companies that handle that resale of distressed debt (or have it later purchased by the Ministry of Finance). Others have warned that some of the debt is serious, such as that incurred by local government financing vehicles, and are dubious about the sustainability of these entities.

    It seems people are starting to listen, and not a moment too soon: as of December 31, China’s corporate debt just hit a record $12 trillion. From Reuters:

    China’s corporate debt has hit record levels and is likely to accelerate a wave of domestic restructuring and trigger more defaults, as credit repayment problems rise.

    Chinese non-financial companies held total outstanding bank borrowing and bond debt of about $12 trillion at the end of last year – equal to over 120 percent of GDP – according to Standard & Poor’s estimates.

    Growth in Chinese company debt has been unprecedented. A Thomson Reuters analysis of 945 listed medium and large non-financial firms showed total debt soared by more than 260 percent, from 1.82 trillion yuan ($298.4 billion) to 4.74 trillion yuan ($777.3 billion), between December 2008 and September 2013.

    While a credit crisis isn’t expected anytime soon, analysts say companies in China’s most leveraged sectors, such as machinery, shipping, construction and steel, are selling assets and undertaking mergers to avoid defaulting on their borrowings.

    More defaults are expected, said Christopher Lee, managing director for Greater China corporates at Standard and Poor’s Rating Services in Hong Kong. “Borrowing costs already are going up due to tightened liquidity,” he said. “There will be a greater differentiation and discrimination of risk and lending going forward.”
    And then there was the worst capital misallocation in history:

    Exacerbating China’s corporate troubles has been the questionable use of 4 trillion yuan in stimulus that Beijing pumped into the economy following the onset of the global financial crisis in 2008, explained Lee of Standard & Poor’s.

    “Many companies invested heavily into competitive and low-return projects because funding was readily available,” he said. “These investments aren’t doing well and are making little contribution to profitability.”

    These numbers tell us that it does not appear that China can bear a very large increase in debt, and that the idea that the government can simply “bail out the financial sector” is erroneous, or at least, a stretch. China does not have the luxury of the United States, which can spend excessively because foreign countries continue to buy U.S. government debt (as the dollar is the world reserve currency). If the leadership attempts to spend down its large cache of dollar reserves, it will lose control of its currency, as a larger supply of U.S. dollars relative to the Chinese RMB would depreciate the currency unless sterilized. The only remaining option is the least savory: the Chinese government must control its debt, and this includes reducing overindulgence within the real economy. It seems that the punch bowl is empty already and the party is winding down. Now the question is, who will clean up the mess?

    Worth reading the whole article

  10. Myrddin Seren

    Chinese non-financial companies held total outstanding bank borrowing and bond debt of about $12 trillion at the end of last year – equal to over 120 percent of GDP

    Is there a clue in every well-Chinese business and political type getting their cash out of China asap ?

  11. Myrddin Seren

    ‘well-connect Chinese’

    Typing with migraine spots swimming in front of your eyes problematic

  12. Tel

    But pessimist that I am, I cannot hear things like this and fear we are all about to plunge off a cliff. How on earth could all this government debt around the world being palmed off to Tomorrow ever be repaid ? And if it can’t be repaid, are there not an awful lot of people sitting on such worthless IOUs that they will make Confederate bonds look like a safe haven ?

    Optimist that I am, I would say it does them good to learn that government bonds are never zero risk. There might well be an easy way to learn this, but many people insist on the hard way. This applies equally in the US and China.

  13. The Hunted Mind

    I had this in an open thread but it’s relevant here. It’s a positive sign that there are some people out there waking up to the stupidity of Keynesianism. This guy mainly rails against the feminisation of Western Civilisation and how it will destroy it. Great writing.

    Like other forms of Natural Law, the Dismal Science is, more often than not, applied precisely in reverse. The economy’s two sides are production and consumption – and it is the former which leads to the latter. An economy without production cannot have consumption, and it is the productive side of the equation where all the hard work, talent, an infrastructure lie; wealth flows from production, to consumption. And yet the knee-jerk reaction to an economic recession is to punish the productive classes, while subsidizing the consumers.

    link

  14. stackja

    Liberty Quotes
    Our Milton, who art in heaven, hallowed be thy name. Your free-market come, and civil liberties be done, in Australia as it is in “Free to Choose”. Give us this day your books, our daily lessons, and forgive us our Keynesianism, as we forgive those who use Keynes against us. And lead us not into populism, but deliver us from big government. For thine is the nobel prize, the wisdom and the glory. Forever and ever, TANSTAAFL.
    — John Humphreys

  15. Elizabeth (Lizzie) B.

    I think Western Australia may be keen on learning the hard way too.
    Greens and Palmer United? I ask you…

  16. Hugh

    When China blows up, is Krugman going to tell us its government didn’t spend enough?

  17. Kingsley

    Another irony is probably the person who has warned against this situation longest and profited from this longest is Jim Chanos a Democratic Party donor and supporter.

  18. Tel

    When China blows up, is Krugman going to tell us its government didn’t spend enough?

    Hasn’t Japan done everything Krugman could have ever asked for? We had money printing, we had both monetary and price inflation, we have seen government forced wage rises and tax hikes, we even had “broken windows” in the form of an “expansionary” earthquake, tsunami and radiation leak. Abenomics is a Keynesian wet dream, let’s see what comes of it… and let’s see how long Krugman can ignore the evidence, then make up an excuse.

  19. Optimist that I am, I would say it does them good to learn that government bonds are never zero risk.

    Tel, unfortunately that is a generational lesson. The problem is, the next generation won’t believe until it happens to them.

    Is there any better history lesson than that provided by economics?

    Economics – where history always repeats itself.

  20. I think Western Australia may be keen on learning the hard way too.
    Greens and Palmer United? I ask you…

    I’d like to apologise on behalf of the entire State.

  21. Peewhit

    Phillipa, less apologies. You are responsible only for yourself and your ideas, not the others in the state. The mass of the electorate is free to decide where it’s present and future advantages are, whether right or wrong.

  22. Peewhit

    Steve, the best way of ending the reign of John Maynard Keynes is to emphasise his words. The spending should be neutral over the cycle. To further quote Ronald Reagan, as probably stolen from another, the nearest thing we will see to eternal life is a temporary government program. Would Keynes have started what he did if he could have forseen the fact that a spending program to avoid a recession would lead inexorably to the next downturn.

  23. Tel

    Peewhit: Saving yesterday, saving tomorrow, but always spending today!

  24. Grigory M

    Grab some tinned food, a rifle, ya dog and head for the hills.

    I prefer the beach. I own plenty of fishing gear, and I can catch beach worms and pippies for bait.

  25. nerblnob

    Phillipa, less apologies. You are responsible only for yourself and your ideas, not the others in the state. The mass of the electorate is free to decide where it’s present and future advantages are, whether right or wrong

    Whimsical choices like Greens and Palmer based on imagined moral imperatives to others rather than self interest are a feature of indulgent wealthy communities. Greenie-ism is rapidly dumped by electorates in recession but WA is still riding the boom.

  26. Peewhit

    Tel, all I said is that Phillipa is not responsible for others doings. Whether I agree or not is not part of it. It has been said by others that the main fault of democracy is the ability of the electorate to vote for charity to be given to themselves. You are probably right that this means too much spending of the money I reluctantly pay to the government at the point of a gun. On the other hand the system rewards those of us inventive enough to avoid paying too much. Entrepreneurs are those of us who do not pay too much attention to the general beliefs of the community.

  27. Elizabeth (Lizzie) B.

    On the other hand the system rewards those of us inventive enough to avoid paying too much.

    Well, good luck with that Peewhit. There’s another thread devoted to how the Tax Office has their eye on you about this, once you get a bit bigger in the entrepreneurial stakes at any rate.

  28. Elizabeth (Lizzie) B.

    Philippa, I hereby accept your apology, on behalf of all New South Welshpersons. As an original South Welshperson in my heritage, I can speak for the newbies out here in the Colonies, I trust. The Victorians, of course, will have to speak for themselves. They will anyway because they are like that. I must say too that the Taswegians have unblotted their copy book and uprooted the Greenery, so good on them. Western Australians now hold the banner for electoral stupidity. South Australians naturally cannot speak at all until they have despatched Gerry Mander.

    All in all, it is a pity the Western Australians have now spilled all of their milk and damned near spilled all of ours too. It will soon be time to cry about that.

  29. Anne

    Yes, Philippa, I too accept your apology. Indeed, I see your apology and raise you a Mea Culpa for the Victorian Debacle come November.

  30. Robbo

    I remain puzzled at why Labor politicians and their loony left friends in the Greens cannot understand the simple facts about debt. It’s not as if they haven’t had some big lessons in the past. One that immediately comes to my mind was the blind stupidity of the Cain Government in Victoria with that idiot Rob Jolly as Treasurer furiously borrowing money and spending it like drunken sailors. That saga ended with them borrowing money to pay the interest bill on the previous borrowings, and yet they still mouth off about debt not being a bad thing and borrowing money in huge chunks to “stimulate the economy” which is Labor Party code for buying votes from the unthinking and uncaring.. God help us all if those ratbags get back into government anywhere in Australia.

  31. sabrina

    Steve K – if any one can changes this in the intermediate term, it will be the Economist academics – you, Sinclair, Judith (not sure if she teaches, she has a Professor title).
    At the height of the GFC, Rudd was swayed by the Economists of the wrong kind, and perhaps accontants and lawyers who dominate the government here. Strictly speaking, that can not be an acceptable excuse as he had the opportunity to consult widely economists of all pesuasions.

    Teach your (you and other like-minded ones) young students with the right theories as you all espouse, and when they eventually take leadership positions, hopefully things will be better.
    You guys have a role to play here in the classrooms.

  32. JABL

    Ok. A quick if dumb question. I thought that both the EC and the USA were deep in debt. Ditto Japan and almost if not every G20 member (?). If China who I thought was lending the money at least to the States is also in debt. Who has the dough? Is it the Middle East? Russia? Fat tony?

  33. Armadillo

    Governments spend other peoples money, individuals money is fluid.

  34. Rafe

    Don’t worry China is too big to fail: )

    Jokes aside, do we need a sophisticated argument to explain that spending massive amounts of borrowed or printed money on assets which don’t yield a return is going to end in tears?

  35. Grigory M

    Ok. A quick if dumb question. I thought that both the EC and the USA were deep in debt. Ditto Japan and almost if not every G20 member (?). If China who I thought was lending the money at least to the States is also in debt. Who has the dough? Is it the Middle East? Russia? Fat tony?

    Globalisation. Musical chairs with money. Heh. What fun.

  36. Arnost

    Ok. A quick if dumb question. I thought that both the EC and the USA were deep in debt. Ditto Japan and almost if not every G20 member (?)

    Who has the dough?

    It is actually a really good question… I too would like to see some opinions on that. For if it is the banks, then the Basel3 – and the local APS210 rules re liquidity seem only designed for them to buy more sovereign debt – and indeed fight over it!

  37. rickw

    “Is there a clue in every well-Chinese business and political type getting their cash out of China asap ?”

    An apparent surge in property purchases in Australia?

  38. motherhubbard'sdog

    Too much unproductive investment by the private sector = recession. Keynesian government response – more unproductive spending!

    Even Blind Freddie should be able to see that is stupid.

  39. Squirrel

    “JABL

    #1255077, posted on April 6, 2014 at 9:55 pm

    Ok. A quick if dumb question. I thought that both the EC and the USA were deep in debt. Ditto Japan and almost if not every G20 member (?). If China who I thought was lending the money at least to the States is also in debt. Who has the dough? Is it the Middle East? Russia? Fat tony?”

    Yes, I think that’s a very interesting question. The BBC report run on Four Corners last week as a good overview, and the interviews with people who seem to know what is going on were illuminating – particularly Charlene Chu’s sobering insights – but there was very little detail on how much of the trillions of Chinese debt is funded domestically, and how much of the foreign debt (assuming there must be a fair chunk of that) is denominated in other currencies. If the great bulk of the debt is funded by those super-thrifty Chinese households, the problem might only be seriously awful, rather than catastrophic.

    Whatever the details on the Chinese debt, the main message of that story for Australians is surely just how vulnerable our economy and Budget is.

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