From a totally different standpoint, the Guardian also presents information its demographic, public sector workers, find attractive. On the 23^rd February 2012 it published an article headlined as ‘Outperforming’ NHS does not need radical reform, study concludes. This was reporting on a report in the British Medical Journal that, in turn, was based upon a report published by the Commonwealth Fund.
The Commonwelath Fund report basically focused on two items. The first was that the US health care system is bad. Well that’s hardly news. And a second of the desirability of a ‘medical home’. That is, a means of co-coordinating care. The NHS ranked well against the plainly worthless US system (not difficult) and the provision of a medical home, i.e. a GP. However, it also contained data from OECD studies that painted a far less-rosy picture.
The amount spent on the NHS was slightly less than that by other western European countires, 9.8% of GDP in 2011 as opposed to 11.8% and 11.6% in France and Germany respectively. With accessibility and co-ordination not being a problem.
However, when it came to deaths from conditions that were treatable it was second worst after the USA in 2006-7. Breast cancer surviva rates were the worst. Mortality after hospital admission for heart problems was second worst after Holland.
When it came to patient services, diagnostics and drugs, the UK had the least use of MRI scanners – an important diagnostic tool. Spending on drugs was third lowest. Yet the wages of doctors was second highest after the USA.
So what you have is a mixed bag. Fine for procedure and hand-holding, very good for remuneration of medical staff and not very good for spending on patients. Not exactly ‘outperforming’, other than for the Guardian demographic of public sector workers.

And these are the best of the bunch. Not like the sensationalist British tabloids that rely on deliberate mis-representations and frequently lies in order to sell their publications.
The problem for elected democracy is that of an electorate far too willing to believe what it reads without the facility to become suspicious when faced with irreconcilable ‘facts’. In the case of the Guardian article, the conclusion being that the British have managed to find managerial expertise in an environment lacking competition and having a religious like status in the British body politic when they have singularly failed to find such expertise, in general, elsewhere. That may be the case but it certainly warrants further digging to see if you can believe any of what you read let alone hear.

“I believe that it is in the interest of the financial sector itself that it should concentrate more on its proper role of financing the real economy, and ensuring that capital is allocated in the most intelligent way, instead of banks conducting the bulk of their trading on their own account,”

So why such opposition from governments that do enjoy taxation?
Taxes are levied on such useful things as jobs, selling goods and lending money – all of which are real economy activities but not on financial betting.
We know how corrupt politicians are. Blair and his cronies fabricated all sorts of claims to invade Iraq. As the Levenson inquiry into press behaviour is showing, both politicians and senior policemen were corrupted by sections of the press. It is wholly to be expected that Wall Street and the City of London, with vast amounts of wealth at their disposal, would seek to spread this around in order to defend their interests. Interests that have very little to do with the real economy.

Of course, politicians need to be seen to exerting some control. Which is quite remarkable bearing in mind that nowadays those politicians that reach high office are professional politicians. They have never held down a ‘proper job’ That is one that produces wealth, goods and services people are willing to buy with their own money.
This is not surprising as most seem to have a degree in Politics, Philosophy and Economics (PPE) from Oxford and therefore are only really able to earn a living, other than in politics, by stocking supermarket shelves.

In order to overcome this considerable intellectual handicap they rely on those who can best exploit the media. Somewhat ironic that, since most people consider a qualification in media studies to be vastly less valuable than any degree churned out by Oxford.
Those who can understand and therefore manipulate populist perceptions are obviously of as much importance in politics as they would in selling the latest brand of hair product to a young woman who may emotionally ‘connect’ with another young female ‘celebrity’. And in a complex world, one where there are lots of simple parts but hugely interconnected, surely there needs to be some means of appearing to be able to condense such complexity into a simple form? Albeit a totally incorrect one.

Despite all the complexity of economics, theories that aim to turn human psychology into a mechanistic process, two terms seem to dominate the headlines – GDP and ‘the markets’. These are held in the sort of reverence that in past centuries might have been confined to a thigh bone that was an alleged holy relic of some character from the New Testament. And with the same sort of absence of any critical analysis of this reverence.
The sages of the age wisely nodding their heads as these ‘truths’ are sagely discussed.

But just what are these irrefutable truths? And are they irrefutable?
So, let’s start with GDP or Gross Domestic Product. That seems straightforward enough. Surely this means the output of an economy, the domestic product – products (both goods and services) produced domestically – after taking into account all the pluses and minuses. After all many final products contain a number of imported components and that needs to be accounted for. Simple.
Well not that simple. Since, as the following formula shows, it doesn’t necessarily do what it says on the tin.

There are three ways of measuring GDP, the value method, the income method and the expenditure method. Furthermore, not all countries measure the same thing the same way. For example, the USA considers military spending as an investment (part of the expenditure GDP model) whereas European countries regard it as expenditure. So right away we have profound inconsistencies.
In the UK the Office of National Statistics prides itself on being the fastest in the developed world at producing its first estimate of the UK GDP it publishes every three months. Of course, it is not the final figure and will be revised later. The revisions arise from the fact that the first estimate is based on the value method that aims to measure industrial output that also includes an estimate of output produced by the government. This estimate assumes every £1 the government spends is £1 of output. The output being defined as that which the ordinary person would be willing to pay for when in fact it is output a politician deems valuable. Just wonder how many people woul dput their hands in their pocket for a whip-round to invade Iraq.
But it’s the subsequent revisions that are of real interest. The expenditure model comprises the following terms
· Investment
· Household expenditure
· Government expenditure
· Trade balance (exports minus imports)
Of those four only the trade balance is really about output. How much output is produced that satisfies the requirements of the domestic market with some left over that is desired by those in other economies. Less imports from other economies desired by the domestic market in preference to domestically produced goods or because those desired items are not produced domestically.

The striking thing about the UK, and the US in recent years, has been its trade deficit that only narrows when the authorities tighten the means of borrowing. In 2007 70% of UK GDP arose from retail (domestic spending), government spending and financial services (including lending money). And those loans are part of the investment term since a loan is an asset every bit as much as a machine for making widgets. They both produce an income stream from expenditure. Presumably the same logic applies to the US authorities counting military expenditure as investment. The returns from ensuring the availability of oil priced in dollars is not insignificant.

So when domestic spending stalls due to household debt having saturated, GDP is maintained as a value greater than zero by government spending and increasing the amount of debt it owes.
Many like to describe this as Keynesian and providing a stimulus. In my youth when people were taught physics the analogy used was that of ‘pump priming’. A little water would be placed in a hand-operated pump that would be pumped out of the pump causing a partial vacuum and so making use of atmospheric pressure to continue the process
Unfortunately, in an open economy (no trade barriers) with a large trade deficit such an action delivers a boost to the GDP value for a short period as the money is spent but simply funds the purchase of imports and so the stimulus is exported.

An example of how crazy this can be is given with the following figures for Greek GDP between 2000 and 2007
· 4.5%
· 4.2%
· 3.4%
· 5.9%
· 4.6%
· 2.2%
· 4.5%
· 4.5%
Compare those figures, giving a median value of 4.5%, with those for Germany over the same period delivering a mediocre median of 1.2%.
· 3.2%
· 1.2%
· 0%
· -0.2%
· 1.2%
· 0.8%
· 3.4%
· 2.7%
What economic giants those Greeks are. Not. That ‘growth’ was delivered by spending borrowed money.

So those GDP figures may signify goodness or they may signify problems ahead. You can’t tell. So they’re meaningless.
Ah, but the markets. They know what they’re doing. Don’t they?
Their wise, calculating heads can encompass all the facts and recognise the wood for the trees.
Ben Graham, Warren Buffett’s mentor, described Mr Market as being a manic-depressive – bipolar disorder. Up one minute down the next.
Alan Greenspan, ex-chairman of the US central bank, the Fed, would describe markets as suffering from ‘irrational exuberance’.
John Maynard Keynes, would use the term ‘animal spirits; to describe market activity. ‘Markets can remain irrational longer than you can remain solvent’.

Of course all these quotes contain a some exaggeration but they also contain a lot of truth and give the unsurprising view that ‘markets’ are in fact simply bunches of human beings with all their faults and inconsistencies and not Vulcans.
However, bearing that in mind, what sort of economy would allow in those who would exploit these weaknesses in such a fashion as to be utterly devastating at times. Certainly not one run by wise politicians with degrees in PPE from Oxford, surely?
And of course the answer is of course oh yes the do. The nutters run the asylum on behalf of crazed nutters.

In theory the maths, and the decisions, are real easy. Someone makes an investment now, be that in a new factory or a pile of shares. They are paying money at today’s value (what it will buy) in order to buy a stream of returns that lie in the future. Each of those returns can be discounted over time (the discount rate), a £1 today is worth more than a £1 in a year’s time even with zero inflation as it would have earned a ‘safe’ return from an interest bearing account. However, risk then enters the picture in the form of inflation, changes in interest rates and the degree of confidence in actually receiving those payments as the years go by. The greater the risk the greater the discount rate.
Once risk enters the scene so does the psychology of those involved. Some are risk-averse, some risk-neutral and some seek risk and some are every graduation between,
So when things look good they can look very good and when they look bad they can look very bad and if you have people in place who can make a bad situation look even worse then it can be a disaster.

The market should be a place where, having made some sort of judgement over risk, capital is made available to those who wish to use it to create wealth – goods and services people are prepared to pay for. Obviously, a lot of that goes on but over the years a pernicious sort of activity has arisen – short selling, naked short selling (how disconcerting an image does that conjure up) and high frequency trading.

Short selling is the process whereby traders borrow shares from the holder, sell them in the hope the price will fall, buy them back to return them to the owner and pay the owner a fee for the privilege.
Now it seems crazy that someone would deliberately undermine their own wealth.

The short-seller relies on others getting spooked by the sell off, selling shares for far less than they are worth and the owner that the share price subsequently recovers and in the meantime they may buy some more themselves. But if you’re a fund manager for a pension fund the pension fund may take the hit. The fund manager takes the lending fee and the pension fund the hit on the assets losing value.
Talk about animal spirits.

With naked short selling the short sellers don’t even bother borrowing the shares and simply sell something they don’t have. They still rely on receiving more for the sale of the asset (be it shares or bonds or whatever) than they eventually have to pay to meet their side of the deal and deliver the asset to the buyer.

Of course you can come unstuck and this is not for the faint-hearted. If the price of shorted asset rises rather than falls you will lose and that could be big time.
In 2008 hedge funds came to the conclusion VW shares were over-priced and started shorting them (selling). Porsche began buying the shares as they wanted to buy a company that made cars and wanted to continue to make cars. A concept few in the market would be able to grasp.
Eventually, Porsche bought so many VW shares at a knock-down price that there were few left to buy. At which point the short-sellers had to buy and the price rose dramatically. When it was all over the hedge funds had lost £18bn.

Since short sellers and the fund mangers they are in cahoots with rely on the market being spooked they dislike the idea of disclosure. If the market can’t tell whether a genuine investor is selling its share holdings or is simply pulling a trick, the less-risky action is to assume the worst and sell. Just what the short-seller wants of course.
But what this ultimately means is that first of all it is in the interest of the short seller to make a bad situation worse and that means it can get out of control. Mr Market can become terminally depressed.

The argument used to justify short-selling is that it brings liquidity to the market. Liquidity is most definitely important. Property investment requires the discount rate to be substantially increased due to the fact that property is an illiquid investment. It can take a considerable amount of time to find a buyer – as any homeowner can testify. But, as property shows, liquidity is provided by buyers not sellers. Short-selling removes liquidity as it removes at least one buyer from the market, the one that has bought the short-sold shares. And, if shorting is working to the advantage of the short-seller, has reduced the number of potential buyers who will only be tempted back when the security has fallen sufficiently in value.

Just another example of the phoney arguments used by those who bring nothing to the table of wealth creation.

The high frequency trader is worse still. This is trading where a security is held for a fraction of a second. This cannot be physically done by a human and so needs a computer with some algorithm that decides what to buy and sell and how much. Of course the old saw applies ‘To Err is Human. To Really Screw Up, You Need a Computer .’
Other computers, doing the same thing, can see this and join in in some sort of frenzied selling spree. This is called a flash crash.

One means of clipping the high frequency traders’ wings is to impose a transaction tax – the Tobin tax. Since they make millions of transactions a day such activities would incur huge cost.
The Eurozone is in favour and the UK and US governments against. So we know whose side the UK and US governments are on. Not because such activities are vital to the functioning of healthy economies – they’re obviously not and the UK and US economies are hardly blossoming. But because European economies are generally keen on creating wealth and the US and UK on promoting the interests of the rich and super-rich, as expressed in such market activity.
Similarly the UK and US governments fight against any controls on short-selling.

So the twin icons of economic perception, GDP and ‘the market’, have huge feet of clay. Yet they are the focus of attention by politicians because they are the focus of attention of an unquestioning media. And, as far as the Anglosphere is concerned, governments of either left (or what passes for the left) or right being totally sold on the idea of what is good for a market distorted and corrupted by these practices is good for the real economy.
The parties of the left following the agenda of the right as they seek to demonstrate what is perceived as economic competence.

The Good, The Bad and The Ugly
If we had an economy where a great deal, perhaps most, of the money passing through a bank and into the wider economy whilst earning a regular stream of payments (in other words a loan) was in fact to business for investment purposes; just what it might look like?

Assuming the investment is a wise one and managed wisely we would expect wealth, goods and services the market desires, to be produced. In order to do this, along with the investment in capital goods and any commodities used, labour would be required and that labour would require a reward. However, if the banking system isn’t lending a great deal to consumers domestic consumers can’t buy the production from this investment in its entirety. Only a proportion, and a small proportion at that, of the funds borrowed for purposes of investment can be spent on wages. And wages will be paid even before any sales have been made.

In order to sell that production other markets will be needed. That is, the production needs to be exported.
Once exported, foreign revenue will be earned that the business wishes to be credited to its domestic account. The banking system earns money from taking foreign currency in at one end of the process and releasing fiat currency into the wider economy via the business account by charging a commission. So everyone is happy. The banking system has earned money from both lending, a flow of earnings from interest, and a one-off charge in the form of commission. The company is happy as it has now sold its production and, being a good investment, made profits. And the workers are likely to be happy as it is now in the interests of the business to increase its wage bill by a combination of more workers and better wages. This results in a motivated workforce with which to repeat the exercise.

So what does this economic vision look like?
Well, it would run a balance of trade surplus, probably a large one. In general, consumers would be consuming domestic output with a small amount of imports, a lot of domestic output would be exported.
It would have low unemployment. Labour is required to produce all that output.
It would have a high GDP per person due to low unemployment.
And personal debt would be low as consumers spend mostly what they earn rather than borrowing in order to pay for imports.

Step forward Germany.

From the above graph we can see a decade long success story built on very simple principles – borrow for wise investment, mange it well and live within your means. Hardly rocket-science.

There has been a perception of Germany that it was something of a dinosaur with its emphasis on manufacturing rather than knowledge-based services (i.e. financial services). Germany’s GDP has grown on average by only 0.9% over the past decade, a mere half of the USA. However, this does not tell the full story. America’s economy grew more quickly in part as a result of population growth, by almost 1% a year, as a result of immigration and a higher birth rate.

In contrast, the number of Germans is shrinking. This is important since it is not growth in GDP pure and simple that is a true measure of prosperity, but growth in GDP per person or average income.

Germany is one of only two countries in the G7 where the unemployment rate was lower at the start of the decade than when it began.
Germany’s public- and private-sector finances are also in much healthier shape. It has a conservative mortgage system that prevented a housing and credit bubble. Household debt has fallen over the past decade from 115% of disposable income to 99%. Over the same period, Britain’s soared from 117% to 170%, America’s from 100% to 128%.
Also, Germany has the smallest budget deficit and least government debt relative to GDP.

Now, let’s take the reverse story.
Money again leaves the banking system via loans but this time to consumers more than to business for investment. Consumers now have two sources of spending power. One from wages, although if investment has been poor or not well managed, that source could be quite low. And if an economy has a large balance of trade deficit that investment is poor, either due to an insufficient amount that produces insufficient output or as a result of simply being invested badly and, once again, producing insufficient output to meet the demands of the domestic market.
The other from loans.

To make matters worse, there has been significant job creation but in low-paid jobs. As a result a rational choice has been made by many that it is better to be poor living off benefits but not having to work than being poor and having to work. This has placed great reliance on immigration and also on government to provide jobs in the public sector. Low taxes from low paid work, unemployment benefits and an increase in the public sector workforce have resulted in a large government deficit even when the economy is seemingly thriving.

Domestic output is relatively low compared to domestic demand so lots of imports are sucked in and there is a large trade deficit. The combination of investment that is actually loans (an asset producing a flow of income) enabling consumer spending and government spending making GDP growth look better than it really is.
This is the basic problem facing both the UK and the US. High household debt has driven GDP in the past and GDP growth, such as it is, is now driven by government debt. With household debt at unsustainable levels in both countries and required to fall only ever increasing government debt can provide any sort of GDP growth.
In the absence of fair exchange of goods and services between economies a thief, in the form of ever increasing debt, comes to steal away the future.

Just what is the implication of money in our pocket or bank account? That may sound daft as most people would reply it’s a measure of wealth. The more I have the more I can go shopping now or next week, or next month or whenever.
So it’s a means of exchange either now or deferred. If deferred then you’re storing up that purchase and so a store of wealth. Both of these aspects I cover in Money it’s a gas.
But I don’t mean how does it function but how does it get into our pockets or bank accounts and how is that linked to general economic activity and are some forms of economic activity more likely to maintain that flow than others? And what, if anything, do those differing forms of activity say about the societies from which they spring? As economic activity is performed by people who form societies.

Money, or at least paper money and coin, comes from the central bank of an economy and enters the wider economy via the banking system and what are known as re-purchase agreements. A re-purchase agreement, also known as a repo or sale and re-purchase agreement, is the sale of securities to the central bank along with an agreement for the seller to buy back the securities at a later date.
The repurchase price is greater than the original sale price, the difference effectively representing interest charged on the sale of money and hence the term repo rate. The central bank that originally buys the securities effectively acts as a lender and the original seller is effectively acting as a borrower, using their security as collateral for a secured cash loan at a fixed rate of interest.
Since the demise of the gold standard and the Bretton Woods agreement, see Money it’s a gas, that money is not backed by anything tangible (it is not a receipt) and is known as fiat money. That is it only has value because of government regulation or law. The term derives from the Latin fiat, meaning “let it be done”, as such money is established by government decree, i.e. it has value because the government says so.
Now if we take wealth as goods and services we value and money as a means of exchange either now or deferred then what this fiat money is actually worth is how much we can buy with it. For example, in my last year at university in 1973 I would put 3 gallons of petrol (13.62 litres) in my car once a week for the princely sum of £1. Nearly 40 years later that petrol has not changed much but that would now cost me something like £18.11. We would all recognise that as inflation. The value of that fiat money has fallen because central banks (and others as I will show later) have supplied more and more of it. That is the money supply has risen enormously and the production of goods and services that represent wealth have not risen by anything like the same amount.
Of course, supply and demand play a part in this. The demand for a particular product may rise and the supply can’t keep up with demand, peak oil for example where production of oil is greater than new discoveries, but prices have risen across the economy in general in those 40 years and the value of one unit of that fiat money, £1 or $1, has fallen.
But if that money stays with the bank and doesn’t enter the general economy it has no effect. So banks have the task of ‘selling’ the money they have bought at a price higher than that which they bought it for, in order to make a profit. In this way the central bank plans to control the amount of money in circulation. The higher the price of money the less people are inclined to borrow and so the less banks buy from the central bank and the growth in the supply of money slows. And if banks do buy the securities back they sold as part of the repurchase agreement it can even shrink.
So in order that tolerable inflation (around 2-3% is the norm) occurs the volume of desirable goods and services in the economy and the rate at which money enters the economy need to be kept more or less in step.
But what does ‘enters the economy’ mean?

Crossing the Rubicon
Ultimately, everything that is produced has to be consumed by the individual or by government. If Rolls-Royce sells an engine to Virgin Atlantic, Virgin Atlantic must recoup part of the cost of that engine as part of the ticket cost. By selling lots of tickets those small parts add up to an engine costing £millions. Similarly, if Rolls-Royce sell the very same engine to the RAF the government is now acting as a consumer.
From the revenue companies earn they have to make a number of payments; interest payments on any loans, payments to other companies, wages, taxes to government, dividends to shareholders. The total of those payments cannot be more than the revenue earned in general or companies go bust. But the revenue derives from wage earners and governments that derive revenue from taxes, the sum of which is less than the revenue earned. So how can wage earners and the government pay out more than they earn?

Well, there is an existing supply of money in the wider economy in the form of savings. So savings can be used, In addition, if the company exports it earns revenue from more than one economy. So if an economy exports it is quite possible for both wage earners and government to earn money from those economies as well.
But, of course, people can also borrow and the act of borrowing can also create money; not necessarily wealth but more means of exchange – money. There are two ways.
First, the same money, or at least a part of it, can be lent more than once. This is known as fractional reserve banking.
Fractional-reserve banking occurs when a bank does not keep all of its customers’ deposits within the bank. Funds received by the bank are generally on-loan to other customers. This means that available funds (called bank reserves) are only a fraction (called the reserve ratio) of the quantity of deposits at the bank. As most bank deposits are treated as money in their own right, fractional reserve banking increases the money supply, so banks can be said to create money.
You can see from this table how this works for an initial deposit of £100 and a reserve ratio of 20%.

The reserves plus the last amount deposited equals the £100. The total sum of money that appears to be available (the amounts deposited) is £244, so £144 has been ‘created’ out of thin air.
This whole system depends upon depositors not asking for all their money or even the bulk of it at the same time. And that depends upon those depositors having confidence in the bank. If they do not, a bank ‘run’ occurs as people worry that the reserves will run out before they have their money back. In the above table if 40% of the depositors with bank A want their money back, £40, it cannot be satisfied from reserves.
This is similar to a cashflow crisis with a normal business. The bank may have assets, loans that produce an income, that exceed the withdrawl request but do not have enough ready money to satisfy the request –they have liquidity rather than solvency problems and are illiquid. In such circumstances the central bank may well organise a rescue by making that liquidity available and so avoid a bank collapse.
Of course problems really begin if some or the majority of those loans are also bad, That is the bank is insolvent where its debts (deposits) are greater than its assets (good or performimg loans) as neither the loan nor payments on the loan (interest payments) can be re-paid. Then you have a banking crisis.But it gets better.

Commercial banks are allowed to create almost all the money we use. They create it out of thin air and put it into circulation in the form of loans. They credit customers’ accounts by a simple accounting procedure, and their customers spend the money and so put it into circulation.
This bank-account money is the money that all of us, people and organisations alike, have in our bank accounts. It is held in electronic form in bank computers. It is far and away the largest part of the money supply. The rest, less than 5% in the UK is “cash” distributed by the repurchase procedure described above.
So even if no exports are made, it is still possible to buy the output from businesses by borrowing money that others haven’t saved and only exists on a computer disk anyway. So the idea that you need so many savers to fund one borrower is not true. Even building societies, which do engage in fractional reserve but not electronic money creation, can take advantage of it by borrowing money from banks.
Of course, not only can individuals borrow but also governments. In fact they are considered a better risk than individuals and so find borrowing easier (cheaper).
An individual has limited human capital. That is, only a relatively few years over which they can earn income with which to pay off debt. Furthermore, life can be capricious – accidents, unemployment, illness can all befall an individual and reduce that human capital further.
Governments represent states comprising not just millions of individuals but generations of millions of people. Human capital, which is always limited in an individual, is, to all intents and purposes, limitless with a nation and its government.
In May 2006 the UK made the last payment on a post-war loan made by the US to the UK. Two generations, those returning from war and their children, had paid this debt off.
In fact, there are debts that predate the Napoleonic wars. The government is still paying out on these “consol” bonds, because it is better value for taxpayers to keep paying the 2.5% interest than to buy back the bonds.
However, that doesn’t mean things can’t wrong and do. Debt issued by the Russian Tsarist regime in 1913 would not have been honoured by the Soviet regime in the 1920s. Similarly, debt issued by Nazi Germany in 1935 would have been worthless in 1945.
There is always some risk.
The net result is an economy, potentially at least, awash with money and, therefore, the ability to buy goods and services. Now if an economy’s capacity to meet that demand exists the overall effect is that of wealth creation – more goods and services people want (wealth) exist. But if an economy does not have the capacity then inflation will occur as vastly more money chases only slightly more good and services. The answer to this is to bring in more goods and services from outside the economy – imports.
This is the defining issue for an economy, how is debt (fiat, basically valueless money) being turned into real wealth (goods and services people want). And the trade statistics are THE defining issue here.
In 1972 Anthony Barber, Chancellor of the Exchequer in the Conservative Heath government, delivered a Budget which was designed to return the Conservative Party to power in an election expected in 1974 or 1975. He told Parliament in 1972 that his Budget would add 10% to the UK’s growth in two years, and claimed to be unconcerned by his own forecast of a £3.4bn public sector borrowing requirement.
He reduced income taxes by £1bn, and gave further huge tax concessions to industry in order to save jobs. And he relaxed hire purchase (HP) restrictions making it easier for individuals to borrow.
The net effect was to cause inflation and eventually suck in imports as British industry could not meet the demand this released. Demand rose, supply couldn’t match it and with more money available (from borrowing, although at a time when money creation was far more difficult than today) prices rose.
Forty years later nothing of substance has changed and due to the demise of the controlling measure that was Bretton Woods (see Money it’s a gas) is substantially worse.
The following graph shows the UK balance of trade over the last 36 years, from January 1975 to June 2011. It shows that across the decades the only way for the UK to satisfy the demand fiat money creates for wealth is via imports. The really fascinating part is the section from around 1979 to the Lawson boom, the budget of 1988 and the section shortly after the Lawson boom where interest rates rise to dal with the consequences of the boom, see interest rate chart.

Balance of Trade UK 1975-2011

UK Interest rates 1985-2010

In both cases interest rate rises reversed the trade deficit. Choking off demand with interest rate rises reverses the trade balance. Similarly, any increase in demand due to the increased capacity to borrow sucks in imports.
But perhaps the most fascinating part is that the huge trade deficit around 1988-1989 was soon followed by interest rate rises that choked off the demand. So a trade deficit lasting a couple of years at most was quickly reversed. But from 1997 onwards, despite the ever worsening trade balance and the increase in debt levels that implies, the following decade saw no general upward movement in interest rates. The party had started and no one wanted to send the jugglers and magicians home.
This is just another example of the Barber boom of the early 1970s. In fact with the drastic reduction of interest rates in 2008 as a reaction to the global financial crisis, and the practice of quantative easing (effectively printing money and then passing that on to the government by using the money to government bonds – debt) the trade balance subsequently worsened. So why should the UK, and since the US also suffers from this problem of converting debt defined in fiat money into genuine wealth, and the US suffer from this curious phenomena.

You fooled us!
The essence of any piece of magic is for the performer to suspend the disbelief of the audience. When a magician cuts his female assistant (and it always seems to be a female assistant scantily clad) in two we really do know she hasn’t been really cut in two but our eyes tell us otherwise. Couldn’t be that the attractively dressed female draws our attention away from the trick, could it?
Newspaper headlines, commentators and politicians treat Gross Domestic Product (GDP) as being next to godliness. It is a sexy little minx. They speak in admiration of the likes of emerging economies growing at 8 or 9% each year. And with tones usually reserved for a much loved personality that has fallen on hard times when speaking of developed world growth rates of 2% or, heaven forbid, even less. But what is this value that causes such reverence?
It is meant to signify wealth and actually comprises four terms – business investment, consumer spending, government spending and last, but by no means least, the trade balance. Wait a minute. If GDP is meant to be the wealth of a country and fiat money from that country only has meaning when backed by wealth the country produces and the wealth a country produces is either consumed domestically (driving imports down) and or consumed by foreigners (driving exports up) why would consumption by individuals and governments count as wealth when they may be consuming imported wealth? And even with investment, that is only wealth if the investment works out and imports are down and exports up. So only the last term, the trade balance ought to matter. But as the following graph shows you can have GDP growth that elicits praise whilst creating no net wealth, i.e. having a trade imbalance.

Balance of Trade UK 1975-2011

UK GDP 1975-2010

Emo ergo sum (I shop therefore I am)
So if eyes (and minds) are distracted from the real issue – can’t create net wealth – by a sleight of hand with numbers, does this matter? After all this money is only ‘monopoly’ money anyway and doesn’t really matter, isn’t it?
It matters because it represents something more than an intellectual exercise in consumption. It’s about how effective a society/economy is in using its resources.
Businesses are to the economy what a fish is to water. If the water is polluted no matter how resilient the fish it will not thrive. Similarly, with the most fish-friendly water in the world, if the fish is diseased it will not thrive.
Both the UK and US economies are ‘fish’ friendly. Relatively low regulation, inflation not a problem – normally that is, the current UK one looks to have become embedded in expectations as the monetary authorities have sought to paper over cracks in a demand-led economy where demand has become exhausted– an adequate labour force, relatively easy access to capital – again, normally so, banking problems (arising from the management of debt) not withstanding – and property rights enshrined in centuries of law.
So we must pull the ‘scales’ from our eyes and come to the conclusion that there is a fundamental problem with wealth creation in both economies. That they share a common culture, termed the Anglosphere, leads to the suspicion that, at root, it is a cultural problem. But after three years of party tricks with fiat money there is no sign of anyone pulling any rabbits out of any hats and it looks as if the act needs to be retired.

This problem arises due to the banking crisis that erupted at the end of 2007 when the UK government bought £76bn of shares in Royal Bank of Scotland and the Lloyds Banking Group. The suggestion mirrors that of the 1980s when major nationalised utilities were privatised. The privatisation of utilities in the 1980s was for sound financial reasons. The Treasury had been the ‘shareholder’ of these utilities, but a rotten one. The desire for money for governments to spend had meant the Treasury was always happy to take a dividend but not prepared to address the other side of the coin – make an investment. That had reached crunch point and rather than raise taxes the use of private capital was seen as the get out of jail card. Of course, the use of private sector management was also a much needed beneficial side-effect.
To sweeten the package, the public could buy shares at give away prices.
But there is a difference this time. Patently with huge exposure to loss making assets those banks, like the utilities required capital to prevent depositors losing their money (the losses being made good out of capital rather than from deposits) but this time the private sector, not knowing how to price this risk, was not going to play ball. But the way banks works, especially in the modern world, is also a problem.
For a share to have long-term value (and these proposals would penslise anyone selling the shares immediately to enjoy a short-term gain) it has to give the owner the right to a flow of dividends. The sum of those dividends, discounted over time – £1 now is not the same as £1 in a year’s time- is the share‘s worth. Those dividends require the company whose shares you own to make substantial operating profits out of which to pay, in order, bond-holders (loans it has agreed), government taxes and dividends. Note shareholders are at the end of the queue and are the only ones who don’t have to be paid.
When judging the worth of a share the debt a company has matters. Taxes can’t be helped (well in theory anyway) but the less debt the better. For a bank debt is its stock in trade. It doesn’t lend its money it lends other peoples. And that lending comes in all sorts of forms and, as the banking crisis showed, many of them a total mystery even to those who made them. And it is that lending that makes the profits out of which dividends are made and the foundation of the ultimate value of that share.
As part of this exercise of making banks and bankers socially acceptable there are also proposals to ‘ring-fence’ retail banking from investment or ‘casino’ banking.
The de-mutualised building societies were pure and simple retail banks, at least initially. They took in deposits from the high street and lend to the same high treet. The only difference in that mode of operation was Northern Rock that only had a few branches and so relied upon other financial institutions (the wholesale market) for its source of loans. When concerns over US sub-prime mortgages first arose (and they represented only a small part of the overall US mortgage market) because of the complexity of products based on those loans no bank knew which banks were exposed to that loss. In fact many didn’t even know if they were. As a result no one dare lend to anyone else in case they lent to someone who couldn’t pay it back. Well they would lend but at very high rates of interest.
Banks lend to each other at rates specified by the London InterBank Offered Rate (LIBOR). Normally, this trades at a small premium of around 0.15% over where the market thinks the bank base rate will be in three months’ time. In autumn 2007 it was hovering at just over 6%, since bank rate was widely expected to be raised from 5.75% to 6%. But then it shot up to 6.6%, hitting an eight-and-a-half year high of 6.7% on August 31.
Since Northern Rock had outstanding loans to either pay off or re-finance (borrow money to pay off existing lenders) and since it had to borrow it from other banks rather than the public it would have to pay more for its money than it was lending it at and simply couldn’t make the payments.
Whilst none of the other de-mutualised societies had this problem they all had problems due to trying to make profits institutional shareholders required. Not one survives today. It is in the investment-banking field where profits are made and that business requires access to retail capital. And retail capital requires investment banking to justify its existence.
So banks with publicly traded shares have to operate in an esoteric, obscure market where the normal means of valuing a company do not apply.
As far as having a say in how a company operates, most shareholders will tell you that is simple rubbish. So why not simply, pay the money back. Buy back the shares the government owns. Because in an economy like the UK, a demand-led, wealth consuming economy, economic ‘growth’ only occurs when people spend and since they are not creating wealth they have to borrow, or in their absence the government borrows, and if banks have paid off those bailout funds they have less to lend. But consumers can’t borrow for ever and, as the Greeks have discovered, even governments have their limitations, so at or close to the top of the borrowing capacity bad loans are made and banking problems occur. Oh dear.
Looks to me like there are more nuts in Brazil than we suspected.

Money is not wealth, goods and services the market is prepared to pay for are wealth. Money serves two functions.

First it is a means of exchange. If a dentist wants his or her house painted rather than promise to give a painter three annual check-ups in exchange for a painter painting the house, the dentist charges for the check-ups and then uses the money to pay the painter. The painter can then use the money to either purchase dental check-ups or other goods and services.

So goods and services, along with the labour used to provide them, have been exchanged. And not necessarily simply between dentist and painter. So the economy goes round for this month at least.

Its second function is that of storing value. Whereas acting as a means of exchange is a short-term function, money spent in a month coming from income earned in a month, storing value is a long-term function. The act of saving is rewarded by income from the saving; it could be interest off a cash deposit or an income stream from an investment.

That income stream’s value is unlikely to maintain a constant value other than in a world of zero inflation. In deflationary times, it increases in value but the norm is that inflation exists so that stream will decrease in value over time. In any event there is always a risk factor, the further away income is the more at risk from events not yet dreamt of. Interest payments on Tsarist debt may have seemed secure in 1914, by 1917 they were worthless. This is why inflation is bad, it makes only high yielding investments worthwhile and acts, effectively, as a tax on returns. This means the productive capacity of an economy is impacted by reducing investment.

Initially, of course, money was made from precious metals, particularly gold. The invention of paper money was a great convenience as it was only a receipt for gold. At one time British notes contained the phrase ‘I promise to pay the bearer on demand..’, meaning the bank note was effectively a receipt and could be exchanged for gold.

One interesting example of bank notes acting as receipts was the discovery of Operation Bernhard during WWII.
Operation Bernhard was the codename of a secret German plan devised by the Reichssicherheitshauptamt (Reich Main Security Office – RSHA) and the SS to destabilise the British economy by flooding the country with forged Bank of England £5, £10, £20, and £50 notes

As late as the 1940s every banknote issued by the Bank of England was recorded in large leather-bound ledgers, still in the Bank’s archives. The operation taking place was identified when it was noted that one of the notes had been recorded as having been paid off.

The psychological link between a piece of paper and gold was maintained by this promise and paper proved easier to carry rather bags of gold.
This mechanism for linking paper with gold was the gold standard. The money supply of a country was linked to its reserves of gold and so was limited by that reserve.

At various times governments found it necessary to break that link. The UK government during the First World War, after the war it returned to the gold standard only to leave it again during the Depression of the 1930s as it sought to encourage economic activity by printing money. This followed the ideas of the economist John Maynard Keynes, hence Keynesianism.

Towards the end of the Second World War, at Bretton Woods in New Hampshire, a new system of money governance was born. The Bretton Woods system linked the dollar to gold and other currencies to the U.S. dollar.

The chief feature of this system was an obligation for each country to adopt a monetary policy that maintained that exchange rate with dollar. In order to facilitate this the IMF was founded to bridge temporary imbalances of international payments.
The consequence of this was that if a country was running too much of an expansionist monetary policy, printing too much money and so creating excessive demand, this would materialise in its trade balance, sucking in imports whilst goods it made were also being consumed domestically and so not exported. This trade imbalance would then manifest itself in its international payments and its exchange rate with the dollar.
Consequently, money supply expansion would need to be slowed. In other words, a recession engineered.

Frequently, those concerned with aid to poor countries often criticise the IMF for imposing such monetary policies on countries that require bridging finance to cover imbalances. The IMF requires that action in order that demand can be brought back into line with a country’s productive capacity (supply) so that the bridging finance is indeed temporary.

On August 15, 1971 the Bretton Woods system collapsed when the then U.S. President, Richard Nixon, unilaterally terminated the convertibility of the dollar for gold. The political and economic requirements of the post Second World War world made it unworkable. This now broke totally the link between money and gold, Welcome to the world of fiat money.

Money for nothing..
Fiat money is backed by nothing but a promise by governments to be good boys and girls with the country’s finances. Mmmh!
The guardians of this new world were meant to be the ‘bond vigilantes’, the market in government debt or bonds. Governments behaving badly would be punished by having to pay more to service their debt (higher interest payments).

When U.S. President Clinton attempted to increase the US budget deficit in the 1990s, it led to such a sell-off (decreasing prices; increasing yields) of U.S. debt that he was forced to abandon the strategy and instead balance the budget. This led to the famous comment his political advisor James Carville
“ I used to think that if there was reincarnation, I wanted to come back as the president or the pope or as a .400 baseball hitter. But now I would like to come back as the bond market. You can intimidate everybody. ”
However, the bond markets (being human) are not as proscriptive as the price or supply of gold. So a huge global monetary expansion took place.

Bearing in mind money’s psychological, means of exchange, function; this also encouraged a massive explosion in production. People are innovative and money motivates people, so it was only to be expected that individuals would find new ways of getting their hands on money and employ others to facilitate that.

However, it also has the store of value function, which has a long-term element to it rather than the short-term means of exchange that works from one salary to the next or one accounting period to the next. Between 1949 and 1969, global money supply rose by 50%. Between 1969 and 2000, the global money supply rose by an astounding 2,000%.
With so much money floating round it also meant asset prices rose – most notably shares and property. Holding cash as an asset, which was constantly being undermined by there being more and more of it, meant other, less easily fabricated, assets needed to be held.

So, the housing price explosion and stock price rises over the last 30 to 40 years now has to face the consequences of a financial world where money supply is unlikely to rise at previous rates. Why should this be so?

The global banking crisis is focused on the ability of banks to lend by using complex financial products and managing the inherent risk with even more complex mathematics in order to generate the necessary funds. That lending was then also managed by similar risk management techniques. The overall effect was to generate an environment where lending and spending were of no great import. And the means to carry out this was an ever degradation in the value of money and the need to find an alternative means of wealth storage – hence the rise in asset prices such as property and equities. The consequence of the global banking crisis will be to be less cavalier with lending and therefore the money supply growth will be less dramatic than in the past.

That isn’t to say a return to the gold standard or even Bretton Woods, in so far as a currency being linked to gold, but a return to a Bretton Woods MKII. This time the linkage of a currency not to gold but to something that would warm the cockles of a bond vigilante’s heart – the Euro operating under a German mindset.
The housing market is driven by lending. Few people can pay for a property outright they have to have a mortgage. If lending is more difficult then borrowing is more difficult and the housing money supply reduces or at least grows far less quickly than in the past. Therefore house prices grow less quickly and lose their ability to be a store of value.

However, shares are a function of genuine wealth creation. Not all shares of course but overall they represent the overall production of wealth. Of course, companies may not share all their wealth with stakeholders. Companies in a global world are able to ‘negotiate’ the tax they pay to governments. They are certainly able to manage their wages costs and so negotiate how much of the created wealth goes to employees. Wage costs being managed down also means that individual lending becomes even ore difficult, adding to the downward pressure on real house prices.
Whilst shareholders frequently fail or are unable to pressurise company management into paying appropriate dividends they do have two advantages the previous stakeholders do not.

First, any retained earnings can be re-invested to create more wealth. Although there is no guarantee that investment will produce more wealth the probability is that it will.
Secondly, having a cash pile is both good and bad. Good in that the company may decide to finally share that investors via share buy backs. Good in that it becomes a takeover target for another company. Bad because it may seek to takeover other companies rather than achieve organic growth. And the track record on company acquisitions is very bad. However, such a move always leaves the shareholder free to sell the shares.
Of course, companies finance themselves by means other than shares. Corporate bonds have the advantage of being top of the list receive payouts, even before governments, and those payouts are mandatory. Companies can’t treat bondholders in the same way as shareholders – making payments as when they see fit.

So the other side of the financial crisis should look like one of reduced growth due to money supply tightening. The traditional store of value in property falling away but companies as a store of value remaining the same.
Share prices have been historically driven over the long term by such institutions as pension funds fuelled by contributions from employees matched by employers. If wage costs continue to be managed down those contributions are also managed down and the upward pressure on shares reduces. But bonds, with their more secure revenue streams, look a much more attractive option than shares where capital gains were always the most attractive feature.

I only caught part of one little ‘show’ but it was very interesting. Basically, it was the age-old female genes seeking male genes show. An attractive, no great beauty but attractive, 20-something woman (I guess) was ‘upset’ that her 20-something (I guess) male ‘partner’ may have been having sex with other women. Which, of course, he was.

He in turn made similar claims about her, which were not totally ill-founded.

Kyle was berating both of them for not understanding what a relationship was. Quite natural, after all he does have ratings to consider and moral outrage never lost an audience.

Of course, economics and its biological equivalent – evolutionary psychology – tells us all we need to know really.

English society, and most likely others too, is three-tier cake. The top (the smallest section) and bottom (the largest) tiers are rule breakers whilst the middle is rule observant. The rich can afford not to observe the rules and, in any event, they are most influential in making them so there isn’t that many they need to break. Those at the bottom are obliged to break the rules in order to survive as the rule makers need and have always needed a large number of workers to do the every day jobs that, if not done, make life intolerable. But the top tier is not sufficient in number to control the bottom tier so they have the middle tier – the rule observers. Of course, by being rule observers they not only seek to control the bottom tier but, by definition, themselves as well, on behalf of the top tier – the real power in any land. In this way society works, always has worked and, in all probability, always will work.

The main rule by which means rule observation works is to observe the main rule – repeat, parrot fashion, that which you have been told. That is, to pass an exam. The public examination system, introduce into England in the mid-19^th century, provides access to large organisations. In other words, it mirrors their hierarchy.

That access provides financial reward that finances a lifestyle, which, in keeping with the concept of ‘rule observation’, has a rule-based approach to it – get married, buy a house with a mortgage, fund a pension, have children in a stable relationship. This is a highly effective way to obtain a stable lifestyle, it will have its ups and downs (some of the downs being quite deep) but it is, generally, very stable.  The key factor is that of stability in the relationship. The young man and woman on the Kyle show were being berated by Kyle for the lack of such an approach to life. The attraction of the young man was fairly obvious; he had a straight face typical of a testosterone well-endowed male. In addition, his success with women made him even more attractive to the young woman as this confirmed, at a sub-conscious level, the worth of those genes. So the young woman faces a dilemma, the man she has identified as being genetically desirable is desirable by others and, therefore, has the incentive to exploit that attraction. But that value in the genetic marketplace makes him unsuitable for the long-term objective, bringing a child to maturity. He is likely to pursue his genetic prowess elsewhere and a human child is both nature and nurture..

Of course, as I have already said, Kyle may be reacting genuinely or merely expressing the attitude of his audience both on TV and in the studio. And if the studio audience is typical of his audience in general, a scan of the audience seems – on the occasions I have seen it – to be overwhelmingly female, then relationships matter to women. But we already know this to be so from the popularity of ‘soap operas’ (or continuing dramas as they are now known), where pseudo-relationships form the plot lines. So why should women be more interested in relationships than men?

Human beings are mammals but do not give birth to a coherent human being. A dog or a cat will give birth to young that within 12 months are quite capable of fending for themselves. This is not the case with a human being. Walking upright, narrow hips, with a large brain, large head, necessitates that women give birth to immature, in the sense of being independent of the parents, individuals. It is unimaginable that a 10-year old child, much less a one-year old child, would be able to support itself. Indeed, only part of the environment humans inhabit is ‘natural’, they also inhabit a manufactured world called society.

In fact this dependency seems to be getting longer. Within the last 20 years we have seen in the UK a larger and larger number of young people, particularly young men, stay with their parents well into sexual maturity. Sexual maturity being, for most animals, the point at which parental ties are broken

http://www.guardian.co.uk/society/2009/dec/08/young-adults-living-parental-home-ons

The interesting point behind this news story is that the number of young men living with parents is twice that of young women. I just wonder how many of those young women have children and are living in social housing..

We know two things about men and women, other than the obvious genitalia issues, women earn less than men, more males are born than females and women can give birth. So to have twice as many women leading independent lives, that is independent of their parents, is extraordinary. I suspect we have here a condition where the state is acting as breadwinner.

My mother, born in 1920 and pre-welfare state, used to tell me that her mother, a miner’s wife, had a truism – any fool can make a baby takes a man to keep one. But that was pre-1945 and pre-welfare state. Pre the state as breadwinner.

Now, the young woman on the Kyle show had no children from this man and was simply willing to give this man access to her body, which, in an age of contraception and terminations, is not the same as access to her genes.

It is only supposition, but using the McClean triune model of the brain we can see that the sub-conscious attraction, the mammalian limbic part of the brain, of this man’s genes might well be counter-balanced by the cortex, almost uniquely human, which recognises that, long-term, this individual is plain useless. So whilst access to the female body maybe be driven by hot sexual attraction (limbic) the nagging reasoned doubt of suitability (cortex) may deny access to genetic material – she is happy to have sex but not get pregnant.

Of course, as economics teaches us, individuals pursue their objectives logically, So becoming pregnant by one, genetically well-endowed, man and having the child raised by another, reliable, man makes perfect sense. After all, it’s a wise child that knows its father.

Economics also describes opportunity costs. In a given market, where consumers have large amounts of the means of exchange (money), the price of commodities rise.  This was first recognised by Milton Friedman  – Inflation is always and everywhere a monetary phenomenon in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output.

The case of Vanessa Peroncell and Wayne Bridge serves as testament to this.

As can be seen from the photograph below, Ms Peroncell is an attractive women. She has the natural attributes of  attraction, a curvy shape and round face indicative of being fertile and able to bear children. However, and with no direspect, not a great beauty.

Mr Wayne Bridge, a professional footballer, has many desirable attributes. Patently good genes, as a professional sportsman, and the earning capacity that puts him in the mega-attractive range. So for Ms Peroncell to be willing to allow access to her genes, she is the mother of Mr Bridge’s son, requires both significant  genes and money supply.  The ‘cost’ of access to Ms Peroncell’s genes is vastly out of proportion to their value (as indicated by her physical appearance) as a result of the supply of money. She produces no more eggs and those eggs are not of a better quality but command a higher price due to the money supply in her ‘economy’ (her social circle being highly paid footballers) – i.e. inflation.

So in the environment in which Ms Peroncell operates, a lingerie model and VIP hostess, the Friedman analysis is all too evident.

The above may seem like mere philosophical meanderings; but no. Wthout the middle class core society implodes. There is nothing to keep the three-teired cake in place, the middle tier being at its centre. Without young middle-class men able to meet the ‘costs’ of access to the genes of young women (women look for men of at least the same status as themselves) then the middle-class, rule observing family diminishes in numbers.

Rule observation is at the heart of any society, without rule observation there is no society, and no one observes rules or causes rules to be observed as well as the middle class.

With a dearth of jobs for those who have observed the educational rules (pass exams, go to university – and become indebted, get a good job) such that they are unable to demonstrate the value of such rule observance – nice wife, nice children, nice mortgage nice pension – all funded by a regular wage, the value of rule observance begins to collapse and society with it.