Blyth Warns Eurozone Austerity Protects Banks, Shrinks Economies

布莱斯警告：欧元区紧缩政策保护银行并导致经济萎缩 在相互关联的经济体中大幅削减公共预算会导致国民产出萎缩，并推高债务与GDP的比率，以此吸收有毒的私人银行债务。 Mark Blyth剖析了紧缩政策的思想基础与政策实践，认为2008年后的财政危机是由私人银行过度放贷和救助造成的，而非过度的公共福利支出。他指出，合成谬误使得相互关联的经济体削减开支的做法适得其反，不可避免地导致GDP萎缩并推高债务与GDP之比。Blyth追溯了从洛克（Locke）、休谟（Hume）到博科尼学派（Bocconi School）300年来自由主义经济学对公共债务的怀疑史，阐释了紧缩政策在历史上如何加剧大萧条和法西斯主义抬头等灾难。最后，通过详尽的国际案例研究，他评估了金融抑制、财富税以及冰岛处理银行破产模式等替代路径。 Mark Blyth认为，2008年后的公共债务危机并非源于过度的福利开支，而是在杠杆率超过40倍的机构倒闭后，私人银行业债务被社会化所导致的。 (2:51) 同时推行开支削减会引发宏观经济上的合成谬误，即总需求萎缩会降低国家GDP并推高债务与GDP之比，而非使其趋于稳定。 (22:10) 20世纪30年代德国和日本的历史先例表明，极端的通缩性紧缩政策直接加剧了政治激进化，并导致自由民主体制的崩溃。 (34:44) 基于德国秩序自由主义的欧元区结构性框架在数学上是不可行的，因为若没有国内需求驱动的对应赤字，所有成员国不可能同时实现出口顺差。 (41:10)

Political economist Mark Blyth argues that austerity is a dangerous, ideologically driven economic fallacy that misdiagnoses a systemic private banking crash as a crisis of sovereign overspending, resulting in self-defeating budget cuts that shrink national economies. The Banking Carry Trade and the Sovereign Debt Myth (13:22) Blyth rejects the conventional narrative that bloated welfare states or reckless southern European borrowers caused the post-2008 debt crisis. Instead, he traces the crisis to an enormous carry trade executed by core European financial institutions. Prior to the crash, major banks in Germany, France, and Britain cleared safe sovereign bonds from their books to chase yield on peripheral debt (such as Greek, Spanish, and Portuguese paper), juicing returns through extreme leverage reaching up to 40-to-1. By 2011, French banks held peripheral exposures equivalent to more than 33% of France's gross domestic product, while the standalone balance sheet of the Dutch bank ING swelled to 211% of Dutch GDP. When these leveraged real estate and sovereign bets soured, the ensuing bailouts socialized private financial liabilities onto public balance sheets. In Blyth's view, political leaders orchestrated a historic bait-and-switch: private banking sector losses were transferred to the state, and the resulting sovereign debt spikes were dishonestly blamed on public sector profligacy, leaving ordinary citizens to pay the bill through gutted public services. The Eurozone Straitjacket and the Fallacy of Composition (22:10) Austerity fails due to the fallacy of composition: what might seem prudent for an individual household is catastrophic when applied to an entire economy, because one actor's spending is another actor's income. Cutting government spending in a synchronized downturn reduces national output faster than it amortizes debt. Blyth demonstrates this mathematically: if public expenditures are halved during a slump, the denominator (GDP) shrinks while nominal debt stays flat, causing the debt-to-GDP ratio to escalate rather than fall. This was demonstrated when simultaneous global cuts in the 1930s caused debt ratios to soar and created fertile ground for political extremism. This structural trap is uniquely severe within the Eurozone, which institutionalized German ordoliberalism across diverse economies. Because Germany's persistent export surpluses mathematically require counterpart trade deficits in other member states, demanding that peripheral nations simultaneously slash wages and emulate Germany's export model is an arithmetic impossibility. Lacking national printing presses, currency devaluation tools, or a central bank authorized to mutualize debt, peripheral countries were locked into destructive internal devaluations until European Central Bank President Mario Draghi halted panic by pledging to do 'whatever it takes.' The Intellectual Failure of Expansionary Austerity (44:48) Blyth links modern austerity doctrines to early liberal thinkers like John Locke, David Hume, and Adam Smith, who viewed state borrowing with deep suspicion and feared the crowding out of private capital. This skepticism culminated in Alberto Alesina's theory of 'expansionary austerity,' which claimed that aggressive government cuts stimulate growth by restoring market confidence. Proponents argued that rational citizens, anticipating future tax reductions resulting from current spending cuts, immediately increase their consumption. Blyth ridicules this logic through the scenario of an insecure worker rushing out to purchase an Ikea couch to cure a national recession. This intellectual consensus crumbled under empirical scrutiny. The International Monetary Fund subsequently acknowledged that fiscal multipliers in the European periphery sat between 1.5 and 1.7, meaning that every dollar cut from public budgets destroyed up to $1.70 of economic output. The academic foundation suffered another blow during 'Excelgate,' when spreadsheet errors were uncovered in Carmen Reinhart and Kenneth Rogoff's study that had purported to prove economic growth stalls once debt-to-GDP crosses a 90% threshold. Alternative Resolutions: Financial Repression and Wealth Taxation (48:20) Rather than inflicting economic contraction, Blyth points to historical precedents for resolving sovereign overhangs. Following World War II, the United States utilized financial repression, using regulatory mandates to require domestic banks to hold sovereign bonds while central banks maintained low nominal yields alongside moderate inflation. This engineered negative real interest rate liquidated debt equivalent to 40% of US GDP within a decade, without halting economic expansion. Blyth also advocates directly taxing concentrated private wealth and cracking down on offshore tax havens, which house an estimated $27 trillion in untaxed assets across five primary jurisdictions. Finally, Blyth warns that preserving mega-institutions under 'too big to fail' doctrines creates severe moral hazard. Megabanks have grown larger and more concentrated since 2007, leaving governments vulnerable to systemic extortion unless financial concentration is dismantled. Blyth concludes that democratic welfare institutions serve as essential insurance for wealth and property, and that starving them through austerity undermines political stability. However, the analysis leaves unresolved how peripheral Eurozone nations can regain competitiveness without sovereign currencies, and whether global regulators can practically implement financial repression and tax harmonisation across competing jurisdictions.

[36:58] Mark Blyth: Redistribution of debt is reinsurance for democracy, and austerity is anorexia for the economy. [44:48] Mark Blyth: Cutting in a slump produces a bigger slump. [36:58] Mark Blyth: Democracy is asset insurance for the rich. [0:00] Mark Blyth: I wrote this book for the following reason—I got really, really pissed off with people with lots of money telling people who don't have any money they need to pay shit back.

[0:00] BORIS DEBIC: Welcome everybody. [0:02] I am extremely pleased to welcome today Mark Blyth. [0:07] Mark Blyth will share with us his insights into austerity as [0:13] it takes shape in the European Union. [0:17] Let me read a little bit from his biography. [0:20] Mark Blyth is a faculty fellow at the Watson Institute, [0:24] professor international political economy in Brown's [0:27] political science department, and director of the [0:29] university's Undergraduate Programs in Development [0:33] Studies and International Relations. [0:36] He's also the author of "Great Transformations-- [0:39] Economic Ideas and Institutional Change in the [0:42] 20th Century." [0:43] He's the editor of the "Routledge Handbook of [0:46] International Political Economy," co-editor of a [0:50] volume on constructivist theory on political economy [0:53] titled "Constructing the International Economy," and [0:57] he's working also on a new book that questions the [1:00] political and economic sustainability of liberal [1:03] democracies, called "The End of the Liberal [1:06] World." That's dramatic. [1:10] Blyth is a member of the Warwick Commission on [1:12] International Financial Reform. [1:14] He is a member of the editorial board of the "Review [1:17] of International Political Economy." And his articles [1:21] have appeared in journals such as "The American Political [1:25] Science Review," "Perspectives in Politics," "Comparative [1:29] Politics," and "World Politics." He has a Ph.D. in [1:32] political science from Columbia University, and [1:35] taught at Johns Hopkins University from 1997 to 2009. [1:41] Please give a hand to Mark Blyth. [1:43] MARK BLYTH: Thank you. [1:45] Cheers. [1:50] Is this mic on? [1:51] Yes? [1:51] Can you hear me? [1:52] Hello? [1:52] Right. [1:54] So I have a Scottish accent. [1:55] There's surprise number one. [1:58] And those slides started to change themselves, which is [2:00] surprise number two. [2:02] OK, how am I going to start this? [2:06] Why did I write this book? [2:07] I wrote this book for the following reason-- [2:09] I got really, really pissed off with people with lots of [2:11] money telling people who don't have any money they need to [2:14] pay shit back. [2:16] That's basically it. [2:17] I grew up on the butt end of the British welfare state. [2:20] I'm an orphan, and I was raised by my paternal [2:22] grandmother. [2:23] So I am the greatest living example of inter-generational [2:26] social mobility you're ever going to see, because I'm a [2:29] freaking Ivy League professor. [2:30] So I went from there to there. [2:32] How did I do that? [2:33] Because of this thing that gets blamed called the welfare [2:36] state, that bloated, paternalist, out of control, [2:39] incentivizing, demotivating piece of crap called the [2:43] welfare state. [2:44] Now, why is this a completely bullshit story? [2:47] Well, that's not, but why does it turn into a bullshit story? [2:49] It turns into a bullshit story for the following reason-- [2:51] back in 2000, the number one concern of financial markets [2:54] globally was there wasn't going to be enough federal [2:56] debt, because we had balanced the budget. [2:59] Seriously, the number one concern was there wouldn't be [3:01] enough T-bills. [3:02] So fast-forward 13 years, ah, we're all freaking out. [3:06] Now, in between, a couple interesting things happened. [3:09] So you have a balanced budget, which basically means over [3:11] time, as the economy grows, your debt [3:13] stock is going to shrink. [3:14] And that's why people had a problem with it. [3:16] So you're going through a period of rapid growth. [3:17] This was the tech boom period, all this sort of stuff. [3:20] And then there's 9/11. [3:22] So there's a little dip in the economy and a guy called [3:24] Greenspan comes along and says, let's cut interest rates [3:26] and essentially do asset protection for everybody who [3:29] has bought assets by giving them more or less free money. [3:31] So then we decide on top of that we're going to [3:33] have two tax cuts. [3:34] Why? [3:34] Because we just need more money. [3:36] Screw it. [3:36] We're just going to do it. [3:37] Let's have some tax cuts. [3:38] No corresponding way of paying it off, or whatever, we'll [3:41] just take the tax cuts. [3:42] And then we'll decide to fight two wars of choice for dubious [3:45] political reasons without raising any taxes. [3:47] That'll be a good one. [3:48] So by the time you get to 2006, there's [3:50] 61% debt to GDP already. [3:53] I don't remember anybody in Congress, particularly [3:55] Republicans, jumping up and down about the crazy level of [3:57] federal debt in 2006. [4:00] And then in 2007 and 2008, there's a [4:03] run on the repo markets. [4:04] Basically, the hidden story of the financial crisis that [4:06] nobody really talks about-- it's actually quite simple-- [4:08] is that because there was a shortage of T-bills, because, [4:11] in fact, many of them were in China, because they keep [4:13] buying a lot of them, we started to use AAA mortgage [4:16] products as collateral for short term financial deals in [4:19] the repo markets. [4:20] As the housing crisis happened, those bonds that [4:23] made up those instruments fell from AAA to B to C. [4:27] At that time, that meant that if you were a heavily [4:29] leveraged financial organization-- a Bear Sterns, [4:31] for example-- [4:32] and you were using these things as pledges and as repo [4:35] collateral, as they fell in value, you had to use more and [4:38] more of them to borrow the same amount of money. [4:40] Unfortunately, you couldn't do that, because there's a fixed [4:42] stock of the assets. [4:43] And they're hugely levered. [4:44] This meant a 3% return against their asset base, rendered [4:47] them effectively insolvent. [4:48] Once everybody figured this out, you shout fire in a [4:51] crowded theater, everybody freaks out, [4:53] heads for the exits. [4:54] You get a liquidity crunch. [4:55] You've got a financial crisis. [4:56] We decided to bail out the system rather than let it [5:00] fail, because it was too big to fail. [5:02] The costs of doing so were basically a 30% drop in tax [5:06] revenue across the OECD countries, because the [5:08] financial sector had become so big, particularly in the [5:10] United States and the United Kingdom, that it was [5:12] generating huge amounts of taxes. [5:14] At the same time, the economy slows down as the liquidity [5:16] crunch hits the real economy and affects lending and [5:18] borrowing and spending. [5:20] Consumer expenditures trend down, as do consumer [5:22] expectations, as do investment expectations. [5:24] You get caught in a slump. [5:26] Once you get caught in a slump, automatic transfers in [5:28] the economy mean that benefits go up at the same time as tax [5:31] revenues go down. [5:32] So you're going to have a bigger deficit. [5:34] As you have a bigger deficit, you multiply that over time, [5:36] you issue more debt, you go from 61% to 100% debt to GDP. [5:40] That's why we're here. [5:42] There was no orgy of public spending. [5:45] It's a lie. [5:46] I take Amtrak every day. [5:48] I would've noticed an orgy of public spending. [5:50] If there was an orgy on public spending, it was on asset [5:53] protection and income protection for the people who [5:56] had made out with the most for the past 30 years when we [5:59] bailed out those assets. [6:00] That's actually what happened. [6:02] Now, here's the inequity of the [INAUDIBLE] in this whole [6:04] thing-- why is it that social security, which isn't even [6:07] part of federal budget calculations on the deficit, [6:09] which, by the way, has a $2.3 trillion surplus, that has to [6:13] be cut so we can pay back the debt accrued by bailing out [6:16] some of the richest people in our society and [6:19] ensuring their assets? [6:20] Does anybody else think that's total horse shit? [6:22] Because I really do, and that's why I wrote this book. [6:25] Now, here's the weird thing. [6:27] We're actually not in that much of a mess. [6:29] It's been a sticky recovery. [6:30] It's been a technological shock to a lot of service jobs [6:33] that we didn't expect, et cetera. [6:34] But nonetheless, we haven't been cutting them. [6:36] Because of that, the federal deficit's projected to be [6:38] around 3% next year-- [6:40] even with a margin of error in the projection, say 4%. [6:43] Britain has its own currency, like us, and has been cutting, [6:47] been doing austerity. [6:48] Having done that, it's now looking at 7%, totally [6:51] [INAUDIBLE] [6:52] growth, and a possible triple-dip recession. [6:54] Europe has been cutting like there's no tomorrow. [6:57] They've got the leaches on the corpse and they're [6:59] opening up the veins. [7:00] Greece has lost 30% of GDP in four years. [7:03] The German army didn't manage that between '41 and '45. [7:08] That's how much damage has been done by this. [7:11] So the question is the following-- [7:12] why is it that Europe, particularly the European [7:15] Union, the part that we think of as the most kind of, if you [7:18] will, welfare-statish-friendly transer, et cetera, suddenly [7:22] became this huge doomsday device for this enormous [7:24] experiment on austerity, which so far has cost around 30% of [7:28] GDP in the periphery and has generated 25 million extra [7:32] unemployed in comparison to the United States? [7:35] Seems like something to investigate. [7:38] So, there's a standard picture of Europe in terms of its [7:40] fiscal balances. [7:41] As you can see, the United States around here, 2012. [7:44] By the way, always look at the net figure, because if you [7:46] look at the gross figure, that assumes [7:48] that nobody pays taxes. [7:50] And given that we all just wrote checks just a little [7:52] while ago, that would tell you that you really shouldn't look [7:54] at that one. [7:55] It also it seems the country has no assets. [7:57] And if that's the case, why do we have the National Security [7:59] Investment Act to stop people buying assets? [8:03] So obviously, look at the net one. [8:04] So you look at the net one, where are you? [8:06] Well, basically, everybody's kind of in the [8:07] mire, more or less. [8:10] So what brought about this fine mess? [8:12] Age check in the room. [8:13] Anybody who's giggling now is over the age of 40. [8:17] On the left, we have Laurel and Hardy, and on the right, [8:20] we have Angela Merkel and Sarkozy. [8:22] There we go. [8:23] I put that in purely for comedic values, just to make [8:26] sure everyone is paying attention. [8:28] And actually, they did bring about this fine mess, so that [8:29] is a serious point. [8:31] So what's the story here? [8:32] Well, there's an official story. [8:33] It's what I call story one, and this is the sort of [8:35] vaguely sophisticated version that you get if you read [8:38] things like "The Economist," "The Financial Times," et [8:40] cetera, et cetera. [8:41] And I'm going to tell you why it's total crap, because it's [8:43] not really true at all. [8:44] So there's story one and story two. [8:46] So here's the official story, story one. [8:47] You do this by looking at this. [8:49] This is interest rate convergence over [8:50] 10 year bond spreads. [8:52] So if you go back in the day before there was this thing [8:54] called the Euro, when everybody had their own [8:56] currency, if you were buying a bit of Greece on 10 years, [8:59] there's a 25% risk premium you're getting paid for [9:03] holding that. [9:03] That means that basically there's a one in four chance [9:06] they're going to default. [9:08] Why would you price that in? [9:09] Well, because they haven't run a budget surplus in 50 years. [9:13] Because they've been taking turns to steal the state and [9:15] using other people's rents and revenues to do it since they [9:18] basically ended the Civil War, so why would you not price [9:22] this at 25%? [9:23] Then have a look at the French, the Italians, the rest [9:26] of the Mediterranean, it's strained around 15%. [9:28] This whole [INAUDIBLE] in here, over 10%. [9:30] That's a lot. [9:31] You're getting paid a lot for just holding a 10 year debt. [9:34] Now, that reflects the real price of the bond, the real [9:37] risk of default that's in the bond. [9:39] Now, the official story goes like this-- [9:41] around 1991 there was this wonderful treaty called the [9:43] Maastricht Treaty. [9:44] Well, that's '86. [9:45] '91 is the Monetary Treaty. [9:47] And we decided that we're going to build this monetary [9:49] union in Europe. [9:50] And what did that mean? [9:51] It meant basically that you're going to have this German bank [9:54] called the Bundesbank generalized [9:56] across the whole area. [9:57] All the people that currently have inflation and exchange [10:00] rate risk and default risk no longer will have it because [10:03] we're going to take away their printing presses. [10:05] And once we've locked up all the printing presses in the [10:07] one time deal and given them to a guy in Frankfurt, and [10:10] he's the only one who can print the money, well, [10:12] basically doesn't that mean that Greece becomes Germany? [10:15] Doesn't that mean that Italy becomes Germany? [10:16] Because after all, they can't inflate [10:18] their way out of trouble. [10:19] So you get rid of that risk. [10:20] You can't devalue your way, which is a backdoor way of [10:23] solving the same problem. [10:24] All you can either do is deflate-- austerity-- [10:27] which is politically unpalatable, or you basically [10:30] sort your economy out and everybody kind of becomes [10:32] German, and that's the great plan. [10:34] And you can see how this is represented [10:35] in this risk premium. [10:36] There's where the Euro comes in. [10:38] And then there's a 7 and 1/2 year period where basically [10:41] all of these countries-- think about how diverse this is-- [10:43] everyone from Belgium to Italy to Greece to Spain to Portugal [10:47] have basically got exactly the same default risks. [10:50] Now, that's kind of odd if you think about it for more than [10:52] two minutes. [10:53] So what's behind this? [10:55] Well, the story goes like this. [10:57] Basically, what's undermining this-- if you go back to the [11:00] end here and you see where the spreads go up right, why does [11:02] it all start to go wrong? [11:04] Well, if you have a look here, your current account and [11:05] balances, exports and imports. [11:07] And you'll find that what you've got here is most [11:09] countries in the Euro, the major countries, are basically [11:12] running deficits all the way through. [11:14] And the only one that starts to run a surplus here is [11:17] Germany, which picks up just as the Euro comes in and [11:20] becomes the export powerhouse. [11:22] Now, when you control for the size of the German economy [11:24] relative to everybody else, what you begin to realize is [11:27] that their surplus is the counterpart [11:29] everybody else's deficit. [11:30] In other words, somebody has to buy all those BMWs. [11:34] And if you're buying all those BMWs, you're not making your [11:36] own [INAUDIBLE] [11:37] and selling them back to the Germans. [11:39] So you start to get these current account imbalances. [11:41] But that begs the question-- [11:42] where did all these guys in the south get the money to buy [11:44] the BMWs in the first place? [11:46] Well, that's your story about lax public finances. [11:49] This is these countries that are spending too much. [11:51] So look, it's the PIGS-- [11:52] Ireland, Spain, Greece, Portugal. [11:54] The Netherlands we'll put in a bracket, right? [11:56] But basically, look-- a huge amount. [11:57] That's 10% year on year annual growth of government [12:00] expenditure. [12:00] They are spending like drunken sailors, there's no doubt [12:03] about this. [12:05] Now, what made this possible? [12:06] As I said before, this is the ECB, being Deutschbank Uber [12:09] Alles, taking inflation and devaluation [12:11] risk off the table. [12:13] And also, the Maastricht criteria for Euro gives [12:16] credible rules against sovereign misbehavior. [12:19] You can have a 60% debt load, 3% deficit, [12:22] and variable inflation. [12:23] And as I said, the yields converge, and the countries [12:26] over-borrow. [12:27] As we saw in those last three slides, they're basically [12:29] spending too much money. [12:31] But then what does that do to your competitiveness? [12:34] Well, it's going to obviously hit your competitiveness. [12:36] If you're spending that much money and you've got a huge [12:38] trade imbalance, you've got to be basically awarding yourself [12:41] way above productivity wage increases. [12:43] And look at what you've got. [12:44] Ireland, Spain, Italy, Greece, Cyprus, Malta, Portugal. [12:48] The PIGS again. [12:49] And look at these massive labor cost changes over the [12:51] last 7 year period. [12:53] You're awarding yourself pay increase you [12:54] can not hope to cash. [12:56] So this is all a very convincing story, right? [12:59] And what made this possible? [13:00] Well, of course, what made it possible is cheap debt. [13:02] Because as those yields [13:04] converge, look what's happening. [13:05] Portugal is borrowing. [13:07] Spain is borrowing. [13:08] Greece is borrowing. [13:08] Ireland is borrowing. [13:09] Look who's actually in surplus. [13:11] The Germans and the Netherlands. [13:13] So their savings are financing their consumption. [13:16] So these countries have massively over-borrowed. [13:19] With the take-home being the southern countries have [13:21] borrowed too much. [13:22] Now, have a look at this network diagram. [13:24] It's kind of interesting, because there's a question [13:25] mark there for a reason. [13:27] There's Portugal. [13:28] Relative sizely economy 123 billion euros. [13:31] Spain, 345. [13:33] Italy, very big-- nearly half a trillion. [13:35] But pretty much all of their bonds are domestically held. [13:38] 60% are long-term domestic. [13:40] The ones that are 10-year rollover escalate by 10%. [13:43] Look at this. [13:44] Look who's popped up here, with a trillion dollars of [13:47] crap assets lying on their balance sheet. [13:49] It's the Brits, the world's largest financial entrepot. [13:52] And look who's up here. [13:54] It's those prudential Germans, who save a lot and tell [13:57] everyone to upgrade their scales. [13:59] They've got half a trillion of debt going on. [14:01] So what do you mean the southern countries have [14:03] borrowed too much? [14:05] There's a rather large problem with this story. [14:07] You can't have over borrowing with over lending. [14:11] This is actually a Citibank advertisement. [14:15] Some of you who are over the age of 16 may remember this. [14:18] The largest ever advertising campaign for a finance company [14:22] in the world was Citi's campaign, "live richly," from [14:26] 2003 to 2006. [14:28] It didn't invite you to save up money. [14:30] It didn't invite you to be prudential. [14:32] It said live richly. [14:34] It didn't even say be rich. [14:37] You kind of have to have rich before you spend it unless [14:40] you've just got a giant line of credit. [14:43] So let's run that story again. [14:46] Here's the greatest moral hazard trade in human history. [14:48] Remember the whole story I told you about the ECB and [14:50] credibility and all the rest of it? [14:52] Here's why it's complete horse shit. [14:53] Because what actually happened was this-- [14:55] I'm a large European bank. [14:57] I know that I've got a sovereign behind me that, if I [15:00] become really big, I'll become too big to fail. [15:04] Which basically gives me a license for doing whatever the [15:07] hell I want because then it will all be bailed. [15:09] It gives me a funding cost advantage, and it means that [15:12] basically I can lever up well beyond human reason with [15:15] pretty much no consequences. [15:17] And the more powerful I become, the bigger threat I am [15:19] to that sovereign. [15:21] And eventually, if the sh-- hits the fan, well, you know, [15:23] I'll get bailed out. [15:23] It's totally fine. [15:24] So imagine I know there's this thing called the Euro coming [15:27] in, and you're all other European banks, and you know [15:31] that you could earn a nice little bit of coupon buying [15:34] this Greek bond at 25%. [15:36] There aren't that many of them-- it's a [15:37] thinly traded market. [15:38] But if you can get it, if you lose, fine. [15:40] But the upside's great-- [15:41] 25%. [15:42] Now, what happens if everybody really believes this Euro [15:45] story and everybody starts to converge down? [15:47] Well, I'm going to make less and less money on [15:49] those bonds over time. [15:50] So a quick bit of math up in your head. [15:53] How would you make even more money on a declining spread? [15:56] You've go to use volume, you've got to use leverage. [15:59] So what you do is you basically get the balance [16:01] sheet of your bank and you cram it with as much periphery [16:04] debt as you possibly can. [16:05] You take all your nice, safe German, Dutch bonds and you [16:08] throw them out. [16:09] And you pile on as much Greek debt and as much Portuguese [16:11] debt and as much French debt as you can. [16:14] And you turbo charge that, running operating leverage of [16:16] around 40 to 1, which means your equity cushion is less [16:19] than 3% percent of your asset footprint. [16:22] You make Lehman Brothers look like a prudentially run [16:25] organization. [16:27] And you do this because you've got a guarantee. [16:29] The guarantee is the state. [16:30] The state will come and rescue you. [16:31] You get in trouble, you're fine. [16:33] Except there's a slight flaw in the plan. [16:34] What happens when the Euro comes in? [16:37] You have to give up your printing press. [16:38] So that means your state can't bail you out anymore. [16:41] Well, that's even better. [16:42] Because then I become a systemic risk. [16:44] I'm not just a risk to France, I become a risk to the entire [16:48] European banking system. [16:49] Score! [16:50] I've got the ECB over a bottle. [16:52] I can do whatever I want because they're going to have [16:54] to bail me. [16:55] Except it's run by Jurgen Stark and a bunch of Germans. [16:59] And they're not going to bail you. [17:01] So when the shit hits the fan, you've got a really, really [17:03] big problem. [17:04] Which is where we are now. [17:07] Core banks get stuffed with periphery debts gone bad, a [17:09] result of over landing. [17:11] Foreign banks consolidated claims on Greece, Ireland, [17:13] Italy, Portugal, and Spain in 2011, last time they published [17:16] any reliable figures. [17:18] French banks have over 33% of GDP equivalent on their [17:22] balance sheets in periphery assets that aren't coming back [17:25] anytime soon. [17:26] Add in the Spanish real estate loans they've got on there-- [17:29] run. [17:30] And you have a SocGen account. [17:34] Netherlands, one bank, ING, 211% of GDP [17:38] is its asset footprint. [17:39] Leverage ratio is over 40 to 1. [17:41] That alone is 30% of Dutch GDP. [17:43] They don't have a printing press anymore. [17:46] Are you beginning to see the problem? [17:48] The result is assets held by banks in Germany, France, and [17:52] the UK are about double the annual GDP of the entire EU. [17:58] Here's the too big to fail USA. [18:00] Top six bank assets, 61% of GDP. [18:03] Any one of them fails, even allowing for systemic [18:05] interconnections, you're going to take out 10% of US GDP. [18:08] That's about $1.4 trillion, $1.5 trillion. [18:12] That's a lot, but when you've got your own currency, you've [18:14] got the global reserve asset, we can deal with that. [18:16] We can bail it. [18:17] We've done it. [18:18] That's what we did. [18:18] It cost of a $3 trillion all told, that's it. [18:20] We're now in recovery mode. [18:24] At least the Brits have their own currency. [18:26] There's British GDP. [18:29] That's the size of their banks. [18:32] You should be very, very afraid now. [18:36] Now let's have a look at this one. [18:38] Here's France. [18:40] BNP Paribas, Agricole, Generale. [18:42] These three banks alone are taking you up to 250% of GDP, [18:47] and they don't have a printing press, and they're seriously [18:50] impaired with bad assets. [18:52] And now here's the kicker. [18:53] You know that ECB? [18:55] It's a fake central bank. [18:56] It's really a currency board. [18:57] Because what it does is it says, we're not doing bond [19:00] buying, we're not mutualizing debt, you have to look after [19:04] the problem yourself. [19:05] So when you have a financial crisis, [19:06] you've got four exists. [19:07] You can either inflate-- [19:09] whoops, you don't have a printing press. [19:11] You can devalue-- [19:12] whoops, don't have your own currency. [19:14] Or you can do austerity. [19:15] You can squeeze and hope you stabilize public finances, add [19:20] liquidity, keep the can kicking down the road-- this [19:23] is LTROs, all the loans that have been given to the banks. [19:25] But at the end of the day, you cannot do a Bernanke. [19:28] So what's a Bernanke? [19:29] A Bernanke is when you go into the banking system and you [19:32] grab the shitty assets on their books and you put them [19:35] on the Federal Reserve's balance sheet. [19:37] And you call them things like Maiden Lane 2, and the [19:40] Termloan Auction Facility 3, and a bunch of completely [19:44] opaque nonsense that nobody will ever understand unless [19:47] they spend time looking into this. [19:49] Congress, who basically don't understand anything, are [19:51] completely oblivious to what's going on-- [19:53] you then flush the entire system out with as much [19:56] liquidity as you can, and you allow them to recapitalize as [19:59] they de-lever. [20:00] Which is why the operational leverage of the American banks [20:02] is now about 50 to 1 rather than 30 to 1 at the height of [20:05] the crisis. [20:06] They've rebuilt, they've recapitalized, they've cleaned [20:08] their balance sheet. [20:09] As the economy recovers, you know all those [20:11] assets that you bought? [20:12] Guess what? [20:13] Those houses in Glendale one day will have value again, and [20:16] you sell them back to the banks. [20:18] It's not a money pump. [20:19] It's an asset swap with liquidity. [20:22] The ECB can't do that. [20:24] It is constitutionally and intellectually incapable of [20:27] making that move. [20:28] Consequently, what the markets were pricing is as yields were [20:31] spiking was the possibility of a breakup of the Euro. [20:34] Because if any one of those banks goes down, it doesn't [20:37] stop at Spain. [20:39] It doesn't stop at France. [20:40] It goes all the way back to the German banks. [20:44] If that goes bad, it's game over for the core European [20:46] banks, which is why we really have austerity policies. [20:50] It's about stopping a bank run around the bond market. [20:53] This is why you've got to keep the Greeks in at all costs. [20:55] Because if you're a bank, and you've got 2% of your assets [20:58] in Greek debt-- [20:59] say you're exposed to Greece heavily. [21:01] How are you going to get rid of that? [21:02] Well, you can't. [21:02] You can sell it on the hedge funds basically at 20% on the [21:05] face value. [21:06] Or you can hope it doesn't go bad. [21:08] But imagine you wake up one day, and you think, this is [21:10] going to go bad. [21:10] You want to sell it, so you sell it first. [21:12] The minute all those contracts hit the floor, what [21:14] happens to the price? [21:15] Everybody else dumps theirs and they go to the floor. [21:17] You've now made a 2% loss to your portfolio. [21:19] How do you balance it back? [21:20] You sell the next asset class before it goes down. [21:23] Hi, Portugal, how are you this morning? [21:25] So you dump Portugal. [21:26] And as those prices go to zero, what do you do? [21:28] You look around and you go, shit, what have I got left? [21:30] Let's dump the Irish, then. [21:31] So you throw the Irish on the floor, prices go to zero. [21:34] You've now knocked 11% of Euro-zone GDP and probably [21:37] about 12% of your portfolio. [21:39] You do that on the lending portfolio of a highly levered [21:41] bank, what's going to happen to its share price once people [21:44] figure out? [21:47] So you're going to have a huge panic that's caused by a [21:49] sovereign bank run, right the way through a currency union, [21:52] something that is supposed to be theoretically impossible. [21:55] That's what this has always been about. [21:57] That's why you keep the Greeks in. [21:58] That's why you're willing to destroy 30% of GDP. [22:01] Because this is about saving Societe Generale, and it is [22:04] about saving Deutsch Bank from their own over borrowing and [22:07] over lending mistakes. [22:10] Consequences. [22:11] You can't solve a banking problem with budget cuts. [22:13] You can cut Greek's public spending to Neolithic levels. [22:16] It's not going to make a damn bit of difference to SocGen's [22:19] balance sheet. [22:20] You can't run a gold standard in a democracy. [22:22] We tried this in the 1920s. [22:23] It really didn't work too well-- ended up with a few [22:26] political parties that were kind of nasty. [22:28] You can't solve a solvency problem with a liquidity [22:30] instrument. [22:31] But God bless Mario, he's been trying. [22:34] You just add enough liquidity and hope the problem goes away [22:36] by saying, I'll do whatever it takes. [22:38] That's what he said six months ago, the yields came down. [22:40] Since then, he's actually done nothing, and yet the yields [22:43] have gone down, proving one thing-- it's about the [22:46] credibility of bank policy. [22:47] It's not about cutting the budget. [22:49] The markets aren't craving an extra 30,000 civil servants [22:53] being thrown out of work in Greece. [22:55] They're worried about the Euro breaking up. [22:57] So once you give a credible guarantee, you do a [23:00] Bernanke-lite, all of the market pressures are relieved. [23:03] That was what was lacking the whole time. [23:06] And the most important one is you can't all cut at once and [23:11] expect to grow. [23:12] Why not? [23:13] Because in order to save, you need to have income [23:15] from which to save. [23:16] So if everybody simultaneously cutting, [23:18] nobody's generating income. [23:20] So imagine the economy with an 80% debt to GDP ratio, and [23:23] turn it into a simple fraction of four over five. [23:26] Now imagine that 40% of the five is government [23:28] expenditure. [23:29] You want to cut in half. [23:29] You're really going to credibly [23:30] commit to cut the budget. [23:32] So you just turn that into four over four. [23:34] On a constant stock a debt, your debt to GDP ratio just [23:37] went from 0.8 to 1. [23:39] Every single country that's undergone an austerity program [23:42] now has more debt than when they started. [23:44] Any country the hasn't cut, including the United States, [23:47] now has proportionately less. [23:49] The evidence is in. [23:51] And the tragedy is it was all avoidable, and [23:53] we knew this already. [23:55] So why did anybody, especially in Europe, ever think this was [23:58] a good idea? [23:59] For that, you have to kind of have to go back in time. [24:01] And it's still about two rival stories. [24:03] This time it's not ECB credibility versus the moral [24:06] hazard trade. [24:07] It's something far more spooky. [24:09] The first one I like call liberalism's emetic economics, [24:13] emetic being a wonderful word meaning to throw up. [24:16] And what's this all about throwing up. [24:18] You go back to John Locke's "Treatise on Government." The [24:21] fifth chapter is really fascinating. [24:22] John Locke is this guy who's basically the intellectual [24:24] propagandist of a bunch of guys who want to kill the king [24:26] and take all the property for themselves. [24:28] They're called the merchant classes, and these are the [24:30] guys that then set up markets and land, labor, capital, [24:33] private property, throw people off the land, [24:35] all the rest of it. [24:36] You ever heard the word vagabond? [24:37] It means a man without bondage. [24:39] Why bondage? [24:40] Because basically, you've been thrown off your land, so you [24:42] basically had your status removed from you. [24:44] So basically, the English Revolution sets up the markets [24:47] in private probably, et cetera. [24:48] And then there's a problem, because the minute you do [24:50] this, you recognize that untrammeled markets lead to [24:52] massive income and wealth inequalities. [24:54] Which is great if you happen to be the guy at the top of [24:56] the pile, and not so great if you're at the bottom. [24:58] So unfortunately, then you need a sate. [24:59] Why do you need a state? [25:00] To make markets, in the first place. [25:02] The notion that they pop out of the ground fully formed is [25:05] a nice fiction, but simply not true. [25:07] In order to turn serfs into workers, you actually need [25:10] acts of parliament and legislation. [25:12] The state makes these things happen. [25:14] But here's the kicker. [25:15] You need to state to police the inequalities that the [25:17] market makes possible. [25:18] Because if you don't-- [25:20] poor Adam Smith on this one-- "for every rich man"-- this is [25:23] out of "The Wealth of Nations"-- [25:24] "for every rich man, there must be 500 poor, and that [25:27] rich man must sleep always with the strong arm of the [25:30] civil magistrate at his side, for he is always regarded with [25:33] jealousy and envy." [25:36] So you need that state to police the inequality. [25:38] But here's the Lockean kicker. [25:39] This is why we have the Second Amendment. [25:41] Any state strong enough to police those inequalities is [25:43] strong enough to come and take your money. [25:46] So you've got a dilemma running into this. [25:47] You need this state, you can't live without it, but at the [25:50] same time, you can't live with it, because you're afraid of [25:52] the damn thing. [25:53] So how are you going to do this? [25:54] And how are you going to pay for it? [25:55] Because most people don't want to pay any taxes. [25:57] Well, that's where this guy comes in, David Hume. [26:00] He has a wonderful essay on money and on interest. [26:03] He talks about merchants being the most useful race of men, [26:06] because when you give it to them, even though money's [26:08] neutral in the long run, if you give it to him and his [26:10] friends, it goes to the right places really fast. [26:13] So basically, you think of money in a Keynesian way from [26:15] Hume, which is short-term stimulus is long-run neutral, [26:18] but really because you give it to my [26:19] friends rather than losers. [26:21] Now, what he comes up with is the problem [26:23] with government debt. [26:24] Liberalism loves debt, because, if you think about [26:26] it, it's a free option for the state. [26:28] So you're the state, I'm the merchant, I've got lots of [26:30] inequality in my society-- [26:32] I'm worried about people coming and [26:33] burning my house down. [26:34] So I say to you, you need to protect me. [26:36] And you say, you need to pay me. [26:37] And I say, I don't want to pay taxes. [26:38] You say, ah, I have this thing called a debt instrument. [26:40] It's fabulous. [26:41] You go, how does that work? [26:42] Well, it works like this. [26:43] You give me a better paper, and I'll give [26:45] you a million pounds. [26:46] Brilliant. [26:47] OK, what happens now? [26:48] In 10 years time, I'll give you the million back, and I'll [26:50] pay you interest. [26:52] What are you going to say? [26:53] So I'll lend you the money you need to protect me, and then [26:56] you'll give me it back and you'll give me interest. [26:59] Fabulous. [26:59] It's a free option. [27:00] Unlimited upside, zero downside. [27:02] Problem. [27:04] Original argument against it. [27:06] Crowding out. [27:07] In order for this to work, you're going to offer a rate [27:09] of interest higher than the market would produce. [27:11] So everybody goes in to government debt. [27:13] Because of this, as Hume says, all the gold and silver [27:15] necessary for commerce gets crowded out of the economy, [27:18] finds its way into debt securities, the whole nation [27:20] ends up in hock, eventually you have to sell yourself to [27:23] foreigners, and you end up with a [27:24] bankruptcy of the nation. [27:26] So easy money and crowding out. [27:27] The downside of debt means that it's an attractive way of [27:31] paying for the state you need but you don't want, but at the [27:33] same time, a terrifying one. [27:34] Because at the end of the day, it's going to result in the [27:36] ruin of the nation. [27:37] Adam Smith picks up on this one. [27:39] For him, it's all about why we actually save and invest, why [27:42] x equals i in economics to this day. [27:44] Savings equals investment. [27:45] Why is this? [27:46] Well, for him, it's because we're all parsimonious Scots, [27:48] we're all hardwired to save. [27:50] There's a wonderful line where he says, "where there is [27:54] tolerable security, a man would be perfectly crazy if he [27:57] did not employ as investment all his available capital." [28:00] So basically, you take the money, you invest, it [28:02] automatically produces economic growth. [28:04] Well, he also recognizes this whole thing about inequality [28:07] in the state. [28:07] My favorite line from Adam Smith. [28:10] "Civil government, insofar as it is instituted, is [28:12] instituted for the defense of the rich against the poor, or [28:16] for those who have property against those who have none." [28:18] That is not Karl Marx. [28:20] That is Adam Smith, end of Book Two of "The Wealth of [28:23] Nations," quote, unquote. [28:25] Now, he recognizes then that you're going to have to pay [28:27] for this, so he goes to taxation. [28:28] But the forward of "The Wealth of Nations" starts off with [28:30] progressive taxes. [28:31] It's totally nuts. [28:32] So here, look, see the people who have got the most stuff? [28:35] They have the most skin in the game. [28:37] They should pay the most taxes. [28:38] And then he goes, wait a minute-- that would mean the [28:40] rich would pay the most taxes. [28:41] Well, we can't have that. [28:42] So then he backs off immediately and turns around [28:44] and argues for exactly what the Republicans [28:46] are arguing to do-- [28:47] a national consumption tax on everything except luxuries. [28:52] So your yacht is fine, but your corn flakes [28:54] are going to be taxed. [28:55] Problem with this. [28:56] Well, it never raises enough revenue. [28:58] And he recognizes that. [28:59] So he's like, shit, what am I going to do? [29:00] And he goes, I suppose there has to be debt. [29:02] But the problem with debt is exactly as Hume's pointed out. [29:05] Everybody's going to invest in the debt markets, the [29:07] underlying economy is going to crumble. [29:09] Because of that you'll end up with more debt on a smaller [29:11] economy, and eventually the whole nation gets bankrupted. [29:14] So what do you end up with? [29:15] Debt perverting parsimony, therefore savings doesn't lead [29:19] to investment doesn't lead to growth. [29:21] All very convincing, and it's all exactly the same story as [29:23] we hear now. [29:24] Now, when you hear the same arguments repeated for 300 [29:26] years without modification regardless of any facts in [29:28] fact in them, you should generally be suspicious. [29:31] The result is you can't live with it, can't live without [29:35] it, don't want to pay for it. [29:36] So I like to call this liberalism's neuralgia and the [29:38] aspirin of austerity. [29:40] You reach for it regardless of if it does you any good. [29:42] But it's a 300-year-old trip. [29:44] Now, how do we know that these guys are wrong about this? [29:46] Well, basically, at the time they were writing, Hume [29:49] predicted the collapse of the British economy by, I [29:52] think it was, 1780. [29:54] And in fact, what happened was they went from the relatively [29:56] low debt levels that they had, but they were accumulating, [29:58] all the way to the highest debt that they ever had, which [30:01] was 240% of GDP at the end of the Napoleonic Wars. [30:04] So never mind 80%, 100%, whatever. [30:07] Back in the day, they had 240% debt to GDP [30:09] at the end of 1815. [30:11] What happened to the British economy after 1815 until 1914? [30:16] It ran the hold goddamn world and expanded faster than [30:20] anyone ever thought humanly possible. [30:22] Reinhart and Rogoff 95%, my ass. [30:27] Now, this creates two liberal stories that go through the [30:31] 19th century. [30:31] Story one, David Ricardo. [30:33] You can't live with it, and you don't want to pay for it, [30:35] and you pretend you don't need it. [30:37] Second one. [30:37] This is John Stuart Mill, handsome fellow. [30:39] I know. [30:41] Accepting the need for it, and also accepting the [30:44] need to pay for it. [30:45] Because if you don't pay for it, then you get into a [30:47] problem, because if you basically leave the state out [30:49] of the equation, you cannot rely on markets to do anything [30:52] except the inequalities that will undermine markets in the [30:55] long-run themselves. [30:57] So you get these two very different versions of [30:59] liberalism come out of this. [31:00] This one goes to the Austrian economist. [31:03] This one goes to the Keynesians. [31:04] That's basically the way it splits down the middle. [31:07] Now, along came the Great Depression. [31:10] I love this picture. [31:11] It's absolutely emblematic. [31:12] It's one of my favorite slides of the Great Depression-- [31:15] the bread line at the same time as the, no way like the [31:17] American way. [31:18] So reality, theory, facts, whatever. [31:21] Now, here's the first one. [31:23] I like to call this the emetic response, American [31:25] liquidationism. [31:26] This is Joseph Schumpeter. [31:27] And by the way, he actually looked like that. [31:29] This is not an exaggeration. [31:31] He really did. [31:32] And he, in the 1920s, had come over from Austria and [31:35] basically taken up residence running Harvard's economics [31:37] department. [31:38] And the basic story was there's the long run capital [31:41] structure of the economy, you can't really see it, you don't [31:43] know what's going on, you should never intervene. [31:46] What happens is that banks, there are booms and bust [31:48] business cycles. [31:49] Banks have a problem, particularly when the bank is [31:51] backed by the government. [31:52] They produce too much credit, entrepreneurs get confused [31:55] about price signals, they invest in things they [31:57] shouldn't, you end up producing things you're never [31:59] going to need, the credit pump dries up, and eventually you [32:01] have this purging that needs to happen. [32:03] So you binge on credit and then you purge. [32:06] This is version one of austerity. [32:08] Because of this misallocation of capital because of credit, [32:11] you end up with too much in the wrong type of investment [32:13] in the capital structure. [32:14] So you basically have the boom, and then you have to [32:16] have the slump, and you have to go barf and you have to get [32:18] it all out and let the clock reset, and off you go. [32:21] Now, the British had a version of this, which, you know, of [32:23] course, the British are a bit more polite than this, so they [32:25] wouldn't be emetic. [32:26] So they have the treasury view, which is a [32:28] more austere response. [32:29] And it's very similar, but again, it's these arguments [32:32] from the 1700s brought back. [32:33] So the basic idea is that free trade is welfare-enhancing. [32:36] Well, the Brits would say that, because they were 50% of [32:39] the global economy at that point in time, and most of [32:41] their free trade was done with empire. [32:43] But putting that to one side, I'm sure the Indians thought [32:46] it was free trade when they showed up, [32:47] and so did the Chinese. [32:48] But anyway, 1910 to 1920s, this is Churchill when he was [32:52] Chancellor of the Exchequer, the finance minister. [32:54] He comes out with this memorandum written by a guy [32:56] called Henderson that basically responds to a guy [32:58] called Lloyd George's thing about, can we do something [33:01] about unemployment? [33:02] The problem had been this-- [33:03] Britain's the largest economy in the world, World War I [33:05] spanked 60% of its national wealth. [33:07] They're on the gold standard. [33:09] Basically, exchange rate clever mechanism for the [33:11] global economy. [33:12] They have a choice. [33:13] If they go back on the gold standard with a high exchange [33:15] rate, it protects all the people who hold sterling [33:17] paper, because you're not devaluing their assets. [33:20] If you go back on a low one, it benefits the domestic [33:23] economy because you'll get an export boost and your domestic [33:25] economy will go up. [33:26] But all the people holding sterling paper will freak out [33:28] because you've devalued their assets. [33:29] So they'll dump them. [33:30] So you've got a run on the pound and a run on the [33:32] exchanges, so you're screwed either way. [33:34] So what did they do? [33:35] They went back on a high exchange rate. [33:36] The result? [33:37] An instant extra million unemployed that [33:38] lasted for a decade. [33:40] So that was one of the lynch pins in the global economy [33:42] that caused the Great Depression. [33:44] So lots of people are saying, can't we do [33:45] anything about this? [33:46] Can't we do something about unemployment? [33:48] And along came the memorandum that says, no-- and there's an [33:50] argument called Ricardian Equivalence-- [33:51] and spending now is going to be zero sum against taxes in [33:54] the future. [33:55] So if you know that, the minute you do it, it nullifies [33:58] its own effects, so don't even try it. [34:00] Second thing, and this is particularly true on [34:01] investment, if government presumes to do the job of the [34:05] private sector, the private sector will let it do it, but [34:07] then it will do it at a cost. [34:08] Because it's still not investing, so it's zero sum [34:10] against itself. [34:11] And the last one you may remember from the Obama [34:14] stimulus was the lack of shovel-ready projects. [34:17] Remember that language? [34:18] It's written in there-- it was called the lack of suitable [34:20] public works. [34:21] Now, here's the second story that comes out of the John [34:24] Stuart Mill tradition. [34:25] Basically, it's not about Keynes right [34:27] in the general theory. [34:28] There's a wonderful line by an [34:29] economist called June Robinson. [34:30] She says that, "in 1936, Keynes was writing down what [34:33] might cause unemployment while Herr Hitler was curing it." [34:38] There's a certain element of teaching [34:39] birds how to fly here. [34:41] And the two critical cases here were the Germans-- [34:43] as it says here. [34:44] There's a story that basically it was all sort of like [34:46] Catholics in the south that voted for Germany. [34:47] No it's not. [34:48] They were industrial workers. [34:49] They were miners. [34:50] And then here's a guy called Takahashi Korekiyo, who is the [34:53] guy who was the guru for the Japanese Central Bank's [34:55] Abenomics policy at the moment of massive [34:58] monetary and fiscal stimulus. [34:59] So this is a guy from '34. [35:01] So what actually happens here is very similar to what's [35:03] going on in the Euro-zone. [35:04] You have simultaneous contractions of the five [35:06] largest economies in the world. [35:08] Everybody cuts at once. [35:09] GDP shrinks, constant stock of debt goes up. [35:12] The British debt to GDP ratio in 1930 was 170%. [35:16] By 1933, despite repeated rounds of cuts, it was 190%. [35:21] It continued to go up. [35:22] In Germany, what happened was, after short-term capital [35:25] United States, post the '23 inflation, had made Germany [35:29] the most stable and fastest growing economy in Europe at [35:31] that point in time. [35:32] There was a swap in the agreement governing war debts. [35:35] The main war debts got seniority. [35:37] The American capital pulled out to take advantage of the [35:40] stock market boom in 1928, '29 and a federal [35:44] interest rate increase. [35:46] If you get 7% per sticking it in a bank, so why would you [35:48] put it in Germany? [35:49] A lot of capital goes flying out. [35:50] To balance the budget, a guy called Bruning comes in as the [35:53] chancellor, and he starts hacking away at the budget. [35:56] So he issues somewhere in the region of about 200 emergency [35:58] austerity decrees. [36:00] At that point in time, there's a minor party that everyone [36:02] had written off. [36:03] They got 8% of the vote in 1928, or thereabouts. [36:06] By 1930, it was up to I think 18%. [36:08] By 1933, it had 43.3% of the vote. [36:12] It was the only party arguing against austerity. [36:14] I don't think I need to tell you what they were called. [36:18] Japan was even worse. [36:20] The brunt of civilian expenditures, the brunt of [36:23] public expenditure cuts in Japan were [36:26] borne by the military. [36:28] They were the biggest item in the budget. [36:30] By 1930, the Japanese military started to assassinate their [36:33] financial elite. [36:35] It took out two finance ministers, two prime [36:37] ministers, several cabinet-level appointees, and [36:40] half a dozen senior bankers. [36:43] You can rack up quite a body count doing this if you piss [36:45] off the military enough. [36:47] So the lesson learned on this was simultaneous contractions, [36:50] when everybody else is doing it, is zero sum against [36:52] everybody else, and leads to really nasty politics. [36:55] So Keynes and events overturn austerity. [36:58] What does it show us? [36:59] It shows there are fallacies of composition and [37:01] non-scalability in labor and money markets. [37:03] What's true about 2 people or 10 people is simply not true [37:05] about 20 million or five interlinked economies. [37:08] There are systemic non-linearities and difference [37:10] that simple cannot be done by type. [37:12] Investment expectations are not about parsimony. [37:14] They're about fear. [37:16] And if everybody's fearful for the future and has myopic, [37:19] short run expectations, and we look to each other for signals [37:22] about whether we should be investing next month or not, [37:24] you discount the time series of the 36 good periods and [37:27] heavily weight the three in the front. [37:29] That's why it's hard to get out of a recession. [37:31] The emetic response, you binge and then you purge, assumes [37:34] you're at the bottom. [37:35] People start saving again. [37:36] You've got [INAUDIBLE] consumption, austerity, you [37:38] start saving. [37:39] And the assumption is that saving is automatically [37:41] investment. [37:41] But there's a drop there, because you have to invest in [37:44] a recession. [37:45] Why would you want to be the guy who takes the chance to [37:47] invest in a recession? [37:48] Surely you'd rather be liquid, so everybody tries to sit on a [37:51] liquidity all at once. [37:52] But you can't-- in order for you to be liquid, somebody [37:54] else has to be illiquid. [37:56] So you end up with a liquidity trap. [37:57] And that's when you get stuck for 14 years. [37:59] That's why the Great Depression lasted so long. [38:02] So because of this, rather than curtail consumption, the [38:05] austerity response, consumption, to repeat the [38:07] obvious, is the sole end of economic activity. [38:10] "General Theory," page 71, if I remember correctly. [38:13] Lessons learned. [38:14] It all goes back to redistribution. [38:16] Democracy is asset insurance for the rich. [38:19] Don't skimp on the payments. [38:21] That's what was going in the '20s, and that's [38:22] what's going on today. [38:24] Redistribution of debt is reinsurance for democracy, and [38:27] austerity is anorexia for the economy. [38:30] That was what was learned by 1940. [38:32] Oh, how we forget. [38:35] And why do we forget? [38:36] We forget because of Germany, because Germany is a very [38:39] peculiar economy. [38:41] It is not a liberal economy. [38:42] It is much closer to Japan than it is to anything else in [38:45] Europe or the United States. [38:46] It is, in fact, the original developmental state. [38:48] What do I mean by that? [38:50] In 1873, there was a huge stock market bubble in [38:53] Germany, and it blew up. [38:55] It was called the Founders Crisis. [38:56] And liberal economic ideas of the type we've been discussing [38:59] were completely discredited. [39:01] At this point in time, there was a guy called Liszt who [39:02] comes along and says, you know, the funny thing about [39:04] the Brits telling us all the story about how to get rich, [39:07] if they had actually done that themselves-- you know what [39:09] their comparative advantage was in? [39:11] Wool. [39:12] They would still be making blankets for [39:14] the people in Flanders. [39:15] How come they're running the world? [39:17] How come they have the biggest navy in the world? [39:19] How come they make steel when they basically [39:21] have no iron ore? [39:23] What the hell is that all about? [39:24] So he rewrote how you think about international trade. [39:26] And at the same time that he did this, he, and also the [39:29] Bismarck who was running the place did what was called the [39:31] marriage or iron and rye, bringing together the [39:33] industrialists in the south, the agrarians in the north. [39:36] You use the surplus from agriculture to basically buy [39:39] flattened equipment. [39:40] You bring it in, you reverse engineer it, you do it faster, [39:42] you do it faster, you build up German industrial capitalism. [39:46] Big firms, big banks, forced saving, a big [39:48] role for the state. [39:49] And it's all driven by exports. [39:52] There's your difference. [39:53] But when you're exporting and your sources of demand lie [39:55] outside your economy, you don't have to worry about [39:57] internal demand. [39:58] The Keynesian story makes no sense if you're Germany. [40:01] Why would you want to stabilize consumption if [40:03] you're export dependent? [40:05] Because all you're going to do is raise your wages and [40:06] prices, and your BMW is going to go from 50,000 to 100,000 [40:10] real fast, and you're not going to sell them. [40:12] So if you don't rely on domestic consumption and rely [40:14] on external consumption, the dynamics of your economy are [40:16] completely different. [40:17] What do you care about price control? [40:20] All this stuff about the neuralgia of the 1920s and the [40:22] inflation experience, this is a post-war construction. [40:24] It's really about remaining price [40:26] competitive in export markets. [40:28] So you need a strong, independent central bank. [40:30] What else do you care about? [40:31] Very important-- [40:32] competition. [40:33] You want to have competition over products, so that you [40:36] have BMW and Audi competing with each other so they can [40:39] sell more to the Chinese both because they're competing [40:42] against product quality. [40:43] You don't get involved in the Apple, Samsung, buy up patents [40:45] and sue each other in court crap. [40:47] You do real competition to get real value out [40:50] at the end of it. [40:51] Given that the role of the state, these Freiburg [40:53] liberals-- this is Walter Euken, one of the guys who, [40:55] post-war, reinvigorates all this stuff. [40:57] Because after Nazism is discredited, they [40:59] needed a new thing. [41:00] And basically it was about the economic constitution, where [41:03] competition rather than consumption becomes important, [41:06] and sound money and central bank [41:08] independence defines the economy. [41:10] Why is this important? [41:11] First of all, for 30 years, this is the entire structure [41:14] of the Euro. [41:17] If you think about the way the European Union is set up, it's [41:19] Generalized Ordoliberalism, to give that type of [41:22] liberalism its name. [41:23] The commission is the important part, not the [41:26] parliament. [41:27] The parliament is a talking shop that very little [41:29] representative rights or power. [41:31] Sound money is far more important than output. [41:33] It's all about the European Central Bank and its policy. [41:36] It has one target-- [41:38] fighting inflation, even if there's a deflation going on. [41:41] Well, what does that reflect? [41:43] The need for cost competitiveness. [41:44] What is it that the commission does? [41:46] The commission basically sets rules. [41:48] What are those rules about? [41:49] Competitiveness. [41:50] What's the largest component of the administrative [41:52] architecture of Brussels? [41:53] The Competition Commission. [41:55] Rules rather than discretion at all times. [41:58] You can't trust politicians to run the economy-- they'll run [42:01] inflationary cycles, that will be bad for growth. [42:04] Yes, if seen through a German perspective. [42:06] But here's what it misses, a giant fallacy of composition. [42:09] For you to sell your BMW, somebody else needs to be [42:11] buying them. [42:12] For somebody to basically be having an export surplus, [42:15] somebody needs to have an important deficit. [42:17] In the aggregate, in theory, it balances out. [42:19] But if you go way back to that picture I showed of the [42:21] current account imbalances, there's only one company [42:24] running a surplus. [42:24] And the sum of that surplus is the sum of that deficit-- [42:27] they're almost exactly equivalent. [42:29] So what you have here is a situation whereby when you [42:31] generalize the economic principles and institutions of [42:34] one country across the whole of the EU, which was fine, so [42:37] long as the banks were spending money all over the [42:39] place so nobody noticed, it's fine. [42:42] But once that credit bubble pops, suddenly you all have to [42:45] be Germany. [42:46] Tell me, how is Greece and Portugal [42:48] going to make an Audi? [42:50] And even of they did, who are they going to sell it to? [42:53] Who's going to buy it? [42:54] Imagine the Competition Commission gets its way and [42:56] everybody becomes more competitive, and [42:57] they all make exports. [42:59] Who's going to buy all this crap? [43:01] The over-tapped American consumer? [43:03] We're already spending too much already. [43:05] So you end up with an economy and an economic structure, an [43:08] economic model for an entire continent which literally [43:11] cannot work. [43:12] It makes no sense on a global level, and yet that's the one [43:15] that it's pursuing. [43:17] Competitiveness rather than complementarity. [43:19] And also, you then have idiotic things like debt [43:21] breaks, Schuldenbremse. [43:23] This says that nobody can ever have more than [43:24] a 5% debt on deficit. [43:26] Really? [43:27] Because that means everybody has to run a budget surplus. [43:29] How is that going to happen? [43:30] That's actually not arithmetically possible, but [43:33] it doesn't stop them writing rules about it, even if it's [43:36] arithmetic nonsense. [43:38] This then leads to Italy. [43:40] I'm getting there. [43:41] This guy was the first Prime Minister of Italy and head of [43:45] the Italian Central Bank post-war. [43:48] He set up the Bocconi School of Public Finance in Milan. [43:50] The Bocconi School was famous for two things. [43:52] Number one, public choice theory. [43:54] Essentially, states are rent seekers and [43:56] they can't be trusted. [43:56] Hey, if I grew up in Italy, I would probably think that [43:59] about the state, as well, but they [44:00] generalized it to everybody. [44:02] They're also very fond of the notion of a European Union as [44:04] a disciplinary device overriding local democracy and [44:07] reigning in state spending. [44:09] The Bocconi School are important because when [44:11] Cambridge-- [44:12] qua Cambridge, UK-- blew up in the '70s intellectually and [44:15] Cambridge and America had their lunch in what was called [44:18] the Cambridge Capital controversies, the only [44:20] economics department in Europe that was mathematically [44:22] sophisticated enough to play with the Americans was the [44:24] Bocconi School. [44:25] And they were hard-wired for seeing the state as a bad [44:28] thing at exactly the time that liberal economics went in the [44:30] same direction, when it went neoliberal. [44:32] Consequence of this-- [44:33] these guys become an aircraft carrier for austerity thinking [44:36] that goes from Milan to Harvard, which leads us to [44:39] today, the financial crisis. [44:42] This is Greenspan's mea culpa. [44:43] I think there's a flaw in my ideology, and it's this big. [44:48] And we get to this guy, who's Alberto Alesina, who, just [44:50] like Joseph Schumpeter, is arguing for emetic economics. [44:53] And he, too, is the head of the Economics [44:54] Department of Harvard. [44:55] He's the guy who came up with what's called the expansionary [44:58] austerity hypothesis. [44:59] It's about debt and time and consistency, which is actually [45:01] that Ricardian equivalence stuff all again. [45:03] And it basically says the following-- this is the [45:05] confidence theory thing. [45:06] This is why you cut spending. [45:08] So imagine the economy is falling around your ears, you [45:10] don't know if you're going to have a job tomorrow, your [45:12] partner is already unemployed, you really don't know about [45:14] the future, but you really worry about the debt. [45:17] You just lie awake all night worrying about the [45:19] debt, as people do. [45:20] So the government credibly signals that it is going to [45:23] massively cut government expenditure. [45:25] And what you do, using your rational expectations that are [45:27] built into your head-- well, you know the true structural [45:29] form of the equation governing the economy and the value of [45:32] the coefficients therein. [45:33] Big assumption, but put that to one side. [45:35] You calculate your lifetime budget and your lifetime [45:38] expenditure in relation to the fact that 20 years from now, [45:41] because of these state spending cuts now, you'll pay [45:44] less taxes then. [45:46] Thereby, you can retro-dict how much extra money you've [45:48] got now, and everybody goes to Ikea and buys a couch. [45:52] And that cures the recession. [45:54] I am not making this shit up. [45:56] Take away all the math, that's what all these papers say. [45:59] And what we actually see at the end of it, you got all [46:01] these countries cases that supposedly [46:03] show this in the '80s-- [46:04] Ireland, Sweden, Denmark, et cetera-- and in the book I go [46:06] through them and show that they do nothing of the kind. [46:09] What actually happens is, take Canada as the [46:11] greatest example of this-- [46:12] the Loonie takes a 40% devaluation from '76 to '86. [46:16] You're export dependent. [46:17] You're a commodity exporter. [46:19] Your major trading partner who takes 75% of your exports is [46:21] the United States. [46:22] The United States' economy is nine times the [46:24] size of your economy. [46:25] You have a 40% devaluation as the American economy takes off [46:28] like a rocket between '86 and '92. [46:30] What do you think is going to happen to [46:32] Canada's budget surplus? [46:33] It gets massive. [46:34] They cut and then it led to growth? [46:36] No. [46:37] They grew and then they cut. [46:39] Because that's what your meant to do. [46:41] Austerity date is best done in the boom, not the slump. [46:44] That's what all these states actually do. [46:46] Cutting in a slump produces a bigger slump. [46:49] It's really that simple. [46:51] So this is taken up by the European Central Bank and was [46:53] called the Ecofin Brief and the G20 finance [46:56] ministers in 2009. [46:57] It's published in all its glory in [46:59] the TCB's 2010 report. [47:01] All the arguments from David Ricardo, et cetera, and John [47:03] Stuart and Hume and Smith, I'm not kidding, are in that book. [47:07] I mean, literally, you could quote them line for line. [47:10] It's exactly the structure of how they did all the bailouts, [47:13] and how they did all the stuff in terms of bailing out [47:14] Greece, et cetera. [47:16] And there result of this is what I call the greatest bait [47:17] and switch in history. [47:18] Because what's actually happened is all that private [47:21] debt that was generated by the banking system through [47:23] over-lending is now on the public balance sheet. [47:25] And to go full circle, all the way back, that means that [47:27] people like me, who have grown up on the welfare state just [47:30] now, have to pay for the mistakes of systemically [47:32] irresponsible bankers. [47:34] Because you can't tax them themselves because they're too [47:36] politically powerful. [47:37] That's why this is fundamentally a problem of [47:39] politics, and not a problem of economics. [47:42] Is there a way out of this? [47:43] People have started to defect. [47:45] The IMF has started to go. [47:46] The IMF has calculated now that, what happens when you [47:49] cut $1 of public spending in the periphery? [47:51] You lose $1.5 to $1.7 in spending, which is why you get [47:55] this wonderful negative convexity, where it goes, ah, [47:58] which is what's happening to periphery economies. [48:00] You end up with more debt, not less. [48:02] The rebel alliance-- [48:03] Romania, Estonia, Bulgaria, Latvia, Lithuania-- [48:05] they tried to blow up the debt star. [48:08] They failed. [48:08] It's been a disaster. [48:10] Excelgate, that's Reinhart and Rogoff's 90%. [48:13] There really was nothing there to start with. [48:15] And we have 25% permanent unemployment in Europe. [48:17] That is not politically sustainable. [48:20] So where does it all end? [48:21] First one, financial repression. [48:23] You take those banks that are heavily levered and filled [48:25] with government bonds and you fill them with even more [48:27] government bonds. [48:28] Then what you do is lower the payment on it that you get [48:31] from it, and you lend to maturity. [48:33] And then what you do is you run a positive inflation. [48:35] Hence, why central banks are now moving [48:37] to inflation targets. [48:38] What does that do? [48:39] It creates a negative real interest rate. [48:40] That cures your debt far better than any amount of [48:44] cutting, which actually doesn't work because it's zero [48:46] sum against itself. [48:47] When did we last do this? [48:48] End of World War II. [48:49] The liquidation tax accounted for the equivalent of 40% of [48:52] American GDP being paid back in 10 years, and the American [48:56] economy boomed at the same time. [48:58] So there's something very, very important. [49:00] That's where this one's heading. [49:01] Who is this bad for? [49:03] This is totally bad for creditors and [49:04] really good for debtors. [49:06] I just took on the largest mortgage in human history [49:08] because I fully expect this to happen. [49:11] I'm bar-belled. [49:12] If the economy recovers, my asset goes up in value. [49:14] If there's an inflationary cycle, it eats [49:16] away half my mortgage. [49:17] Screw them-- [49:18] I've been paying for their bailouts. [49:20] Second one. [49:21] Higher taxes. [49:22] Carried interest exemption. [49:23] Mitt Romney pays 15% tax. [49:25] I pay 30%. [49:26] You pay 30%. [49:26] Do you think that's fair? [49:28] I don't think that's fair. [49:28] I think that's coming to an end. [49:30] And we're going to shut down every goddamn tax haven on the [49:32] planet, as well. [49:33] Because you know how much is hidden there? [49:35] $27 trillion in untaxed wealth-- [49:38] estimate-- [49:39] is sitting in five tax havens. [49:41] How many divisions does the Cayman Islands have? [49:45] None. [49:45] Let's go get it. [49:46] It's so much easier than slashing the fire brigade. [49:49] And the last one, if you think about this as payback for the [49:51] bailouts who started it all, is Hippocratic economics. [49:55] First do no harm. [49:57] The United States was meant to die. [50:00] We had spent too much. [50:01] We were the profligate. [50:02] We were all going to die. [50:03] Remember all those articles about, oh, it's coming, the [50:05] great end, the great crash, the whole lot? [50:08] We've de-levered, we've cleaned up the balance sheets [50:09] of the financial sector, we're lending again, we've got [50:11] positive growth. [50:12] In three years' time-- we actually have stabilized the [50:15] debt already. [50:15] In three years, we'll be effectively reducing it. [50:18] The Brits are in for a decade of recession. [50:21] Ireland has a lost generation because they bailed their [50:23] banks and they did austerity. [50:25] Periphery Europe is stuck with 25% permanent unemployment. [50:28] This doesn't work. [50:30] It is a human disaster. [50:32] But most of all, it's politics. [50:34] Because it's always about one thing. [50:35] Somebody got all the benefits, then they cost all the costs, [50:39] now they want somebody to pay for the costs while they keep [50:40] all the benefits. [50:42] That's what this is really all about. [50:44] Thank you. [50:46] [APPLAUSE] [50:52] MARK BLYTH: Went on a bit longer than anticipated, [50:55] despite talking faster than JFK on speed. [50:57] Sorry about that. [50:59] AUDIENCE: Much as I'd like to take out a huge mortgage and [51:02] buy stuff, there's something of a bubble [51:04] going on around here. [51:05] Any other suggestions for how to take advantage of this? [51:09] MARK BLYTH: Well, as I switch onto my [51:11] financial adviser mode. [51:13] How do you make money in a positive inflationary [51:15] environment? [51:17] It's not easy, but it's not impossible. [51:19] If you have a look at companies that did really, [51:21] really well in the 1980s, late '70s, early '80s, they tended [51:26] to be sort of conglomerate trusts. [51:29] So they owned a little bit of everything. [51:30] That's like the Abu Dhabi Investment Corporation, whose [51:33] unofficial slogan is, we own half a percent of everything [51:35] that isn't nailed down on the entire planet. [51:37] And the idea behind it is that you don't know where the [51:40] upside is coming from. [51:41] So what you should be is maximally diversify. [51:43] It's like an index fund. [51:44] So basically, anything at all that is internally [51:47] diversified, so buying cut shares in companies that have [51:50] that type of structure is probably the best way of [51:52] bar-belling yourself against them. [51:54] But ultimately, you know, investing in debt markets is [51:57] probably a bad idea right at this point. [51:59] But it's still sort of-- at the end of the day, about this [52:01] paranoia that inflations lead to [52:03] hyperinflations, it's total crap. [52:05] When I went through the book and did the research on this, [52:08] I wanted to-- [52:08] I'm married to-- [52:09] background information-- [52:10] I'm married into a bunch of Germans. [52:12] Well, I'm only married to one, but the whole family comes [52:14] with them, right? [52:17] And my [GERMAN], as I like to call him, my father-in-law, [52:22] [GERMAN], he's a classic German. [52:24] He's like 71 years old, he's retired, and he still saves. [52:29] What the? [52:30] You'll die-- [52:31] what are you doing? [52:32] Why? [52:32] He's totally hardwired for saving, and he's totally [52:35] paranoid about inflation. [52:36] So I went and read a lot about the German hyperinflation. [52:39] And it was deliberate government policy to stuff the [52:41] French over reparations. [52:43] I mean, they did it quite deliberately. [52:45] And the weird about it was after they did it, it ended in [52:47] eight months. [52:48] And the entire economy was stabilized within 12. [52:51] And then it grew for five years. [52:53] And then what actually happened was austerity, [52:55] through the economy of a cliff, and that's when the [52:57] Nazis came to power. [52:58] So we have this story about the least degree of inflation [53:02] leads to some kind of infinity curve hyper-convexity where, [53:05] boom, off it goes. [53:06] And it's simply not true. [53:08] Post-war Europe ran positive rates of inflation with [53:11] positive real rates of growth all the way through the [53:13] postwar period until about 1980. [53:16] So the inflation panic is there. [53:20] AUDIENCE: So I've heard Krugman and others bring up [53:25] Japan as an example to support these kind of arguments. [53:28] Can you just talk a bit about how they're able to run a high [53:31] debt for so long and things don't seem to-- [53:33] MARK BLYTH: Sure, sure. [53:34] Absolutely. [53:35] I actually think these guys are wrong about Japan. [53:37] I think what goes on in Japan is actually deeply structural. [53:39] There is a wonderful book by guy called Sven Steinmo, [53:42] called "The Evolution of the Modern State." And he has a [53:44] chapter on Japan. [53:45] And if you ever wanted to read, I think, the definitive [53:46] story on Japan, this is it. [53:48] He spent two years there on an Abe fellowship and had access [53:51] to all the people. [53:52] Well, it was two books. [53:52] It was Richard Koo's "Holy Grail of Macroeconomics." So [53:55] basically what happens is Japan goes through a balance [53:57] sheet recession. [53:58] What's a balance sheet recession? [54:00] Basically, your companies are de-levering but don't want to [54:03] tell anyone because if they do, there [54:04] will be a run on them. [54:05] And everybody's complicit together because they've all [54:08] over borrowed. [54:08] So basically, you have this kind of slow bleeding that [54:12] goes on as it's sort of monetized by the central bank, [54:15] and it ends up in debt. [54:16] So you're not growing. [54:17] And that's sort of the obvious part of the story. [54:20] The less obvious part of the story goes like this. [54:22] Go back to 1986. [54:24] There's a thing called the Plaza Accord. [54:25] The Plaza Accord was when the United States turns around to [54:27] its two major trading partners, Japan and then West [54:29] Germany, and said, our exchange rate is too high. [54:33] People are buying dollars, we're doing well just now. [54:37] And it's killing our exports. [54:38] You guys are wiping us out. [54:39] Remember the whole paranoia about Japan that went on? [54:41] They were going to take over the world, all that. [54:42] You ever see the film, "Rising Sun," Michael Crichton? [54:45] Possibly the most racist film ever made in human history, [54:48] but put that to one side. [54:49] So Japan's going to take everything over, blah, blah, [54:51] blah, the rest of it. [54:52] And then, of course, what actually happens is they do [54:55] the exchange rate thing, the United States exchange rate [54:56] goes down, the German one and the Japanese one goes up. [54:59] Now, the Japanese economy is entirely export dependent. [55:01] It's sort of like Germany on steroids. [55:03] So what they do is they move the plant and equipment from [55:05] the Japanese home islands out to the second tier tigers. [55:08] So you start to get investment in Vietnam, Malaysia, all [55:11] these places, and they move the entire thing with the [55:13] supplier networks, the whole lot. [55:15] Well, the way that the Japanese welfare state was [55:17] constructed, it was all in-house to the firm. [55:19] It was meant to be cradle to grave, but the firm [55:21] took care of you. [55:22] Well, the firm has just broken the social contract. [55:24] So how did people protect themselves? [55:25] They wanted another asset they could have that would have a [55:28] positive upside, that would retain its value, and they [55:30] could sell it in their retirement. [55:31] What did they buy en masse? [55:33] Real estate. [55:34] So you get a giant real estate bubble. [55:36] The real estate bubble gets so out of control that it popped [55:38] and the banking system can't support it. [55:40] That collapses and that starts the recession. [55:43] But the important part is the sociological story. [55:46] You've got a cultural and generational shift. [55:48] Because you've got a very old population who are now 45 [55:51] years old, facing unemployment, with a very, [55:53] very narrow safety net for the first time. [55:55] So what do they do when the government gives them money to [55:57] spend to stimulate the economy? [55:59] They stick it under the mattress. [56:01] It doesn't go anywhere. [56:02] It gets hoarded. [56:03] So the savings rate goes up. [56:05] And where do they put the savings? [56:06] In the post office account and in the bank account. [56:08] And what do the bank and the post office do with it? [56:10] They buy government bonds. [56:11] So that's why you end up with this massive [56:13] extension in debt. [56:14] Now, the thing is, the Japanese propensity to consume [56:17] is really, really low, particularly the higher up the [56:19] demographic you get. [56:20] So 80-year-olds are not just buying bonds and then [56:23] liquidating them in retirement, they're actually [56:25] keeping them whole and handing them onto the next generation. [56:28] So you've got an inter-generational debt [56:31] transfer going on. [56:32] So the story that basically it's just a monetary policy [56:36] story in, you know, Japan, I think that's wrong. [56:39] I think there's actually a deeply structural problem [56:41] that's going on there, and it goes all the way back to the [56:43] Plaza Accord. [56:44] So that's my short version of Sven Steinmo's argument, but I [56:47] find it quite convincing. [56:48] AUDIENCE: How can an individual state in the EU, [56:51] like Ireland or something, try to fix things for itself with [56:54] all the constraints under it? [56:55] MARK BLYTH: They can't. [56:56] Look, and it's good. [56:58] Because you're in the Euro. [57:00] So once you're in the Euro, it's a kind [57:01] of a one-time game. [57:03] Because the problem was if you're Argentina and you tie [57:05] yourself to the dollar, as they did back in the day, back [57:08] in the late 1990s into 2000, and then you have the default. [57:11] And they had a default because Argentina is the graveyard of [57:14] all bad economic policies gone wrong, there's [57:16] no doubt about that. [57:17] But also because their major trading partner is Brazil. [57:19] And basically, the Real had a 40% exchange rate gain, and [57:22] basically it screwed up all their exports and the whole [57:24] thing fell down. [57:25] Now, because they were just on a peg, they actually still had [57:28] their own domestic currency. [57:30] So they could go, to hell with the peg. [57:32] We've still got it. [57:33] And then you lock up the banks and people bang on the doors [57:35] and all that sort of stuff. [57:35] But you still have your currency. [57:37] Ireland doesn't have a pound anymore. [57:40] I mean, literally, the bits of paper don't exist. [57:43] So if you were going to get out of the Euro-- [57:45] just think about the complexity [57:46] of this for a second-- [57:47] you would have to kind of freeze time. [57:50] Everybody freezes, some kind of government agency with a [57:53] time machine would freeze time, you'd go around, you'd [57:55] vacuum up all the bills out of everybody's wallets, the whole [57:58] lot, and you'd stamp them all and reissue them the new [58:00] currency, and then you'd unfreeze time. [58:03] And then you would have an economic crisis. [58:05] So just that alone adds a level of complexity to it [58:08] which makes it just incredibly difficult. [58:11] Bigger countries like France and Italy can do this. [58:14] The Italian economy, North Italy, is actually globally [58:16] competitive, totally solvent, the whole lot. [58:19] The south is a basket case. [58:21] It's a bit like the north and south of the United States. [58:22] Shh. [58:23] Anyway. [58:24] But you get transfers across the region, that's [58:26] what keeps it going. [58:27] The problem is Greece has nothing to export. [58:30] It really doesn't. [58:31] It has olive oil. [58:32] But so does Italy, and they can make more of it. [58:34] Spain makes even more of that. [58:36] Do you know when you buy your EVOO and it says, [58:38] Italian olive oil? [58:39] It's actually Spanish olives they've bought and they [58:40] brought to Italy and then they grind them and call it [58:42] Italian olive oil. [58:44] So that's all zero sum against itself. [58:46] So if you don't have something to export, then the [58:49] devaluation thing that you'll get won't benefit you because [58:51] you don't have anything. [58:52] And all you'll do is end up with hyperinflation because [58:55] your imports become so incredibly expensive. [58:58] So Ireland, Greece, Portugal, they are stuck because they've [59:02] got nothing to sell. [59:04] That's it. [59:04] So they're kind of trapped in this worst of [59:06] all possible worlds. [59:07] Ireland is really screwed for a whole generation. [59:11] The debt to GDP figures you see in Ireland [59:13] are a big, fat lie. [59:14] Because they basically book services exports from this [59:17] company as exports. [59:19] So basically, the profits from this farm go to [59:21] an office in Dublin. [59:22] Has anybody ever been to the office in Dublin? [59:24] No? [59:25] There's about 25 people who work there. [59:27] And your entire corporate profits get declared through [59:29] them, because you only pay 12.5% tax. [59:32] So that 12.5% gets booked as an Irish services export and [59:35] appears in their balance of payments. [59:37] Well, it's complete paper. [59:38] It's nothing. [59:39] It's complete garbage. [59:41] And they also have all the bad assets from their banks that [59:43] blew up and this thing called NAMA, which is a super bad [59:45] bank, and that's never coming back. [59:47] And that's off balance sheet. [59:49] So when you add it all together, Ireland is actually [59:51] worse than Greece. [59:52] Shh. [59:53] Just don't tell the Irish. [59:54] AUDIENCE: Speaking of people, what do you think about [59:56] Iceland, how they dealt with their financial? [59:59] MARK BLYTH: Iceland is a brilliant example of no good [60:01] deed goes unpunished. [60:05] So when I started all this off, I was a member of this [60:07] thing called the Warwick Commission on Financial Form. [60:09] And you know, the crisis happens, and people are like, [60:12] it's the shadow banks. [60:13] And I'm like, what's a shadow bank? [60:15] I mean, you need to do a little bit [60:16] of catch-up on this. [60:17] So at first, I bought the whole narrative [60:19] of too big to fail. [60:20] Systemic interconnections, the rest, the whole lot, blah, [60:22] blah, blah, blah. [60:23] And by the time I finished the book, I said, no, I actually [60:26] totally don't buy this-- [60:27] I think we should have let them fail. [60:28] Oh, but what about systemic risk, all the rest of it? [60:30] Well, I know what lost GDP is, I know how much unemployments [60:33] cost, I know all that. [60:34] I know the real costs of not bailing them. [60:37] And more to the point, the banking system, even though [60:39] it's de-levered, is actually more concentrated now than it [60:41] was in 2007. [60:43] So Citibank is even too bigger to fail. [60:46] And the European system is that on steroids. [60:49] So you've basically given someone not just a banking [60:51] license with a subsidy, an extortion [60:54] racket on the taxpayer. [60:55] And that's just, it is literally criminal. [60:58] Best example of this-- [60:59] UBS. [61:00] Fined $1.2 billion a few months back for doing [61:04] terrorism financing and money laundering with drug dealers. [61:08] Now, if you or I did this, we would be in the jail. [61:11] They get a fine. [61:12] Why do they get a fine? [61:14] Because if you are an investor in an American or [61:16] American-licensed broker/dealer entity-- [61:18] a big bank-- [61:20] and one of your corporate officers is charged with a [61:23] criminal liability, you are under legal obligation to [61:26] withdraw your investments. [61:28] So if UBS is actually criminally charged, or their [61:31] senior officers are charged. [61:32] And then CalPERS has to pull the money out. [61:35] If CalPERS pulls the money out along with everybody else, [61:37] what happens to that bank? [61:41] So what happens to the system? [61:42] So you're basically playing systemic moral hazard as a [61:45] business model. [61:46] This is screwed up beyond belief. [61:48] So Iceland, to finish this one, basically [61:50] let their banks fail. [61:52] Now, a lot of the debt, most of the debt was externally [61:54] held, so the cost of that went on to others. [61:55] But here's the interesting part of the story. [61:57] All of the super geniuses who were working in the banks [62:00] engineering derivatives now had to get a real job. [62:03] So what happened was the domestic economy, the real [62:05] economy, rebounded, because all these start-ups happened. [62:08] Because all these really bright people went, shit, I [62:09] need something else to do. [62:10] So they started doing all these new businesses which [62:13] didn't appear before. [62:14] They became a huge hub for online gaming, because you can [62:17] stick the servers in the ground-- [62:18] and it's bloody cold-- [62:19] and you've got all the people with the math skills who can [62:21] do the software engineering and make the whole thing work. [62:23] So there were all of these positive externalities of [62:25] actually letting them fail. [62:27] Their unemployment level is now about one point higher [62:30] than Germany . [62:31] Compare it with Iceland, which is 14% on the official rate, [62:34] and that's with migration going out. [62:36] So the people who did this, the government that came in [62:38] and basically allowed this to happen, it's been a bit tough. [62:41] They actually do things like pay back the debt and are [62:43] fiscally responsible. [62:44] So they've just been voted out, and the people who blew [62:47] up the banks in the first place are now back in power. [62:49] No good deed goes unpunished. [62:52] AUDIENCE: I don't know if you're familiar with what [62:55] happened in Australia. [62:55] I'm from Australia. [62:57] But people have largely missed the financial crisis. [63:01] And there are two stories running. [63:02] And I don't know if you know which one is the-- [63:06] anyway, they're competing. [63:07] One is saying that, well, the government did spending and [63:10] gave people money. [63:11] And they spent it. [63:12] And that saved the economy. [63:13] And the other story running is that, no, [63:15] it's the mining boom. [63:16] We just dig everything up, sell it to [63:18] China, China went well. [63:19] And it has nothing to do with what the government did. [63:21] Have you got a view on that? [63:22] MARK BLYTH: The second one is completely right. [63:24] And the way you can see this is you can't trade the Chinese [63:27] currency easily, because of capital controls, et cetera. [63:31] But what you can do is basically look at the shadow [63:34] markets on the Chinese currency versus [63:36] the Australian dollar. [63:37] And they move like this. [63:40] And it is because, basically, Australia [63:42] literally is owned by China. [63:43] I mean, people say this about the United States. [63:44] Oh, China owns the USA. [63:46] And it's like, well look, only 17% of bills are actually [63:48] owned by China. [63:49] And it's brilliant. [63:50] Because for the past 30 years, we've been giving them bits of [63:52] paper that bear 2% net. [63:54] And they've been giving us televisions. [63:56] It's a sweet deal. [63:57] I don't know why anybody would ever want to end it. [63:59] It's brilliant for us. [64:01] The Australian one is the other way around. [64:02] They actually do own your assets completely. [64:05] Because if it wasn't for the western Australian mining [64:07] boom, and just all the commodities they're sucking [64:09] out at the peak of a commodity cycle, I mean, do you really [64:12] think a house in Perth would cost 2 [64:13] million Australian dollars? [64:16] And it does. [64:17] It's totally that. [64:17] It's totally the mining boom. [64:19] So what that means is either the commodity cycle peaks or [64:21] China slows down, Australia is in serious trouble. [64:24] Now, the price to income multiples in [64:26] Sydney are 13 to 1. [64:29] So you need to marry two people and have family money [64:32] in order to get a house. [64:34] So it's not 3 times your income, it's 13 times your [64:37] income for a three bedroom flat in a nice part of Sydney. [64:40] That's a colossal housing bubble, and it's Chinese [64:43] liquidity that's pumping it. [64:44] If that every goes away, boom. [64:47] AUDIENCE: The housing bubble has never crashed in [64:48] Australia, unlike everywhere else. [64:49] MARK BLYTH: Yeah, absolutely. [64:50] And you know what? [64:50] All bubbles pop. [64:51] It is just a question of time. [64:53] AUDIENCE: I was hoping you could talk a little bit about [64:55] the BRIC countries, and especially what Brazil needs [64:57] to be doing. [64:58] MARK BLYTH: Brazil needs to do what Brazil's been doing, [65:01] which is awesome. [65:02] So quite primer on the Brazilian political economy. [65:05] For years and years and years they had one of the highest [65:07] Gini coefficients in the world. [65:08] They were incredibly unequal. [65:09] And they had a problem because wealth being so concentrated [65:12] meant that the people who make effective investment decisions [65:14] decided that their own economy was too risky, because it [65:16] would either be run by the military or run by the [65:18] communists or run out of town. [65:20] So they would take their money and they would put it in [65:21] Citibank, which is nice and secure. [65:23] And you got a lesser rate of return, but you don't mind [65:25] because you own everything, anyway. [65:26] So that's the way it went on for years and years, until it [65:28] got to a point where basically you had to spend so much money [65:30] on private kidnap insurance and mining your house against [65:34] the people who would try and kill you, that they did a deal [65:37] with a guy called Lula. [65:38] Lula u to run the Worker's Party. [65:40] So the guy who ran the Worker's Party, the lefty guy, [65:42] comes in and basically does exactly as I said on the [65:44] bottom of that slide. [65:45] Democracy is asset insurance for the rich-- stop skimping [65:48] on the payments. [65:49] So did this strategy whereby they got BNDES, the Brazilian [65:52] National Development Bank, to bank-- their lending [65:55] portfolio, by the way, is twice the size [65:57] of the World Bank-- [65:58] to subsidize domestic corporations so that they [66:01] could multinational. [66:02] So you've got companies like Embraer, the aircraft company, [66:05] the big cement company, and the others, that are now [66:07] globally successful corporations. [66:09] Because of that expansion, bankrolled by the development [66:11] bank, what they do is they tax the companies on their [66:14] earnings abroad, bring that back in, and they set up [66:16] something called Bolsa Familia, which is the welfare [66:18] state that Brazil never had. [66:20] This has squeezed the income distribution like this at the [66:22] same time as it has gone up, which enables the Brazilians [66:25] to finally build a middle class. [66:26] It empowers the middle class. [66:28] And it dis-empowers the durational land-owning elites. [66:30] So what you end up with-- [66:32] there's a little fixey-do with domestically high interest [66:34] rates to keep these guys happy. [66:36] Well, what you've actually done is to engineer is to [66:38] engineer a kind of new developmental welfare state, [66:40] which has actually been great for Brazilian growth and has [66:42] actually brought down the Gini coefficient. [66:44] Because of this, everybody wants to buy Brazilian assets, [66:46] which is why the Real is going up. [66:48] And they're export-dependent, so they're freaking out. [66:50] So what they've done is they've put inward capital [66:52] controls on inward investment. [66:54] And usually, the big fear is you put your money in, they [66:56] put up capital controls, you can't get it out, it's [66:58] expropriation. [66:59] They're doing it totally different. [67:00] They're like, you want to come here? [67:01] Dead easy. [67:02] Pay a transactions tax and a deposit. [67:04] Because if you're not coming in for the long term, forget [67:06] about sitting here earning high interest rates just [67:08] because you can. [67:09] So they're making it difficult for that money to come in. [67:11] But as a growth node in a big country, it is happening [67:14] nonetheless. [67:15] So the Real is going up, the economy is slowing down. [67:17] But what they've done over the past 10 years, I think, is [67:19] nothing short of remarkable. [67:23] BORIS DEBIC: Thank you, Mark. [67:24] [APPLAUSE]