Boston V Berlin:Part 1

In a recent blog entry, Paul Krugman wrote that perhaps"the productivity gap between America and Europe never happened" as much of the apparent US productivity miracle may have been nothing more than a statistical illusion created by the USA's bloated finance industry.

He writes this based on a recent report by Dean Baker and David Rosnick. In the paper they calculate the “usable productivity”, the productivity that can actually be used to raise living standards. They contend that the "usable productivity" offers a more accurate assessment of economic well being than simply relying on productivity data because it can be directly translated into improvements in living standards

When the "productivity performance" of the United States is compared to those of other OCED countries it is substantially worse than what the conventional data indicates in both the period 1980-1995 and in the period 1995-2005.

The consequences of this data for Irish and European economic and social policymakers are momentous as for the last 10 years, Politicians throughout Europe have looked at America's wealth and opulence with great envy.

Thus, many European politicians have adopted the American neo-liberal ideology in the hope of creating the same for their citizens wealth. For example Tony Blair, Gordon Brown , Sarkozy and Schroder were all elected on the back of neo-liberal market reforms and low taxation.

While specifically, in relation to Ireland Mary Harney declared in 2000, that "Geographically we are closer to Berlin than Boston. Spiritually we are probably a lot closer to Boston than Berlin."

Part 3--The Collapse Of The Housing Bubble

06/05/2005 - -------------------- 24/03/2007 -------------------------------04/10/2008

The above actions of the Federal Reserve in the aftermath of dot com bubble and the 9/11 terrorist attacks allowed the US economy to avoid a severe economic slowdown

However, once the housing market bubble imploded the Federal reserve was unable to find another medium that would allow the economy to operate at its full potential because consumer and business confidence was so low, the levels of debt they were carrying are so great, and personal saving rates were minimal.

Today, consumers and business are more concerned with paying off debt instead of buying Channel hand bags and new equipment. Employment thus falls as does the use of existing capital stock.

As we continue to pay back the debt, the values of our houses collapse, our pension funds crumple, unemployment soars and the economy may become deflationary. This will result in debt becoming relatively greater and becoming even harder to repay resulting in even greater levels of savings.

Part 2--The Beginning Of The Housing Bubble

24/03/2001                                  21/04/2001                               30/03/2002

Following the collapse of the dot com bubble , the American and world economy experienced a significant slow down. For example, $10 trillion was wiped off global share values from 2000 to 2001, the net worth of American households fell in 2000 for the first time since records began 55 years ago and America's corporate sector suffered its deepest recession since the 1930s

Moreover, the Japanese economy, the second biggest economy in the world at time was on the verge of re-entering a recessionary and deflationary period.

This economic situation was destabilized further by the September 11th terrorist attacks.

In order to avoid a deep recession and to stimulate economic growth in light of these events, Alan Greenspan, chairman of the federal reserve cut interest rates from 6.5 % in November 2000 to 1.75% in July 2002.

These reductions allowed credit to become cheap and easy to obtain. For example, in 2003, there was wide spread promotion of mortgages with low introductionary rates. All this cheap money filtered into other sectors of the American economy and allowed consumers to go shopping once more.

Perhaps, the economist magazine put it best when it wrote of these interest rates reductions " as one bubble burst, another started to inflate. "

Part 1--Economic Bubbles:Boom and Bust

On the 10th of March 2000, the NASDAQ index reached 5132.52. This was its peak value and was more then double the value of index from the previous year.

This represented the end of one of greatest bull markets of our modern time. From then, the market began a steady decline downwards. Even today, the NASDAQ has never returned to those heady heights.

The reason for the metamorphosis of market sentiment is unknown. It could of been related to the negative findings of the United States V Microsoft case which was being heard in the Federal Court. Or the reduction in spending by companies on information communication technology following the passing of the Y2K switchover deadline.

The conclusion of the unrelentless upward advance of the New York Stock Exchange in October 1929 is equally unknown. It could of been caused by the refusal of the Massachusetts Department of Public Utilities to allow Boston Edison to split its stock into four highlighting in its decision that "due to the action of speculators" stock levels had reached a level" where no one in our judgement... on the basis of earnings, would find it to his advantage to buy". Or by some negative comments by economists in the press at the time.

These bubbles were created by rising share prices commonly in new emerging markets such as internet or radio companies. These rising prices encouraged more people to invest in the hope that the share price would rise further. These investments were not based on economic fundamentals such as price earnings ratios but on stupid speculation. This caused further rises and resulted in the creation of massive economic bubble.

When these bubbles finally collapsed, significant social and economic costs developed. These included large unemployment, wealth destruction, the collapse of consumer confidence and the start of a deflationary spiral as was the case during the great depression.

Time to accept some responsibility

Many people are of the opinion that the economic problems that we are experiencing in Ireland were not of their making them. No, the general sentiment is that the huge party which we have experienced during the past 10 years was destroyed by a couple of gate crashers known as the "american sub primers" and we are nothing more than innocent victims.

This is a cop out and just simply abdicates us of any responsibility. It was always going to end in misery because we were living on credit and even if the sub prime problems had not developed we would have to pay alll the money back someday.

The economy in Ireland never had a truly sound foundation because so much of our economic resources were focused on us simply trading goods and services between ourselves. Such activity does not bring money from foreign shores which is then reinvested in the economy to produce more goods or high quality public services.

Short Termism-Government

The symptoms of an economic bubble include prices deviating strongly from intrinsic values and market players acting irrationally. Example of such behaviour in Ireland include Sean Dunne spending €54 million per acre for a hotel in Dublin 4 to middle class famillies owning three or four investment properties.

Though there is plenty of evidence from economic history such as Japan(1990-2003) and Tulip mania(1630's), to suggest that "the bigger the boom the bust" this government did nothing to prevent or limit the size of this bubble.

Why? Any action by the government to limit the size of the bubble would damage its survival because its fate was inextricably linked with that of the construction sector. Evidence to suggest this includes;

• in 2004 the construction sector represented 12% of GDP, there were 262,700 people employeed in the sector (as opposed to 165,200 in 2002),
• One eighth of workforce employed in construction; 1 in 5 of private sector workforce depending on construction ,
• And finally a Davy Stockbrokers report says tax revenue from the property market - including VAT, stamp duty and capital gains tax - has tripled since 2002 and will account for almost 17% of tax receipts this year. This report finished by stating "the public finances are now exposed to a downturn in the property market."

Therefore, they did nothing because they were only concerned with the short term; winning the next news cycle, the next opinion poll or the next election.

Recession

Today, AIB had a very important earning call. In it they announed that there earning per share would be 1.20 as opposed to between 185-190 cents as they said in July. Additionally, they said they would incur bad debts of about 750 million and did not see any meaningful recovery in the mortgage market until 2011.

This above announcement highlights how unaware the establishment in Ireland were to economic downturn. They were living in an economic land where bust did does not occur and the old adage of "There is no such thing a free lunch" does not exist

The sudden nature of this downturn, with much of the media in Ireland declaring that the our fundamentals are still sound as late as June, suggests that the recession will be prolonged, sustained and severe.

George Soros on market equilibrium

Presently, George Soros is on a book tour promoting his new book.George Soros,  In the book he questions neo-classical economics where markets reach a state of equilibrium where buyers and sellers are content.

His main argument is that the neoclassical economics that postulates that markets tend to equilibrium is nonsense. He founds this view on what he calls the theory of reflexivity, which broadly says that use of scientific methodology in economics is wholly inappropriate, because economic agents cannot avoid influencing the outcomes they forecast.

If markets do not find equilibrium and thus are as likely to overshoot on the way up as they are on the way down, then should governments interfere to avoid the euphoria on the way up (i.e. during the dot com boom the peak, at March 2000 the Nasdaq was 5,132.52 ) and the despair on the way down (i.e. dot com boom collapse, in which by October 2002 the NASDAQ lost 78% of its March 2000 valuation)

However, by interfering in this way governments will limit and reduce the possibility of economic growth and thus vast improvements of standard of living and income are unlikely.

Instead,we would perhaps become a France or Germany, every year we  would just limp along with 1% economic growth. 

Would citizens be happy with this?

Ireland's Reckless Banks

Irish banks have placed themselves into a very difficult position. They have lended so much money to Irish property developers that they will find it difficult to remain solvent if the continued downward trends in the property market continues.

In a note, by Morgan Kelly of UCD, he notes that lending to builders and
developers continues to grow rapidly and now stands at almost €100 billion, an increase of
€20 billion on last October. To put these numbers in perspective, €20 billion is twice the market value of Bank of Ireland shares; while €100 billion is the approximate value of all public deposits with retail banks. Effectively, the Irish banking system has taken all its shareholders' equity, with a substantial chunk of its depositors' cash on top, and handed it over to builders and property speculators.

He adds international experience shows that developers will walk when markets turn down, leaving banks, and often governments, to pick up the pieces.

Therefore, all this money has been thrown recklessly into the irish economy by Irish banks. Creating positions which were completely unsustainable, once the tap was closed off. Thus, the returns for developers will be significantly reduced and perhaps in some cases result in developers holding loans greater than the returns possible in the current market conditions.

There will have to be major movement in the coming months in the economy for us to reach a position where the equilibrium is based on real market fundamentals and not on speculators greed.

Prolegomenon

There is a beauty associated with objects and systems being in a state of equilibrium.

This is well represented by jeff Koons two ball total equilibrium tank. It displays the serene nature associated with systems and objects being in a state of equilibrium. There are no victims, no damage is being done.

When objects migrate towards unequal states, it is dangerous and perilous. There is hurt and pain being inflicted a upon someone. Sometimes under the surface, that only becomes visible when the system moves towards a more equal state or when "when the tide moves out".

A healthy and happy individual is one that in balance. They are not overweight ( a condition that can cause insomnia, diabetes and cardiovascular disease), they are not underweight( a condition that causes clinical depression, reduced immune system function and headaches), they do not receive small amounts of daylight (sunlight deficit disorder) or consume large quantities of drugs.

Additionally, many injuries that the human bodies undergo are caused by certain muscles being stronger than other counteracting muscles. Once, the initial injury has been rectified, long term avoidance of the injury can only be secured by ensuring that the weaker muslces become stronger so that they are in balance.

There are countless other adverse effects of unstable natural systems. For examples earthquakes, hurricanes or landslides.

The danger of unequal systems is represented forcefully in the economic world. For example, recently there has a huge push towards increased oil seed production in the west to meet its growing demand for biofuels. This has resulted in large increases in rice and corn prices, resulting in riots in Haiti and increasing hunger and poverty in developing countries.

The effects of this increased demand for wheat is now beginning to be felt in the west with Wal-Mart introducing a rationing scheme for rice in its stores.

Moreover, as the production of biofuels requires a huge amount of resources from land, labour, raw materials and capital. The use of biofuels to limit GHG emissions will become a zero sum game, as the large amounts of GHGs will emitted in the actual production of the wheat. This is recognised by many, and thus the search for cellulosic ethanol technology.

Currently, the stock market and many other economic indicators such as employment, house prices and are falling. These falls are heavily associated with financial institutions closing the credit taps which have been flowing in recent years. The large amount of lending by financial houses in recent years has allowed states of equilibrium (i.e high stock and property valuations) to develop which were not based on any economic foundation but cheap and easily available credit. This easy credit has pushed up living standards, produced low levels of unemployment and allowed people to become people to become house owners who would have previously of only dreamt of it. However, it was unsustainable and resulted in a state of equilibrium that entirely unstable.

Hopefully in this blog, the nature of equilibrium, how little movements can result in the creation of an entirely new balance and the positive/negative outcomes of certain unstable systems will be examined.

Finally, music and film will also be highlighted.