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THE DEATH OF ECONOMICS: Aircraft design vs flat-lining financial models

Fags and booze to the rescue

By John Watkinson, 21 Sep 2014

Crawling from the Wreckage John Watkinson continues his series of essays for El Reg in which he examines failures in society from banking and education to transport and IT. Here, with a critical eye on our economic plight, he looks at the methods employed by those doing the sums and their consequences.

Here we are, several years into the aftermath of the latest and greatest economic crash. They occur with near regularity; just irregular enough to be unpredictable. In any discipline, catastrophes are studied and changes are made to eliminate them. There are complex systems behind the water that comes out of my tap and the electricity that comes from the wall socket, others stop airliners and trains bumping into each other and by and large they work. The conclusion must be that economics is not a discipline.

Any half decent audio amplifier uses negative feedback so that if the output deviates from what it should be, the input is tweaked in such a way that brings it back. Have you ever wondered why the engines on an airliner are set forward of the wings? Well, if the wing is flexed upwards by a gust, the mass of the engine resists upward movement and the effect is to twist the wing down, so that it flies itself back to the undisturbed position.

Imagine what would happen if the engine were behind the wing. The mass of the engine would amplify the effect of a gust and the wing might tear itself off. This is called divergence or positive feedback. Moreover, the wing might twist to an extreme angle and stall, so it would then twist alternate ways in a phenomenon called flutter. How ironic that flutter is also a term for gambling.

Flying without wings

When a crisis goes on for seven years it is no longer a crisis and becomes the new normal. Economists think that they have control of economies using interest rates, but they don’t. Interest rates have been at an all time record low for years now and nothing is happening. In servo parlance, the system has gone hard over. The input isn’t controlling the output.

Economies are more complex than was thought. I believe it is axiomatic that, as economists are unable to prevent the instability, they either don’t have a model of how economies work and/or they don’t have control. When the wings have come off, applying up-elevator is pointless. All Draghi but no lift. In that sense, it doesn’t matter who wins the next election. When the wings have come off, the pilot’s intentions don’t mean a lot.

Pilot atop sinking vintage aircraft

Pilot atop sinking vintage aircraft

Unstable systems are self-crashing. The divergent behaviour can be triggered by any small random disturbance. So blaming an individual disturbance is foolish. If it had not been that disturbance, it would have been another one.

So-called toxic loans and sub-prime mortgages are widely blamed for the latest crash. A sub-prime mortgage is one where there is some risk that the mortgagee may not be able to pay regularly. Someone like that must be a loser, so it’s plausible to blame them. But it’s a fanciful presumption and the blame lies elsewhere.

I went to buy a candy bar in Palm Springs airport and came away with Charlie LeDuff’s Detroit: an American Autopsy. I recommend this book to anyone interested in mending our broken society. Among the chilling stories of a broken city, one stood out, and that was the story of the negative amortisation mortgage.

I have said before that it is the mission of banks to cause debt. In a negative amortisation mortgage, the monthly repayments are incredibly low, so, superficially, it’s attractive. But the repayments don’t even cover the interest, even though in some cases the mortgagee thought the loan simply had a low interest rate. What happens is that every month the amount you owe goes up: banking heaven.

You end up in a house that you can’t afford, that you will never own, owing more every month, until the amount you owe crosses a threshold and then there is a massive jump in the repayments. That might work if the value of the house had risen, or if your salary had gone up, but it’s a gamble; a gamble in the Las Vegas sense, where you can’t beat the house. In a stagnant economy where salaries are not rising or your employer has just gone turtle, the outcome of a negative amortisation mortgage isn’t a gamble, it’s a certainty.

Climbing the debt mountain

But what happened when mortgagees were faced with these enormous hikes in their repayments that they could not pay? Did they negotiate with the banks? No, they realised that they had been screwed and many of them decided that as they were going to lose everything they would get their own back. They simply left town, vanished, leaving the property to its fate; property that was worth significantly less than the amount outstanding. And a glut of repossessed property depressed prices, making negative amortisation mortgages even more of a gamble. The rest is history.

So this is a classic and totally predictable example of a divergent system. It was dreamed up by bankers to create debt and it worked. It worked so spectacularly well that the consumer couldn’t support the debt and it rebounded on the banks.

You might think that no-one with an ounce of sense who was in possession of the facts would get themselves into a mess like that, especially someone with a position of responsibility that we are supposed to look up to, like a Chancellor of the Exchequer, for example.

So let’s look at what governments do. Well, if a bank’s purpose is to cause debt, a government’s purpose is to get re-elected and that means lots of public spending to make them popular. Be afraid when a politician becomes popular. If these things cannot be afforded, then the money is borrowed, so the spending costs more because of the interest that has to be paid.

Now this is where the need for growth comes in. First, let’s define growth. It’s usually measured as the rate of increase in GDP (gross domestic product) year on year. A proportion of GDP will be available to the government as taxation. That’s their income, if you will.

Collapsed house

A collapsed house

What the government does is to gamble that it can borrow more than it can afford on the assumption that future growth will provide increased tax revenues to pay the interest. The sum that has been borrowed is the National Debt. But it’s reckless because the gamble fails when growth falters. We can re-define a government as an entity that is forced by its own recklessness to stimulate growth.

Spend it like Beckham

The need for growth is behind the creation of the consumer. A consumer is an entity that is either brainless or brain-washed who works so he can pay tax and uses his net pay to buy brand new commoditised rubbish (oxymoronically called goods) on which he will pay VAT, that allows a manufacturer to make a profit that will be taxed.

A good consumer, then, takes that rubbish to the dump: the sooner the better. Really good consumers borrow money to buy even more stuff to take to the dump, so they pay interest as well as VAT and income tax. VAT went up just after the crash. No prizes for guessing why.

If there is another fundamental requirement for growth, I don’t know what it is. I think it is an assumption that has never been questioned, a bit like respect for institutions. Indefinite growth on a finite planet is not possible. I don’t need to explain that. Fortunately the rapid growth which, if sustained, would make Earth uninhabitable never continues because of the crashes.

As living standards increase people become better educated. Educated people understand the need to limit population growth, and access to contraception allows them to choose to educate a small number of children well, rather than a lot badly.

Another factor is that traditionally people had lots of children so they would be looked after in their old age. As people become more affluent they can look after themselves. Thus birth rates fall and we find an ageing population that costs more to look after in pensions and other care, so the tax income available to pay interest goes down. In addition it becomes obvious what was known all along, which is that reliance on fossil fuel is unsustainable and energy costs go up, curbing growth.

My dear, never confuse efficiency with a liver complaint

Entrance to Bethnal Green Underground station A homeless person sits at the top of the steps, too dispirited even to beg

A homeless person sits at the top of the steps, too dispirited even to beg.
Photo by Dr Neil Clifton, licensed under CC BY-SA 2.0

These restrictions to tax revenue have not been effectively acted upon, so the result is an over spend, the annual amount of which is known as the budget deficit. How is this deficit funded? Well, you’ve guessed, by borrowing. The government does not even seem to be able to bring the budget deficit under control, let alone to reduce the National Debt, which presently stands at about £1.3tn, or around three quarters of GDP.

After bumbling along at 40-50 per cent of GDP, it started to climb steeply following the last crash. It presently corresponds to about £40,000 for every Brit who has a job. The astute reader will have noticed the precise parallel between the ever increasing National Debt and the ever increasing amount owed in the negative amortisation mortgage. Finger in mouth time.

Once the desperation for growth to pay for reckless borrowing is accepted, most government action, or lack thereof, can be understood. Pensioners are very much on their own. They have no voice; it’s not as if they can go on strike. The need to cut carbon emissions cannot and will not result in much government action because fossil fuels are heavily taxed and they need the money. Cutting carbon reduces spending on fossil fuels and reduces the taxation.

But all I need is cigarettes and alcohol

It should now be clear that the creeping approach to dealing with smoking and drinking is because less spending on fags and booze reduces growth. It should also be clear why politicians deregulated banks so they could get more people into more debt, in order to finance a consumer spending boom that would lead to growth that would keep the crazy scheme going for a bit longer. In fact, it led in the end to repossessions, negative equity, millstones around the necks of consumers and governments alike and an underclass of people with no hope. Economics, as it is practiced, isn’t a discipline: it’s an indiscipline.

The long standing need for tax revenue raised on energy has led to the UK’s housing stock being appallingly insulated and inefficient, so now we face a winter of energy poverty where we will be selling the silver and chopping up the furniture to put on the stove, or dying of hypothermia. If the weather was better we would be growing bananas.

The reason for sustained flat line near-zero interest rates becomes clear. This is why Mark Carney invents a new and unmet criterion for raising interest rates every week. The European Central Bank just cut rates to 0.1 per cent. There is so much debt that any increase in interest rates will result in a collapse in which consumers, businesses and government alike find it impossible to pay the interest.

If consumers by some miracle come by some money, they are not going to rush out and buy goods with it; they are going to pay off some of their debts. People are ceasing to be consumers. In a future piece I intend to take a good look at consumerism and how not to take part.

Although GDP is now back to pre-crash level, the population has gone up so per capita GDP has fallen, as has average income. Unemployment has not fallen because our industry is picking itself up but because thousands of people who were laid off in the aftermath of the crash have started working for themselves. Perhaps crucially, tax revenues are down while the cost of interest on the National Debt is up. Some recovery.

Looked at another way, GDP is also an indicator of the amount of the world’s resources that were used up by commerce. In other words it is the rate at which the planet is being raped. So it is immediately possible to see that politicians are in a bind, because they are financially unable to stop raping the planet, which is why environmental summits are a joke.

We need to look very carefully at how and why economics has got us where we are, to ensure that the changes we need to make reduce the recklessness and improve stability. One issue that is glaring is that the average person has no idea about economics on any scale from domestic to national. This is due to its being completely ignored in our educational system, which is scandalous, and, I suspect, deliberate.

It’s high time that the principles of economics were incorporated in the school curriculum. It won’t help the immediate crisis, but it would be nice to think that a future generation would be better equipped to understand risk and not get in over its head, and possibly to convey that more or less bluntly to our so-called leaders. ®

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