A different kind of political blog.

Yesterday in Parliament, I chaired an event with Gordon Kerr, launching his report The Law of Opposites, which is covered in the Guardian today:

Banks use accounting loopholes to inflate their profits and bolster staff bonuses, according to a report published on Wednesday that calls for changes to the international accounting rules.

According to the paper by the Adam Smith Institute, banks are able to use complex financial products such as credit default swaps to report profits that they might not otherwise be able to.

via Banks use accounting loopholes to inflate profits and bolster bonuses | The Guardian. In related news, The Telegraph reports Watchdog’s verdict could put Sir Fred Goodwin in the dock.

As the Adam Smith Institute blogs:

The Adam Smith Institute report is structured around six shortcomings in the rules governing bank profit and capital reporting, which must be addressed:

• Uncertain future cashflows can be recognised as certain by purchasing a credit default swap (CDS) or similar “protection”, even though the supplier of the protection is likely to default if the insured event occurs;
• Profits can be recognised from the increased value of assets, or decreased value of liabilities, on the basis of a market price, even though the totality of revalued assets or liabilities could not be sold at that price;
• Profits can be recognised from the increased value of assets, or decreased value of liabilities, even when the revaluation of assets is estimated, not by market prices, but by a model built by bank employees. This is the so-called mark-to-model approach to valuation;
• The net present value of uncertain future cashflows can be recognised as profits even when they are estimated using implausibly optimistic forecasts. (This is a variation of the mark-to-model problem listed above);
• The EU’s IFRS accounting system, voluntarily adopted by UK and Irish banks at the banking company level, is inconsistent with UK law;
• Banks need not make provision for expected losses when calculating their profit.

The implications of all this are profound, not just for the solvency of banks, but for the justice of taxpayer bailouts and bank bonuses. I’m sure we have not heard the last of the flaws in IFRS and the problems it causes.

I spoke last night in the general debate on the economy, saying*:

As I rise to speak I am reminded of a quotation from an economist who was a fierce critic of Keynes, a chap called Henry Hazlitt, who said:

“Today is already the tomorrow which the bad economist yesterday urged us to ignore.”

We have heard today some moving accounts of individual and collective suffering in different regions of the country and among different sections of the public. We should be asking ourselves why, oh why, have we been delivered into this misery, which looks as if it will extend over years. Much of the conversation we have heard has been along the lines of aggregates, coarse economic aggregates, and has tended to stray away from individual choices and consequences. We have talked about markets in the abstract, and it is a pity that we seem to have forgotten that markets are a social phenomenon, and that they are about people co-operating. When we talk about markets, we tend to imagine overpaid people, high-frequency trading and those who add nothing to society.

I am reminded of something a constituent said to me recently after hearing a Minister’s speech. He asked, “Why is it that everything always seems to get harder for the working man, whoever is in power?” Indeed, in my constituency unemployment is up by 6.3% among the over-50s, up by 9.5% among those aged 25 to 49 and, scandalously, up by 23% among the young. We have heard that child poverty increased by 200,000 under the previous Government and that it is likely to increase by up to 100,000 under this Government. In the 21st century, that should not be our economic position.

Why are we in this debt crisis? I have just checked the M4 money supply figures—I am sorry to return to aggregates, but needs must. When Labour came to power the money supply was about £700 billion and it is now about £2.1 trillion, so it has tripled over the past 14 years. Unfortunately, most economists talk about money flowing into the economy as if it were water poured into a tank that found its own level immediately, but what if it is like treacle or honey? What if it builds up in piles when poured into the economy and takes a while to spread out? What if that money was loaned into existence in response to individual choices led by the excessively low interest rates pushed by the central bank? What if it was loaned into existence in particular sectors, such as the housing sector, where prices have more than doubled over the same period, and what if it was the financial sector that received the benefit of that new money first? Would that not explain why financiers and bankers are so much wealthier than everyone else, and why economic activity and wealth has been reorientated towards the south-east?

Unfortunately, the idea that money takes some time to move around the economy is lost on most economists, which I very much regret. Why did most economists not see the crisis coming? I put it to the House that it is because their theories of credit are mistaken. They make fundamental errors. Unfortunately I do not have time to go into that, but the fundamental point is that credit is a choice to consume more now and less later. It is about the exchange of present goods for future goods, and co-ordinating the economy through time, and I am afraid that the current intellectual mainstream in economics has dropped us into this desperate mess.

Opposition Members criticise the Thatcher and Reagan years. I think that there was much to applaud in those years, but unfortunately their intellectual underpinning was monetarism, which, like Keynesianism, is infected with those dreadful mistakes. People in the Occupy movement, and our constituents, are right to question the justice of our economic processes. The hon. Member for Penistone and Stocksbridge (Angela Smith) said earlier that the system cannot endure, and I am inclined to agree. I agree that the current debt-based and—I am afraid to say—statist system cannot endure. However, if this system is not to endure, which way should it fall? [Humanity] tried the statist direction in the past and it led to misery and murder. I stand for free markets and free co-operation, but I say this to the House: if this is capitalism, I am not a capitalist.

* (I have made a small correction to the quote and a clarification in [], both of which I have requested from Hansard)

Related reading can be found here:

• Hazlitt, Economics in One Lesson (buy, PDF), chapters 1, 6 and 23 in particular.
• Mises, Human Action (buy, online), especially chapter 20 “Interest, Credit Expansion, and the Trade Cycle”
• Hulsmann, The Ethics of Money Production (buy, PDF).

The Bank of England’s money supply measure M4, which I referred to, may be found here. I used M4 in this context because it is the conventional mainstream measure, but I prefer Kaleidic Economics’ MA for reasons explained on that site (Notes and Coins is too narrow and M4 too broad). MA tells a clear story of where jobs and growth came from and where they went – money supply growth created the illusion of prosperity, broke the banking system and collapsed, taking the illusion with it:

Year on year change in Kaleidic Economics' MA - click for source

Update: Video here. My delivery picked up after about the first minute.

Having just read Chuka Umunna’s speech yesterday, I am sorry I was not able to make the debate. There is one particular fallacy underlying Labour’s rhetoric and this particular speech’s bluster: government cannot live forever beyond its means.

Evidence I have presented elsewhere shows that the total tax burden has been around 42% of GDP for 40 years, whoever has been in power. It looks like there is a practical limit to how much of national income the state can seize. If the state spends over about 40% of GDP for a long time, it must borrow and yet never repay. That this reality was hidden through currency debasement – inflation – for a generation is one of the most important causes of the present crisis.

In Economics in One Lesson, Henry Hazlitt wrote:

The precaution of looking for all the consequences of a given policy to everyone may seem elementary. Doesn’t everybody know, in his personal life, that there are all sorts of indulgences delightful at the moment but disastrous in the end? Doesn’t every little boy know that if he eats enough candy he will get sick? Doesn’t the fellow who gets drunk know that he will wake up next morning with a ghastly stomach and a horrible head? Doesn’t the dipsomaniac know that he is ruining his liver and shortening his life? Doesn’t the Don Juan know that he is letting himself in for every sort of risk, from blackmail to disease? Finally, to bring it to the economic though still personal realm, do not the idler and the spendthrift know, even in the midst of their glorious fling, that they are heading for a future of debt and poverty?

Yet when we enter the field of public economics, these elementary truths are ignored. There are men regarded today as brilliant economists, who deprecate saving and recommend squandering on a national scale as the way of economic salvation; and when anyone points to what the consequences of these policies will be in the long run, they reply flippantly, as might the prodigal son of a warning father: “In the long run we are all dead.” And such shallow wisecracks pass as devastating epigrams and the ripest wisdom.

But the tragedy is that, on the contrary, we are already suffering the long-run consequences of the policies of the remote or recent past. Today is already the tomorrow which the bad economist yesterday urged us to ignore. The long-run consequences of some economic policies may become evident in a few months. Others may not become evident for several years. Still others may not become evident for decades. But in every case those long-run consequences are contained in the policy as surely as the hen was in the egg, the flower in the seed.

From this aspect, therefore, the whole of economics can be reduced to a single lesson, and that lesson can be reduced to a single sentence:

The art of economics consists in looking not merely at the immediate but at the longer effects of any act or policy; it consists in tracing the consequences of that policy not merely for one group but for all groups.

Today is indeed already the tomorrow which the bad economist yesterday urged us to ignore. It’s a pity Labour want us to keep on ignoring it. If their goal isn’t poverty and general immiseration, one wonders what it is.

In this mad age of yet further taxpayer-backed lending, the BBC’s new series may or may not be something to look forward to:

More here.

Part I, the price system:

Part II, profit and loss:

See also, Kirzner, How Markets Work: Disequilibrium, Entrepreneurship and Discovery (PDF), which is a wonderful rebellion against the over-simplification of neo-classical economics. For example:

Austrian theory, as presented here, places great weight on ‘entrepreneurial discovery’ which enables decentralised decision-makers to recognise when present decisions can be improved upon, and to anticipate future changes in the decisions being made by others. Movements in prices, production methods, choices of outputs, and resource owner incomes generated by entrepreneurial discovery tend to reveal where current allocation patterns are faulty, and to stimulate changes in the corrective direction.

In other words, don’t tinker with the complex, dynamic, creative process that is life in society: it’s not helpful. And if contemporary mainstream theorists had understood the application of this idea to interest rates, we might not be in this mess.