08/08/2012

By Michael Baxter, economics writer

If you spend more than you earn, you feel poor, if you earn more than you spend, you feel rich. That’s what some people say. Maybe that is true, maybe it isn’t. But here is something that is definitely wrong, but it is also something many people in power state as if it is fact: "An economy is successful if it produces more than it consumes.”

Not only is that view wrong, it is dangerously wrong. Here is another falsehood: "We must all live within our means". These are the errors that threaten to bring down the global economy.

The first point is a simple matter of mathematics. Across the world, output must equal income. What we spend, and what we earn must be the same. So, if one country produces more than it spends, another country must do the opposite.

If every country tries to spend less than it produces, the result will be… well, it won’t be good. The underlying force across the global economy will always be for demand to be inadequate. Spare capacity will result, unemployment will rise, and economic depression will beckon.

Countries that post trade surpluses may accuse others of living off their credit, but in fact the surplus countries are just as guilty of running an unsustainable economy.

Keynes understood this. That is why in 1944, at the town of Bretton Woods in the US, he — along with the great and the good of the global economy, at least those who could make it, after all a war was on — met up and talked. Keynes advocated a new way of running the global economy. He wanted to see surplus countries as well as deficit countries penalised. He wanted to try to force surplus countries to buy more goods and services from deficit countries. “Who is this smart arse Brit?” asked the US delegation. “He represents a country that lives off the kindness of Uncle Sam, and somehow he wants to see this kind Uncle admonished,” they said. And their conclusion was:“No thanks.” Instead, we got the Bretton Woods system of international trade and the IMF and the World Bank. Keynes died soon afterwards, reportedly exhausted.

It’s a shame; had his ideas been accepted, the global recession may have been an awful lot less serious, and 70 years on the biggest beneficiary may well have been the US itself.

The second point is a matter of slightly more complicated mathematics. Take debt. Hyman Minsky was a disciple of Keynes. He argued that for an economy to grow, companies must be planning to increase output, which must mean people must be planning to increase their expenditure. And given that, in the real world, we don’t get paid the day we produce; given that in the real world we have this thing called money; this may mean that the only way we can have growth is if we also have debt.

But how much is too much debt, and how much debt creates a bubble? If you had asked the boss of Lehman Brothers whether the bank had taken on too much debt, he would have argued: "No, the bank is exercising a caution policy.” That’s the problem with bubbles. For those in the middle, things don’t seem excessive. And given that it seems to be human nature to be optimistic, doesn’t that mean that if we need debt to grow, it is inevitable that we will have the odd bubble? As far as the economy goes, it seems West Ham supporters have got it right. If we want growth, we must be forever blowing bubbles.

Michael Baxter, mike@iabn.co.uk

Editor the investment and Business news newsletter , blog.share.com and author of the Blindfolded Masochist