Terry Smith Straight Talking

Newsnight: Krugman v Moulton and Leadsom

I am in New York at present so I did not see the Newsnight confrontation between Paul Krugman, Jon Moulton and Andrea Leadsom MP. But a combination of my blog post on Krugman’s LSE lecture and the Newsnight piece created an unusually large number of comments on my blog so I thought I would post a response now that I have seen the programme on BBC iPlayer. You can view the interview here (starts 31mins in).

Alcuin asked me for my impressions of the debate. I thought that Moulton and Leadsom more than held their own. I hope that Jeremy Paxman’s remarks that you can’t disagree with a Nobel prize winning economist was, as it seemed, tongue-in-cheek. Jon is a very sensible financier. I have not come across Andrea Leadsom before but I agree with DarwenLad - she is one of the few MPs whom I have heard say anything sensible about the financial crisis and depression we are in. I know this - I would rather have the economy, government, and/or my money run by Jon Moulton than I would by Paul Krugman or any other economist.

I found Krugman condescending and dismissive, for example, when Moulton cited Antonio Afonso’s research showing that the size of the state is negatively correlated with economic growth, saying he could disprove it but it would require ‘some equations and charts’. Translation - “I need pictures in order for me to be able to explain this to mere mortals like you”. In my view if you are good, you can explain your arguments and a concept.

Krugman was almost a case study of accusing others of committing the sin he himself could be accused of being guilty of when he accused Moulton and Leadsom of wanting to cut the size of public spending for doctrinaire political reasons and using the crisis as an excuse to do so. Perhaps what has sensitised him to such concealed motivations is that he is a left wing economist who wants to pursue a big state and public spending for social engineering and who distrusts the private sector?

I was disappointed that Krugman was allowed to get away with the assertion that we have experienced two years of austerity already when there has been very little austerity in the sense of cuts in government spending, particularly in the UK, and none at all in places such as the United States.

To answer John Healy no one is engaging with me from government. I have made numerous offers to work with politicians from any party who want to try to fix this situation and my approaches have been universally ignored or rejected. This does not improve my view of the motivation and perspicacity of those in power.

Keith Price I will let you know where I think the cuts should fall. I have already promised to post on this blog on that for an earlier Commenter on my Austerity v Growth piece and will do so.

Ken Charman - what a good idea. You are right. All ministers should be taught a litany which they should deliver at the start of any media interview which spells out the reality of this situation. I would add that any debate on austerity should be preceded by the simple statement “There hasn’t been any yet”.

Dropsopkcin: I don’t have a chart of tax v GDP but since tax is to fund the state I suggest you may get what you want from the study which Jon Moulton was referring to which I believe is by Antonio Afonso and Davide Furceri “Government, Composition, Volatility and Economic Growth” January 2008 available online here. Ironically it’s a European Central Bank research paper!

Paul Krugman

I am in New York at the moment but word reaches me from friends in the City who attended Paul Krugman’s talk at the LSE last night. I am told there was a very long queue ‘a bit like the one at the iPad launch [at] an Apple store’ but that his talk was ‘empty of details’ ‘woolly’ and that he offered ‘no evidence [to support] his theory. ‘He only repeats that we have to get out of depression now and spend our way out.’

Krugman is an ideologue not an empiricist.

He’s another believer in the magic money tree which will just enable us to spend our way out of this crisis. He shares that view with idiots like the Spanish authorities who thought that they could issue government bonds to Bankia in return for equity and Bankia could then deposit the bonds with the ECB for cash. You can see better conjuring tricks at a child’s birthday party.

There is also the small point that if you take the UK as an example, we have so far had GBP500bn of deficit spending, GBP325bn of Quantitative Easing, and interest rates have been at a 300 year low for over three years and the economy is still in recession. Krugman’s call to do more of this breaches Einstein’s axiom that to keep repeating the same action whilst expecting a different outcome is a definition of insanity.

The only way out is to cut state spending back to where it was 10 years ago-in the UK that’s a reduction of one third. What is it that the government didn’t provide 10 years ago that you can’t live without? Nothing. Then you can cut taxes and that will stimulate economic growth. Individuals and companies that earn the money are much more efficient at spending it than governments, so why not leave more of it with them? If you don’t believe that you are either a) mad and/or have no experience of real life; and/or b) are ignoring the statistic that between March 2000 and March 2010, individual and government debt increased by £3.11 for each £1 increase in GDP. Plus if you cut back the size of the state you can relieve business from the growth of regulatory interference.

Austerity v Growth

I have appeared recently on Newsnight, ITV News and BBC News talking about the debate over austerity v growth.

I also appeared on Robert Peston’s BBC2 programme about the Eurozone crisis - The Great Euro Crash.

These appearances were prompted by the Eurozone crisis coming back into focus, and in particular by a period of a week in which the Dutch government fell; elections in Greece failed to produce a government, and in particular failed to produce a consensus which supported the austerity measures which Greece had agreed to as part of its last bailout deal; and the socialist candidate Francois Hollande defeated the incumbent Nicholas Sarkozy to become President of France. Clearly the electorates are rejecting austerity. It has now led David Cameron to start making supportive noises about Monsieur Hollande’s call for policies to support growth. It seems strange to scramble to align oneself with a soundbite. But then I’m not a politician.

The appearances were also a result of the publication of the latest piece of research by my colleague Dr Tim Morgan – Blowing the Whistle on UK Austerity.

Tim’s research explodes the myth that the UK economy is struggling under the impact of government spending cuts. Government spending was cut by just 1.5% in 2011-12 and is only planned to fall by 5-6% by 2016-17 (so far away, who cares?). It is still over £20bn higher than government expenditure in 2008-09 under Labour. More worryingly, it is 50% higher in real terms than it was 10 years ago. As Tim succinctly puts it: what is it that the government wasn’t supplying ten years ago that we now cannot live without? The answer of course is nothing. Expenditure can be radically reduced and needs to be if there is to be any chance of closing the deficit which is currently running at over £120bn per annum and adding to the national debt which is already too high.

Such a miniscule cut did not send the UK economy back into recession-it never exited in reality (see below about the size of the stimulus which has been applied just to get it to stand still).

My stance is clear and it has been so since the onset of the financial crisis and the Eurozone crisis:

1. The debate between those who propose policies designed to promote growth and those who see the need for austerity is a sterile one for a number of reasons.

The simplest reason is that we are going to get austerity whatever people want. There is simply no source of additional money to spend to stimulate growth. The bond markets have had enough of governments who continually run unsustainable deficits. You cannot borrow your way out of a debt crisis.

Additional deficit spending funded by increased borrowing would not produce the desired result even if it were possible. So far the UK economy has been the recipient of £500bn of deficit spending, £325bn of Quantitative Easing and interest rates have been at a 300 year low for over three years. These so-called Keynesian measures (I say “so-called” because most of their proponents seem to me to have about as much grasp of Keynesian economics as they do the topography of the far side of the Moon) have not managed to get the economy growing so far, and they will not. The velocity of circulation of money has slowed-people want to pay down debt where they can. The government is also an incredibly inefficient spender (unsurprisingly as it’s not their money)-in the years prior to the recession it borrowed £2.18 for every £1 of growth. As Einstein said, to keep repeating the same actions whilst expecting a different outcome is a definition of insanity.

2. The only way to generate growth is to cut the size of public spending sufficiently to allow for tax cuts. Individuals and companies are much more efficient at spending the money they earn than the government is on their behalf, so better to leave more of it in their hands.

Yes, I do have a plan for exactly where to make the cuts.

3. With regard to the Eurozone I first predicted that Greece would leave in April 2010. I have not changed my mind.

There have been no fundamental solutions applied to correct the problems of the Eurozone. You cannot solve a problem of solvency and lack of competitiveness with liquidity and rhetoric. If you could, it would have been solved long ago.

When Greece leaves, the crisis will roll on into Portugal (I know it’s a small country but everyone seems to have forgotten them) followed by Spain, Italy, Ireland and ultimately France. Yes, the horrible truth is that financially France is a peripheral country, one of the PIIGS.

The Euro is doomed

I was surprised to see the headline in Friday’s Financial Times “Seven days which shook Europe” looking back over the fall of the Dutch government, the election of Francois Hollande in France and the Greek elections. As I have been predicting for more than a year that Greece will leave the Euro and that this will produce a domino effect which will probably see Portugal, Spain and Italy follow suit, I am surprised that anyone could be surprised by these events. But then I suppose I don’t spend my life swallowing a diet of PR spin from the Eurozone “elite” and their acolytes.

As ever, people are looking in the wrong place for the source of trouble. All eyes have been on the bond market, whereas they should now be on bank deposits as most Greek bonds are now in official and/or local hands so the bond market is no longer playing a central role in the Greek tragedy/farce. There is an old saying that a currency can endure despite a lack of faith in it from foreign investors, but not when it is rejected by its own population (see Argentina in 2001 for details). Greece’s bank deposits have been fleeing its banking system as its citizens fear that they will wake up one day soon and discover that they are New Drachma deposits rather than Euros. When this happens, the €3 trillion of deposits in Italian and Spanish banks are going to try to do the same. This will represent a tsunami which no amount of Eurozone spin can prevent and which will require drastic action - like exchange controls.

Whilst we await these events, herewith a piece of research which tells you why the Euro was doomed from the outset:

 

Return on Capital Employed

Today's Financial Times carries a letter from me about the subject of how to measure managerial performance.

This is a matter which has attracted a lot of attention as a result of the debate about executive pay. Having a yardstick of company performance which aligns the rewards for managers with the interest of investors is vital to this debate.

I have been amazed by the poor quality of the debate and the work on managerial incentives. Probably the most commonly used measure of fundamental performance is growth in Earnings Per Share or EPS. This is garbage: it takes no account of the amount of shareholders' capital employed to achieve that growth. This is a mistake that a novice investor choosing a bank savings account would avoid.

I was therefore pleased but slightly irritated to read that the Association of British Insurers, one of the trade associations which seeks to represent the interests of insurance investors, and which has expressed many views on executive pay, has said that growth in EPS may not be a suitable measure for this purpose. Neither is Total Shareholder Return, another commonly used measure, or even Return on Equity or ROE as it can be distorted by leverage or debt gearing. They are beginning to recommend Return on Capital Employed or ROCE. So are some institutional investors.

What is galling about this is that not only have I been saying that for about 20 years, but Warren Buffett said it in his 1979 Chairman's letter for Berkshire Hathaway. It has taken these self-appointed guardians of investors' interests a mere 33 years to catch up.

The next concept they may need to study is asset life or the duration of those returns. At their present rate of progress we can expect a result is 2045.

Buffoonery.