Ending The Doomsday Cycle


Interesting article by ex-IMF supremo Simon Johnson and Peter Boone on how to correct a severe systemic fault in our economic system they believe could cause complete financial meltdown / economic collapse.

The doomsday cycle has several simple stages. At the start, creditors and depositors provide banks with cheap funding in the expectation that if things go very wrong, our central banks and fiscal authorities will bail them out. Banks such as Lehman Brothers – and many others in this past cycle – use the funds to take large risks, with the aim of providing dividends and bonuses to shareholders and management.
Through direct subsidies (such as deposit insurance) and indirect support (such as central bank bailouts), we encourage our banking system to ignore large, socially harmful ‘tail risks’ – those risks where there is a small chance of calamitous collapse. As far as banks are concerned, they can walk away and let the state clean it up. Some bankers and policymakers even do well during the collapse that they helped to create.
Regulators are supposed to prevent this dangerous risk taking. Adair Turner, chairman of the Financial Services Authority, is calling for more radical change than most regulators. But banks wield substantial political and financial power, and the system has become remarkably complex, so eventually regulators become compromised.

The extent of regulatory failure ahead of the current crisis was mind boggling. Many banks, including Northern Rock, convinced regulators that they could hold just 2% of capital against large and risky asset portfolios. The whole banking system built up many trillions of dollars in exposures to derivatives. This meant that when one large bank failed, it could bring down the whole system.

Given the inability of our political and social systems to handle the hardship that would follow economic collapse, we rely on our central banks to cut interest rates and direct credits to bail out the loss-makers. While the faces tend to change, each central bank and government operates similarly. This time, it was Mervyn King, Gordon Brown, Tim Geithner and Ben Bernanke who oversaw policy as the bubble was inflating – and are now designing our rescue.

When the bailout is done, we start all over again…

The real danger is that as this cycle continues, the scale of the problem is getting bigger. If each cycle requires greater and greater public intervention, we will surely eventually collapse.

Link to read the full article – The Doomsday Cycle .

Johnson and Boone believe that as the regulatory system is prone to capture (the Banks have the most money & the best lawyers) regulation alone is not the answer. Their solutions are briefly presented beneath the fold.
And the solutions, they propose three steps –

1 –

We believe that the best route to creating a safer system is to have very large and robust capital requirements, which are legislated and difficult to circumvent or revise. If we triple core capital at major banks to 15-25% of assets, and err on the side of requiring too much capital for derivatives and other complicated financial structures, we will create a much safer system with less scope for “gaming” the rules.

2 –

Second, we need to make the individuals who are part of any failed system expect large losses when their gambles fail and public money is required to bail out the system. While many executives at bailed-out institutions lost large amounts of money, they remain very wealthy.

3 –

Third, we need our leading fiscal and monetary policymakers to admit their role in generating this doomsday cycle through successive bailouts. They need to develop solutions so that their institutions can credibly stop this cycle. The problem is simple: most financial institutions today have now proven too big to fail, as our policy-makers have bailed them all out. The rules need to change so that creditors do not expect another bailout when the next crisis happens.

No bio, some books worth reading – The Rational Optimist: How Prosperity Evolves – Matt Ridley .

Crisis Economics: A Crash Course in the Future of Finance -Nouriel Roubini, Stephen Mihm

  • BryanS

    One aspect of the situation we find ourselves in confuses me. Where did the money go?
    Take the sitution where a developer paid (with borrowed money from a bank or banks) a ludicrous amount for a site in Dublin4. The vendor got a huge amount of money. What did he do with it? Did he put it under the bed? No, he put it in a bank. The bank then lent it again to another crazy developer who paid a stupid amount for another bit of ground.The vendor got the money and presumably put it in his bank – and so on and on. The point is there must be a lot of people with a lot of money in banks which contra the bad loans. there is the same amount of money as there was in the beginning? Or am I wrong?

  • tuatha

    BryanS – the question you ask is the same one every half sentient person has, who has the ill gotten gelt, where?
    The explanation is simple but devastating to anyone with a sense of fairness & equity – the vast majority of the funny money never existed in any real, or physical, sense as in the days of the gold standard (disclaimer – I am not a ‘gold bug’, the stuff is useful for jewellery & electrical circuits and that’s about it).
    Since the relaxation of the principal rules, banks and assorted shysters have been able to lend ‘fiat’ money,created out of thin air based on their good standing as reputable, well regarded fellows who would never do the dirty.
    In case anyone still recalls, it was the BigBang of the financial world, when thatchernomics allowed the stipey shirted wideboys of Canary Wharf to start trading in exotics concepts (with the emphasis on ‘con’) such as derivatives and ever more illusory ‘products’ that was the beginning of the endless money-go-round. Basically as long as the muzak kept playing and the coke was plentiful, the toxic parcels of debt could be traded round & round and where it ended up few knew and none cared.
    Mypersonal recommendation is Voltaire’s Candide, “tend your garden”. At least it’ll feed you.

  • BryanS

    We had a very good example of the musical chairs syndrome here in northern Ireland. there are a bunch of ‘property developers’ (parasites to my mind) who sold on their shopping centres etc to each other for bigger and bigger amounts, The strange thing is I havent heard of any of these usual suspects going bust!

  • BryanS

    I suppose the answer to my question is Switzerland.

  • tuatha

    BryanS – I wish that it were that simple (salted away in the vaults of GnomeBank gmbh) as then it could be retrieved, one way or tuther.
    Unfortunately no – it never existed. The solution, for we mere citizens & taxpayers, is to say “the obligation to repay a debt based of false accounting is NIL”.
    That’d learn ’em.

  • Scaramoosh

    Those that were involved in milking the banks from the start of boom,managed to build up sufficient assets and collateral so as to survive the downturn. In many instances they have allegedly lost 200/300m;but they still remain very wealthy.

    It was those got on to the train late; or who over-extended themselves through greed, that got caught out in the end (to the extent that they have gone bankrupt owing hundreds of millions).

    Why has nobody compiled a list of all of these characters?

  • Alias

    BryanS, the property developers aren’t bankrupt – but some of their companies are. Bubbles are created when assets inflate in value to soak up the excess in the supply of money. That’s the effect that inappropriate monentary policy has on an economy. Is there more money in the system? Yup, 1.67 trillion euros more of it than when we joined the eurozone 10 years ago. But don’t feel so rich since it’s all borrowed money and all of it has to be paid back plus interest, with the defualting sums being underwritten retrospectively by the taxpayer.

  • Mack


    One aspect of the situation we find ourselves in confuses me. Where did the money go?

    there is the same amount of money as there was in the beginning? Or am I wrong?

    Banks need to keep around 10% of the money they have on deposit on reserve. That means 90% of the money they have on deposit is lent out. When they lend it out it they create new money, backed by debt. E.g.

    A puts €100 on deposit
    B borrows €90 from the bank
    B spends it in A’s shop
    A puts the new €90 on deposit

    The initial €100 euro deposit has become €190, what’s more the bank can lend out another €81 so the cycle begins again, the deposits build up – but importantly so does the debt.

    Note – the deposits are backed by debt and not the other way around. If B can’t repay the bank his €90, then the bank can’t pay A his €100 never mind his €190.

    So when everything is booming and banks are making new loans – lot’s of new money is created and everybody seems wealthier. But when the process goes in reverse – money is destroyed and everyone get’s poorer. The banks are insolvent because B is insovlent. They can’t pay A. So the government (taxpayer) is stepping in to repay A’s money. It isn’t possible for A to step in and pay himself…

  • Alias

    If they lent from their own deposits then there wouldn’t be any problem. It’s the leverage ratio that creates the problem. So it’s a case of the bank having 1 billion in deposits and being able to leverage up to 100 billion in borrowing from other lenders within the eurosystem. Fortunately, while the EC allowed Irish banks to leverage far higher than they actually did, none of the major Irish banks have a leverage ratio above 26, whereas none of the major German banks have a leverage ratio below 52. The reason the EC allowed banks within the Eurosystem to leverage to insanely high amounts was to support the expansionist monetary policy of the ECB. In contrast, the major US banks are not permitted to leverage above a ration of 10.

  • tuatha:

    it was the BigBang of the financial world, when thatchernomics allowed the stipey shirted wideboys of Canary Wharf to start trading in exotics concepts (with the emphasis on ‘con’) such as derivatives and ever more illusory ‘products’ that was the beginning of the endless money-go-round.

    This is to misunderstand the role of derivatives in the economic system. In a broad sense, derivatives are a form of insurance. Properly used, they make the system more stable, not less. The current economic problems were caused by an asset price bubble, the likes of which have been known for centuries. The mistake that those in power made was to throw out those centuries of experience and shut their eyes to the obvious dangers.

  • Alias

    What is a sensible leverage ratio? 10 for domestic lending and 6/7 for commercial lending.

  • Mack


    If they lent from their own deposits then there wouldn’t be any problem

    Yes, absolutely. Borrowing huge amounts to fund developments on the European wholesale markets caused the problems in Ireland.

    It was a simple illustration to show how the money had been destroyed once the debt couldn’t be repaid (and the money borrowed from the European banks would have ended up on deposit in Ireland and been multiplied into more debt back money one way or the other too)..

  • Alias

    The culprit was called the European Capital Requirements Directive – that deregulated leverage ratio, thereby allowing banks to go on a borrowing spree. 😉

  • Greenflag

    The above is one way to break the cycle. All Mr Hoskins needs is for 10% of the more than 3 million American foreclosures out there to follow his example. The banks are out of control and only resolute and determined action by Governments across the developed world will bring some semblance of equity and responsibility back to the banking and financial and insurance services sectors .

  • Greenflag

    andrew gallagher,

    ‘The mistake that those in power made was to throw out those centuries of experience and shut their eyes to the obvious dangers.’

    Those in power had no experience -remember they are elected every four /five or six years . By the time they figure out what’s going on they’re out the door.

    Most of them had’nt a clue what was going on in the Wall St /hedge fund /derivatives world . How could they when some of the most arcane mathematical formulae used by the con men had been devised by some chinese mathematicians out of Shanghai ? Even GOP Presidential candidate admitted he was ‘weak ‘ on the economy .

    So out of touch with the voters are the political elites not just in the USA, Ireland or the UK that they appear to be and in many cases are the political playpuppets of international finance and the huge multinational corporations .

    The ‘real’ mistake that those in power made as Alan Greenspan even admitted was to assume that ‘bankers’ and ‘insurance ‘ companies would behave responsibly and would not be tempted by greed or lax or non existent regulation to pillage and loot wherever they could .

    Capital punishment for capital crimes !!!

  • Brian MacAodh

    The more I understand it, the more depressing it is.

    Is another artifical boom and very real bust inevitable?

  • Jud

    There are positive examples out there.
    Canada has taken a very active regulatory role with its banks and in particular blocked mergers which would result in ‘too big to fail’ situations along with enforcing reasonable leverage ratios.

    They are looking pretty smart through this whole mess imo.

    I saw this issue as Obama’s open net for the ‘change’ agenda. He passed up a once in a lifetime (or more) opportunity to make major positive changes to this institutionalized insanity and I have been most disappointed ion him as a result.

  • Brian MacAodh


    So Canada has taken these actions in response to the recent crisis? Or had they done so some time ago

  • BryanS

    Brian They did a long time ago and avoided this crisis. prudence was alive and well in Canada when she was another gordon Brown lie.

  • BryanS

    I still cant get my head round it.
    I am a farmer with a few acres of land not scheduled for development and some ejit comes along and offers me £1million a acre for ten acres. Ok he borrows the money from a bank but I STILL HAVE IT in my bank cause I know the value of a pound.

  • BryanS:

    Then you’re one of the lucky ones. When the eejit defaults on his loan, we all have to pay to bail out the bank with our taxes, not to mention the knock-on consequences of inflation and economic collapse. All things considered, you end up much better off (although not by the full ten million), while the rest of us pay for it by being moderately worse off. But that’s what we get for electing gombeens.

  • BryanS

    That was an example! I am not a farmer. I have no acres. But there are those who had acres and sold them for £1million an acre and I bet they have it still.
    I wish I was a farmer!

  • BryanS:

    I knew that! I was getting into the role-playing spirit…

  • Greenflag

    ‘To them that hath shall be given and to them that hath not even that which they haven’t got will be taken from them’

    Except in Canada of course where many are called and all are frozen from October through April anyway 😉

  • Mack


    Ok he borrows the money from a bank but I STILL HAVE IT in my bank cause I know the value of a pound.

    Not quite. You don’t have it & the bank certainly doesn’t have it. What you do have is some sort of contract with the bank that they will repay you that money (perhaps with interest) should you ask for it. Normally (even in good times) the banks can’t repay all of the money on deposit (if depositers ask for it simultaneously – this is what causes bank runs). But it get’s worse if the people they’ve lent to can’t repay.

    In that case the bank can’t ever hope to repay you and they and you are relying on the state to bail you out and cover your deposit.

    Incidentally, imagine there are 10 similar farms nearby. Last year one sold for £500,000. The asset has now doubled, doubling the land wealth of all the farmers. – Total value of farm land increased from £5 million to £10 million – ON ONE SINGLE TRANSACTION FOR £1 Million. Next year when the market crashes a desperate farmer (who needs to repay a bank loan) sells his farm for what he can get, let’s say £100k. Now the total value of the farmland is only £1 Million, again it’s the last transaction setting the market price.

    So even if a developer was savy enough to get out of debt prior to the blow up he could have left his money in the bank (now technically gone but for taxpayers largese) or invested it in some assets – the value of which have also collapsed.

    Either way, the money is gone..

  • Michael Gillespie

    In my understanding of economics the current banking crisis goes back to the economic philosophy of Milton Freidman in the 20th century. He was a right wing laizze faire nobelist who put forward the philosophy that the correct way to promote economic growth and create wealth was to free up the money market and let it rip unregulated by government. In this way the economy would grow forever and slumps would be a thing of the past. Milton Freidman was economic adviser to Ronald Regan who adopted Freidman philosophy in his trickle down Reganomics. Margaret Thatcher then adopted Freidman philosophy and this philosophy was adopted
    in turn by Tony Blair in new Labour. Finally this philosophy was adopted by the right wing Fianna Fail. The adoption of Freidman philosophy is clear in Gordon Brown’s claim when Chancellor of the Exchequer that slumps were a thing of the past.

    It was a free market monetary system unregulated by government that caused the current economic crisis. To avoid this in future all banks should be nationalized and placed under the control of government. In this way bankers should have their wings clipped and they should be paid a generous state salary like doctors and civil servants and bonuses abolished. The banks should return to their basic role of: –
    (a) Lubricating the wheels of industry commerce and households.
    (b) Making a profit for shareholders

    In the current crisis (a) broke down and (b) was over indulged in.

    Michael Gillespie.

  • Michael,

    That was a one-dimensional caricature of Friedman and his works. As for completely nationalising the banking sector, what makes you think that government control would be any better?

  • Mack

    Michael –

    He was a right wing laizze faire nobelist who put forward the philosophy that the correct way to promote economic growth and create wealth was to free up the money market and let it rip unregulated by government

    Not quite. He was the father of Monetarism, the economic doctrine that inflation and monetary policy issues were best managed by tight state control of the money supply.

    This put him at direct odds, for example, with the ideas of Austrian school economists who argued for free market monetary systems (E.g. Ludwig Von Mises).

    Friedman certainly believed that regulation by the state impeded business and was often unnessesary. I think as far as the banks go he has been proven wrong, but reduced regulation has led to more competition and growth in other areas. Perhaps better regulation in the banking system might have reduced the problem. But note that Johnson and Boone above argue that regulation is ineffective in banking as the banks are so powerful they can capture the regulator.

    Moving the banks into state control would mean concentrating even more power in the hands of a few politicians and their friends (there is at least competition among banks, and between political parties under the current arrangements that prevents an absolute concentration of economic power)…

  • Greenflag

    Michael Gillespie,

    Broadly correct. Margaret Thatcher for all her Iron Lady machismo was something of a disappointment to Milton Friedman who advised her to clamp down even harder on welfare and the ‘nanny state’ etc . Thatcher had to tell Friedman that the British people would ‘revolt’ if the NHS was taken from them .She at least had the political cop to understand that much 😉

    I agree with your point re ‘bank nationalisation’ . At least people can vote out a government that mismanges it’s finances or abuses taxpayers assuming we’re still a democracy 😉

    Banking under State control could be divided into Commercial , Home Loans , Savings , Retirement Pensions – Business Development etc operating units to reduce institutional concentration .

    Mack’s point that there is at least competition among banks is largely illusory and for most ordinary people cosmetic .

    While ‘reduced ‘ regulation sounds all very well in theory any reading of economic history will tell you that left entirely to their own devices corporations will ‘kill’ and ‘permanently maim’ their employees and customers if they could get away with it . Just look at the Tobacco industry.

    Employees of the Ethyl Corporation died on the job of lead induced poisoning and it was hushed up as ‘overwork ‘

    We forget that the reason we have government and regulation is to prevent a return to the industrial working conditions , pay rates and shortened lives of the mid 18th century Industrial revolution .

    Our present economic system demands of companies (including banks) that they make a profit to survive . Those companies that make the most generally survive the longer term economic cycles over others who are less profitable . Thus over a period of say 60 years since 1945 financial capital becomes ever more concentrated in the hands of fewer people who as a consequence can ‘buy’ the politicians .

    Nationalising the banks would be a good first step to restoring confidence in the system . Of course there would have to be safeguards built in which would ‘prevent ‘ any government from just ‘printing ‘ more pounds/dollars/euros to pay for political promises if the tax yield was insufficient . But it could be done .

  • Mack

    Greenflag –

    Mack’s point that there is at least competition among banks is largely illusory and for most ordinary people cosmetic .

    I disagree strongly here, the competition is not as strong as it should be – but your logic is haywire, the competition needs to be stronger and cosy relationships with government weaker not vice versa! You’ve swung wildly to the left with that post – if you speed up a little you might catch Marx and Trotsky up ahead 😉

    The vast bulk of the noveua riche in China, where the main banks are state controlled, are Scions of the upper ranks of the Chinese Communist Party. Quelle Surprise? The results are similar everywhere banks are state run..

    We have a very cosy relationship between bankers and politicians in Ireland – we’re suffering for it now, and our children will suffer for it through NAMA.

    The solution is not to strengthen that relationship into an explicit monopoly – but to weaken it into smaller competing entities that can fail without placing a burden on the people. To ensure economic power remains diffuse and that banks must compete to fund the best projects that drive economic growth and wealth creation for the nation not make political cronies rich…

  • Mack

    Also worth noting that Friedman’s views on welfare aren’t really relevant here, but you might be surprised to find out that they are way more progressive than common mythology would suggest.

    E.g. His proposal for negative tax payments for low earners – (which looks very like the basis for Ireland’s progressive income tax credit system, that sees 40% of the lowest earners in Ireland pay no tax – compare that to non-macho Britain)


    Relevant points re Friedman

    1/ He did not support a free market monetary system – quite the opposite – arguing that central banks should act to strictly control the money supply

    2/ He did support banking deregulation. A mistake in some areas, but because of regulatory capture may only have sped up rather than enabled the process we see today.

  • Mack

    Incidentally this is an interesting critique of Friedman by Paul Krugman

    In the long run, great men are remembered for their strengths, not their weaknesses, and Milton Friedman was a very great man indeed—a man of intellectual courage who was one of the most important economic thinkers of all time, and possibly the most brilliant communicator of economic ideas to the general public that ever lived. But there’s a good case for arguing that Friedmanism, in the end, went too far, both as a doctrine and in its practical applications


  • Greenflag


    In case you missed the economic news China managed 9% economic growth last year despite the main banks being state controlled . The UK and USA etc did a whole lot worse with little or no state control .

    I can agree re your comments on the Chinese ‘nouveau riche ‘ etc .

    How do you get stronger competition in today’s economic environment when the largest banks are becoming continuously larger . Some 150 smaller banks went under last year in the USA and many have become subsumed into the big 4 banking groups .

    The first move would be ‘nationalisation ‘ of the very biggest -only then can they be broken into smaller competing entities.

    Your comment re NAMA is on the ball .

  • Mack


    In case you missed the economic news China managed 9% economic growth last year despite the main banks being state controlled

    Certainly didn’t miss it. Hugh Hendry’s views on this are well worth listening too (he starts around 14mins 30 secs or so, actually he talks about China at 45mins or so, then again at 55 mins or so. 55 mins is where he talks of the big problems – goes back to faber then he continues..) –


    The Chinese, coming from a low base, are gaming the system (Dollar peg with the Yuan, focused on export growth not domestic demand, internal standard of living that would be intolerable in the West, take advantage of huge supply of cheap labour etc..) and are certainly building up problems for the future. The Japanese ploughed a similar path to growth and are still dealing with the fall out.

    Temporary nationalisation is a different kettle of fish from putting the banking system permanently under state control.

  • Greenflag


    Krugman’s critique of Milton Friedman is all the more interesting given that your link above was for 2007 i.e before the Wall St meltdown and the current financial crisis of ‘confidence’ .

    Trust Krugman to posit three persons in the one Friedman, not Father , Son and Holy Ghost but Economist’s economist , Policy entrepreneur , and Free market ideologue 🙂

    It’s with the last MF i.e the free market ideologue where Krugman finds ‘fault’ . The sequence of events since 2007 just adds to Krugman’s viewpoint imo.

    From another perspective Friedman’s homo economicus in the guise of the smartly suited bankers and finance men of Wall St turned very quickly into the human equivalent of a self eating wounded shark feeding frenzy when the first pillars began to fall under Lehman Bros.

    It seems that Mr Friedman for all his ‘professional ‘ and world class skills as an economist forgot that human beings can be rapacious thieves and untrustworthy liars at the same time as proclaiming they are on the side of the angels 😉 . And what goes for human beings also applies to bankers , CEO,s and your local bishop /minister or televangelist of the ‘prosperity gospel ilk .

    The trick of course is to try to ensure via effective ‘regulation’ that that particular side to the human condition is never allowed to run the entire economy into the ground . And in that respect I believe Krugman’s ideology is closer to dealing effectively with the vagaries of human nature than Friedman the ideologue’s ever could be .

    btw -thanks for that link -I’ve read some of it before under other covers 🙂

  • Mack

    Well, worth pointing out that unlike a lot of people who quote him on this side of the Atlantic Krugman’s criticsm of Friedman’s evangelism for Free Market economics is that he went to far. Not that markets can’t work at all.

    From another perspective Friedman’s homo economicus in the guise of the smartly suited bankers and finance men of Wall St turned very quickly into the human equivalent of a self eating wounded shark feeding frenzy when the first pillars began to fall under Lehman Bros.

    From what I’ve seen Friedman never assumed people were angels or would act like angels (in fact this was the basis for one robust criticism of socialism, that you are giving power to politicians and then expecting them to act as angels) – but rather that the market would root out the rogues. In banking, with regulatory and government capture, it doesn’t work that way.

    It doesn’t mean markets can’t work, it just means there is no such thing as a free market in banking and Friedman was deluding himself that such a thing could exist..

  • Michael Gillespie

    I read with interest the response to my piece on Friedman. It is surprising to see there are still a few champions of Friedman left. Keynes was of the opinion that the unfettered activity of bankers and speculators after the First World War was at the root of the Great Depression. The same can be said of the current recession. Keynes through his influence on Roosevelt in the New Deal was a benign influence in world economics. Friedman on the other hand was a malign influence of a free money market in Reganomics worldwide. He may have advocated a state restricted money supply but only a person out of their minds would defend a free money supply. The supply of money and the money market aren’t the one and the same thing. Friedman was at one with Hayek when it comes to a free money market.

    Keynes is back again in the ascendancy and the work of Friedman has become a “one dimensional caricature” in economics. In my view the government regulation of banks will no more concentrate power in the hands of politicians anymore than the regulation of taxation concentrates economic power in the hands of the Chancellor. As for the question – Why should politicians do better at regulating the banks than
    bAankers? —at least politicians will not be motivated by greed. In my view those champions of Friedman should join the Conservatives

    Michael Gillespie

  • Greenflag

    mack ,

    I did’nt state that Friedman assumed people were angels but I believe he’s on record as stating he did not expect bankers to act against their own interest , up to the point of near world wide systemic collapse anyway . I probably should have left out the Friedman in that quote above as I can see how it could be misinterpreted .

    Not only is there no free market in banking -there’s none in the diamond trade either and in many other cartels worldwide .

    But markets do work I’ll grant you . At the same time often what we assume to be the spectacular advances of the market driven economy turn out on investigation to have their creative roots in the public sector a decade ago or more .

    The Internet got it’s start as a public program at the Pentagon, the Human Genome project by the US National Institute of Health and the GPS network by the US Air Force . The US Government could not have created ‘Google ‘ but Google could not have existed without the government effort to establish the Internet long before the founders of Google were born .

    We’ve seen in Ireland how increased investment in education has given the economy a boost as have the efforts of the IDA over several decades .

    Hugh Hendry’s points are well made and I can imagine their appeal to the fearful jeremiah’s of the west . But he underestimates the Chinese capacity for rapid ‘change ‘ . He forgets that China is a top down one party authoritarian state which would seem at face value to reinforce Hendry’s points re China’s bubble propensities .

    But China is also now a dynamic ‘capitalist’ society and the combination of one party rule with a top down leadership will also allow the Chinese to adapt more quickly to changing circumstances than say the more lethargic western democracies .
    Think Tokugawa Japan . The Chinese will probably revalue the yuan and move to more domestic consumption in the years ahead . They have a birds eye view of what happens to ‘creditor’ nations whose reach extends way beyond their grasp .

    If you can get your hands on it there is an excellent article in the Atlantic Monthly (Jan/Feb) issue by James Fallows re ‘How America Can Rise Again -After the Crash . He’s been in China for three years and has a less fearful view of the oncoming East Asian Colossus .


  • Greenflag

    Michael Gillespie ,

    ‘ Why should politicians do better at regulating banks than bankers?—-at least politicians will not be motivated by greed.’

    I had to read that comment twice 😉 Politicians not motivated by ‘greed’ ? Perhaps on Mars or in Burkina Faso (The incorruptible very corrupt Republic in west Africa) . Perhaps had you stated that the Civil Service Mandarins would do better you would have been closer to the truth .

    It seems that most of our politicians in the Anglophone world had’nt a clue what was happening in worldwide banking and financial services up to a day before the meltdown and many are still groping around in the dark for the exit 😉

  • Mack

    Greenflag –

    Not to totally undermine your argument about the benefit of government programs – they certainly can be very beneficial but in this particular instance –

    The US Government could not have created ‘Google ’ but Google could not have existed without the government effort to establish the Internet long before the founders of Google were born

    I disagree. The Internet or something like was inevitable. It grew out of Arpanet, adopting it’s protocols and standards initially. But it just as easily could have grown out of a network at IBM, Bell labs or perhaps a grouping of tech companies coming together to define interoperability standards amongst themselves – as has happened many times since. Remember historically computers weren’t very powerful, but that processing power & storage capabilities were doubling every couple of years.

    The relentless increase in the capacity of the hardware made the emergence of some form of global network inevitable.

  • Greenflag

    Mack ,

    Apologies Mack that point re Google was made by Fallows in that article quoted above . I should have known better than to trust a journalist 😉

    As a general axiom I’m not a believer in inevitability -scientific -economic -political or demographic . Death and taxes certainly 😉

    Good stuff happens and crap too sometimes via the same pipeline. Personalities can skew so called inevitable history. Climate and geography can make and unmake empires and nations.

    Even ‘humanity’ as we know it was not inevitable . We are not the apex of any evolutionary tree merely the one that survived by the skin of our teeth and random happenstance.

    Who made the first computer ? Where did the research funds come from . Who paid for the education of the scientists and engineers ? Where did the educational infrastructure come from that produced more scientists today than ever existed in the whole of human history ?

    This is not to deny that some public sector programs can be less than beneficial and some even worse than harmful .

    I’ll not argue the toss over that instance quoted 😉 You can take it up with Fallows 😉

  • Mack

    The first computer was either Charles Babbage, who certainly designed the first computer, but I don’t think quite finished his ‘Babbage machine’. He designed it way back in 1832. Konrad Zuse built the Z1, the first programmable computer in 1936.

    Though government spending in WWII no doubt propelled things much further along. And publicly funded Universities had a big impact to.

    As a general axiom I’m not a believer in inevitability -scientific -economic -political or demographic . Death and taxes certainly 😉

    A fair point. The probability of the emergence of a global scale open interconnected network of computers was incredibly high once the technology advanced beyond a certain point.

    It’s inconceivable to me that we could be sitting around with machines as powerful as those we have today and there not be some form of Global network. The Internet as we know it today did beat of competition, and it succeeded largely because it was open – while competing networks were not.

  • Greenflag


    ‘it succeeded largely because it was open ‘

    True. There are those who would prefer it were less open and more amenable to government or corporate control . And I would’nt mind being able to control accursed e-mail from the purveyors of viagra ,etc etc etc 😉

    The ‘planetisation of mankind ‘continues . Where this will lead to in terms of greater or ultimately lesser individual freedom is still imo unclear even if at first sight and experience the benefits of instant knowledge and communication seem manifest .

  • Michael Gillespie

    “ As for the question —“Why should the government be better at regulating the banks than bankers?” — at least politicians won’t be motivated by greed”

    A respondent has taken exception to this statement saying that greed and corruption can be found among politicians especially in Africa This is true but what was in mind was a liberal democracy not an African dictatorship. In this liberal democracy the chancellor regulates taxation but were he personally pocketing Inland Revenue he would personally be answerable to the electorate and/or the police. If the banks were nationalised there would be a minister of banking. If this minister were to pocket bank funds for himself he would be answerable to the electorate and/or the police. Bankers however can pocket obscene bonuses from banking funds and are answerable to no one. This should not be tolerated in a liberal democracy.

    IN the original piece on Friedman the question of how wealth is created in a state was raised. Friedman in line with Hayek claims that wealth is created in a free market. This is far from the truth. Some respondents have wandered away from this and are now thrashing around wildly in the jungle of economics like brain damaged gorillas.

    In a modern economy wealth creation is knowledge based. Knowledge is of two forms: –
    (a) Know-that knowledge.
    (b) Know-how knowledge.
    This can be illustrated by considering the knowledge of a car. Know –that of a car is knowing it is of a certain colour that it has at least three wheels and that it should be taxed and insured. This know- that is useless knowledge in that no practical use can be made of it. Know-how of a car is knowing how to proceed in driving it or knowing how to proceed in fixing it when it breaks down. This is useful knowledge.

    In a modern knowledge based economy know-how procedural knowledge is the basis of wealth creation and is developed by insightful individuals or by a team of such individuals In the Industrial Revolution there was an explosion of know-howful procedure in manufacturing which dramatically increased wealth in England and raised that country to economic strength. American pre-eminence in wealth is due to American Know-how something that Americans are justly proud of. The insightful procedural know-how of Edison Ferguson Marconi and Bell has created unprecedented wealth in the world. China is creating wealth today by taking over and exploiting the industrial know-how of the West. Japan did the same and good luck to them.

    Know –how is teachable and can be learnt. Traditionally the schools and universities have taught know-that. To tie in with a modern knowledge based economy know-how in the school disciplines should be taught from as early an age as possible. Pupils should learn how to proceed in writing a letter or an essay on, say, My Street. They should learn how to proceed in history by investigating an old castle or old workhouse in the neighbourhood. They should learn how to proceed in setting up a simple scientific experiment and how to proceed in solving a mathematical problem. They should learn how-to proceed in speaking a second language or in painting a picture or how to proceed in playing a musical instrument. In this way a know-howful population can be developed which befits a know-howful community.

    In my understanding of economics a state or community should specialise in that aspect of its economy in which it holds a relative advantage. Ireland has a relative advantage in food production. Education should be geared up to develop that relative vantage and should develop food production as an economic specialisation by turning out a know-how driven graduate population in vet nary science, in agricultural science, in food science and in business and marketing studies. That is not to rule out a know-how driven graduate population in technology engineering and in pharmaceuticals Know –how can also be imported from abroad but such know-how is foot loose and fancy free and can migrate to any spot-on planet earth where profit can be maximized. The Irish economy will never put a man on the moon or place a probe on Mars but it could place a plate of good wholesome Irish food on every table on planet earth. That could be an achievable economic goal in a know-how driven food-producing economy.

    In this analysis of wealth creation the markets don’t come into it. Wealth is derived from the insightful know-how of the individual or team of such individuals. What we don’t want in Ireland is a population of Know –that graduates who can only shine in University Challenge or in a Pub Quiz. Such Graduates are fit for neither Queen nor country and are the drones of the community.

    Michael Gillespie

  • Michael,

    Of course knowledge is the driver of the modern economy, and you may be surprised to hear that “comparative advantage” is at the heart of modern economics theory. But:

    In this analysis of wealth creation the markets don’t come into it.

    Nonsense. The market is a means of allocating resources. If resources are not allocated in an efficient manner, all the know-how in the world won’t help you. State control has been proven time and time again to be a shockingly inefficient method compared to the market. There are lots of good arguments to be made for regulating the market, but your kind of Marxist-Leninism has been totally discredited.

  • Mack

    Hi Michael,

    It sounds like you are itching for a debate! To be honest I found your posts a little confusing – it’s not clear what you are arguing in favour of or against!

    For example –

    Do you think that the banks should be privately owned and subjected to state regulation? A rather benign assertion most of us would agree with.

    Or do you believe that the banks should be owned and managed by the state? It certainly seemed that way from your original posts, but your late posts muddied the waters.

    My gut reaction reading it, is that you are arguing for a centrally planned economy (although it’s not 100% clear if that is the case). We have good real world evidence that these types of economy struggle to achieve any degree of sophistication (compare shopping at Tescos to queing for Bread once a week in Soviet Russia).

    Knowledge isn’t enough – without a market and trade, you need complete knowledge (i.e. end-to-end knowledge) and resources to build your products from the ground up.

    The classic rhetorical question is “Who feeds Paris?”. Who decides how many loaves of bread to bake or fish to catch? The answer of course is no-one decides – if the demand for bread increases beyond the available supply the price rises encouraging bakers to bake more bread to meet the supply. Thus the demand for bread is met, and if it is exceeded the price of bread falls discouraging investment in bakeries until such a time as some sort of equilibrium is reached.

    That’s the magic of markets in action – bread in your supermarkets 24/7, not once a week on Tuesday.

    But – it get’s better. If a particular bakery produces a better quality of bread, customers may well prefer that bakery over a rival. They place their orders at the superior bakery, which in turn expands to meet the demand (the other bakery is forced to improve or go out of business). The end result is not only bread available everyday – but better quality bread available everyday.

    Creative destruction, is why West Germans had Volkswagons, Audis, Mercs and BMWs while the Easties drove Ladas and Yugos

  • Michael Gillespie

    Wealth Creation.

    Reading the responses to my piece on wealth creation I ask myself— Why bother? Given the low level O level response to my piece. The question—Who feeds Paris? is an O level question suitable for those who are 16 or under and has to do with the allocation of resources in supply and demand and the price mechanism, normal and abnormal profits and competition. I am not saying that all of that be struck from the O level syllabus and central planning be put in its place.

    I’m not asking the O level question —Who feeds Paris? But a more advanced deeper and more difficult question— Who creates wealth in Paris? Wealth creators in Paris are well known. They are individuals who have know- how of Haute Couture like Anne Marie Biretta Balenciaga Balmain Willkelm Carrin Celine Chanel Chloe Christian Dior Saint Laurent and Givenchy. If you ask these couturiers— Do you feed Paris? They will laugh and say –No we make Paris wealthy. These are people who have a Know-how insight into fashion design and such people create wealth. Furthermore the French are famous for know-how in wine and cheese making and this is a further example of wealth creation in France but while the market distributes French wine and cheese through the world the market doesn’t create these the individual does.

    I’m accused of being a Marxist-Leninist. That is a joke and is quite laughable. The respondents find Reds under the bed in what I write. This is an irrational phobia and the respondents may be in need of help. There is nothing in what I write that hints on central planning. The O level syllabus on the market is fine with me but there’s much more to economics than that.

    It is true to say I’m in favour of nationalising the banks but that doesn’t make me a Marxist- Leninist. The banks have been nationalised in Iceland but Iceland remains a liberal democracy with a vibrant market. The Royal Bank of Scotland is 84% state owned but Scotland remains a liberal democracy with a buoyant market.

    A respondent has difficulty in working out what I’m arguing for or against. The truth is I’m not arguing for or against any thing. I am not into that. I am simply putting constructive ideas by giving a philosophical analysis of the Question –Who creates wealth? —which the reader can take or leave. But I will say this. Wealth resources when created by the know-how of an individual or a team of such individuals is not allocated or distributed by supply and demand but should be reallocated and redistributed by a system of progressive taxation.

    I end with the question— why bother writing to Slugger because there are those who are so far to the right that if they take one more step further in that direction they will fall off planet earth.

    Michael Gillespie

  • Greenflag

    Michael Gillespie ,

    ‘The Royal Bank of Scotland is 84% state owned but Scotland remains a liberal democracy with a buoyant market.’

    And it’s in deep doo doo right now . And if it goes o too will Scotland . Not exactly the 1700’s Darien bust but it would have a huge impact on the British attempt at economic recovery.

    The Guardian comments

    ‘This(RBS) is a huge institution with a £1,900bn balance sheet – three times the size of HBOS, which was rescued last month by Lloyds TSB. If the markets can give up on RBS, one of the ten largest banks in the world, all bets on Britain’s and the world’s financial system are off. Who knows what might happen next.

    ‘A respondent has difficulty in working out what I’m arguing for or against. ‘

    So has this respondent .

    Perhaps you need to define what you see or mean by wealth ? And how a system of progressive taxation would reallocate and redistribute ‘wealth’ without of course killing the goose that lays the golden egg ?

    Nobody is going to fall off planet earth . Gravity works 😉

  • Michael Gillespie

    Reply to Greenflag

    “But if the Royal Bank of Scotland goes so too will Scotland. It would have a huge impact on the British attempt at economic recovery.” (Greenflag)

    “If the markets give up on the R.B.S. all bets on Britain’s and the world’s financial systems are off.”(The Guardian)

    IN this Greenflag and The Guardian are being prophetic about a future calamity in the R.B.S. It is to be hoped that like Cassandra the prophesies of Greenflag and The Guardian won’t be believed and will never happen I’m not a prophet and I can’t foretell the future of the R. B. S. all I can do is deal with the here and now and recognise that despite a large measure of state control in the R.B.S. Scotland remains a liberal democracy with a healthy market so in the nationalisation of banks no “nasty communist plot” is involved. If however the prophesies of Greenflag and The Guardian prove to be self fulfilling and the ultimate calamity befalls the R.B.S. the calamity cannot be blamed on the partial nationalisation of the bank but on other factors.

    “Perhaps you ought to define what you see or mean by wealth.”

    The best I can do is refer Greenflag to G.D.P. and G.N.P. which can be found in the dictionary or in any basic economic text. What follows from a previous piece on Know-how is that when G.D.P. is traced to its root source it originates in active know-how by an individual or team of individuals. It also follows that growth in G.D.P is directly related to the active quality and quantity of Know-how in the state population. It also follows that the quantity and quality of know-how in the population can be nurtured in education.

    “How would a system of progressive taxation reallocate and redistribute wealth without of course killing off the goose that lays the golden egg?”

    What is considered is a progressive system of taxation not a draconian system..

    It is good to know that Greenflag is still clinging to planet earth.

    Michael Gillespie

  • Mack

    Michael –

    GDP and GNP aren’t necessarily good measurements of wealth. They include any economic activity including those that destroy wealth. I.e. malinvestments, the building of a ghost estates that will never be populated in the Irish midlands, that will fester and decay, cause social problems and crime and eventually be demolished – contribute greatly to the headline GDP / GNP figures in truth they destroy wealth not create it.

    Therein you have an example of market failure, markets tend to deliver what the participants collectively desire. If the participants on the demand side are deluded that they can get rich flipping properties that no-one will ever live, then someone somewhere will attempt to supply them. The last line of defence should have been that the bankers were not so dumb as to fall prey to this delusion, but no…

  • Michael Gillespie

    The Free Market and Harry Potter.

    You write : –
    “ Markets tend to deliver what the participants collectively desire”
    How true is that? Is that not a fallacy?

    To take the book publishing industry as an example of which I have experience as an author does your statement mean that the participating public desired (demanded) Harry Potter and J.K. Rowling delivered (supplied) the book? Is that not putting the cart before the horse? Surely the know-how of |J. K.Rowling delivered (supplied) the Harry Potter book and found the participating public desired (demanded ) the book and through the original know- how J.K.Rowling became immensely wealthy. It isn’t demand that made the author rich because if the know- how of the author hadn’t created the book in the first place how could there be a demand for it? You seem to claim that demand creates supply. I am of the opinion that know-how creates supply and there may or may not be a demand for the supplied product. If there is a demand wealth will follow due to the original know-how of the individual. In the book industry tens of thousands of books are written (supplied) every year less than 5% of these are published i.e. put on the market and only a handful of these are best sellers i.e. demanded. Why there is a demand for only for a few and little demand for the many is an unexplained mystery because the nature of demand is not understood and is an enigma.

    The thesis I am putting forward is that know-how creates supply for which there may or may not be a demand but where there is a mysterious demand wealth will follow of which know – how is the original source. Some say a free market creates wealth. I don’t accept that. A free market in books distributed Harry Potter worldwide the know –how of J .K.Rowling supplied the books and with this know- how the author made herself rich not a free market. In this how you define wealth is immaterial. If you don’t accept G .D.P. as a valid measure of state wealth it is up to you to supply a better one.

    Michael Gillespie

  • Mack

    Michael –

    The know-how to write a good book is certainly a neccessary condition of that particular form of wealth creation, but it isn’t a sufficient one.

    If you don’t accept G .D.P. as a valid measure of state wealth it is up to you to supply a better one.

    It’s flawed. I would define wealth broadly as anything (products, services) people want. Paul Graham has a convincing definition of wealth, which I will post below.

    Wealth under this definition is defined in terms of what people want – this makes demand key.

    To take your Harry Potter example, many members of the public gain enormous pleasure from reading – the output of your labour is pure wealth (as opposed to money which is a medium of exchange, store of value & unit of account) and is hugely valuable. Because they enjoy reading so much they are willing to pay (exchange the fruits of their wealth creation activities for yours) for good books. Authors such as JK Rowling can make a living by fulfilling that demand, as can the publishers, suppliers, book shops etc. If the demand didn’t exist, the supply chain wouldn’t exist and JK Rowling probably wouldn’t have written Harry Potter.

    The thesis I am putting forward is that know-how creates supply for which there may or may not be a demand but where there is a mysterious demand wealth will follow of which know – how is the original source

    This is also certainly true & innovation is at the root of it – but it is also true that JK Rowling would find it much easier creating a blockbuster by writing another Harry Potter than an unkown would creating a new genre of writing.

  • Mack

    Paul Graham’s definition of wealth


    Money Is Not Wealth

    If you want to create wealth, it will help to understand what it is. Wealth is not the same thing as money. [3] Wealth is as old as human history. Far older, in fact; ants have wealth. Money is a comparatively recent invention.

    Wealth is the fundamental thing. Wealth is stuff we want: food, clothes, houses, cars, gadgets, travel to interesting places, and so on. You can have wealth without having money. If you had a magic machine that could on command make you a car or cook you dinner or do your laundry, or do anything else you wanted, you wouldn’t need money. Whereas if you were in the middle of Antarctica, where there is nothing to buy, it wouldn’t matter how much money you had.

    Wealth is what you want, not money. But if wealth is the important thing, why does everyone talk about making money? It is a kind of shorthand: money is a way of moving wealth, and in practice they are usually interchangeable. But they are not the same thing, and unless you plan to get rich by counterfeiting, talking about making money can make it harder to understand how to make money.

    Money is a side effect of specialization. In a specialized society, most of the things you need, you can’t make for yourself. If you want a potato or a pencil or a place to live, you have to get it from someone else.

    How do you get the person who grows the potatoes to give you some? By giving him something he wants in return. But you can’t get very far by trading things directly with the people who need them. If you make violins, and none of the local farmers wants one, how will you eat?

    The solution societies find, as they get more specialized, is to make the trade into a two-step process. Instead of trading violins directly for potatoes, you trade violins for, say, silver, which you can then trade again for anything else you need. The intermediate stuff– the medium of exchange– can be anything that’s rare and portable. Historically metals have been the most common, but recently we’ve been using a medium of exchange, called the dollar, that doesn’t physically exist. It works as a medium of exchange, however, because its rarity is guaranteed by the U.S. Government.

    The advantage of a medium of exchange is that it makes trade work. The disadvantage is that it tends to obscure what trade really means. People think that what a business does is make money. But money is just the intermediate stage– just a shorthand– for whatever people want. What most businesses really do is make wealth. They do something people want. [4]

  • Michael Gillespie

    Know-that won’t do.
    In reply to the respondents to the Harry Potter piece what was written was totally beside the point. The respondents gave a know- that useless academic spiel in answer to the question, which isn’t being asked namely —What is wealth? That is not the question under consideration. That question is –Who creates wealth and what is its origin?

    It is true that at one time wigwams were part of American Indian wealth. I know that. My interest is in the question —Who creates American Indian wigwam wealth and what is the source of its creation?

    I am claiming that this wigwam wealth originates from inside the heads of American Indians in knowing-how to build a wigwam and create wealth and that demand for wigwams didn’t put that Know-how there but a form of tribal schooling did. The white man came to America and brought with him in his head the superior know-how of how to build houses The American Indians internalised this superior Know –how and created a new wealth of houses but the old inferior know-how of the creation of wigwams became obsolete and was no longer inside the heads of American Indians.

    The history of— what wealth is?—is irrelevant know- that. As I see it Know –how is all-important in a modern economy in the creation of wealth and the know-that of —what wealth is?—is academic know-that of little importance. I request the respondents stick to the point and answer the question under consideration.

    Michael Gillespie