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Fallacy of composition driving global economy to the brink

John Lancaster in the London Review of Books gets it right. It is self-evidently good  for an individual who is in excessive debt to cut back spending, less good for a single nation to adopt this stance and downright dangerous for the developed countries as a whole to do so. The Lancaster article expresses this idea more eloquently than I did in a recent post.

“It is this failure of political will both in the EU and US which is starting to make the contemporary economic scene resemble that of the 1930s. The discipline of macro-economics was born out of the study of the Great Depression, in an attempt to understand what had happened and avoid a repetition. That’s why it’s so depressing to see the developed world not just sleepwalking towards another recession, but actively embracing policies which make it more likely. Governments can’t all simultaneously cut spending while also continuing to grow their economies: it just defies common sense to think they can. The problem is in large part to do with the application of an incorrect metaphor, the easy-to-understand idea that a household has to live within its income. But governments are not households, and the idea of cutting your way to prosperity cannot be read across from an individual’s finances to those of the state. It’s a manifest fact that these policies, and the refusal to embrace stimulus spending, are causing economic slowdowns all over the world that are triggering the current anxiety in the markets, which is in turn causing the predicament of governments to intensify, as confidence sinks and the self-fulfilling expectations of a second downturn take hold. This in turn puts pressure on expectations about governments’ abilities to repay their debts, which further lowers confidence, and so on”.


1 comment to Fallacy of composition driving global economy to the brink

  • observa

    There’s an equal fallacy of composition that all nations can borrow from each other and spend their way into full employment. Whilst the PIIGS can and did, there was an end game whereby the surplus countries’ inhabitants want to be repaid with interest or else why would they lend?

    The kicker is that we’re talking about real savings (ie forgone consumption) and not just funny money IOUs. That’s the problem. Govts don’t hold stocks of forgone consumption ready to ‘spend’ and get their economies moving again should the total level of C+I fall and unemployment rise. They can resort to borrowing from other countries to kick things along, but there’s a fallacy of composition to think they can all do that. The problem becomes transparent when so many are holding worthless IOUs instead of bunkers of coal, silos of wheat, tanks of oil and warehouses full of flat screens ready to ‘spend’ and ‘stimulate’.

    If one Dept of Climate Change is good for ‘Green’ jobs and employment, why not two or three or four…? Well unfortunately predatory spending is the flip side of predatory lending- when each side of the transaction prints the paper. However with gold coin of the realm the markings on either face are of no consequence. It’s the intrinsic value of the store of forgone consumption in between that matters. You aint got none you can’t ‘fiscally stimulate’ unless you can find some to borrow.

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