Are Democracies Pathetic at Managing Economies?

[Exarch]

excluding economies based on commodities ie mining, oil etc etc

Are democracies pathetic at managing the economy?

a great piece that explores this,
Part 1

Spoiler Alert, click show to read: 

THE POLITICS OF DEBT
Debt and democracy
By Chan Akya
This is the first article of a two-part report.

A full-scale revolt appears on the cards between the demands of markets and those of citizens facing either austerity or spiraling deficits in developed democracies. [COLOR=green ! important][COLOR=green ! important]Creditors[/COLOR][/COLOR]
may well start preferring the debt issued by dictatorships to that issued by democracies as a simple means of avoiding uncertainty.

Central banks are confusing the picture further for markets, as are the increasingly shrill comments from multilateral agencies and some creditors. All of that's not good news for potential growth in coming years, and perhaps even clouds the outlook for democracy itself.

Debt and democracy
Many years ago, when I was a rookie looking at the debt of emerging market countries, a senior chap took me aside and confided in his versions of a "trade secret" - namely to always avoid the debt issued by democracies. Of course, the person providing me with these nuggets was himself from a Western democracy, but that didn't quite cloud his view of how poorer countries should be run.

The "logic" was as follows: democracies tend to be messy, and new governments may change agreements that were painstakingly put in place with any other government. In contrast, dictatorships were fairly dependable - any internal opposition would of course disappear, and all external contracts would be honored because "after all, that's where the money is coming to these guys from".

This "mentor" even showed me a fancy graph to prove his point; but the main point that came through loud and clear from that meeting was that the concept of democracy was simply inapplicable, or at the very least detrimental, to the way poor countries with a lot of debt could be run. As I don't have the graph at hand now, two from Bloomberg this week help to illustrate the point. The first highlights the credit default swap (CDS) levels of five-year debt issued by various European democracies:



Contrast this with the CDS of various non-democratic societies, for example China, Russia and Saudi Arabia as in the following graph, also from Bloomberg:



So my "guru" was right after all - democracies do perform worse than dictatorships, at least in terms of debt markets. [1] Of course, I have my tongue firmly in cheek here, for among many other reasons I have taken non-representative samples of both ends of the spectrum (democracies and dictatorships).

However, it bears noting that general averages of credit default swaps (so-called CDS Indices) are not far away in making the same point about the elevated risk of European sovereigns relative to companies domiciled in Europe as well as the general risk of countries situated on the periphery of Europe (in the graph below, marked as CEEMEA, or Central and Eastern Europe, Middle East and Africa).



The interesting thing about this graph is of course that after tracking each other for a long period of time, since June this year the cost of insuring European companies and high-risk emerging sovereigns has gone down steadily while the equivalent cost of insuring the debt issued by wealthy, developed countries (the white line) has gone up steadily.

Talk about decoupling.

The simplest explanation for this dichotomy is provided in the following chart, produced by the International Monetary Fund (IMF) and carried by a number of publications including the Wall Street Journal last week; this details the biggest borrowing relative to gross domestic product (GDP) by various developed countries, all of which add up to a truly staggering figure of US$10.2 trillion in borrowings next year. It is worth pointing out that the only country seeing any marked decline in its borrowing relative to GDP is Ireland, which implemented a dramatic austerity plan to cut government expenditure.



If you were the finance minister of a country that had massive borrowing requirements for the next couple of years and your CDS was blowing out, what really are the choices you'd look to embrace? What would you tell the citizens of your country about the situation? What, more importantly, would you expect your citizens to be signaling to you?

So it was with some sense of irony that I watched the events of the past few weeks unfolding across Western democracies. Notable ones included:
a. Last week's vote against President Barack Obama's policies in the United States with a triumphant return for the Republicans to the scene of their last crime, namely the US financial crisis of 2008.
b. Germany's insistence on new policies across the European zone that would force investors in European [COLOR=green ! important][COLOR=green ! important]debt[/COLOR][/COLOR] to share the pain of any default rather than blithely expect (or secure) a simple bailout.
c. Strikes in France paralyzed the country for a few days over the past few weeks but worse appears to be on the horizon across transport, government and [COLOR=green ! important][COLOR=green ! important]banking[/COLOR][/COLOR] sectors.
d. While the United Kingdom's austerity drive appears to be proceeding with less drama than others, there were some strikes on the London underground network last week, causing billions of pounds of losses to an already frail economy.
e. Greece witnessed an increase in anti-government protests, with extremists mailing a bunch of letter bombs to the heads of various European countries as well as a number of embassies and consulates in Athens.

Meanwhile, central banks have jumped in apparently to defend some sort of a status quo in their backyards:
1. The US Federal Reserve announced a plan to purchase $600 billion in [COLOR=green ! important][COLOR=green ! important]bonds[/COLOR][/COLOR] as part of further quantitative easing (see The Incorrigibles, Asia Times Online, October 16, 2010).
2. The European Central Bank left rates on hold while reiterating its preference for European governments to work closely together while implementing a more realistic fiscal austerity plan.
3. The Bank of England, while leaving rates on hold, warned of an "extended period of inflation", in effect signaling its willingness to allow negative real interest rates to take hold of the UK economy.
4. After running out of all other types of assets to purchase, including government bonds, the Bank of Japan has now started purchasing Japanese [COLOR=green ! important][COLOR=green ! important]stocks[/COLOR][/COLOR], particularly real estate investment trusts even as it tries to push the yen lower against major [COLOR=green ! important][COLOR=green ! important]currencies[/COLOR][/COLOR].
5. The central banks of Australia and India raised interest rates during the week, worried about the effects of imported inflation on their economies and political systems.

Central banks and their idiotic policies are however not the subject of this article - I will write at length about their shenanigans at another time. In any event, and just to make things really interesting, externalities have gone out of control:
a. Germany criticized the "clueless" policies of the US in trying to pump prime the economy, with a focus on fiscal austerity that would render Ludwig von Mises proud.
b. China is set for a showdown against the US at this week's Group of 20 meeting over a plan to implement numerical limits on deficits / surpluses even as its central bank has issued a bunch of statements condemning QE2.
c. The head of the World Bank has asked for renewed discussion on a re-introduction of a gold standard, updated to reflect the requirements of today's global economy.

All of this sets the stage for what happens in democracies that are inhibited by high debt loads around the world.

Exhibit A - Obama is rejected
The sheer scale of popular revolts against governments across the developed world over the past few weeks is the main subject of this article. In this regard, Exhibit A would be the popular rejection of President Obama's policies by US voters.

His Democratic party was thrashed at the polls by the Republicans, who took control of the House of Representatives by a significant margin, even as the senate remained barely under the control of the Democrats. If one followed US media on the subject, it appears that the rejection was all about the presidential failures in stimulating the economy, spending too much on pork-barrel projects and protecting people who didn't deserve his protection (ie bankers).

That said, it is difficult to figure out what exactly the opposition that unseated Obama's political party actually stands for. The common refrain is that "deficits must be controlled", although a simple math lesson would tell you that a deficit is simply the result of excess spending relative to revenues. Given that the Republicans would never consider revenue increases (ie [COLOR=green ! important][COLOR=green ! important]tax-rate[/COLOR][/COLOR] hikes) to even be remotely acceptable, what then are the options in terms of cutting expenditure?

This is where the tire meets the road, in a manner of speaking. I would be terribly interested to see politicians in the middle of a recession arguing about ways to impose austerity on the populace and in particular to cut the entitlements of millions of people for the greater social good. Just to avoid any doubts on the subject, the statement above implies that I do not expect any such outcome - that is, to see the Republicans willingly shoot themselves by proposing or pushing through effective austerity measures.

That view in turn brings us back to the question of what all the drama was really about, ie change for the sake of change rather than anything substantive. If voters were less emotional, they would look at the failure of supervision that was central to the Federal Reserve's mishandling of the financial sector since 2000 aided and abetted by the Republican leadership of the time. In turn, this caused multiple episodes of predatory [COLOR=green ! important][COLOR=green ! important]lending[/COLOR][/COLOR]
and over-eager expansion of leverage across the financial system.

If the opposition is in a mess, the president's own party doesn't appear to have a clue about what it wants or indeed has learnt from the election debacle. A number of suggestions are being made - from the left, Nobel economics laureate and New York Times columnist Paul Krugman and company accuse the president of losing the elections because of not being left-leaning enough, that is, not proposing more government intervention than he already has. Others in the party blame the defeat on the president's failure to be sufficiently centrist.

What all of this means to an external investor in US government debt is of course confusion on a grand scale. There is no clear way forward in terms of government policy; and while it cannot be reasonably said that Obama is a "lame duck", such a suggestion doesn't appear completely unreasonable either.

The only certainty from that observation would therefore be the policy uncertainty of the kind my "guru" warned me about in respect to investments in emerging markets, referred to at the start of this article. The simple fact that political fissures are deepening across various countries so early into the aftermath of a financial crisis suggests that the path forward is likely to be paved with obstacles for all democracies, not to mention increasingly knee-jerk reactions from debt markets until the outlook for growth stabilizes.

Note
1. Credit default swaps (CDS) are quoted as basis points where 100 basis points is equal to 1%; as with bond yields, the bigger the number the worse the supposed quality of the referenced issuer. Thus when CDS levels increase, the general comment is that insurance has become more expensive, ie that the referenced entity is being perceived as more risky by the markets.

Next: Pay up, or wiggle out

Part 2

Spoiler Alert, click show to read: 

THE POLITICS OF DEBT: Part 2
Pay up, or wiggle out
By Chan Akya

This article concludes a two-part report PART 1: Debt and democracy

Vox populi, pox debitum

If I may be allowed to indulge in some small Latin, this article should start with a new pig Latin phrase that implies that the voice of the people (vox populi) is anathema to their ability to service national debt (pox debitum).

In Part 1, I wrote about the significant failings of popular movements to establish the primacy of longer-term prosperity over the expedience of near-term welfare, inevitably choosing expediency over efficiency.

The expectation that a people confronted with hardships would make every attempt to wiggle out of the situation rather than confront matters a bit more directly is the main reason for markets to panic on every occasion that a democracy encounters hardships.

Last week's graphs showed clearly the widening credit spreads of various Western democracies in this column. Over the weekend, fears of the European contagion spreading to the next possible victim, Ireland, were discernible in last week's startling decline in bond prices. The country's largest-selling newspaper, the Irish Independent, reported on Sunday as follows:

The Government has denied for the second time in 24 hours that it is in bailout talks with the EU, after the BBC reported yesterday that "preliminary talks" on financial support are taking place.

The BBC report made the unsubstantiated statement that recourse to the EU bailout fund was "no longer a matter of whether but when". But a spokesman for the Department of [COLOR=green ! important][COLOR=green ! important]Finance[/COLOR][/COLOR]
was adamant last night: "There are no talks on an application for emergency funding from the European Union."

It then quotes a slew of economists who have a slightly different view and assessment of the Irish situation:

Nobel laureate Joseph Stiglitz said Ireland is in a "dismal" position and there is little chance that the Government's measures to reduce the budget and bail out banks will be a success.

"The austerity measures are weakening the economy, their approach to bank resolution is disappointing," Stiglitz, a Columbia University [COLOR=green ! important][COLOR=green ! important]economics[/COLOR][/COLOR] professor, said in an interview in Hong Kong today. "The prospect of success is very, very bleak" for the government's plan to resolve the problem, he said.

The newspaper then quotes Simon Johnson, a former chief economist at the International Monetary Fund (IMF) as saying the following:

"For the sake of the Irish people, it's time to go to the IMF. If you go in now and if you go in with your partners, you will get a good deal. You may not get such a good deal next week. It would have been a much better deal if they'd gone in February because Ireland wouldn't have had to go through all this discretionary tightening along the route."

While he agreed with the Governor of the Central Bank, Patrick Honohan, that the IMF might not change the policies already being implemented by the Government, he warned that this situation would not last.

"It's not untypical that countries wait too long and find themselves in more desperate straits. If you bring the IMF in this weekend, then Mr Honohan is exactly on target, but the longer you wait, the longer the politicians prevaricate, the worse it's going to be for everyone."

He is referring to the very democratic process of countries filing their national budgets. With the government looking at other austerity measures in the new budget to be unveiled early next month, speculation is rife that the political opposition will likely push for the bill being rejected in parliament, which would in turn automatically trigger elections.

The obvious implication of political fracture in Ireland and the possibility of the government going back on its austerity plans is the main reason for markets to fret.

All of which brings this article to a favorite question of mine that has been posed rather a lot recently to a bunch of my associates - "what is the most important lesson from Japan for the past 20 years?"

We're all Japanese now - redux
Last year, I wrote about the Japanese style of broad market intervention as the new standard for capitalists around the world (see "We're all Japanese now", Asia Times Online, September 5, 2009). Perhaps I was too subtle in that article because everything since then has only reiterated the simple truth that folks don't seem to have learnt the proper lesson from the Japanese malaise of the past 20 years.

Here is what Paul Krugman wrote in his blog as recently as October 28, 2010:

David Wessel has an article asking what Milton Friedman would say about quantitative easing, and concludes that he would have been in favor. But I was struck by Friedman's 1998 remarks about Japan, in which he basically said that increasing the monetary base would do the trick:

"The Bank of Japan can buy government bonds on the open market ... " he wrote in 1998. "Most of the proceeds will end up in commercial banks, adding to their reserves and enabling them to expand ... [COLOR=green ! important][COLOR=green ! important]loans[/COLOR][/COLOR] and open-market purchases. But whether they do so or not, the money supply will increase.... Higher money supply growth would have the same effect as always. After a year or so, the economy will expand more rapidly; output will grow, and after another delay, inflation will increase moderately."

Well, they did that: staring in 2000, the BOJ nearly doubled the monetary base over a period of three years.

And the money just sat there. Banks did not, in fact, expand loans. In fact, Japan's experience is a key element of the case against monetarism. Just printing notes does not work when you're in a liquidity trap.

All fair points, but slightly off topic because here is what Paul Krugman wrote in the New York Times last week in an article entitled "Doing it Again" (emphasis mine):

The case for a more expansionary policy by the Fed is overwhelming. Unemployment is disastrously high, while US inflation data over the past few years almost perfectly match the early stages of Japan's relentless slide into corrosive deflation.

Unfortunately, conventional monetary policy is no longer available ... So the Fed is shifting from its usual policy of buying only short-term [COLOR=green ! important][COLOR=green ! important]debt[/COLOR][/COLOR], and is now buying long-term debt - a policy generally referred to as "quantitative easing."

... This time, much of the noise is coming from foreign governments, many of which are complaining vociferously that the Fed's actions have weakened the dollar ... the hypocrisy is so thick you could cut it with a knife.

As a practical matter, however, this foreign criticism doesn't matter much. The real damage is being done by our domestic inflationistas - the people who have spent every step of our march toward Japan-style deflation warning about runaway inflation just around the corner. They're doing it again - and they may already have succeeded in emasculating the Fed's new policy.

So there you have the nonsense of the Keynesians (to be differentiated from the actual articles of Keynes, but that's another story for another day) in two short articles. First Krugman suggests that monetarism is ineffective and then quietly contradicts himself with a suggestion that it would be the magic solution to America's problems if only it were allowed to work properly. That whole federal government deficit-expansion thing is called a failure, you see, because the rest of the economy didn't play ball.

Therein lies the core of the discussion of what the real lessons of Japan were in the first place. To cut to the chase, the answer is political not economic sclerosis.

The changing demographics of America broadly reflect the economic decline in as many words as the decline we see in the case of Japan for the past 20 years. An aging demographic requires stable [COLOR=green ! important][COLOR=green ! important]income[/COLOR][/COLOR] and for the sanctity of savings to be maintained. That is the reason the Japanese government bailed out the banks - not any great attachment to the businessmen themselves.

In turn, the rock-solid support of pensioners and those benefiting from fiscal expansion (eg the construction industry) ended up becoming the dominant political forces in Japan. Readers of my forum will note that this is precisely the line of argument that various forum members ended up with in discussing the apparent flip-flops of American polity in the most recent election.

This trajectory is well known and widely predicted; I wrote the "New Brahmins" (see Asia Times Online, March 29, 2008) highlighting this trend - and of course, this was hardly the first or only news outlet to express such opinions. Banks are central to populist reactions because a store of savings becomes doubly important to an ageing demographic; in the same way that it did to Japan and now the United States.

With one part of the policy constrained - ie a predilection to protect banks - comes the other side of the coin, namely the failure to stimulate balance sheet expansion due of course to stagnant asset prices and the lack of [COLOR=green ! important][COLOR=green ! important]credit[/COLOR][/COLOR] availability.

Low economic growth or stagnation is the easy result; it has the effect of slowly drawing the noose around the mountain of debt that is accumulated meanwhile. As the immediacy of [COLOR=green ! important][COLOR=green ! important]debt [COLOR=green ! important]repayment[/COLOR][/COLOR][/COLOR] becomes more stringent, countries have a choice of either collectively tightening their belts or else choosing to resort to brinkmanship.

A better alternative is to allow banks to fail while protecting the interests of depositors. The resulting decline of asset prices combined with a meaningful adjustment of factor costs (wages, rents etc) allows the resumption of a fresh economic activity much faster.

Blanket protection of banks doesn't deliver this result, but clearly politicians feel constrained to do so in order to protect their voting base. That nexus between savings administration and popular perceptions is quickly emerging as the Achilles' heel of all democracies that find debt loads unbearable.

Vox populi, pox debitum indeed.

source:http://www.atimes.com/atimes/Global_.../LK17Dj01.html

so are democracies inept at managing debt? especially with the shortsighted goal of trying to maintain office leading to stupid spending and avoiding the responsibility of cutting the deficit until the literally hits the fan???

discuss

[Ciabhán]

Democracy isn't. Democracy with socialist policies and big government is. The gov needs to stay out of private affairs.

[Marie Louise von Preussen]

Democracy isn't. Democracy with socialist policies and big government is. The gov needs to stay out of private affairs.

I love that. I consider this sort of Libertarianism as pure utopia, because it ignores the very meaning of 'Democracy'. And precisely because of that, once you give the people full voice on how to run their country, they will prefer a government that showers them with benefits over a government that demands any effort from them.

The situation with the US is the classic example of a Democracy in an advanced state of decomposition. The people are afraid of getting their benefits cut down, and now that the economy has crashed they want even more help from the State - so they elect the latest media hype, that is Obama, who promises them everything while at the same time claims he'll fix the situation. When he doesn't, another media hype candidate promising all too easy solutions appears, and so on - all of this in parallel with a disastrous deficit that increases by unsurmountable amounts at every second and two wars where there's simply no easy way out as we're all too tempted to believe.

What the US needs, and what many other democracies in Southern Europe also need, is someone capable of telling people they'll need cuts. They'll need discipline. They'll need stiff measures, even when the situation is already terribly grim - because all the alternatives are worse. Yet such a candidate cannot possibly appear, because the people would never elect him; rather, they would believe in any idiot who showers them with promises, and another on, and on. The average voter is too short-sighted to see any world beyond his pensions, his pockets and all his own petty needs.

[xcorps]

What the US needs, and what many other democracies in Southern Europe also need, is someone capable of telling people they'll need cuts. They'll need discipline. They'll need stiff measures, even when the situation is already terribly grim - because all the alternatives are worse. Yet such a candidate cannot possibly appear, because the people would never elect him; rather, they would believe in any idiot who showers them with promises, and another on, and on. The average voter is too short-sighted to see any world beyond his pensions, his pockets and all his own petty needs.

You got it. How could anyone expect a government to "manage" an economy if the politicians running that government focus on an agenda of reelection instead of good policy? Every member of the House is up for reelection every two years. Every Senator is up for reelection every six, every President every four. Even with a political scene where those responsible for fiscal policy have the best intentions, the policymakers change too often. Economic health requires much greater foresight and planning than our government is even capable of. The only solution I can see are laws that reduce the impact of political whim on economic policy. A balanced budget amendment might be such a solution

When the people find that they can vote themselves money, that will herald the end of the republic. -Benjamin Franklin

[★Bandiera Rossa☭]

Democracy isn't. Democracy with socialist policies and big government is. The gov needs to stay out of private affairs.

Socialist policies and big government are oxymoronic..

[♔DeusVult!♔]

excluding economies based on commodities ie mining, oil etc etc

Are democracies pathetic at managing the economy?

There is your issue. When a government "manages" an economy, it will inevitably lead to disaster.

[Exarch]

There is your issue. When a government "manages" an economy, it will inevitably lead to disaster.

Governments are expected to 'manage' the economy though, and do so-in terms of rules and regulations and manipulating interest rates.
for eg, insider trading was almost the norm in 19th century america-these days, it's a criminal offence

[Furious Mental]

It's not apparent to me that they necessarily are, or that authoritarian regimes are better at it. During World War Two, democratic governments in the US and UK managed their economies much better than the dictatorship in Nazi Germany. The USSR also achieved tremendous economic feats, but the Soviet economy was not actually managed in a particularly efficient manner - it just extracted a tremendous of labour from the populace. Nowadays, democratic governments simply do not bother to coordinate economic activity in the same way, because socialism is evil and whatnot.

[Mr. Scott]

Are authoritarian governments with a highly centralized government good at exploiting the free markets of democracies? yes
Are there any authoritarian first world nations? No

[hellheaven1987]

Are there any authoritarian first world nations? No

Italy does not count as one??

[Plant]

Italy does not count as one??

Italy is not an authoritian country.

[CiviC]

Italy is not an authoritian country.

You're right, it's a pornocracy

[Rolling Thunder]

Are authoritarian governments with a highly centralized government good at exploiting the free markets of democracies? yes
Are there any authoritarian first world nations? No

Keenly observed and well pointed out. I wish I could Rep you.

[Exarch]

Are authoritarian governments with a highly centralized government good at exploiting the free markets of democracies? yes
Are there any authoritarian first world nations? No

not yet

is there a non commodities based democracy that doesn't have skyrocketing debt? No.

[Dr. Croccer]

That very much depends on what you mean with ''managing''.

[CiviC]

Historically free societies were more successfull economically and the success lasted longer then totalitarian societies.

Totalitarian/authocratic regimes can have in the short run greater success then democracies, but in the long run they fail miserably.

I don't share the enthusiasm about the development of China, sometimes in the future China will experience a crisis, economical, social and political (all go hands in hands) with heavy consequences for her and the world itself.

As for the debt of the West, consider that the growth of China herself is artificial in some measure as well, by manipulating the exchange rates, but in economy you can lie for a while, but not forever.

[Boer]

Interesting that India and Brazil were basically ignored in those articles.

[Exarch]

Interesting that India and Brazil were basically ignored in those articles.

India and Brazil exercise a degree of State Capitalism similar to the Chinese model, so they're not like 'liberal democracies' to which we're accustomed to

[Armenum]

You need a mixture of government owned and private enterprise/free market. That way both sectors can be equally responsible for the upholding of the economy. You cannot have one without the other.

[Ciabhán]

You need a mixture of government owned and private enterprise/free market. That way both sectors can be equally responsible for the upholding of the economy. You cannot have one without the other.

Why?

Give me an example of a government, with all the dead weight a government generates(particularly a government with a socialist leaning that would pay an employee who failed at his government salaried job and then continue to pay said worker public money for being unemployed, IF and it's a big if, he were to be fired).

Governments are the WORST example of success when it comes to a business model. No government that has existed for an extended period of time has ever made a profit. Very few have ever had a balanced budget. The very nature of government generally precludes it ever giving back to it's 'investors'.

As an example... A government that takes a billion pound in taxes should provide a billion pound worth of infrastructure and national defense. It shouldn't provide an additional billion pound worth of services for those who have no share(the permanent welfare types), another billion pound of 'services' based on future incomes that may never happen, etc. That kind of mindset leads directly to insolvency.

However the worst problem with shared government ownership stems from motivation. If a person knows that all they have to do is an average job then they have no reason to work harder. They won't lose their jobs because the government will subsidise their work. They won't be promoted because there are few if any openings for it. The end result is inferior products with inflated costs. This then has an impact on the economy and everyone except the most wealthy become poorer. Nothing is solved and the monetary level that indicates poverty slowly increases until everyone is subject to some level of poverty. In a non-intervention economy a company that produces an inferior product or a similar product for higher cost fails. They shut their doors and the company that produces the same product with acceptable quality and cost thrives, it grows, and it hires the workers from the company that went under. People thrive. More production means more workers, means more supervisors, means more inspectors, means more management, means more money for everyone... More money generally means more expendable income and overall more charitable mindsets. The middle class, generally the largest percentage of and most 'humane' of society have more money to give those who CANNOT work and the only people who suffer are those who WON'T work.