A letter to my family on peak oil and the global economy

Tim turned 16 the other day. By the time Tim is 30 the world will be producing only half the oil it is producing now and when he is 40 it will be producing less than a third.

Since I found out about peak oil in 2004 I have bothered you with my dire predictions. I know we got the timing wrong, and I know we have subsequently found shale oil and the global economy has continued on a business as usual path. You think I was wrong, do you?

Well here we are at 2017 and the article I have just read several times explains why the timing was wrong. We didn’t allow for fracking and we didn’t factor in the financing of oil. But now we are stuck. You tell me where the Nafeez Ahmed article falters. He quotes from an HSBC report and that is the sixth to biggest bank in the world. The HSBC article quotes from the International Energy Agency and from a Swedish University’s energy programme. Ahmed quotes further from a recent Cornell University paper which in turn quotes a paper from the Italy’s premier agency for government research.

I know very few of you will want to read the Ahmed paper. After all it is holiday season and we all have books to read, swimming to enjoy, bike rides and tramps to accomplish and screens to attend to.

So let me summarise this paper a little, adding an odd bit for explanatory reasons:

Conventional oil peaked in 2005. Unconventional oil (shale oil, deep sea oil) peaked in March 2015. Oil is the most dense energy form human beings have ever found and nothing has yet replaced it. Consequently it is closely correlated with economic growth and population growth. The current economic system requires constant economic growth. Oil has fuelled the growth in global wealth.

Ten years ago some of you replied, “Don’t worry, we will find something”. Oh yes we found fracking, and China went back to coal. But we also had already found debt instruments. If you don’t understand what these are you are in good company. Not even the heads of hedge funds or big banks know what strange derivatives (bets) are being invented by their traders sometimes. Ahmed says simply “the world is borrowing from the future to sustain our present consumption levels”. I know the shale oil companies were largely funded not from banks but from selling bonds. Ordinary people bought company bonds and got paid very high interest rates. The interest rates have risen so high that many shale companies are going broke paying them.

As oil exploration is yielding fewer and smaller fields and the oil is getting deeper and more expensive to extract, the oil companies abandon uneconomic fields. This happened around New Zealand and we attributed it largely to the actions of Greenpeace. But it was more than that. It costs them too much to extract it. Oil prices have recently climbed to just over $50 a barrel and companies need about $60 to break even. So they borrow. The trouble is this debt doesn’t produce real wealth.

Remember back in 2008 just before the Global Financial Crisis we had soaring oil prices? Oil went to $150 a barrel. Since nearly all goods are transported and the transport cost went up there was less money left for the rest of the economy. So we had a huge recession. So if oil prices are too high we get a recessionary effect that destabilises the global debt bubble. That debt is now higher than the pre-2008 crisis. If oil prices are too low we get too much debt which brings with it huge bank risks.

The economy can’t grow without oil. So we are stuck. The article says “the economy can quite literally never recover unless it transitions to a truly viable new energy source which can substitute for oil.”

Ahmed won’t of course have read my essay that I just submitted to the Next System Project essay competition where I propose an entirely new way of constructing a political economy so that we are not dependent on oil or on money as debt. (More of this later, I have just entered it into their international competition)

Ahmed says that because on 1 Jan 2018 there are new regulations coming into force in the finance industry, there will be a massive collapse shortly after that. He called it in 2008 and he is calling it now.

So while you are reading soothing headlines about how the economy is ‘in recovery’ or angsting over Donald Trump’s appointment of Exxon Mobil chief as Secretary of State or yet another climate change denier to a key position, think about your preparation for next year. The economy can't recover, given its present structure and its geophysical limitations. Where will you get your food? Cash? Petrol? Will your local authority be able to maintain a good supply of drinkable water or a sewerage system if they are in increasing debt? What about power?

Now there will be those who say this is wonderful for climate change. Yes it may be the only thing that makes our planet habitable. But it is an awful way for billions of us to learn. Actually the people who will be best off will be those who are already scraping a subsistence living. But that is another matter.

If only half the today’s global oil supply is available to Tim when he is 30, what is the future for your grandchildren? Or your old age? Can you devote an hour of your precious time to getting a handle on the reality of all this? We are so privileged in New Zealand and have had it so good for so long. I have missed out on a share price boom I know. Yes I got the timing wrong. Yes I have been a doomster. But please think for yourself now. You are educated, you probably have unlimited data for your computer, use it. Plan now for a massive, tightly interconnected, global financial collapse now. You might have a year.

The Precariat , Trump and cheap-to-extract Energy

When job figures in the US came out in early November 2016 the unemployment rate was 4.9 percent and hardly anyone worried. For economists a 5% unemployment rate is a really good figure. But remember the new definition of who is employed? Employment in most developed nations these days is "at least one hour of work done in the past week by a person aged 16 or older". So the "employed" includes all those who lack job security, and those with intermittent employment or underemployment and the resultant precarious existence.

This is what the Democrats missed. There is many a commentator who has observed that the urban privileged are completely out of touch with those who experience the worry of a day to day precarious existence, always uncertain whether they can pay their bills. This is the precariat. Professor Guy Standing, in a book published well before Brexit and Trump's election warned that the rapid growth of the precariat is producing instabilities in society. He warns it is a dangerous class because it is internally divided, leading to the villainisation of migrants and other vulnerable groups. And, lacking agency, its members may be susceptible to the siren calls of political extremism.

Something familiar there? While they might not call it the precariat, Bernie Sanders, Donald Trump and Nigel Farage all appeal to this group. So while the question is legitimate, the solutions of Trump and Farage are wrong, wrong, wrong.

The tragedy is that just as politicians miss the precariat, economists miss energy. And strangely they are related. Here is how:

Oil is a remarkably dense energy source with one barrel of oil supplanting eleven years of human labour. Graph its use with the rise in GDP and they are in complete lockstep. The economy as it is currently structured is utterly dependent on growing supplies of cheap to extract energy. Only a fool would deny it is extremely unwise to build an economic system that relies on ever growing expansion in oil supply. In real terms energy supply is already on the decline due to the expanding internal energy requirements of the oil industry.

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The cost of oil exploration and extraction is rising and with it debt

Actuary Gail Tverberg writes that peak oil didn’t play out as expected because we didn’t factor in the financing of the oil industry. As the cheap-to-extract oil ran low, the cost of extracting non-conventional oil grew higher. This meant the firms had to go into more debt in the form of bank debt, bonds and derivatives. Eventually the debt overwhelms the oil companies and the layoffs begin. In order to pay interest on all their debt, indebted firms have had to keep wages low. The same happens for all firms that extract commodities, because they all require cheap-to-extract energy. The last step is that these low wages reduce the general demand for goods.

Nicole Foss points out that if demand collapses, the money supply declines and a deflationary spiral begins that few notice. 18 months after the decline in oil prices started, by February 2016 Bloomberg Business reported there had been 250,000 oil jobs lost and apparently each of these jobs supports over three basic wage jobs.

Tverberg says, "Why is the price of oil so low now? In fact, why are all commodity prices so low? I see the problem as being an affordability issue that has been hidden by a growing debt bubble. As this debt bubble has expanded, it has kept the sales prices of commodities up with the cost of extraction, even though wages have not been rising as fast as commodity prices since about the year 2000. Now many countries are cutting back on the rate of debt growth because debt/GDP ratios are becoming unreasonably high, and because the productivity of additional debt is falling."

So the drop in oil prices leads us to an underlying problem. The world is reaching the limit of its debt expansion. This is what is called Debt Deflation.

So even though we are living in a time of energy constraints, our blinkers don't allow us to see that. Risk analyst David Korowicz wryly observes,"The irony is that people may rarely notice they are living under energy constraints. Energy retraction from the global economy can be achieved by production declines or collapses in demand, though as we have seen, they are deeply inter-related. We may experience energy use collapse not as an energy constraint, but as a systemic banking collapse and vanished purchasing power."

So here is the source of the vanished purchasing power of the precariat. In a post election blog energy analyst Richard Heinberg observes that the problems won't go away when Trump is elected. In the face of the door being closed to national action on climate change, build community resilience is his message. "The most promising responses to our twenty-first century crises are showing up at the community level anyway. It’s in towns and cities across the nation, and across the world, where practical people are being forced to grapple with weird weather, rising seas, an unstable economy, and a fraying national political fabric."

None of these arguments will be known to the incoming president, though some advisors may try to educate him.Good luck to them. He is an anti-science president. If he slaps tarriffs on as he has promised, purchasing power will decline still further and accelerate the already active deflationary spiral.

trump-digs-coal

Trump's attitude to women seems the same as his attitude to the environment – if it's there, it is there for my use. Coal stocks soared on his election and renewables dropped. However, oil stocks didn't rise much, possibly a sign that reality of constraints are already priced into the market. 

An interesting question with Trump is how committed he actually is to his own ideas, from the potentially sensible to the crazy.   He is a “top of the head” sort of a guy, who changes position and contradicts himself on exposure to new things (or simply because he finds himself in a new context). Is the Presidency just a vanity project for him, in which he will blow with any policy wind he encounters? His victory speech, and his abandonment of the “Lock her up” approach, suggested that.

At the worst, if his “vision” as expressed during the campaign carries through, the US (and to a lesser extent the world) are in for an appalling time – racist, misogynist, anti-environment, pro-individualist, pro-violence and so on. And if the Republican Party as a whole gets the bit between its teeth, the US Government will be gutted and corporates will simply finish their take over. At the best, there’s no doubt he has created more space for these sorts of behaviours at the fringes in the short term. In between, as seems more likely, the direction as a whole will probably be negative, but it’ll be muddled and maybe not so fast moving.

There are a few bright spots, less likelihood of a war with Russia and above all, an increased energy and commitment of climate change activists. Our lives depend on it. He has focussed our minds. There is no spare planet. Somehow we must find a way.

Commodity bubbles, oil derivatives and the price of petrol

This week several questions in Parliament were about the drop in the price of dairy products and the effect on the New Zealand economy. But the price of wool, beef, timber and logs are not dropping. I began wondering about commodity prices.

On the radio I heard a journalist say that if oil prices are down then economic growth rises. He went on to say how well the economy will do now that the price of oil is falling.

That is a deceptive argument. As Automatic Earth blogger Raul Ilargi Meijer pointed out the oil companies are already mired in debt, and when they receive less for their oil their finances will be in real trouble. He says, “there is no industry like the oil industry and it’s highly doubtful there’s another one with such debt levels”. The drop in crude prices has undercut the profitability of many oil projects and if you are an oil-exporting country you are vulnerable. Russia is being hammered right now and the ruble is in freefall. The share market in Saudia Arabia is falling.

Meijer points out that plummeting oil prices don’t just mirror the state of the real economy they will drag the whole economy down. The oil industry swims in debt not reserves.

Remember in 2012 Petrobras pulled out of New Zealand? They said they hadn’t found enough oil. Rather than giving the credit to Greenpeace for their vigorous opposition to deep sea drilling, the company’s explanation about low profitability is probably nearer the truth. Petrobras is the world’s third biggest oil company with sales of $150 billion a year.

The Telegraph writer Ambrose Evans-Pritchard in an article on oil company indebtedness wrote “Petrobras is committed to spending $102bn on development by 2018. It already has $112bn of debt. Petrobras’s share price has fallen by two-thirds since 2010.

This led me back to the whole commodity issue. I found a good article by bubble analyst Jesse Colombo and will summarise it. https://web.archive.org/web/20120302222518/http://www.thebubblebubble.com/commodities-bubble

He says “China’s economic boom since 2009 is actually a debt-driven bubble, and that its unsustainable, resource-intensive growth has temporarily boosted the prices of commodities.” He has been expecting the bubble to burst for a while now.

China's consumption of commodities drove real money into a new "asset class". But production has spiked and the bubble is popping now as real money leaves. We are now at the end of the commodities supercycle.

Three years ago the same Jesse Colombo warned of a commodity bubble. He said “The price of nearly every commodity from wheat to uranium exploded during the past decade as hundreds of billions of dollars of capital entered commodities as the new “hot” investment destination.”

He wrote then “Commodities prices, as measured by the Continuous Commodity Index (CCI), have risen a staggering 275% since the start of their bull market in November 2001”

He said Crude oil (WTI) is up 1,050%, gasoline 1,050%, heating oil 1,000%, gold 528%, silver 1130%, copper 666%, platinum 435%, palladium 443%, wheat 275%, corn 348%, soybeans 250%, oats 300%, sugar 600%, coffee 635%, cocoa 435%, orange juice 245%, cotton 650%and lean hogs 213%. (measured at the peak in mid-2011)

“Like all bubbles, from the Roaring Twenties bubble to the Dot-com bubble, the 2000s commodities bubble started as a legitimate economic trend and devolved into a “hot money”-fueled speculative mania.

“Record-high commodities prices led to ambitious plans such as Quebec, Canada’s $80 billion investment and decision to open its vast northern region to mining development – an area twice the size of France with an abundance of iron, nickel and copper ore deposits.

“High oil prices have incentivized the development of a wide range of technologies that are helping the discovery and production of far more oil than originally estimated and helping to allay Peak Oil fears for the time being. Fracking in US made US the biggest oil producer in the world.

“China and India’s real estate development and infrastructure construction soared in the early 2000s, causing economic growth and the demand for raw materials to hit a powerful upward inflection point.

“While the Chinese government builds scores of excessively extravagant government buildings, entire uninhabited “ghost cities” are cropping up, as can be seen in satellite images.

“When China and India’s economic bubbles pop, the commodities bubble is sure to crash along with them.

We have also seen the rise of commodities as an investment class. The boom has taken place across a wide range of commodities, and, indeed, is unprecedented in scope and size. These commodities include sugar, cotton, soybean oil, soybeans, nickel, lead, copper, zinc, tin, wheat, heating oil.

derivatives-3“The unprecedented aspects of the commodities boom and bubble are due to a relatively recent fundamental change in the commodities market – financialization, or the large-scale transformation of the commodities market into an investment asset class like stocks and bonds.

“Pension funds have become one of the largest sources of capital parked in long-term commodity investments ever since Congress essentially forced them to diversify into commodities by law. The tsunami of new investment capital flowing into the commodities market has been a major contributor to the boom in prices. In addition, the financialization of commodities paralleled the financialization of, and bubbles in, the US housing and mortgage markets.

But it is not just the commodities themselves. There is now a staggering range of commodities derivatives products. They call it “financial innovation”. Here is Jesse Colombo again in 2011 “The market value of agriculture commodities derivatives grew from three quarters of a trillion in 2002 to more than $7.5 trillion in 2007, while the percentage of speculators among agriculture commodities traders grew from 15 to 60 percent. The total number of commodities derivatives traded globally increased more than five-fold between2002 and 2008. The commodities market has become increasingly dominated by big banks, hedge funds and other speculative participants.

According to Wikileaks cables, speculators, not supply and demand, were the main cause of the 2008 oil bubble when oil hit $147/barrel.

One of the main catalysts for the second phase of the commodities bubble (2009-to-Present) was the launch of the Federal Reserve’s quantitative easing (QE) programs.”

Further to the topic of derivatives. If you want something scary to read then try reading about how big banks hold a great many oil derivatives and are at the losing end of the bet as oil drops in price. http://www.activistpost.com/2014/12/plummeting-oil-prices-could-destroy.html

And here is an article from earlier this year. The author is one Harry Dent and the website http://economyandmarkets.com/markets/foreign-markets/2014-the-year-china-bubble-burst/ and I quote it in full.

“For two years now, I’ve been warning in our Boom & Bust newsletter that China is going to be the ultimate and largest trigger for the next global financial crisis… a crisis that will be deeper and last longer than the first one that governments quickly combatted with unprecedented quantitative easing and bailouts.

And the cracks in the greatest bubble in modern history are finally starting to show. China bubble burst? Yes. And 2014 is the year that happens. When it does, it will trigger a market crash around the world.

George Soros warned late last year that China’s subprime lending was starting to look like the U.S. just before its crisis.

Now Leland Miller, President of China Beige Book International, is warning that 2014 will be the year of defaults for China.

Defaults will occur in trust products… wealth-management products… corporate bonds… and even some government bonds.

China’s subprime lending has mushroomed to more than $2 trillion in the last five years.
Its corporate bond market now totals $4.2 trillion.

Its total credit has surged from $9 trillion to $23 trillion since late 2008, or 250% of GDP.
Once again, additional borrowing and spending adds very little to GDP…

Just like it was, right before our subprime crisis, right now every dollar of debt China incurs adds only 15 cents to its GDP. At the height of our crisis in 2009, each additional dollar of debt created 85 cents of GDP.

China is currently getting very little bang for its borrowed buck.
As I always say: Debt is like a drug. It takes more and more to create less and less effect until the system fails.

Now, China’s system is starting to fail… and the bubble is starting to blow up and the fallout will affect us all.

As Miller warns, this is a different China than that of the past two decades. The government understands that it has to slow growth after massively overbuilding and inflating bubbles.


This, he warns, will impact China’s neighbors — places like South Korea, Japan, and Australia (where I recently issued strong warnings about the China burst) — more than most people assume.


Societe Generale’s analyst, Albert Edwards, warns: “Australia is a leveraged time bomb waiting to blow up. It is not a CDO (meaning collateralized debt obligation), it is a CDO squared. All we have in Australia is, at its simplest, a credit bubble (consumer debt) built upon a commodity boom, dependent for its sustenance on an even greater credit bubble in China.”


Exactly!

Already, an agricultural financial co-op has closed its doors, and depositors couldn’t withdraw their money. And a China Credit Trust wealth-management product of $496 million blew up.
The Chinese government bailed them out.

Then, on March 7, China saw its first corporate bond default, when Shanghai Chaori Solar defaulted on its bond payments. It’s unlikely the government will bail it out.”

Why our are farmers farming for capital gain?

Andrew Gawith, Director of Gareth Morgan Investments, described the economics of farming in New Zealand as “speculative” as the financial benefits are almost entirely dependent on capital gains. Other than dairy, income is puny and unreliable, he said."Farm finances don't add up." (NZ Herald, Nov 30, 2010)

Alvin and Judy ReidWhereas UK and US price of rural land doubled in a decade, the value of farmland in New Zealand has risen at 10.7% a year over the past 20 years. (That is the value of farmland doubles in less than seven years). “That’s a real after tax return of something in the order of 7 percent to 8 percent a year.” He points out this is double the return of sharemarkets.

He says, “Farming is the most popular business for banks to lend to. While other areas of economic endeavour are starved of capital, banks have very nearly drowned farming with debt. The ease with which farmers can get capital has helped push up the price of land.”

If farmers are drowning in debt, they will not be able to withstand a rise in interest rates. An article in NZ Farmer warns that with the drop in the price of milk, a quarter of farmers are heading for loss unless prices rise. So as China’s economy slows the high debt farmers are most vulnerable. Winston is watching.

gw-speech-the-significance-of-dairy-to-the-new-zealand-economy-7-may-201400This is our dairy debt from 1990-2014. It has multiplied by eight over those 24 years. Gareth Vaughan reminds us that nearly 70% of this dairy debt is on floating mortgages. Dairy debt was around $32 b in 2013, up from $8 b in 2003, which makes a quadrupling in a decade!

Farming is very capital intensive, with only mining and utilities more so. According to a NZIER study “Around three quarters of value added in agriculture is from capital (land, plant and machinery). This is higher than the economy wide average of around 50%.”

If dairy farming turns out to be the cause of our country’s Minsky moment, can we avert a crisis by taking control of our currency creation and land tenure system at Community Board level? Not only is this our only hope, but it will lead eventually to greater productivity and equality – as well as getting good young farmers on the land at an affordable entry level.

IMF economist Michael Kumhof says the key function of banks is to create money

imfToday I made the mistake of going to a website where there was a sentence which made me mad. It said that in New Zealand, banks like finance companies can only lend out deposits made with them. Well I rarely get mad these days but I don't like untruths being perpetrated. So I thought the best way to recover would go and transcribe the first seven minutes of a talk Michael Kumhof, economist from the IMF made to a seminar in January 2013.  It is on youtube here and here is my transcript, give or take the odd aside I left out.

"Virtually all money is bank deposits.

The key function of banks is money creation not intermediation. The entire economics literature that you see out there today is that it is intermediation, taking the money from granny, storing it up and then when someone comes and needs it I can lend it out to them. That is complete nonsense. Intermediation of course exists, but it is incidental and secondary and it comes after the actual money creation. Banks do not have to attract deposits before they create money. I’m a former bank manager. I worked for Barclays for five years. I’ve created those book entries. That is how it works. And if a leading light economist like Paul Krugman tries to tell you otherwise, he does not know what he is talking about.

When you approve a loan, as a bank manager you enter on the asset side of your balance sheet the loan, which is your claim against this guy and at the exact same time you create a new deposit on the liability side. You have created new money because this gives this guy purchasing power to go out and buy something with it. Banks have created money at that point. No intermediation, because the asset and liability are in the same name at that moment. What happens afterwards is that that guy can spend it somewhere else later but it is still in the banking system. I care about the aggregate banking system. Looking at the microeconomy and transferring the logic to the macroeconomy is really wrong. Someone will accept that payment.

money

What that means is that it becomes very, very easy for banks to start or lead a lending boom even though policy makers might not, because if they feel that the time is right, they simply expand the money supply. There is no third party involved, just the bank and the customer and I make the loan. The only thing that is required is that someone else will accept that deposit, say as payment for a machine, and he knows that is acceptable because it is legal fiat.

There is an important corollary to this story. A lot of loans are not for investment purposes, in physical capital. Loans that are for investment purposes are a small fraction. The story that is often told in development economics is that first you need to have savings, then once you have the savings, you can have investment. So a country needs to have sufficient savings in order to have enough investment. Nonsense too – at least for the part of investment that is financed through banks because when a bank makes a new loan it creates new purchasing power for the investment to go ahead. The investment goes ahead. Then the investor takes his new bank deposit and gives it to someone else In the end someone is going to leave that new deposit in the bank. That is saving.  The saving is created along with the investment. It’s not that saving has to come before investment. Saving comes after investment, not before. This is important for development economics.

The deposit multiplier that is taught in economics textbooks is a fairytale. I could use less polite terms. The story goes that central bank creates narrow money and there is a multiplier because banks can lend out a fraction. It is actually exactly the opposite. Broad monetary aggregates lead the cycle and narrow monetary aggregates lag the cycle."

How To Build A Life-Supporting Economic System

How To Build A Life-Supporting Economic System

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Earth is a Living System

Earth is a living ecosystem and necessarily the model for the human economic system. The words ecology and economy have the same Greek root ‘ekos’, meaning ‘home’ or ‘earth’, so our economy is a subset of our ecology. All life-based systems are unique home economies – Earth, nations, states, cities, towns, communities, families, and each living being. Each economy can only survive in balance within natural limits.

Every global crisis derives from an unbalanced economy:

  • Financial collapse is caused by an interest-bearing debt-based money system and a grossly overinflated ‘shadow economy’. These cause rising debt as “promises to pay” that cannot be met by the real economy.
  • Energy collapse is caused by our economic dependence on fossil fuels and the new reality of relentlessly declining energy returns, leaving less energy to drive the economy.
  • Biosphere collapse is caused by the real world demands of the growth-based economy, required to service exponentially expanding interest-bearing debt.
  • Societal collapse is the descent into social unrest, the police state and militarism, driven by the above.

We have a Deadly Economy

In an interest-bearing debt system of money creation:

  • Private banks create money as a commodity for private profit, causing cycles of boom and bust as the money supply expands and shrinks. The lack of balance is destabilizing. Scarcity of money during recessions/depressions causes unemployment and turmoil.
  • The interest mechanism automatically transfers wealth upward from those with the least to those with the most, increasing income inequality. This undemocratic money system leads to social polarization and social collapse.
  • Interest-bearing debt expands exponentially, demanding perpetual growth of GDP despite our finite Earth, which exhausts all human and natural ‘capital’.
  • The need for growth is inflationary, promoting unproductive speculation in financial markets and real estate, inflating house prices, and eroding the productive economy.

A tax system which taxes labour, sales or enterprise discourages work discourages trade and discourages enterprise. It also greatly reduces people’s purchasing power (though there are cases for reducing this e.g. tobacco, alcohol, fossil fuel etc.). A tax system like this encourages property speculation, reduces productivity and concentrates wealth with landowners.

When we tax these three but fail to tax land, we invite taxpayers to use tax havens and do under-the-counter trades, resulting in lost government revenue. Land cannot be hidden offshore.

However, though it has been recommended for centuries, a land tax in the 21st century is a politician’s nightmare. Successive tax review by Inland Revenue, Treasury and universities have recommended land tax, but no government has implemented them. In fact there is actually a law prohibiting land tax in New Zealand, probably enacted to please the banks.

People already pay on their property two payments – rates and mortgage – so the possibility of government imposing a third burden is zero. In fact it is political suicide for any politician to recommend land tax, no matter how small. Yes, the banks have claimed land for themselves, as it is their best security on their loans. They vehemently oppose land tax and so governments have to be content with taxing a less secure asset – income taxes.  Banks love lending on property because as the price of land rises, so does the size of their loan portfolio.

A means tested welfare system with an intrusive state and a ‘benefit trap’ is trapping our unemployed and dampening enthusiasm for working. It is also complicated and expensive to run and requires billions being spent on IT systems. The benefit system with its various income support schemes which favour the children of employed over the children of the unemployed like Working for Families is basically unfair. A Universal Basic Income has been recommended for centuries, starting when someone saw thieves hanging in the street and said it would be better to pay them a living wage. However there has been no progress.

All of the above – monetary reform, a Georgist tax reform and a Citizens Dividend – would if introduced suddenly shock the economy. All of the above have attracted loyal movements that have made virtually no progress over the centuries. It is important to reflect on the reasons for inaction. Each major reform would shock the economy.

We Need a Living Economy

A living economy will feature:

  • Publicly created permanent debt-free money as a medium of exchange for public benefit, circulating permanently, its volume regulated by a publicly accountable body. A sufficient, balanced supply of money is stabilizing, promoting business and employment.
  • Reliable public revenue without debt or interest is spent directly into the economy. It is critical to take the power from the banks to create the country's money and return this to the people.
  • Tax will be removed from ‘good’ activity like work and enterprise and trade, and will be imposed where people take more than their share of the commons or impose a burden on the commons.
  • A Citizen’s Basic Income removes the need for Social Welfare and numerous income support programmes. It avoids the ‘benefit trap’ and allows voluntary work and new businesses to thrive.
  • A stable money supply that is neither inflationary nor deflationary, and flows freely into productive investment in the real economy.

Transition To A Healthy Public Money System and to a Reformed Tax and Welfare system

First we need to explain why we are applying a broad-brush approach to reform, not doing it piece by piece.

When family therapists are presented with the problem of a difficult adolescent, it is important to treat the family as a whole system, rather than just look at the presenting problem, the adolescent. Tweak just one part of the system and the whole becomes healthier. You seem to solve all sorts of problems. But if you just try and fix one problem at a time, it won’t work. The original problem tends to persist. That is because the issues don’t exist in isolation and the relationships continue. You can’t divide up a system because you break the links and destroy the patterns. It is the same for any living system. The challenge is to intervene at the points where it is going to effect the greatest change. This is in the areas of goals of an economy and the fundamental paradigms which are taken as gospel. Those paradigms are the basic beliefs and ‘givens’ of a system.

In our case, we have an economic system showing a range of Big Problems. First we have the property bubbles in Auckland and Christchurch while the economy in the regions stagnates.  Second we need to sort out the welfare mess by introducing a universal payment, the UBI. Third we need to get a tax system that taxes what we hold or take, not what we do or make. (Taxing labour and enterprise is counterproductive, while it is quite fair to tax those who take or use more than their share of the commons.) Fourthly we need to move from privately created interest-bearing money to publicly created interest-free money.

These big issues are all connected through banks, land and taxes. If there is quite a simple solution where, if you tweak one or two parts of the system and the other problems solve themselves naturally, then we should use it. This is the systems approach. You don’t tackle the intractable problems issue by issue; you look at the whole integrated system and choose your point of intervention that gives the greatest leverage. In that way the fundamental relationship between the elements of an economic system will remain intact.

You will notice we are suggesting the point of intervention that has the most leverage – the currency, tax and land. We have paid attention to what is important. Changing the paradigm from a currency monoculture to a currency ecosystem is going to bring big change. Changing the tax and welfare systems will also have a major effect.

Second we set up a small new system parallel to but very different from the old system.

This proposal will put in place the small beginnings of a new and healthier system to coexist with the earlier deadly system as the old system dies away.

So we are going to start a new currency with new rules. This will be the beginning of the new healthy economy. The old economy will die and a new one will be born. It’s a transformational change. In order to transform the tax system from taxing labour, sale and enterprise to only taxing land and the use of the commons, you need to link that new tax system to a completely new currency.

It can’t be done effectively otherwise. New life is full of health and vitality. Just as new growth in a forest after a fire appears slowly, so will this process be gradual.

Note that by setting up a fledgling parallel system we have not just fiddled round the edges. We have changed the whole paradigm. So we would expect major change.

Step one

Government issues a new currency called Tradeable Tax Credits. These are acceptable by Treasury for tax on a certain date. (The Reserve Bank is left out)

Step Two

Using Tradeable Tax Credits, Treasury gradually buys up the land of homeowners who opt into the system voluntarily. Government doesn’t want to use New Zealand dollars – first because it hasn’t got enough of it and second because Government wants to link the vouchers to a new tax regime. The dated Tax Credits are to ensure that Treasury issues just the right amount so as not to cause inflation. The date by which it must be redeemed also serves as a circulation incentive.

Step Three

Then Government makes the rules for these tradeable tax credits. They say trades in Tax Credits will not incur income tax, GST or company tax. IRD is not involved with them except insofar as it imposes "land rates" and resource taxes.

Step Four

Full land rates would be set if possible by tender or auction and the lessee will pay it in perpetuity to Government, the revenue to be shared in some proportion between central and Local Government.

Step Five

A Land Rates Index would be established for each general area and rates adjusted annually or biennially according to the rates index. Note the rates are not indexed to inflation. Rates vary very little unless there is an earthquake, subsidence or new infrastructure or a significant business arrives in the area or departs from it.

Step Six

There would be no impediment preventing the Tradeable Tax Credits from being freely traded with NZ Dollars. Employers will want the Tax Credits and importers will want the New Zealand Dollars. The Tax Credits would be issued at par and redeemed at par. What happens in between will depend on the sentiment of the market.

Step Seven

From time to time Government will issue all men, women and children with a small Citizens Dividend in Tradeable Tax Credits to share some of the revenue with its citizens. This dividend would gradually grow as the area of land in the scheme grew.

Step Eight

Resource taxes are imposed on anyone with a monopoly on any part of the commons e.g. Oil, Coal, minerals, water, fisheries etc.

Step Nine

The homeowner who has opted into the scheme receives Tradeable Tax Credits to the value of their land and either puts it in the bank or uses it to pay labour for home improvements or for productive investment and always to pay taxes.

Step Ten

The bank lends out the new Tradeable Tax Credits to businesses to pay a portion of their labour and New Zealand materials. New jobs are created. As there will be no need to move to Auckland, labour intensive industries will attract young people back to regions, back to New Zealand. Organic farming and manufacturing will want them. At first some workers are paid only a small proportion of their wages in the new credits.

Step Eleven

No rates will be payable on any property where the land is Government owned and full land rates are paid.

 

The land to be changed to publicly owned leasehold land would include: -

  1. All land owned by those who do not pay income tax in New Zealand. This would have to be done in steps. It also includes trusts and companies who don't pay tax in New Zealand.
  2. All land owned by government or local government and intended to be sold off to private buyers would stay with the Government e.g. The “green frame” in central Christchurch.
  3. Any other freehold land through an-opt in scheme. This would not alarm those who are capital rich and income poor like the elderly and would not alarm farmers. It would also take the worry from our would-be subsistence farmers on small holdings.
  4. All land under infrastructure like roads, hydroelectric power stations, airports, sewerage or stormwater or water servicing will be required to be converted to leasehold land. Once again to avoid inflation, this must be only done in stages.

The circulation incentive

Dated Tradeable Tax Credits will circulate relatively fast. They will not pool for long in anyone's bank account. People don’t want to find themselves in possession of them when the date arrives, so they trade with it, put it in the bank for the bank to lend out or else pay their land rates early. When a tax credit circulates smoothly without pooling anywhere, it nourishes everything in its path. A trade mutually benefits the buyer and the seller. Even if the Tax Credit goes out of the country there is an incentive for the holder to get it back to New Zealand before its maturity date.

The NZ Dollar and the Tradeable Tax Credit

These can be exchanged. A market will develop naturally. There are two opposite forces acting. The NZ dollar will be used for importing goods and for those who are travelling overseas. The Tax Credits will be particularly attractive to those who plan to use it to pay for labour because this currency is completely delinked from all disincentives to show initiative. The labour they buy will not be taxed, their employers business will not be taxed and the goods and services produced will not be taxed. The Tax Credits will always be worth one NZ Dollar when it is paid for taxes before the expiry date. It is rather like the NZ Postage stamps they sold us when the 70c stamp replaced the 40c stamp. One stamp will take the letter anywhere in the country.

The Tradeable Tax Credits would be digital only

Kiwibank has a “Loaded” card. It is a debit card with embedded chips for each currency. It is issued when a customer travels overseas. Perhaps the Tax Credit could be issued this way, with EFTPOS machines dealing with both types of currency. It is possible each new voucher could have a unique identity so that their circulation speed could be tracked.

Results

Transformational reform when carefully and gradually introduced has an exciting range of effects. This policy gives us low cost housing while gradually but fundamentally changing the tax structure. According to the Productivity Commission, the value of land is on average half of the total value of an urban property, but for Auckland it is 60%. Secondly it makes an important but gradual change in the money creation process. Thirdly it starts on an overdue reform of the welfare mess. Fourthly it gradually changes the way we fund local authorities.

While it releases much needed liquidity for new businesses it has to be implemented along with adequate controls on resource use through resource taxes e.g. carbon tax.

Wouldn’t people cheat the system?

History tells us that wherever money is involved people will try and find a way to cheat the system. Some suggest that people will exchange their Tax Credits for NZ dollars and go and buy another property and do it again. But these people haven’t planned to pay their ground rent and this is a large ongoing obligation. In fact wise people will not opt in unless they have a plan to use the new credits productively to create sufficient revenue flow to pay the rent. Most will pay their land rates in advance. Remember the Tax Credits are issued at par and redeemed at par. The sorts of things that happen in between will soon settle down as people learn the rules. The new law will have meaningful penalties for those who default on their obligations to pay land rates.

How much land rates?

A full ground rent  or land rates for an urban or suburban property is ideally set by auction. However, rule of thumb indicates it is around five percent per annum or more depending on the zoning and other restrictions on the land. Location is important. The further away the property is from government services, the lower the rate. Certain land is however, already overvalued e.g. Auckland land and dairy land, so allowances for that would then have to be made. Other restrictions would include land with a  QE2 covenant or land under historic buildings or land otherwise used for the public purpose.

The Citizens Dividend

Although this starts out being small, the first payout will attract a great deal of attention. When people realise these Tax Credits will pay for food and other essentials, they will begin to trust them. Their value relative to the standard currency will rise. As time goes by this dividend will be repeated and will increase, perhaps allowing, say working couples to opt to care for their own children rather than drive to jobs they don’t like. It might also enable inventors to spend more time inventing. Because the dividend of a dependent will go to the nominated carer, it will redress the economic balance of power between those who care for dependents and those who don’t. This raises the status of carers – usually women, raises the standard of care for children and reduces the social service burden on the state. Many carers will opt to spend their dividends on further education. There is also a long known fact that as the education of women rises so does the control over fertility.

Shouldn’t relief of mortgages be a first priority?

Yes. However in practicality those who opt in at the start will probably be those who are mortgage free because those with mortgages don’t want the hassle of going to their banks and having the bank refuse the Tax Credits. It would be easier in the case of New Zealand owned banks like Kiwibank, the Cooperative Bank, TSB and the SBS. However over 90% of New Zealanders’ mortgages are with the Australian owned banks and the banks might take the case to the World Trade Organisation or other authority to challenge it. So it is better to do the easy things first until the public is onside.

Is there a precedent for Step One?

Yes. These Tradeable Tax Credits are the same as the Treasury Notes that have been used before in history e.g. China 1912 when there was an uprising.  Abraham Lincoln used the US Treasury to issue Greenbacks in 1865 and The UK Chancellor of the Exchequer Lloyd George, on the advice of John Maynard Keynes, issued Emergency Bradbury Treasury Notes in 1914 to pay for World War I. Lord Bradbury was the Secretary of the Treasury.

Bernard Lietaer and Stephen Belgin in their book New Money for a New World describe three periods of history in which there were dual currencies. First, Dynastic Egypt, where there was gold for long distance trade and also pottery chards that were receipts for corn taken to a store. The built-in circulation incentive was that when, after a year, farmers came back with ten chards, they were only given nine bags of corn. These pottery pieces circulated for sixteen centuries in a period of relative prosperity.

Secondly in the Central Middle Ages in Europe people used gold for long distance trade but silver coins for local trade. The local Lord or Duke, who owned the land and issued the coins, reminted the silver coins at irregular and unpredictable intervals. Though the periods between reminting varied from area to area, a lord might give out, for example, four coins for every five that were brought in. Reminting happened when the Lord died. This practice coincided with a massive period of cathedral building and the authors say the enthusiasm cannot only be explained in terms of religious devotion but in the currency system. Maintenance of water wheels, mills and wine presses was excellent. Ordinary people wore silver buckles. Nutrition was so good that the average height of a woman in London at that time was 1 cm higher than today.

Thirdly in Wørgl Austria in 1933 during the depth of the Depression, ‘work certificates’ were paid to council workers who could in turn have them accepted by the butcher, baker, etc because they were redeemable for tax. But each month the bearer of the note had to place a stamp on the note to validate it. During the 18 month period these work certificates circulated, unemployment declined dramatically, bridges were built, people paid their local tax early and visitors came from far and wide to witness the ‘Miracle of Worgl’.

Lietaer and Belgin claim that in each period there was prosperity across all classes and a huge building programme. They attribute this favourable economic outcome to the dual currency, and in each case the domestic currency had a built-in circulation incentive. The authors did not describe the tax system of each society, but to my knowledge there was no income tax, sales tax or company tax during this period. In the central Middle Ages tax was more likely to be a regular tithe to the lord or duke, possibly paid in produce. This is basically a land tax.

There is also a precedent in New Zealand history for Step Six, a Citizens Dividend. In 1951, after a particularly high wool cheque, the government gave out a five pounds dividend to all families.

Why can we see so many bad symptoms start to reverse?

If we observe the results of these small actions being set in place, it is truly astonishing. It is almost as though a fallen domino set has begun to rise, piece by piece. Some are totally disbelieving, because we are so used to thinking that only one result is possible.

  1. A better, fairer tax system with reliable revenue.
    You can see it works towards a much simplified tax system where tax evasion becomes impossible, because you can’t hide land offshore. Many tax-based subsidies will cease to exist as GST, income and company taxes are gradually phased out. For example, tax exemptions on aviation, fuel, interest on mortgages simply disappear. The black and criminal economies no longer gain an unfair advantage. When you use the new money to employ a tradesman, you won’t have to hand it under the table.
  2. New life in industry, and a sea change in horticulture and agriculture. The new Tax Credits,  with a built-in circulation incentive, give opportunities for labour intensive industries to return. The post fossil fuel age will require a whole new set of businesses and these Tax Credits will provide the lubrication. It will be great for organic farming and pest destruction, both of which require a large labour input. Clean green technology will finally blossom and green jobs will no longer need to be subsidised.
  3. Lower prices and higher wages. The increased purchasing power, which results when Tax Credits are free of all other taxes, cannot be underestimated. The affordability of labour and of New Zealand produced goods increases dramatically. Holders of the credits find they can access the basics of food and clothing. Import substitution starts to happen and clothing factories may re-open. When the Tax Credits circulate unburdened by taxes on labour or trade, prices inevitably drop. When employers pay their employees in Tax Credits, which have no income tax, you get a contented workforce. And when workers discover their Tax Credits can buy necessities without GST they are doubly happy.
  4. Issuing of Tax Credits starts a process of gradual but inexorable reduction of private debt. This can only be good for our population and our businesses as all debt under the current system incurs interest.
  5. Because there will no longer be the necessity to move to Auckland for employment, it will be great for regional development, which will take some pressure off Auckland housing. The new Tradeable Tax Credits will flow to the regions without impediment. The attraction of Auckland where a growing portion of the economy is in the FIRE section – finance, insurance and real estate – will no longer apply. The two speed economy, where Auckland  and Christchurch are going ahead yet the regions are withering and suffering unemployment, will even out.
  6.  It is the origin of a new method of funding local authorities. No longer will all of their revenue come from the regressive policies of universal fixed charges or from rating on capital values that discourages investment.
  7. Maori and Pacific Islanders and low income people will benefit from this policy, as they will all be recipients of the jobs created, and from time to time of a Citizens Dividend.

This is quite a list of achievements.

 

Summary

The policy is powerful, elegant and simple. It creates jobs, provides cheaper housing and transforms interest-bearing money to government interest free money all simultaneously. And it does the whole thing gradually without shock to the economy.

 

More discussion needed

Among the issues to be fleshed out are: -

  1. Policy as it affects Maori. Because this is a policy dealing with land and its ownership, it is important to take the proposal round the country from iwi to iwi, preferably by group including Te Reo speakers, because in each rohe and iwi there would be a different situation with respect to the various types of Maori land, incorporations and trusts. However, because the system is an opt-in arrangement, nobody is immediately penalised.
  2. A programme to be devised for gradual rollout without causing inflation. There will have to be robust research on the value of foreign owned land, the tax take and the value of land in each category.
  3. We need a plan to handle the possible fear engendered in those who want their land to be made leasehold but have their mortgage with one of the big four Australian banks, which comprise over 90% of all mortgages.
  4. What is the role of Government in encouraging retail business to accept Tradeable Tax Credits, especially in the early days of implementation?
  5. Since the cost of the house and improvements are not included in the proposed mortgage relief, there needs to be other interest-free arrangements similar to the JAK Bank of Sweden6.   The role of banks in making loans to businesses wanting Tradeable Tax Credits to finance wages and materials.  Does this mean the banks finally get to be an intermediary between saver and borrower?

 

Deirdre Kent deirdre.kent@gmail.com 06 364 7779

021 728 852

New Economics Party

http://neweconomics.net.nz

With acknowledgement to the late Dr Adrian Wrigley of Cambridge UK

 

We write to the Minister of Finance about the IMF paper The Chicago Plan Revisited

This week we wrote a letter to the Minister of Finance and look forward to the response Dear Mr English Re The IMF Paper ‘The Chicago Plan Revisited’ Our attention has been drawn to a working paper published on the website of the International Monetary Fund entitled The Chicago Plan Revisited by Jaromir Benes and Michael Kumhof and dated August 2012. Its abstract reads as follows:- At the height of the Great Depression a number of leading U.S. economists advanced a proposal for monetary reform that became known as the Chicago Plan. It envisaged the separation of the monetary and credit functions of the banking system, by requiring 100% reserve banking for deposits. Irving Fisher (1936) claimed the following advantages for this plan: (1)           Much better control of a major source of business cycle fluctuations, sudden increases and contractions of bank credit and of the supply of bank-created money. (2)           Complete elimination of bank runs. (3)           Dramatic reduction of the (net) public debt. (4)           Dramatic reduction of private debt, as money creation no longer requires simultaneous debt creation. We study these claims by embedding a comprehensive and carefully calibrated model of the banking system in a DSGE model of the U.S. economy. We find support for all four of Fisher’s claims. Furthermore, output gains approach 10 percent, and steady state inflation can drop to zero without posing problems for the conduct of monetary policy. (There has also been a recent paper from the Bank of International Settlements site by the economist Borio http://www.bis.org/publ/work395.pdf, which calls for a rethink of the business cycle model and for significant adjustments to macroeconomic policies, and to an article in the Economist Dec 14, 2012, discussing that paper at http://www.economist.com/blogs/freeexchange/2012/12/reforming-macroeconomics) We therefore ask you, as Minister of Finance:- a) Are you aware of the existence of the IMF paper, the Chicago Plan Revisited? b) Does your government agree that the four results outlined in this paper are desirable? c) Does your government support the method used to achieve these four goals? d) If you differ from the method outlined in the paper to achieve these four goals or argue with it in any way, could you outline your disagreement and how would you achieve these goals differently? Yours sincerely Deirdre Kent and Phil Stevens New Economics Party