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boris debic: welcomeeverybody. i am extremely pleased towelcome today mark blyth. mark blyth will share with ushis insights into austerity as it takes shape in theeuropean union. let me read a little bitfrom his biography. mark blyth is a faculty fellowat the watson institute, professor internationalpolitical economy in brown's political science department,and director of the university's undergraduateprograms in development

studies and internationalrelations. he's also the author of "greattransformations-- economic ideas and institutionalchange in the 20th century." he's the editor of the"routledge handbook of international politicaleconomy," co-editor of a volume on constructivist theoryon political economy titled "constructing theinternational economy," and he's working also on a newbook that questions the

political and economicsustainability of liberal democracies, called "theend of the liberal world." that's dramatic. blyth is a member of thewarwick commission on international financialreform. he is a member of the editorialboard of the "review of international politicaleconomy." and his articles have appeared in journals suchas "the american political science review," "perspectivesin politics," "comparative

politics," and "world politics."he has a ph.d. in political science from columbiauniversity, and taught at johns hopkinsuniversity from 1997 to 2009. please give a handto mark blyth. mark blyth: thank you. cheers. is this mic on? yes? can you hear me?

hello? right. so i have a scottish accent. there's surprise number one. and those slides started tochange themselves, which is surprise number two. ok, how am i goingto start this? why did i write this book? i wrote this book for thefollowing reason--

i got really, really pissed offwith people with lots of money telling people who don'thave any money they need to pay shit back. that's basically it. i grew up on the butt end ofthe british welfare state. i'm an orphan, and i wasraised by my paternal grandmother. so i am the greatest livingexample of inter-generational social mobility you're evergoing to see, because i'm a

freaking ivy league professor. so i went from there to there. how did i do that? because of this thing that getsblamed called the welfare state, that bloated,paternalist, out of control, incentivizing, demotivatingpiece of crap called the welfare state. now, why is this a completelybullshit story? well, that's not, but why doesit turn into a bullshit story?

it turns into a bullshit storyfor the following reason-- back in 2000, the number oneconcern of financial markets globally was there wasn't goingto be enough federal debt, because we had balancedthe budget. seriously, the number oneconcern was there wouldn't be enough t-bills. so fast-forward 13 years, ah,we're all freaking out. now, in between, a coupleinteresting things happened. so you have a balanced budget,which basically means over

time, as the economygrows, your debt stock is going to shrink. and that's why people hada problem with it. so you're going through aperiod of rapid growth. this was the tech boom period,all this sort of stuff. and then there's 9/11. so there's a little dip in theeconomy and a guy called greenspan comes along and says,let's cut interest rates and essentially do assetprotection for everybody who

has bought assets by giving themmore or less free money. so then we decide on topof that we're going to have two tax cuts. why? because we just needmore money. screw it. we're just going to do it. let's have some tax cuts. no corresponding way of payingit off, or whatever, we'll

just take the tax cuts. and then we'll decide to fighttwo wars of choice for dubious political reasons withoutraising any taxes. that'll be a good one. so by the time you getto 2006, there's 61% debt to gdp already. i don't remember anybody incongress, particularly republicans, jumping up and downabout the crazy level of federal debt in 2006.

and then in 2007 and2008, there's a run on the repo markets. basically, the hidden story ofthe financial crisis that nobody really talks about-- it'sactually quite simple-- is that because there was ashortage of t-bills, because, in fact, many of them were inchina, because they keep buying a lot of them, we startedto use aaa mortgage products as collateral for shortterm financial deals in the repo markets.

as the housing crisis happened,those bonds that made up those instrumentsfell from aaa to b to c. at that time, that meant thatif you were a heavily leveraged financialorganization-- a bear sterns, for example-- and you were using these thingsas pledges and as repo collateral, as they fell invalue, you had to use more and more of them to borrow thesame amount of money. unfortunately, you couldn't dothat, because there's a fixed

stock of the assets. and they're hugely levered. this meant a 3% return againsttheir asset base, rendered them effectively insolvent. once everybody figured thisout, you shout fire in a crowded theater, everybodyfreaks out, heads for the exits. you get a liquidity crunch. you've got a financial crisis.

we decided to bail out thesystem rather than let it fail, because it wastoo big to fail. the costs of doing so werebasically a 30% drop in tax revenue across the oecdcountries, because the financial sector had become sobig, particularly in the united states and the unitedkingdom, that it was generating huge amountsof taxes. at the same time, the economyslows down as the liquidity crunch hits the real economyand affects lending and

borrowing and spending. consumer expenditures trenddown, as do consumer expectations, as do investmentexpectations. you get caught in a slump. once you get caught in a slump,automatic transfers in the economy mean that benefitsgo up at the same time as tax revenues go down. so you're going to havea bigger deficit. as you have a bigger deficit,you multiply that over time,

you issue more debt, you go from61% to 100% debt to gdp. that's why we're here. there was no orgy ofpublic spending. it's a lie. i take amtrak every day. i would've noticed an orgyof public spending. if there was an orgy on publicspending, it was on asset protection and income protectionfor the people who had made out with the most forthe past 30 years when we

bailed out those assets. that's actually what happened. now, here's the inequity of the[inaudible] in this whole thing-- why is it that socialsecurity, which isn't even part of federal budgetcalculations on the deficit, which, by the way, has a $2.3trillion surplus, that has to be cut so we can pay back thedebt accrued by bailing out some of the richest peoplein our society and ensuring their assets?

does anybody else think that'stotal horse shit? because i really do, and that'swhy i wrote this book. now, here's the weird thing. we're actually not inthat much of a mess. it's been a sticky recovery. it's been a technological shockto a lot of service jobs that we didn't expect,et cetera. but nonetheless, we haven'tbeen cutting them. because of that, the federaldeficit's projected to be

around 3% next year-- even with a margin of errorin the projection, say 4%. britain has its own currency,like us, and has been cutting, been doing austerity. having done that, it's nowlooking at 7%, totally [inaudible] growth, and a possibletriple-dip recession. europe has been cutting likethere's no tomorrow. they've got the leaches onthe corpse and they're

opening up the veins. greece has lost 30% ofgdp in four years. the german army didn't managethat between '41 and '45. that's how much damage hasbeen done by this. so the question isthe following-- why is it that europe,particularly the european union, the part that we think ofas the most kind of, if you will, welfare-statish-friendlytranser, et cetera, suddenly became this huge doomsdaydevice for this enormous

experiment on austerity, whichso far has cost around 30% of gdp in the periphery and hasgenerated 25 million extra unemployed in comparisonto the united states? seems like somethingto investigate. so, there's a standard pictureof europe in terms of its fiscal balances. as you can see, the unitedstates around here, 2012. by the way, always look at thenet figure, because if you look at the gross figure,that assumes

that nobody pays taxes. and given that we all just wrotechecks just a little while ago, that would tell youthat you really shouldn't look at that one. it also it seems the countryhas no assets. and if that's the case, why dowe have the national security investment act to stoppeople buying assets? so obviously, lookat the net one. so you look at the netone, where are you?

well, basically, everybody'skind of in the mire, more or less. so what brought aboutthis fine mess? age check in the room. anybody who's giggling nowis over the age of 40. on the left, we have laurel andhardy, and on the right, we have angela merkeland sarkozy. there we go. i put that in purely for comedicvalues, just to make

sure everyone is payingattention. and actually, they did bringabout this fine mess, so that is a serious point. so what's the story here? well, there's anofficial story. it's what i call story one,and this is the sort of vaguely sophisticated versionthat you get if you read things like "the economist,""the financial times," et cetera, et cetera.

and i'm going to tell you whyit's total crap, because it's not really true at all. so there's story oneand story two. so here's the officialstory, story one. you do this by lookingat this. this is interest rateconvergence over 10 year bond spreads. so if you go back in the daybefore there was this thing called the euro, when everybodyhad their own

currency, if you were buying abit of greece on 10 years, there's a 25% risk premiumyou're getting paid for holding that. that means that basicallythere's a one in four chance they're going to default. why would you price that in? well, because they haven't runa budget surplus in 50 years. because they've been takingturns to steal the state and using other people's rents andrevenues to do it since they

basically ended the civil war,so why would you not price this at 25%? then have a look at the french,the italians, the rest of the mediterranean, it'sstrained around 15%. this whole [inaudible]in here, over 10%. that's a lot. you're getting paid a lot forjust holding a 10 year debt. now, that reflects the realprice of the bond, the real risk of default that'sin the bond.

now, the official storygoes like this-- around 1991 there was thiswonderful treaty called the maastricht treaty. well, that's '86. '91 is the monetary treaty. and we decided that we're goingto build this monetary union in europe. and what did that mean? it meant basically that you'regoing to have this german bank

called the bundesbankgeneralized across the whole area. all the people that currentlyhave inflation and exchange rate risk and default risk nolonger will have it because we're going to take awaytheir printing presses. and once we've locked up allthe printing presses in the one time deal and given themto a guy in frankfurt, and he's the only one who canprint the money, well, basically doesn't that mean thatgreece becomes germany?

doesn't that mean that italybecomes germany? because after all, theycan't inflate their way out of trouble. so you get rid of that risk. you can't devalue your way,which is a backdoor way of solving the same problem. all you can either do isdeflate-- austerity-- which is politicallyunpalatable, or you basically sort your economy out andeverybody kind of becomes

german, and that'sthe great plan. and you can see how thisis represented in this risk premium. there's where theeuro comes in. and then there's a 7 and 1/2year period where basically all of these countries-- thinkabout how diverse this is-- everyone from belgium to italyto greece to spain to portugal have basically got exactlythe same default risks. now, that's kind of odd if youthink about it for more than

two minutes. so what's behind this? well, the story goeslike this. basically, what's underminingthis-- if you go back to the end here and you see where thespreads go up right, why does it all start to go wrong? well, if you have a look here,your current account and balances, exports and imports. and you'll find that whatyou've got here is most

countries in the euro, the majorcountries, are basically running deficits allthe way through. and the only one that startsto run a surplus here is germany, which picks up justas the euro comes in and becomes the export powerhouse. now, when you control for thesize of the german economy relative to everybody else, whatyou begin to realize is that their surplus isthe counterpart everybody else's deficit.

in other words, somebody hasto buy all those bmws. and if you're buying all thosebmws, you're not making your own [inaudible] and selling them backto the germans. so you start to get thesecurrent account imbalances. but that begs the question-- where did all these guys in thesouth get the money to buy the bmws in the first place? well, that's your story aboutlax public finances.

this is these countries thatare spending too much. so look, it's the pigs-- ireland, spain, greece,portugal. the netherlands we'll putin a bracket, right? but basically, look--a huge amount. that's 10% year on year annualgrowth of government expenditure. they are spending like drunkensailors, there's no doubt about this.

now, what made this possible? as i said before, this is theecb, being deutschbank uber alles, taking inflationand devaluation risk off the table. and also, the maastrichtcriteria for euro gives credible rules against sovereignmisbehavior. you can have a 60% debtload, 3% deficit, and variable inflation. and as i said, the yieldsconverge, and the countries

over-borrow. as we saw in those last threeslides, they're basically spending too much money. but then what does that doto your competitiveness? well, it's going to obviouslyhit your competitiveness. if you're spending that muchmoney and you've got a huge trade imbalance, you've got tobe basically awarding yourself way above productivitywage increases. and look at what you've got.

ireland, spain, italy, greece,cyprus, malta, portugal. the pigs again. and look at these massive laborcost changes over the last 7 year period. you're awarding yourselfpay increase you can not hope to cash. so this is all a very convincingstory, right? and what made this possible? well, of course, what made itpossible is cheap debt.

because as those yields converge, look what's happening. portugal is borrowing. spain is borrowing. greece is borrowing. ireland is borrowing. look who's actuallyin surplus. the germans and thenetherlands. so their savings are financingtheir consumption.

so these countries havemassively over-borrowed. with the take-home being thesouthern countries have borrowed too much. now, have a look at thisnetwork diagram. it's kind of interesting,because there's a question mark there for a reason. there's portugal. relative sizely economy123 billion euros. spain, 345.

italy, very big-- nearlyhalf a trillion. but pretty much all of theirbonds are domestically held. 60% are long-term domestic. the ones that are 10-yearrollover escalate by 10%. look at this. look who's popped up here, witha trillion dollars of crap assets lying on theirbalance sheet. it's the brits, the world'slargest financial entrepot. and look who's up here.

it's those prudential germans,who save a lot and tell everyone to upgradetheir scales. they've got half a trillionof debt going on. so what do you mean the southerncountries have borrowed too much? there's a rather large problemwith this story. you can't have over borrowingwith over lending. this is actually a citibankadvertisement. some of you who are over the ageof 16 may remember this.

the largest ever advertisingcampaign for a finance company in the world was citi'scampaign, "live richly," from 2003 to 2006. it didn't invite youto save up money. it didn't invite youto be prudential. it said live richly. it didn't even say be rich. you kind of have to have richbefore you spend it unless you've just got a giantline of credit.

so let's run that story again. here's the greatest moral hazardtrade in human history. remember the whole story i toldyou about the ecb and credibility and allthe rest of it? here's why it's completehorse shit. because what actuallyhappened was this-- i'm a large european bank. i know that i've got a sovereignbehind me that, if i become really big, i'll becometoo big to fail.

which basically gives me alicense for doing whatever the hell i want because thenit will all be bailed. it gives me a funding costadvantage, and it means that basically i can lever up wellbeyond human reason with pretty much no consequences. and the more powerful i become,the bigger threat i am to that sovereign. and eventually, if the sh-- hitsthe fan, well, you know, i'll get bailed out.

it's totally fine. so imagine i know there's thisthing called the euro coming in, and you're all othereuropean banks, and you know that you could earn a nicelittle bit of coupon buying this greek bond at 25%. there aren't that manyof them-- it's a thinly traded market. but if you can get it,if you lose, fine. but the upside's great--

25%. now, what happens if everybodyreally believes this euro story and everybody startsto converge down? well, i'm going to makeless and less money on those bonds over time. so a quick bit of mathup in your head. how would you make even moremoney on a declining spread? you've go to use volume, you'vegot to use leverage. so what you do is you basicallyget the balance

sheet of your bank and you cramit with as much periphery debt as you possibly can. you take all your nice, safegerman, dutch bonds and you throw them out. and you pile on as much greekdebt and as much portuguese debt and as much frenchdebt as you can. and you turbo charge that,running operating leverage of around 40 to 1, which means yourequity cushion is less than 3% percent of yourasset footprint.

you make lehman brothers looklike a prudentially run organization. and you do this because you'vegot a guarantee. the guarantee is the state. the state will comeand rescue you. you get in trouble,you're fine. except there's a slightflaw in the plan. what happens when theeuro comes in? you have to give up yourprinting press.

so that means your state can'tbail you out anymore. well, that's even better. because then i becomea systemic risk. i'm not just a risk to france,i become a risk to the entire european banking system. score! i've got the ecbover a bottle. i can do whatever i want becausethey're going to have to bail me.

except it's run by jurgen starkand a bunch of germans. and they're not goingto bail you. so when the shit hits the fan,you've got a really, really big problem. which is where we are now. core banks get stuffed withperiphery debts gone bad, a result of over landing. foreign banks consolidatedclaims on greece, ireland, italy, portugal, and spain in2011, last time they published

any reliable figures. french banks have over 33% ofgdp equivalent on their balance sheets in peripheryassets that aren't coming back anytime soon. add in the spanish real estateloans they've got on there-- run. and you have a socgen account. netherlands, one bank,ing, 211% of gdp is its asset footprint.

leverage ratio isover 40 to 1. that alone is 30%of dutch gdp. they don't have a printingpress anymore. are you beginning tosee the problem? the result is assets held bybanks in germany, france, and the uk are about double theannual gdp of the entire eu. here's the too bigto fail usa. top six bank assets,61% of gdp. any one of them fails, evenallowing for systemic

interconnections, you're goingto take out 10% of us gdp. that's about $1.4 trillion,$1.5 trillion. that's a lot, but when you'vegot your own currency, you've got the global reserve asset,we can deal with that. we can bail it. we've done it. that's what we did. it cost of a $3 trillionall told, that's it. we're now in recovery mode.

at least the brits havetheir own currency. there's british gdp. that's the size oftheir banks. you should be very,very afraid now. now let's have a lookat this one. here's france. bnp paribas, agricole,generale. these three banks alone aretaking you up to 250% of gdp, and they don't have a printingpress, and they're seriously

impaired with bad assets. and now here's the kicker. you know that ecb? it's a fake central bank. it's really a currency board. because what it does is it says,we're not doing bond buying, we're not mutualizingdebt, you have to look after the problem yourself. so when you have afinancial crisis,

you've got four exists. you can either inflate-- whoops, you don't havea printing press. you can devalue-- whoops, don't have yourown currency. or you can do austerity. you can squeeze and hope youstabilize public finances, add liquidity, keep the can kickingdown the road-- this is ltros, all the loans thathave been given to the banks.

but at the end of the day,you cannot do a bernanke. so what's a bernanke? a bernanke is when you go intothe banking system and you grab the shitty assets on theirbooks and you put them on the federal reserve'sbalance sheet. and you call them things likemaiden lane 2, and the termloan auction facility 3,and a bunch of completely opaque nonsense that nobody willever understand unless they spend time lookinginto this.

congress, who basically don'tunderstand anything, are completely oblivious towhat's going on-- you then flush the entiresystem out with as much liquidity as you can, and youallow them to recapitalize as they de-lever. which is why the operationalleverage of the american banks is now about 50 to 1 rather than30 to 1 at the height of the crisis. they've rebuilt, they'verecapitalized, they've cleaned

their balance sheet. as the economy recovers,you know all those assets that you bought? guess what? those houses in glendale one daywill have value again, and you sell them backto the banks. it's not a money pump. it's an asset swapwith liquidity. the ecb can't do that.

it is constitutionally andintellectually incapable of making that move. consequently, what the marketswere pricing is as yields were spiking was the possibilityof a breakup of the euro. because if any one of thosebanks goes down, it doesn't stop at spain. it doesn't stop at france. it goes all the way backto the german banks. if that goes bad, it's gameover for the core european

banks, which is why we reallyhave austerity policies. it's about stopping a bank runaround the bond market. this is why you've got to keepthe greeks in at all costs. because if you're a bank, andyou've got 2% of your assets in greek debt-- say you're exposed togreece heavily. how are you going toget rid of that? well, you can't. you can sell it on the hedgefunds basically at 20% on the

face value. or you can hope itdoesn't go bad. but imagine you wake up one day,and you think, this is going to go bad. you want to sell it, soyou sell it first. the minute all those contractshit the floor, what happens to the price? everybody else dumps theirsand they go to the floor. you've now made a 2% lossto your portfolio.

how do you balance it back? you sell the next asset classbefore it goes down. hi, portugal, how areyou this morning? so you dump portugal. and as those prices go tozero, what do you do? you look around and you go,shit, what have i got left? let's dump the irish, then. so you throw the irish on thefloor, prices go to zero. you've now knocked 11% ofeuro-zone gdp and probably

about 12% of your portfolio. you do that on the lendingportfolio of a highly levered bank, what's going to happen toits share price once people figure out? so you're going to have a hugepanic that's caused by a sovereign bank run, right theway through a currency union, something that is supposed tobe theoretically impossible. that's what this hasalways been about. that's why you keepthe greeks in.

that's why you're willingto destroy 30% of gdp. because this is about savingsociete generale, and it is about saving deutsch bank fromtheir own over borrowing and over lending mistakes. consequences. you can't solve a bankingproblem with budget cuts. you can cut greek's publicspending to neolithic levels. it's not going to make a damnbit of difference to socgen's balance sheet.

you can't run a gold standardin a democracy. we tried this in the 1920s. it really didn't work too well--ended up with a few political parties thatwere kind of nasty. you can't solve a solvencyproblem with a liquidity instrument. but god bless mario,he's been trying. you just add enough liquidityand hope the problem goes away by saying, i'll do whateverit takes.

that's what he said six monthsago, the yields came down. since then, he's actually donenothing, and yet the yields have gone down, proving onething-- it's about the credibility of bank policy. it's not about cuttingthe budget. the markets aren't craving anextra 30,000 civil servants being thrown out ofwork in greece. they're worried about theeuro breaking up. so once you give a credibleguarantee, you do a

bernanke-lite, all of the marketpressures are relieved. that was what was lackingthe whole time. and the most important one isyou can't all cut at once and expect to grow. why not? because in order to save,you need to have income from which to save. so if everybody simultaneouslycutting, nobody's generating income.

so imagine the economy with an80% debt to gdp ratio, and turn it into a simple fractionof four over five. now imagine that 40% ofthe five is government you want to cut in half. you're really going to credibly commit to cut the budget. so you just turn thatinto four over four. on a constant stock a debt, yourdebt to gdp ratio just went from 0.8 to 1.

every single country that'sundergone an austerity program now has more debt thanwhen they started. any country the hasn't cut,including the united states, now has proportionately less. the evidence is in. and the tragedy is it wasall avoidable, and we knew this already. so why did anybody, especiallyin europe, ever think this was a good idea?

for that, you have to kind ofhave to go back in time. and it's still abouttwo rival stories. this time it's not ecbcredibility versus the moral hazard trade. it's something farmore spooky. the first one i like callliberalism's emetic economics, emetic being a wonderful wordmeaning to throw up. and what's this allabout throwing up. you go back to john locke's"treatise on government." the

fifth chapter is reallyfascinating. john locke is this guy who'sbasically the intellectual propagandist of a bunch of guyswho want to kill the king and take all the propertyfor themselves. they're called the merchantclasses, and these are the guys that then set up marketsand land, labor, capital, private property, throwpeople off the land, all the rest of it. you ever heard theword vagabond?

it means a man withoutbondage. why bondage? because basically, you've beenthrown off your land, so you basically had your statusremoved from you. so basically, the englishrevolution sets up the markets in private probably,et cetera. and then there's a problem,because the minute you do this, you recognize thatuntrammeled markets lead to massive income and wealthinequalities.

which is great if you happento be the guy at the top of the pile, and not so greatif you're at the bottom. so unfortunately, thenyou need a sate. why do you need a state? to make markets, inthe first place. the notion that they pop out ofthe ground fully formed is a nice fiction, butsimply not true. in order to turn serfs intoworkers, you actually need acts of parliamentand legislation.

the state makes thesethings happen. but here's the kicker. you need to state to policethe inequalities that the market makes possible. because if you don't-- poor adam smith on this one--"for every rich man"-- this is out of "the wealthof nations"-- "for every rich man, there mustbe 500 poor, and that rich man must sleep always withthe strong arm of the

civil magistrate at his side,for he is always regarded with jealousy and envy." so you need that state topolice the inequality. but here's the lockean kicker. this is why we have thesecond amendment. any state strong enough topolice those inequalities is strong enough to comeand take your money. so you've got a dilemmarunning into this. you need this state, you can'tlive without it, but at the

same time, you can't live withit, because you're afraid of the damn thing. so how are you goingto do this? and how are you goingto pay for it? because most people don'twant to pay any taxes. well, that's where this guycomes in, david hume. he has a wonderful essay onmoney and on interest. he talks about merchants beingthe most useful race of men, because when you give it tothem, even though money's

neutral in the long run, ifyou give it to him and his friends, it goes to the rightplaces really fast. so basically, you think of moneyin a keynesian way from hume, which is short-termstimulus is long-run neutral, but really becauseyou give it to my friends rather than losers. now, what he comes upwith is the problem with government debt. liberalism loves debt, because,if you think about

it, it's a free optionfor the state. so you're the state, i'm themerchant, i've got lots of inequality in my society-- i'm worried about peoplecoming and burning my house down. so i say to you, youneed to protect me. and you say, youneed to pay me. and i say, i don't wantto pay taxes. you say, ah, i have this thingcalled a debt instrument.

it's fabulous. you go, how does that work? well, it works like this. you give me a better paper,and i'll give you a million pounds. brilliant. ok, what happens now? in 10 years time, i'll give youthe million back, and i'll pay you interest.

what are you going to say? so i'll lend you the money youneed to protect me, and then you'll give me it back andyou'll give me interest. fabulous. it's a free option. unlimited upside,zero downside. problem. original argument against it. crowding out.

in order for this to work,you're going to offer a rate of interest higher than themarket would produce. so everybody goes into government debt. because of this, as hume says,all the gold and silver necessary for commerce getscrowded out of the economy, finds its way into debtsecurities, the whole nation ends up in hock, eventually youhave to sell yourself to foreigners, and youend up with a bankruptcy of the nation.

so easy money andcrowding out. the downside of debt means thatit's an attractive way of paying for the state you needbut you don't want, but at the same time, a terrifying one. because at the end of the day,it's going to result in the ruin of the nation. adam smith picksup on this one. for him, it's all about why weactually save and invest, why x equals i in economicsto this day.

savings equals investment. why is this? well, for him, it's becausewe're all parsimonious scots, we're all hardwired to save. there's a wonderful line wherehe says, "where there is tolerable security, a man wouldbe perfectly crazy if he did not employ as investmentall his available capital." so basically, you take themoney, you invest, it automatically produceseconomic growth.

well, he also recognizes thiswhole thing about inequality in the state. my favorite line fromadam smith. "civil government, insofaras it is instituted, is instituted for the defense ofthe rich against the poor, or for those who have propertyagainst those who have none." that is not karl marx. that is adam smith, end of booktwo of "the wealth of nations," quote, unquote.

now, he recognizes then thatyou're going to have to pay for this, so he goesto taxation. but the forward of "the wealthof nations" starts off with progressive taxes. it's totally nuts. so here, look, see the peoplewho have got the most stuff? they have the mostskin in the game. they should pay themost taxes. and then he goes, wait aminute-- that would mean the

rich would pay the most taxes. well, we can't have that. so then he backs off immediatelyand turns around and argues for exactlywhat the republicans are arguing to do-- a national consumption tax oneverything except luxuries. so your yacht is fine,but your corn flakes are going to be taxed. problem with this.

well, it never raisesenough revenue. and he recognizes that. so he's like, shit, whatam i going to do? and he goes, i supposethere has to be debt. but the problem with debt isexactly as hume's pointed out. everybody's going to investin the debt markets, the underlying economy isgoing to crumble. because of that you'll end upwith more debt on a smaller economy, and eventually thewhole nation gets bankrupted.

so what do you end up with? debt perverting parsimony,therefore savings doesn't lead to investment doesn'tlead to growth. all very convincing, and it'sall exactly the same story as we hear now. now, when you hear the samearguments repeated for 300 years without modificationregardless of any facts in fact in them, you shouldgenerally be suspicious. the result is you can't livewith it, can't live without

it, don't want to pay for it. so i like to call thisliberalism's neuralgia and the aspirin of austerity. you reach for it regardless ofif it does you any good. but it's a 300-year-old trip. now, how do we know that theseguys are wrong about this? well, basically, at the timethey were writing, hume predicted the collapse of thebritish economy by, i think it was, 1780.

and in fact, what happened wasthey went from the relatively low debt levels that they had,but they were accumulating, all the way to the highest debtthat they ever had, which was 240% of gdp at the endof the napoleonic wars. so never mind 80%,100%, whatever. back in the day, theyhad 240% debt to gdp at the end of 1815. what happened to the britisheconomy after 1815 until 1914? it ran the hold goddamn worldand expanded faster than

anyone ever thoughthumanly possible. reinhart and rogoff95%, my ass. now, this creates two liberalstories that go through the 19th century. story one, david ricardo. you can't live with it, and youdon't want to pay for it, and you pretend youdon't need it. second one. this is john stuart mill,handsome fellow.

i know. accepting the need for it,and also accepting the need to pay for it. because if you don't pay forit, then you get into a problem, because if youbasically leave the state out of the equation, you cannot relyon markets to do anything except the inequalities thatwill undermine markets in the long-run themselves. so you get these two verydifferent versions of

liberalism come out of this. this one goes to theaustrian economist. this one goes tothe keynesians. that's basically the way itsplits down the middle. now, along came thegreat depression. i love this picture. it's absolutely emblematic. it's one of my favorite slidesof the great depression-- the bread line at the same timeas the, no way like the

american way. so reality, theory,facts, whatever. now, here's the first one. i like to call this the emeticresponse, american liquidationism. this is joseph schumpeter. and by the way, he actuallylooked like that. this is not an exaggeration. he really did.

and he, in the 1920s, had comeover from austria and basically taken up residencerunning harvard's economics department. and the basic story was there'sthe long run capital structure of the economy, youcan't really see it, you don't know what's going on, youshould never intervene. what happens is that banks,there are booms and bust business cycles. banks have a problem,particularly when the bank is

backed by the government. they produce too much credit,entrepreneurs get confused about price signals, theyinvest in things they shouldn't, you end up producingthings you're never going to need, the credit pumpdries up, and eventually you have this purging thatneeds to happen. so you binge on creditand then you purge. this is version oneof austerity. because of this misallocation ofcapital because of credit,

you end up with too much in thewrong type of investment in the capital structure. so you basically have the boom,and then you have to have the slump, and you have togo barf and you have to get it all out and let the clockreset, and off you go. now, the british had a versionof this, which, you know, of course, the british are a bitmore polite than this, so they wouldn't be emetic. so they have the treasuryview, which is a

more austere response. and it's very similar, butagain, it's these arguments from the 1700s brought back. so the basic idea is that freetrade is welfare-enhancing. well, the brits would say that,because they were 50% of the global economy at that pointin time, and most of their free trade wasdone with empire. but putting that to one side,i'm sure the indians thought it was free trade whenthey showed up,

and so did the chinese. but anyway, 1910 to 1920s, thisis churchill when he was chancellor of the exchequer,the finance minister. he comes out with thismemorandum written by a guy called henderson that basicallyresponds to a guy called lloyd george's thingabout, can we do something about unemployment? the problem had been this-- britain's the largest economyin the world, world war i

spanked 60% of itsnational wealth. they're on the gold standard. basically, exchange rate clevermechanism for the global economy. they have a choice. if they go back on the goldstandard with a high exchange rate, it protects all thepeople who hold sterling paper, because you're notdevaluing their assets. if you go back on a low one,it benefits the domestic

economy because you'll get anexport boost and your domestic economy will go up. but all the people holdingsterling paper will freak out because you've devaluedtheir assets. so they'll dump them. so you've got a run on thepound and a run on the exchanges, so you'rescrewed either way. so what did they do? they went back on a highexchange rate.

the result? an instant extra millionunemployed that lasted for a decade. so that was one of the lynchpins in the global economy that caused the greatdepression. so lots of people aresaying, can't we do anything about this? can't we do somethingabout unemployment? and along came the memorandumthat says, no-- and there's an

argument called ricardianequivalence-- and spending now is going to bezero sum against taxes in the future. so if you know that, the minuteyou do it, it nullifies its own effects, sodon't even try it. second thing, and this isparticularly true on investment, if governmentpresumes to do the job of the private sector, the privatesector will let it do it, but then it will do it at a cost.

because it's still notinvesting, so it's zero sum against itself. and the last one you mayremember from the obama stimulus was the lack ofshovel-ready projects. remember that language? it's written in there-- it wascalled the lack of suitable public works. now, here's the second storythat comes out of the john stuart mill tradition.

basically, it's notabout keynes right in the general theory. there's a wonderful line by an economist called june robinson. she says that, "in 1936, keyneswas writing down what might cause unemployment whileherr hitler was curing it." there's a certain elementof teaching birds how to fly here. and the two critical caseshere were the germans--

as it says here. there's a story that basicallyit was all sort of like catholics in the south thatvoted for germany. no it's not. they were industrial workers. they were miners. and then here's a guy calledtakahashi korekiyo, who is the guy who was the guru for thejapanese central bank's abenomics policy at themoment of massive

monetary and fiscal stimulus. so this is a guy from '34. so what actually happens hereis very similar to what's going on in the euro-zone. you have simultaneouscontractions of the five largest economiesin the world. everybody cuts at once. gdp shrinks, constant stockof debt goes up. the british debt to gdp ratioin 1930 was 170%.

by 1933, despite repeated roundsof cuts, it was 190%. it continued to go up. in germany, what happened was,after short-term capital united states, post the '23inflation, had made germany the most stable and fastestgrowing economy in europe at that point in time. there was a swap in theagreement governing war debts. the main war debtsgot seniority. the american capital pulled outto take advantage of the

stock market boom in 1928,'29 and a federal interest rate increase. if you get 7% per sticking itin a bank, so why would you put it in germany? a lot of capital goesflying out. to balance the budget, a guycalled bruning comes in as the chancellor, and he startshacking away at the budget. so he issues somewhere in theregion of about 200 emergency austerity decrees.

at that point in time, there'sa minor party that everyone had written off. they got 8% of the vote in1928, or thereabouts. by 1930, it was upto i think 18%. by 1933, it had 43.3%of the vote. it was the only party arguingagainst austerity. i don't think i need to tellyou what they were called. japan was even worse. the brunt of civilianexpenditures, the brunt of

public expenditure cutsin japan were borne by the military. they were the biggestitem in the budget. by 1930, the japanese militarystarted to assassinate their financial elite. it took out two financeministers, two prime ministers, several cabinet-levelappointees, and half a dozen senior bankers. you can rack up quite a bodycount doing this if you piss

off the military enough. so the lesson learned on thiswas simultaneous contractions, when everybody else is doingit, is zero sum against everybody else, and leads toreally nasty politics. so keynes and eventsoverturn austerity. what does it show us? it shows there are fallaciesof composition and non-scalability in laborand money markets. what's true about 2 people or10 people is simply not true

about 20 million or fiveinterlinked economies. there are systemicnon-linearities and difference that simple cannotbe done by type. investment expectations arenot about parsimony. they're about fear. and if everybody's fearful forthe future and has myopic, short run expectations, and welook to each other for signals about whether we should beinvesting next month or not, you discount the time seriesof the 36 good periods and

heavily weight the threein the front. that's why it's hard to getout of a recession. the emetic response, you bingeand then you purge, assumes you're at the bottom. people start saving again. you've got [inaudible]consumption, austerity, you start saving. and the assumption is thatsaving is automatically investment.

but there's a drop there,because you have to invest in a recession. why would you want to be theguy who takes the chance to invest in a recession? surely you'd rather be liquid,so everybody tries to sit on a liquidity all at once. but you can't-- in order foryou to be liquid, somebody else has to be illiquid. so you end up witha liquidity trap.

and that's when you getstuck for 14 years. that's why the great depressionlasted so long. so because of this, rather thancurtail consumption, the austerity response, consumption,to repeat the obvious, is the sole endof economic activity. "general theory," page 71,if i remember correctly. lessons learned. it all goes back toredistribution. democracy is asset insurancefor the rich.

don't skimp on the payments. that's what was going inthe '20s, and that's what's going on today. redistribution of debt isreinsurance for democracy, and austerity is anorexiafor the economy. that was what waslearned by 1940. oh, how we forget. and why do we forget? we forget because of germany,because germany is a very

peculiar economy. it is not a liberal economy. it is much closer to japan thanit is to anything else in europe or the united states. it is, in fact, the originaldevelopmental state. what do i mean by that? in 1873, there was a hugestock market bubble in germany, and it blew up. it was called thefounders crisis.

and liberal economic ideas ofthe type we've been discussing were completely discredited. at this point in time, therewas a guy called liszt who comes along and says, you know,the funny thing about the brits telling us all thestory about how to get rich, if they had actually done thatthemselves-- you know what their comparative advantagewas in? wool. they would still be makingblankets for

the people in flanders. how come they're runningthe world? how come they have the biggestnavy in the world? how come they make steelwhen they basically have no iron ore? what the hell isthat all about? so he rewrote how you thinkabout international trade. and at the same time that hedid this, he, and also the bismarck who was running theplace did what was called the

marriage or iron and rye,bringing together the industrialists in the south,the agrarians in the north. you use the surplus fromagriculture to basically buy flattened equipment. you bring it in, you reverseengineer it, you do it faster, you do it faster, you build upgerman industrial capitalism. big firms, big banks,forced saving, a big role for the state. and it's all drivenby exports.

there's your difference. but when you're exporting andyour sources of demand lie outside your economy, you don'thave to worry about internal demand. the keynesian story makes nosense if you're germany. why would you want to stabilizeconsumption if you're export dependent? because all you're going todo is raise your wages and prices, and your bmw is goingto go from 50,000 to 100,000

real fast, and you're notgoing to sell them. so if you don't rely on domesticconsumption and rely on external consumption, thedynamics of your economy are completely different. what do you care aboutprice control? all this stuff about theneuralgia of the 1920s and the inflation experience, this isa post-war construction. it's really aboutremaining price competitive in export markets.

so you need a strong,independent central bank. what else do you care about? very important-- competition. you want to have competitionover products, so that you have bmw and audi competing witheach other so they can sell more to the chinese bothbecause they're competing against product quality. you don't get involved in theapple, samsung, buy up patents

and sue each otherin court crap. you do real competitionto get real value out at the end of it. given that the role of thestate, these freiburg liberals-- this is walter euken,one of the guys who, post-war, reinvigoratesall this stuff. because after nazism isdiscredited, they needed a new thing. and basically it was about theeconomic constitution, where

competition rather thanconsumption becomes important, and sound money andcentral bank independence defines the economy. why is this important? first of all, for 30 years, thisis the entire structure of the euro. if you think about the way theeuropean union is set up, it's generalized ordoliberalism,to give that type of liberalism its name.

the commission is the importantpart, not the parliament. the parliament is a talkingshop that very little representative rightsor power. sound money is far moreimportant than output. it's all about the europeancentral bank and its policy. it has one target-- fighting inflation, even ifthere's a deflation going on. well, what does that reflect?

the need for costcompetitiveness. what is it that thecommission does? the commission basicallysets rules. what are those rules about? competitiveness. what's the largest componentof the administrative architecture of brussels? the competition commission. rules rather than discretionat all times.

you can't trust politicians torun the economy-- they'll run inflationary cycles, thatwill be bad for growth. yes, if seen through agerman perspective. but here's what it misses, agiant fallacy of composition. for you to sell your bmw,somebody else needs to be buying them. for somebody to basically behaving an export surplus, somebody needs to havean important deficit. in the aggregate, in theory,it balances out.

but if you go way back to thatpicture i showed of the current account imbalances,there's only one company running a surplus. and the sum of that surplus isthe sum of that deficit-- they're almost exactlyequivalent. so what you have here is asituation whereby when you generalize the economicprinciples and institutions of one country across the whole ofthe eu, which was fine, so long as the banks were spendingmoney all over the

place so nobody noticed,it's fine. but once that credit bubblepops, suddenly you all have to be germany. tell me, how is greeceand portugal going to make an audi? and even of they did, who arethey going to sell it to? who's going to buy it? imagine the competitioncommission gets its way and everybody becomes morecompetitive, and

they all make exports. who's going to buyall this crap? the over-tapped americanconsumer? we're already spendingtoo much already. so you end up with an economyand an economic structure, an economic model for an entirecontinent which literally cannot work. it makes no sense on a globallevel, and yet that's the one that it's pursuing.

competitiveness ratherthan complementarity. and also, you then have idioticthings like debt breaks, schuldenbremse. this says that nobody canever have more than a 5% debt on deficit. really? because that means everybody hasto run a budget surplus. how is that going to happen? that's actually notarithmetically possible, but

it doesn't stop them writingrules about it, even if it's arithmetic nonsense. this then leads to italy. i'm getting there. this guy was the first primeminister of italy and head of the italian centralbank post-war. he set up the bocconi schoolof public finance in milan. the bocconi school was famousfor two things. number one, publicchoice theory.

essentially, states arerent seekers and they can't be trusted. hey, if i grew up in italy, iwould probably think that about the state, aswell, but they generalized it to everybody. they're also very fond of thenotion of a european union as a disciplinary device overridinglocal democracy and reigning in state spending. the bocconi school are importantbecause when

cambridge-- qua cambridge, uk-- blew up inthe '70s intellectually and cambridge and america had theirlunch in what was called the cambridge capitalcontroversies, the only economics department in europethat was mathematically sophisticated enough to playwith the americans was the bocconi school. and they were hard-wired forseeing the state as a bad thing at exactly the time thatliberal economics went in the

same direction, whenit went neoliberal. consequence of this-- these guys become an aircraftcarrier for austerity thinking that goes from milan to harvard,which leads us to today, the financial crisis. this is greenspan's mea culpa. i think there's a flaw in myideology, and it's this big. and we get to this guy, who'salberto alesina, who, just like joseph schumpeter, isarguing for emetic economics.

and he, too, is the headof the economics department of harvard. he's the guy who came up withwhat's called the expansionary austerity hypothesis. it's about debt and time andconsistency, which is actually that ricardian equivalencestuff all again. and it basically says thefollowing-- this is the confidence theory thing. this is why you cut spending.

so imagine the economy isfalling around your ears, you don't know if you're going tohave a job tomorrow, your partner is already unemployed,you really don't know about the future, but you reallyworry about the debt. you just lie awake all nightworrying about the debt, as people do. so the government crediblysignals that it is going to massively cut governmentexpenditure. and what you do, using yourrational expectations that are

built into your head-- well, youknow the true structural form of the equation governingthe economy and the value of the coefficients therein. big assumption, but putthat to one side. you calculate your lifetimebudget and your lifetime expenditure in relation to thefact that 20 years from now, because of these state spendingcuts now, you'll pay less taxes then. thereby, you can retro-dict howmuch extra money you've

got now, and everybody goesto ikea and buys a couch. and that cures the recession. i am not making this shit up. take away all the math, that'swhat all these papers say. and what we actually see atthe end of it, you got all these countries casesthat supposedly show this in the '80s-- ireland, sweden, denmark, etcetera-- and in the book i go through them and show that theydo nothing of the kind.

what actually happens is,take canada as the greatest example of this-- the loonie takes a 40%devaluation from '76 to '86. you're export dependent. you're a commodity exporter. your major trading partner whotakes 75% of your exports is the united states. the united states' economyis nine times the size of your economy.

you have a 40% devaluation asthe american economy takes off like a rocket between'86 and '92. what do you think isgoing to happen to canada's budget surplus? it gets massive. they cut and then itled to growth? no. they grew and then they cut. because that's whatyour meant to do.

austerity date is best done inthe boom, not the slump. that's what all thesestates actually do. cutting in a slump producesa bigger slump. it's really that simple. so this is taken up by theeuropean central bank and was called the ecofin briefand the g20 finance ministers in 2009. it's published inall its glory in the tcb's 2010 report.

all the arguments from davidricardo, et cetera, and john stuart and hume and smith, i'mnot kidding, are in that book. i mean, literally, you couldquote them line for line. it's exactly the structure ofhow they did all the bailouts, and how they did all the stuffin terms of bailing out greece, et cetera. and there result of this is whati call the greatest bait and switch in history. because what's actually happenedis all that private

debt that was generated by thebanking system through over-lending is now on thepublic balance sheet. and to go full circle, all theway back, that means that people like me, who have grownup on the welfare state just now, have to pay for themistakes of systemically irresponsible bankers. because you can't tax themthemselves because they're too politically powerful. that's why this is fundamentallya problem of

politics, and not a problemof economics. is there a way out of this? people have started to defect. the imf has started to go. the imf has calculated now that,what happens when you cut $1 of public spendingin the periphery? you lose $1.5 to $1.7 inspending, which is why you get this wonderful negativeconvexity, where it goes, ah, which is what's happeningto periphery economies.

you end up with moredebt, not less. the rebel alliance-- romania, estonia, bulgaria,latvia, lithuania-- they tried to blowup the debt star. they failed. it's been a disaster. excelgate, that's reinhartand rogoff's 90%. there really was nothingthere to start with. and we have 25% permanentunemployment in europe.

that is not politicallysustainable. so where does it all end? first one, financialrepression. you take those banks that areheavily levered and filled with government bonds and youfill them with even more government bonds. then what you do is lower thepayment on it that you get from it, and you lendto maturity. and then what you do is yourun a positive inflation.

hence, why central banksare now moving to inflation targets. what does that do? it creates a negativereal interest rate. that cures your debt far betterthan any amount of cutting, which actually doesn'twork because it's zero sum against itself. when did we last do this? end of world war ii.

the liquidation tax accountedfor the equivalent of 40% of american gdp being paid back in10 years, and the american economy boomed atthe same time. so there's something very,very important. that's where thisone's heading. who is this bad for? this is totally badfor creditors and really good for debtors. i just took on the largestmortgage in human history

because i fully expectthis to happen. i'm bar-belled. if the economy recovers, myasset goes up in value. if there's an inflationarycycle, it eats away half my mortgage. screw them-- i've been paying fortheir bailouts. higher taxes. carried interest exemption.

mitt romney pays 15% tax. i pay 30%. you pay 30%. do you think that's fair? i don't think that's fair. i think that's comingto an end. and we're going to shut downevery goddamn tax haven on the planet, as well. because you know how muchis hidden there?

$27 trillion in untaxedwealth-- estimate-- is sitting in five tax havens. how many divisions does thecayman islands have? none. let's go get it. it's so much easier thanslashing the fire brigade. and the last one, if you thinkabout this as payback for the bailouts who started it all,is hippocratic economics.

first do no harm. the united states wasmeant to die. we had spent too much. we were the profligate. we were all going to die. remember all those articlesabout, oh, it's coming, the great end, the great crash,the whole lot? we've de-levered, we've cleanedup the balance sheets of the financial sector, we'relending again, we've got

positive growth. in three years' time-- weactually have stabilized the debt already. in three years, we'll beeffectively reducing it. the brits are in for adecade of recession. ireland has a lost generationbecause they bailed their banks and they did austerity. periphery europe is stuck with25% permanent unemployment. this doesn't work.

it is a human disaster. but most of all,it's politics. because it's alwaysabout one thing. somebody got all the benefits,then they cost all the costs, now they want somebody to payfor the costs while they keep all the benefits. that's what this isreally all about. thank you. [applause]

mark blyth: went on a bitlonger than anticipated, despite talking fasterthan jfk on speed. sorry about that. audience: much as i'd like totake out a huge mortgage and buy stuff, there's somethingof a bubble going on around here. any other suggestions for howto take advantage of this? mark blyth: well, asi switch onto my financial adviser mode.

how do you make money ina positive inflationary environment? it's not easy, but it'snot impossible. if you have a look at companiesthat did really, really well in the 1980s, late'70s, early '80s, they tended to be sort of conglomeratetrusts. so they owned a littlebit of everything. that's like the abu dhabiinvestment corporation, whose unofficial slogan is, we ownhalf a percent of everything

that isn't nailed downon the entire planet. and the idea behind it is thatyou don't know where the upside is coming from. so what you should be ismaximally diversify. it's like an index fund. so basically, anything atall that is internally diversified, so buying cutshares in companies that have that type of structure isprobably the best way of bar-belling yourselfagainst them.

but ultimately, you know,investing in debt markets is probably a bad idea rightat this point. but it's still sort of-- at theend of the day, about this paranoia that inflationslead to hyperinflations, it's total crap. when i went through the book anddid the research on this, i wanted to-- i'm married to-- background information--

i'm married into abunch of germans. well, i'm only married to one,but the whole family comes with them, right? and my [german], as i like tocall him, my father-in-law, [german], he's aclassic german. he's like 71 years old, he'sretired, and he still saves. what the? you'll die-- what are you doing?

he's totally hardwired forsaving, and he's totally paranoid about inflation. so i went and read a lot aboutthe german hyperinflation. and it was deliberate governmentpolicy to stuff the french over reparations. i mean, they did it quitedeliberately. and the weird about it was afterthey did it, it ended in eight months. and the entire economy wasstabilized within 12.

and then it grewfor five years. and then what actually happenedwas austerity, through the economy of a cliff,and that's when the nazis came to power. so we have this story about theleast degree of inflation leads to some kind of infinitycurve hyper-convexity where, boom, off it goes. and it's simply not true. post-war europe ran positiverates of inflation with

positive real rates of growthall the way through the postwar period untilabout 1980. so the inflationpanic is there. audience: so i've heard krugmanand others bring up japan as an example to supportthese kind of arguments. can you just talk a bit abouthow they're able to run a high debt for so long and thingsdon't seem to-- mark blyth: sure, sure. absolutely.

i actually think these guysare wrong about japan. i think what goes on in japan isactually deeply structural. there is a wonderful book byguy called sven steinmo, called "the evolution of themodern state." and he has a chapter on japan. and if you ever wanted to read,i think, the definitive story on japan, this is it. he spent two years there on anabe fellowship and had access to all the people.

well, it was two books. it was richard koo's "holy grailof macroeconomics." so basically what happens is japangoes through a balance sheet recession. what's a balance sheetrecession? basically, your companies arede-levering but don't want to tell anyone becauseif they do, there will be a run on them. and everybody's complicittogether because they've all

over borrowed. so basically, you have thiskind of slow bleeding that goes on as it's sort ofmonetized by the central bank, and it ends up in debt. so you're not growing. and that's sort of the obviouspart of the story. the less obvious part of thestory goes like this. go back to 1986. there's a thing calledthe plaza accord.

the plaza accord was when theunited states turns around to its two major trading partners,japan and then west germany, and said, our exchangerate is too high. people are buying dollars, we'redoing well just now. and it's killing our exports. you guys are wiping us out. remember the whole paranoiaabout japan that went on? they were going to take overthe world, all that. you ever see the film, "risingsun," michael crichton?

possibly the most racist filmever made in human history, but put that to one side. so japan's going to takeeverything over, blah, blah, blah, the rest of it. and then, of course, whatactually happens is they do the exchange rate thing, theunited states exchange rate goes down, the german one andthe japanese one goes up. now, the japanese economy isentirely export dependent. it's sort of like germanyon steroids.

so what they do is they move theplant and equipment from the japanese home islands outto the second tier tigers. so you start to get investmentin vietnam, malaysia, all these places, and they movethe entire thing with the supplier networks,the whole lot. well, the way that the japanesewelfare state was constructed, it was allin-house to the firm. it was meant to be cradleto grave, but the firm took care of you.

well, the firm has just brokenthe social contract. so how did people protectthemselves? they wanted another asset theycould have that would have a positive upside, that wouldretain its value, and they could sell it in theirretirement. what did they buy en masse? real estate. so you get a giant realestate bubble. the real estate bubble gets soout of control that it popped

and the banking systemcan't support it. that collapses and thatstarts the recession. but the important part isthe sociological story. you've got a cultural andgenerational shift. because you've got a very oldpopulation who are now 45 years old, facing unemployment,with a very, very narrow safety netfor the first time. so what do they do when thegovernment gives them money to spend to stimulatethe economy?

they stick it underthe mattress. it doesn't go anywhere. it gets hoarded. so the savings rate goes up. and where do theyput the savings? in the post office accountand in the bank account. and what do the bank and thepost office do with it? they buy government bonds. so that's why you endup with this massive

extension in debt. now, the thing is, the japanesepropensity to consume is really, really low,particularly the higher up the demographic you get. so 80-year-olds are not justbuying bonds and then liquidating them in retirement,they're actually keeping them whole and handingthem onto the next generation. so you've got aninter-generational debt transfer going on.

so the story that basically it'sjust a monetary policy story in, you know, japan,i think that's wrong. i think there's actually adeeply structural problem that's going on there, and itgoes all the way back to the plaza accord. so that's my short version ofsven steinmo's argument, but i find it quite convincing. audience: how can an individualstate in the eu, like ireland or something, tryto fix things for itself with

all the constraints under it? mark blyth: they can't. look, and it's good. because you're in the euro. so once you're in theeuro, it's a kind of a one-time game. because the problem was ifyou're argentina and you tie yourself to the dollar, as theydid back in the day, back in the late 1990s into 2000, andthen you have the default.

and they had a default becauseargentina is the graveyard of all bad economic policiesgone wrong, there's no doubt about that. but also because their majortrading partner is brazil. and basically, the real had a40% exchange rate gain, and basically it screwed up alltheir exports and the whole thing fell down. now, because they were just on apeg, they actually still had their own domestic currency.

so they could go, tohell with the peg. we've still got it. and then you lock up the banksand people bang on the doors and all that sort of stuff. but you still haveyour currency. ireland doesn't havea pound anymore. i mean, literally, the bitsof paper don't exist. so if you were going toget out of the euro-- just think about the complexity

of this for a second-- you would have to kindof freeze time. everybody freezes, some kindof government agency with a time machine would freeze time,you'd go around, you'd vacuum up all the bills out ofeverybody's wallets, the whole lot, and you'd stamp them alland reissue them the new currency, and then you'dunfreeze time. and then you would havean economic crisis. so just that alone adds a levelof complexity to it

which makes it just incrediblydifficult. bigger countries like franceand italy can do this. the italian economy, northitaly, is actually globally competitive, totally solvent,the whole lot. the south is a basket case. it's a bit like the north andsouth of the united states. shh. anyway. but you get transfers acrossthe region, that's

what keeps it going. the problem is greece hasnothing to export. it really doesn't. it has olive oil. but so does italy, and theycan make more of it. spain makes even more of that. do you know when you buyyour evoo and it says, italian olive oil? it's actually spanish olivesthey've bought and they

brought to italy and then theygrind them and call it italian olive oil. so that's all zero sumagainst itself. so if you don't have somethingto export, then the devaluation thing that you'llget won't benefit you because you don't have anything. and all you'll do is end up withhyperinflation because your imports become soincredibly expensive. so ireland, greece, portugal,they are stuck because they've

got nothing to sell. that's it. so they're kind of trappedin this worst of all possible worlds. ireland is really screwedfor a whole generation. the debt to gdp figuresyou see in ireland are a big, fat lie. because they basically bookservices exports from this company as exports.

so basically, the profitsfrom this farm go to an office in dublin. has anybody ever been tothe office in dublin? no? there's about 25 peoplewho work there. and your entire corporateprofits get declared through them, because you onlypay 12.5% tax. so that 12.5% gets booked as anirish services export and appears in their balanceof payments.

well, it's complete paper. it's nothing. it's complete garbage. and they also have all the badassets from their banks that blew up and this thing callednama, which is a super bad bank, and that's nevercoming back. and that's off balance sheet. so when you add it all together,ireland is actually worse than greece.

just don't tell the irish. audience: speaking of people,what do you think about iceland, how they dealtwith their financial? mark blyth: iceland is abrilliant example of no good deed goes unpunished. so when i started all this off,i was a member of this thing called the warwickcommission on financial form. and you know, the crisishappens, and people are like, it's the shadow banks.

and i'm like, what'sa shadow bank? i mean, you need todo a little bit of catch-up on this. so at first, i boughtthe whole narrative of too big to fail. systemic interconnections, therest, the whole lot, blah, blah, blah, blah. and by the time i finished thebook, i said, no, i actually totally don't buy this--

i think we should havelet them fail. oh, but what about systemicrisk, all the rest of it? well, i know what lost gdp is,i know how much unemployments cost, i know all that. i know the real costsof not bailing them. and more to the point, thebanking system, even though it's de-levered, is actuallymore concentrated now than it was in 2007. so citibank is even toobigger to fail.

and the european systemis that on steroids. so you've basically givensomeone not just a banking license with a subsidy,an extortion racket on the taxpayer. and that's just, it isliterally criminal. best example of this-- ubs. fined $1.2 billion a fewmonths back for doing terrorism financing and moneylaundering with drug dealers.

now, if you or i did this,we would be in the jail. they get a fine. why do they get a fine? because if you are an investorin an american or american-licensed broker/dealerentity-- a big bank-- and one of your corporateofficers is charged with a criminal liability, you areunder legal obligation to withdraw your investments.

so if ubs is actually criminallycharged, or their senior officers are charged. and then calpers has topull the money out. if calpers pulls the money outalong with everybody else, what happens to that bank? so what happens to the system? so you're basically playingsystemic moral hazard as a business model. this is screwed upbeyond belief.

so iceland, to finishthis one, basically let their banks fail. now, a lot of the debt, mostof the debt was externally held, so the cost of thatwent on to others. but here's the interestingpart of the story. all of the super geniuses whowere working in the banks engineering derivatives nowhad to get a real job. so what happened was thedomestic economy, the real economy, rebounded, because allthese start-ups happened.

because all these really brightpeople went, shit, i need something else to do. so they started doing all thesenew businesses which didn't appear before. they became a huge hub foronline gaming, because you can stick the serversin the ground-- and it's bloody cold-- and you've got all the peoplewith the math skills who can do the software engineering andmake the whole thing work.

so there were all of thesepositive externalities of actually letting them fail. their unemployment level isnow about one point higher than germany . compare it with iceland, whichis 14% on the official rate, and that's with migrationgoing out. so the people who did this, thegovernment that came in and basically allowed this tohappen, it's been a bit tough. they actually do things likepay back the debt and are

fiscally responsible. so they've just been voted out,and the people who blew up the banks in the first placeare now back in power. no good deed goes unpunished. audience: i don't know if you'refamiliar with what happened in australia. i'm from australia. but people have largely missedthe financial crisis. and there are twostories running.

and i don't know if you knowwhich one is the-- anyway, they're competing. one is saying that, well, thegovernment did spending and gave people money. and they spent it. and that saved the economy. and the other story runningis that, no, it's the mining boom. we just dig everythingup, sell it to

china, china went well. and it has nothing to do withwhat the government did. have you got a view on that? mark blyth: the second oneis completely right. and the way you can see this isyou can't trade the chinese currency easily, because ofcapital controls, et cetera. but what you can do is basicallylook at the shadow markets on the chinesecurrency versus the australian dollar.

and they move like this. and it is because, basically,australia literally is owned by china. i mean, people say this aboutthe united states. oh, china owns the usa. and it's like, well look, only17% of bills are actually owned by china. and it's brilliant. because for the past 30 years,we've been giving them bits of

paper that bear 2% net. and they've been givingus televisions. it's a sweet deal. i don't know why anybody wouldever want to end it. it's brilliant for us. the australian one is theother way around. they actually do own yourassets completely. because if it wasn't for thewestern australian mining boom, and just all thecommodities they're sucking

out at the peak of a commoditycycle, i mean, do you really think a house in perthwould cost 2 million australian dollars? and it does. it's totally that. it's totally the mining boom. so what that means is either thecommodity cycle peaks or china slows down, australiais in serious trouble. now, the price to incomemultiples in

sydney are 13 to 1. so you need to marry two peopleand have family money in order to get a house. so it's not 3 times your income,it's 13 times your income for a three bedroom flatin a nice part of sydney. that's a colossal housingbubble, and it's chinese liquidity that's pumping it. if that every goes away, boom. audience: the housing bubblehas never crashed in

australia, unlikeeverywhere else. mark blyth: yeah, absolutely. and you know what? all bubbles pop. it is just a question of time. audience: i was hoping you couldtalk a little bit about the bric countries, andespecially what brazil needs to be doing. mark blyth: brazil needs to dowhat brazil's been doing,

which is awesome. so quite primer on the brazilianpolitical economy. for years and years and yearsthey had one of the highest gini coefficientsin the world. they were incredibly unequal. and they had a problem becausewealth being so concentrated meant that the people who makeeffective investment decisions decided that their own economywas too risky, because it would either be run by themilitary or run by the

communists or run out of town. so they would take their moneyand they would put it in citibank, which isnice and secure. and you got a lesser rate ofreturn, but you don't mind because you own everything,anyway. so that's the way it went on foryears and years, until it got to a point where basicallyyou had to spend so much money on private kidnap insurance andmining your house against the people who would try andkill you, that they did a deal

with a guy called lula. lula u to run theworker's party. so the guy who ran the worker'sparty, the lefty guy, comes in and basically doesexactly as i said on the bottom of that slide. democracy is asset insurance forthe rich-- stop skimping on the payments. so did this strategy wherebythey got bndes, the brazilian national development bank,to bank-- their lending

portfolio, by the way,is twice the size of the world bank-- to subsidize domesticcorporations so that they could multinational. so you've got companies likeembraer, the aircraft company, the big cement company, andthe others, that are now globally successfulcorporations. because of that expansion,bankrolled by the development bank, what they do is they taxthe companies on their

earnings abroad, bring thatback in, and they set up something called bolsa familia,which is the welfare state that brazil never had. this has squeezed the incomedistribution like this at the same time as it has gone up,which enables the brazilians to finally builda middle class. it empowers the middle class. and it dis-empowers thedurational land-owning elites. so what you end up with--

there's a little fixey-do withdomestically high interest rates to keep theseguys happy. well, what you've actuallydone is to engineer is to engineer a kind of newdevelopmental welfare state, which has actually been greatfor brazilian growth and has actually brought down thegini coefficient. because of this, everybody wantsto buy brazilian assets, which is why the realis going up. and they're export-dependent,so they're freaking out.

so what they've done is they'veput inward capital controls on inward investment. and usually, the big fear isyou put your money in, they put up capital controls, youcan't get it out, it's expropriation. they're doing it totallydifferent. they're like, you wantto come here? dead easy. pay a transactions taxand a deposit.

because if you're not coming infor the long term, forget about sitting here earninghigh interest rates just because you can. so they're making it difficultfor that money to come in. but as a growth node in a bigcountry, it is happening nonetheless. so the real is going up, theeconomy is slowing down. but what they've done over thepast 10 years, i think, is nothing short of remarkable.

boris debic: thank you, mark.