Dispelling OPEC oil prices as the cause of the 70's economic recession

1
The Old, The New and the Ugly
119th
Annual Henry George Dinner
By Steven Spadijer
Georgist Insights Into Business Cycle:
Some Empirical Evidence

Structure of The Presentation
• Section I: THE THEORY
A. Georgist Perspective
B. Supplementary Perspectives
- The Post-Keynesians and Institutionalists (Minsky, Veblen)
- The Austrians (Schumpeter, Hayek)
• Section II: THE DATA
• What caused the 1970s Recession?
- Not the 1970s Oil Shocks
B. What caused the GFC?
- The ‘GeoAustrian Synthesis’
C. Why Are There no ‘Great Depressions’ anymore?
• Some Concluding Remarks and Predictions

THE THEORY: George observed...
“...the speculative advance in land values...is the main cause of
those periodical industrial depressions [in] every civilized
country... I do not mean to say that there are not other
proximate causes. The growing complexity and
interdependence of the machinery of production, which makes
each shock or stoppage propagate itself through a widening
circle; the essential defect of currencies which contract when
most needed, and the tremendous alternations in volume that
occur in the simpler forms of commercial credit...the
protective tariffs which present artificial barriers to the
interplay of productive forces... But land speculation is the
‘great initiatory cause...a fact..clearly evident in the United
States. In each period of industrial activity land values have
steadily risen, culminating in speculation which carried them up
in great heights”.

Minsky on ‘euphoric expectations’...
“…Stability is destabilising…The natural starting place for
analyzing the relation between debt and income is to take an
economy with a cyclical past that is now doing well… As the
period over which the economy does well lengthens, two things
become evident in board rooms. Existing debts are easily
validated and units that were heavily in debt prospered; it paid
to lever… Such a financial system will be capable of both
generating signals that induce an accelerating desire to invest
and of financing that accelerating investment... It follows
that the fundamental instability of a capitalist economy is
upward. The tendency to transform doing well into a
speculative investment boom is the basic instability in a
capitalist economy; we have self-fullfilling expectations”

But 100 years before this George also said...
“... THERE IS ANOTHER CAUSE, not yet mentioned, that must
be considered before we can fully explain the impact of
progress on the distribution of wealth. It is the confident
expectation that land values will increase in the future. The
steady increase of rent in all growing countries leads to
speculation - holding onto land for a higher price than it would
otherwise bring at that time. ....With rapid advancement, the
swift and steady increase of rent gives confidence togives confidence to
calculations of further increascalculations of further increase. It leads to land being
withheld from use, as higher prices are expectedas higher prices are expected. Thus, the
margin of production is forced out farther than required by
the necessities of production. As landowners confidently
expect rents to increase further, they demand more rent
than the land would provide under current conditions”.

Schumpeter asks of business cycles...
“Why do entrepreneurs appear, not continuously, that is singly in
every appropriately chosen interval, but in clusters?
Exclusively because the appearance of one or a few
entrepreneurs facilitates the appearance of others, and these
the appearance of more, in ever-increasing numbers. For the
new demand … is, directly and indirectly, chiefly a demand for
labor. Therefore employment must first increase and with it
the sum total of wages of labor, then the rate of pay and with
it the income of the individual worker. It is from this rise in
wages that the increased demand for consumption goods
proceeds which results in the rise in the general price level…
At the beginning of the boom costs rise in the old businesses;
later their receipts are reduced, first in those businesses
with which the innovation competes…”

Schumpeter...
but then in all old businesses, in so far as consumers' demand
changes in favor of the innovation… outbreak of a crisis—
panic, breakdown of the credit system, epidemics of
bankruptcies, and its further consequences— …Subjectively,
the turning point appears to producers, especially if they
resist the unavoidable fall in prices, as an outbreak of
hitherto latent overproduction, and the depression as its
consequence. The unsaleableness of commodities already
produced, still more of those producible, at prices which
cover costs calls forth the well known further phenomenon
of the tightness of money, possibly insolvency, which is so
typical that every theory of the business cycle must be in a
position to explain it…

Hang on... These ideas sound similar...
HG observed: “Distinct and independent industrial communities,
[but which are] geographically or politically separated
communities, blend and interlace their industrial organizations
in different modes and varying measures... These seasons of
depression are always preceded by seasons of activity and
speculation, and on all hands the connection between the two
is admitted—the depression being looked upon as the reaction
from the speculation, as the headache of the morning is the
reaction from the debauch of the night.... People want the
things the manufacturer makes as much as ever, just as the
operatives want the things the storekeeper has to sell. But
they do not have as much to give for them. Production has
somewhere been checked, and this reduction in the supply of
some things has shown itself in cessation of demand for
others...”

Hang on... These ideas sound similar...
“the check propagating itself through the whole framework of
industry and exchange. Now, the industrial pyramid manifestly
rests on the land... The primary and fundamental occupations,
which create a demand for all others, are evidently those
which extract wealth from nature, and, hence, if we trace
from one exchange point to another, and from one occupation
to another, this check to production, which shows itself in
decreased purchasing power, we must ultimately find it in
some obstacle which checks labour in expending itself on
land...this explains the observation of overproduction and
overconsumption”

General Propositions that can be distilled...
- Presumption in Favour of endogenous causes of business
cycles: internal, not external causes of economic shocks
- Presumption that asset markets can affect commodity
markets (and thus unemployment) in several ways: (1) high
asset prices stimulate capital-intensive industries which
increase the demand for commodities (e.g. building or
construction equipment, through wealth effects, higher
personal disposable income); (2) in a downturn complimentary
industries collapse; (3) high vacancy rates, unsold goods and
commodities precipitates bankruptcies
- Presumption of inequality amid prosperity: high debt and high
rents belie the labour/working classes

Direct Impacts: Wealth Transfer Effect
Theory: ‘Wealth transfer effect’ and ‘uncertainty effect’
Reality: ‘Petro-dollars’ mostly rrecycledecycled back in the US, UK and
Oz economy via new purchases in cars and real estate; surveys
show indifference toward oil shock
• 8 billion went into purchasing “real estate and other assets in
the UK and US alone” (Economic Report to the President,
1977)
• 25% increase in car exports after oil shock (Olson, 1988)
• After oil shock general consumer surveys found indifference,
although irritation, on the impact of the oil shock; oil shock
and I expenditure do not correlate
• March 1974 survey by the ABS found only 21% of Australians
expected a recession (i.e. after oil shock)
• 500 000 new jobs in the US petroleum sector

SECTION II: SOME EMPIRICAL EVIDENCE
Cross Correlation of Real GNP With
Var. SD% x(t-5) x(t-4) x(t-3) x(t-2) x(t-1) x(t) x(t+1) x(t+2) x(t+3) x(t+4) x(t+5)
Real GNP 1.71 -0.03 0.15 0.38 0.63 0.85 1 0.85 0.63 0.38 0.15 -0.03
Consumption 1.25 0.25 0.41 0.56 0.71 0.81 .82 0.66 0.45 0.21 -0.02 -0.21
Nondurables 1.23 0.29 0.42 0.52 0.62 0.69 0.69 0.57 0.38 0.16 -0.05 -0.22
Services 0.63 0.03 0.25 0.46 0.63 0.73 0.71 0.6 0.49 0.39 0.23 0.07
Durables 4.99 0.25 0.38 0.5 0.64 0.74 0.77 0.6 0.37 0.1 -0.14 -0.32
Investment 8.3 0.04 0.19 0.39 0.6 0.79 0.91 0.75 0.5 0.21 -0.05 -0.26
Fixed Investment 5.38 0.09 0.25 0.44 0.64 0.83 0.9 0.81 0.6 0.35 0.08 -0.14
Nonresidential 5.18 -0.26 -0.13 0.05 0.31 0.57 0.8 0.88 0.83 0.68 0.46 0.23
Structures 4.75 -0.4 -0.31 -0.17 0.03 0.29 0.52 0.65 0.69 0.63 0.5 0.34
Equipment 6.21 -0.18 -0.04 0.14 0.39 0.65 0.85 0.9 0.81 0.62 0.38 0.15
Residential 10.89 0.42 0.56 0.66 0.73 0.73 0.62 0.37 0.1 -0.15 -0.34 -0.45
• All strongly
pro-cyclical
• Leading
• Lagging

Direct Impacts: Hamilton (1988)
Theory: Reduction in demand for oil-intensive consumer
durables (particularly cars) caused output to fall
Reality: Durable consumption actually increased (e.g. Oz, UK) or
were falling well before the oil shock (e.g. US)
Barsky and Killian (2002, 2005, 2009, 2010)

Indirect Impacts: Bernanke (1998)
Theory: Inflation caused by the oil shock forced the central
bank to lift interest rates (IRs), halting growth
Reality: IRs were rising well beforebefore the oil shock hit and central
banks were explicitly targeting asset (and not simply
consumer/commodity price) inflation
Japan: Hit 7.25% in September from 5.25% from March ‘73,
peaking in 1974 at 9% (BOJ cited ‘property bubble’)
UK: Reached 11.5% in Sept. 73 (BOE cited ‘property bubble’),
peaking at 13% in October as the oil shock hit
US: Hit 12% before Oct 1973 and the Fed actually decreaseddecreased
interest rates after oil shock (Burns was more worried about
“commodities and real estate speculation”)
Aus: 4% to 9% from Jan to Sept 73 (Whitlam said of the rise in
IR that he “hoped this would stop the speculative rush into
land and property construction”)

Georgist: Oz, Japan, US and the UK
• Tax exemptions (Idle Land)
• Deregulation
• Population Growth
• Technology and Infrastructure

Georgist Perspective: Role of Expectations
• Progress and Poverty: Land speculation as the “great initiatory
cause” of business cycles/downturns...

Georgist: Kakuei Tanaka’s Plan For Japan
• Commercial Land prices
http://www.imes.boj.or.jp/english/publication/mes/1989/me7-2-5.pdf

Georgist Perspectives

Georgist Perspective

Oz Construction Sector
• NEW BUILDING SUPPLY (SYDNEY CBD)
• Mainline Gearing ($m), Year to 30/6
Years No. Of new buildings Gross Floor area
(sq. m)
1958-64
1965-70
1971-76
66
60
84
511 000
574 000
1 460 000
1969 1970 1971 1972 1973
Total Assets
Ext. Liabilities
Gearing (%)
4.8
4.0
83.3
16.7
13.0
77.8
26.9
17.8
66.1
34.1
25.1
73.6
65.6
50.5
77.0

Cambridge Credit…
• Cambridge Gearing ratios ($m), Year to 30/6
In November-December 1973, Cambridge had their real-
estate assets re-valued and this suggested a surplus of $43
million after deducting intangible assets and providing for tax.
The reality of the estimates depended upon Cambridge being
able to realise and sell its land holdings, and at the value at
which they were assessed in the books. In 1974, neither was
possible. Their assets were illiquid. No one wanted to buy. Land
values slumped.
Years Current Borrowing Long-Term Borrowing
1971
1972
1973
2.74:1
2.89:1
3.48:1
4.79:1
4.96:1
9.58:1

Cambridge Credit…
Cambridge Credit operated at a ridiculous gearing ratio. The
ratio of stockholders and shareholder funds to liabilities was
1: 6.4 as early as 1968 and had grown 1:7.85 in 1972. At the
time of its collapse, the ratio was 1:14.75. This extreme
gearing appeared to be matched by a respectable swelling of
assets over liabilities, the excess growing from $5.851 million
in 1968 to $21 million in 1971. However, in addition to balance-
sheet implications, Cambridge Credit had entered into
guarantees on loans worth $56.4 million on 31 December 1973.
There were, as well, enormous liabilities not listed on its
balance-sheet arising out of joint ventures, and the Melbourne
receiver claimed that $100 million of liabilities were cancelled
from account in this way. Cambridge was engaged in some 650
individual projects, only eight percent of which were wholly
owned by Cambridge.

Austrian Perspective: Hayek and Schumpeter
Hayek
• ‘cluster of business errors’ in ‘high order’ goods: e.g.
construction goods (‘Round-aboutness’)
• A disequilibrium theory due to credit expansion; artificial,
policy induced boom
• Role of the price signal
Schumpeter
• ‘Branching out’
• The Entrepreneur
• Complimentary sectors
• Oversupply, IRs
• Minsky and Schumpeter

Austrian: Overinvestment
• Arthur Burns (Chairmen of the Fed) put it well in 1975:
• Sure enough there were was a huge ‘oversupply’ in commercial
property. Vacancy rates were as extreme as: Oz (37% in Syd
CBD); US (13-16 nationwide%); 35% UK

Austrian: Residential & NR Investment

In Aus Fixed K investment collapsed the most

• Empirical evidence: BOE paper found that construction and
complimentary, interrelated industries to housing sector
were mainly affected during UK recessions:
http://www.bankofengland.co.uk/publications/quarterlybulletin/q
b960302.pdf

GFC
• Like the 1970s recession, GFC characterised by...
(a)High vacancy rates (15%+) and mass bankruptcies in the
residential and commercial property sectors...
(b) Mass unemployment in construction and manufacturing
sectors as well as and housing output....
(c) Exotic financial instruments
(d) World-wide real estate boom

Income and Employment Effects
• PDI did not fall for even one quarter; transfer payments
exploded just as the economy started to “recover”
(1975:II-IV)
Year
(Quarterly)
Disposable Personal
Income
(Billions)
Total Government
Transfer Payment to
Individuals
(Billions)
Government Transfer
Payments ÷ Disposable
Personal Income (%)
1973
(1)
(2)
(3)
(4) Recession start*
866.6
891.7
914.1
939.9
110.0
111.9
114.5
117.5
12.69
12.55
12.53
12.50
1974
(1)
(2)
(3)
(4)
953.8
968.2
996.1
1015.9
123.5
130.7
138.4
145.5
12.95
13.50
13.89
14.43
1975
(1) End (Recovery)*
(2)
(3)
(4)
1024.0
1081.7
1087.1
1114.4
157.7
169.4
172.4
175.2
15.40
15.66
15.96
15.72

Income and Employment Effects
• 83% of recipients of transfer payments (in 1974-75) were
either to the retired (old age) or disabled (Vets)
• Food stamps, education infrastructure building also exploded:
quintessentially Keynesian ‘socialisation of investment’
response to the 1973-74 recession.

Cash-flow Effects: Watch the Profits!
Sectors and Their Compositions 1972 1973 1974 1975
Households
Disposable Personal Income
Personal Outlays
Personal Savings (Surplus)
Business
Gross Internal Funds
Gross Private Investment
Deficit or surplus
Government
Federal gov. deficits or surplus
State gov. deficit or surplus
Total gov. deficit or surplus
Total surpluses
Total deficits
Discrepancy
Household savings as % of disposable
personal income
Business deficits as % of gross private
investment
801.3
-751.9
+49.4
131.3
-179.2
-47.9
-17.3
13.7
-3.6
49.4
-51.5
-2.1
6.08
26.73
903.1
-830.4
+72.7
141.2
-220.2
-79.0
-6.9
12.9
+6.0
78.7
-79.0
-.3
8.05
35.88
983.6
-909.5
+74.0
141.6
-209.5
-67.8
-11.7
8.1
-3.6
74.0
-71.4
+3.6
7.52
32.4
1076.8
-987.2
+89.6
174.8
-196.3
-21.5
-73.4
10.0
-63.4
89.6
-84.9
+4.7
8.92
10.95
Sectoral Surpluses and Deficits, 1972-75 (Billions of Dollars)

Cash-flow Effects: A Form of Corporatism?
• The difference between the downturns is corporate profits; in 1929, 1930,
1933 they were 10.1, 6.6 billion and 1.7 billion respectively. In 1974,
corporate profits were $83.6 billion, but in 1975 they rose to $95.9 billion!
• In 1930s the impact of government was not able to sustain profits and
therefore investment, but 1970s it sustained profits!
1929 1930 1933 1974 1975
Gross Private Investment
Government Deficit
Total
16.2
-.9
15.3
10.1
-.9
9.2
1.4
+1.3
2.7
229
+11
240
206
+69
275
Year GNP Gross Private
Investment
Federal Gov.
Outlays
% of GNP
Private Federal Gov.
1929
1933
1940
1950
1955
1960
1965
1970
1975
103.4
55.8
100.0
286.2
400.0
506.5
691.1
992.7
1549.2
16.2
1.4
13.1
53.8
68.4
75.9
113.5
144.2
206.1
2.6
4.0
10.0
40.8
68.1
93.1
123.8
204.2
356.6
15.7
2.5
13.1
18.8
17.1
15.0
16.4
14.5
13.3
2.5
7.2
10.0
14.3
17.0
18.4
17.9
20.6
23.0

Balance-Sheet Effects: Gov. Bonds
Sector 1972 1973 1974 1975
Households
Non Financial Corporations
State & Local Governments
.6
-2.4
-3.4
20.4
-1.8
-.2
14.5
3.5
-.1
-.9
16.1
-5.8
Total NFS 1.6 18.8 18.1 21.1
Commercial Banking
Savings and Loans
Mutual Saving Banks
Credit Unions
Life Insurance
Private Pension Funds
State and Local Gov. Ret. Funds
Other Investment Co.
6.5
4.3
1.4
.8
.3
1.0
-.6
-.4
-1.3
*
-.5
.2
.1
.6
.1
-.1
1.0
3.3
.1
.2
*
1.1
.6
-.3
30.3
11.1
3.6
1.9
1.3
5.4
1.7
-1.0
Total Financial Sector
Total
13.6
15.2
-.4
18.4
6.7
24.9
57.1
78.1
Total Private Domestic Acquisition of U.S. Gov. Securities, 1972-75

Balance-Sheet Effects: Fiat Currency
Sectors and Their Compositions 1972 1973 1974 1975
Net acqs. Of financial assets
Demand deposits + currency
Total Bank Credit
Credit-market securities
U.S. Gov securities
Direct
Agency issues
Other securities + mortgages
S&L Obligations
Corporate Bonds
Home mortgages
Other mortgages
Other cr. Excl. Security
Consumer Credit
Bank Loans
Open-market paper
Corporate Equities
Security Credit
Vault cash / member bank reserves
Other interbank claims
Miscellaneous assets
78.3
.2
75.4
70.5
6.5
2.4
4.1
25.7
7.2
1.7
9.0
7.8
38.4
10.1
28.5
-.2
.1
4.8
-1.0
1.4
2.3
100.2
.3
83.3.
86.6
-1.3
-8.8
7.6
25.9
5.7
.5
11.0
8.8
62.0
10.6
52.1
-.8
.1
-3.4
3.5
6.0
7.2
83.9
-.2
62.2
54.6
1.0
-2.6
3.6
19.1
5.5
1.1
6.5
6.1
44.5
2.8
39.5
2.2
-
-2.4
-3
7.1
15.0
32.9
*
27.8
26.6
30.3
29.1
1.2
6.4
1.3
2.1
1.9
1.2
-10.1
-.6
-12.9
3.4
-
1.2
1.0
-5.4
9.5
Commercial Banking: Net Acquisition of Financial Assets, 1972-75 ($ billions)

Observation for Australia…
Industry Growth Growth Percent
Agriculture 20,503 5.7%
Mining 20,659 13.0%
Electricity -7,923 -5.5%
Construction 29,935 3.0%
Wholesale 11,759 3.0%
Retail -32,859 -2.7%
Accommodation & Food 49,279 6.9%
Transport -2,513 -0.4%
Information
Technology -7,753 -3.5%
Finance -1,982 -0.5%
Real Estate 23,287 13.4%
Professional 78,640 10.4%
Administration 15,609 4.4%
Education 28,853 3.6%
Health 47,060 4.0%
Arts -13,156 -6.2%
Other Services 17,641 4.0%
Total Victoria 109,894 4.1%
Total Australia 158,710 2.1%
Victorian Employment Growth by Industry March-December 2009
Industry Growth Growth Percent
Agriculture 8,026 9.8%
Mining 978 9.4%
Electricity -5,953 -16.9%
Construction -8,366 -3.7%
Wholesale 5,029 4.4%
Retail 22,724 7.8%
Accommodation & Food 996 0.6%
Transport -6,782 -4.7%
Information Technology -1,236 -1.9%
Finance 21,275 22.4%
Real Estate -1,631 -4.6%
Professional 24,157 12.2%
Administration 7,456 8.5%
Education 14,673 7.4%
Health 13,718 4.8%
Arts -2,276 -3.6%
Other Services -704 -0.7%
Total Victoria 70,005 2.6%
Total Australia 62,953 0.8%

Conclusion
• Don’t listen to neo-classicals…empirical data suggests there
should be a presumption against the claim that exogenous
‘shocks’ are the primary cause of stagflation…‘Stag’ =
collapse of property/debt bubble; ‘flation’ = due to big
governments‘ attempt in stabilising output
• Keynesianism saved the day…even though, as Minsky puts it,
‘stagflation [was] the bitter price we pay to avoid a
depression…’
• History of Economic Thought is a more viable in exploring
the causes of stagflation…Perhaps a ‘synthesis’ between the
Georgist, Austrian and Post-Keynesian schools is in order in
analyzing the endogenous dynamics of stagflation…

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Dispelling OPEC oil prices as the cause of the 70's economic recession