Thirty years since Mexico’s default, Greece must break this sadistic debt spiral

We must retake control of our economies from the banks.

As Greece’s leaders pay down the latest multi-billion euro instalment on their debt, they would do well to take notice that tomorrow is the anniversary of an event of great resonance.

On 20 August 1982, Mexico declared a debt moratorium - effectively defaulting on its massive debts. Although debts in many Latin American countries had caused suffering for a number of years, this was the moment the leaders of the West were forced to confront what came to be called the ‘Third World Debt Crisis’.

Mexico owed over $50 billion, 90% to foreign private creditors - primarily US, Japanese and British banks. These banks had gone on a lending binge during the 1970s using the profits oil exporting countries had deposited with them from the oil spike. American overspending, notably on the Vietnam War, was recycled as debt to the rest of the world and, to help this, controls on international movements of money were dismantled.

Just as in our current financial crisis, bank loans to Third World countries had tended to be organised through syndicates: loans were packaged up together and then lent on in one go. This bundling meant many banks felt no need to conduct their own risk assessment. Four of the fifteen largest lenders to Latin America by 1982 were British banks: Lloyds, Midland, Barclays, and Natwest. American lenders included Citicorp, Bank of America, and Chase Manhattan.

At the end of the 1970s the US Federal Reserve sprung the trap, massively hiking interest rates in order to save their banks from inflation. The costs for this move were pushed onto Third World countries like Mexico. Two years later, the inevitable happened.

Now US and British banks faced a crisis. If loans from Mexico and other Latin American countries were not paid, they could go bankrupt. The banks stopped lending to Latin America, pushing more countries closer to default, and lobbied the US government to get them out of their mess. The US responded by getting the International Monetary Fund, and later the World Bank, to provide bailout loans to Latin American governments.

In 1982 the IMF lent Mexico $4 billion, which went straight back out of the country to pay western banks - a perfect mirror of what is happening with so-called bail-outs to Greece and other Eurozone countries today. At the same time, the IMF insisted Mexico introduce radical austerity and liberalisation. There were cuts in every area of government spending.

The economy collapsed and stagnated, many industries shut down, with the loss of at least 800,000 workers altogether. By 1989, the Mexican economy was still 11% smaller than 1981. Meanwhile, the debt doubled from 30% of GDP in 1982 to 60% by 1987.

The same story was repeated across Latin America. In 1990 Latin American economies were on average 8% smaller than they had been in 1980, and the number of people living in poverty increased from 144 million to 211 million. Former Colombian Finance Minister Jose Antonio Ocampo calls the bail-out responses "an excellent way to deal with the US banking crisis, and an awful way to deal with the Latin American debt crisis".

Meanwhile, government external debt more than doubled (from an average of 17% in 1982 to 44% by 1988). Just as in Greece today, the bailouts had nothing to do with long-term sustainable finances - they were bailing out reckless lenders who had over-stretched themselves.  

In fact, the banks gradually wrote-down the ‘book value’ of how much they regarded the debts to be worth, even while they were being repaid. They were allowed to set these theoretical losses off against profit for tax reasons, greatly reducing the tax bill of US and British banks. In 1987 alone, Barclays, Midland, Lloyds and Natwest received a tax relief subsidy of up to $1.75bn across the four banks. Then campaign organiser for War on Want John Denham accused the Thatcher government of "joining in the banks' attempts to have the burden of repayment pushed onto taxpayers."

The policies of bailout and austerity went on to be practiced across the world in the years that followed the Latin American catastrophe. That experience forced dozens of countries through two lost decades of development and enthroned the financiers as the new masters of the universe.

Today Greece, as well as other European countries, can share in the experience of Latin America from the 1980s. Then as now, bailout money was used to repay reckless banks, whilst austerity has served only to shrink economies and increase the relative size of the debt. Since 2010 the Greek government’s external debt has increased from 118% of GDP to 150% in 2012. The economy has shrunk by 15% since the start of 2010 and unemployment has reached 19%.

To repeat such failed policies is more than carelessness. The future of Europe’s economy, indeed the world economy, will be decided by a battle between the financial masters on the one side, and the peoples of the most indebted states in Europe on the other - Greece first. We either retake control of our economy from the banks, or we deepen an economic experiment which has had an incalculable cost in terms of the lives and livelihoods of millions of people. 

Nick Dearden is the director of the Jubilee Debt Campaign

Employees of Greece's ATEbank shout anti government slogans on August 3 in Athens. Photo: Getty
Getty
Show Hide image

We're racing towards another private debt crisis - so why did no one see it coming?

The Office for Budget Responsibility failed to foresee the rise in household debt. 

This is a call for a public inquiry on the current situation regarding private debt.

For almost a decade now, since 2007, we have been living a lie. And that lie is preparing to wreak havoc on our economy. If we do not create some kind of impartial forum to discuss what is actually happening, the results might well prove disastrous. 

The lie I am referring to is the idea that the financial crisis of 2008, and subsequent “Great Recession,” were caused by profligate government spending and subsequent public debt. The exact opposite is in fact the case. The crash happened because of dangerously high levels of private debt (a mortgage crisis specifically). And - this is the part we are not supposed to talk about—there is an inverse relation between public and private debt levels.

If the public sector reduces its debt, overall private sector debt goes up. That's what happened in the years leading up to 2008. Now austerity is making it happening again. And if we don't do something about it, the results will, inevitably, be another catastrophe.

The winners and losers of debt

These graphs show the relationship between public and private debt. They are both forecasts from the Office for Budget Responsibility, produced in 2015 and 2017. 

This is what the OBR was projecting what would happen around now back in 2015:

This year the OBR completely changed its forecast. This is how it now projects things are likely to turn out:

First, notice how both diagrams are symmetrical. What happens on top (that part of the economy that is in surplus) precisely mirrors what happens in the bottom (that part of the economy that is in deficit). This is called an “accounting identity.”

As in any ledger sheet, credits and debits have to match. The easiest way to understand this is to imagine there are just two actors, government, and the private sector. If the government borrows £100, and spends it, then the government has a debt of £100. But by spending, it has injected £100 more pounds into the private economy. In other words, -£100 for the government, +£100 for everyone else in the diagram. 

Similarly, if the government taxes someone for £100 , then the government is £100 richer but there’s £100 subtracted from the private economy (+£100 for government, -£100 for everybody else on the diagram).

So what implications does this kind of bookkeeping have for the overall economy? It means that if the government goes into surplus, then everyone else has to go into debt.

We tend to think of money as if it is a bunch of poker chips already lying around, but that’s not how it really works. Money has to be created. And money is created when banks make loans. Either the government borrows money and injects it into the economy, or private citizens borrow money from banks. Those banks don’t take the money from people’s savings or anywhere else, they just make it up. Anyone can write an IOU. But only banks are allowed to issue IOUs that the government will accept in payment for taxes. (In other words, there actually is a magic money tree. But only banks are allowed to use it.)

There are other factors. The UK has a huge trade deficit (blue), and that means the government (yellow) also has to run a deficit (print money, or more accurately, get banks to do it) to inject into the economy to pay for all those Chinese trainers, American iPads, and German cars. The total amount of money can also fluctuate. But the real point here is, the less the government is in debt, the more everyone else must be. Austerity measures will necessarily lead to rising levels of private debt. And this is exactly what has happened.

Now, if this seems to have very little to do with the way politicians talk about such matters, there's a simple reason: most politicians don’t actually know any of this. A recent survey showed 90 per cent of MPs don't even understand where money comes from (they think it's issued by the Royal Mint). In reality, debt is money. If no one owed anyone anything at all there would be no money and the economy would grind to a halt.

But of course debt has to be owed to someone. These charts show who owes what to whom.

The crisis in private debt

Bearing all this in mind, let's look at those diagrams again - keeping our eye particularly on the dark blue that represents household debt. In the first, 2015 version, the OBR duly noted that there was a substantial build-up of household debt in the years leading up to the crash of 2008. This is significant because it was the first time in British history that total household debts were higher than total household savings, and therefore the household sector itself was in deficit territory. (Corporations, at the same time, were raking in enormous profits.) But it also predicted this wouldn't happen again.

True, the OBR observed, austerity and the reduction of government deficits meant private debt levels would have to go up. However, the OBR economists insisted this wouldn't be a problem because the burden would fall not on households but on corporations. Business-friendly Tory policies would, they insisted, inspire a boom in corporate expansion, which would mean frenzied corporate borrowing (that huge red bulge below the line in the first diagram, which was supposed to eventually replace government deficits entirely). Ordinary households would have little or nothing to worry about.

This was total fantasy. No such frenzied boom took place.

In the second diagram, two years later, the OBR is forced to acknowledge this. Corporations are just raking in the profits and sitting on them. The household sector, on the other hand, is a rolling catastrophe. Austerity has meant falling wages, less government spending on social services (or anything else), and higher de facto taxes. This puts the squeeze on household budgets and people are forced to borrow. As a result, not only are households in overall deficit for the second time in British history, the situation is actually worse than it was in the years leading up to 2008.

And remember: it was a mortgage crisis that set off the 2008 crash, which almost destroyed the world economy and plunged millions into penury. Not a crisis in public debt. A crisis in private debt.

An inquiry

In 2015, around the time the original OBR predictions came out, I wrote an essay in the Guardian predicting that austerity and budget-balancing would create a disastrous crisis in private debt. Now it's so clearly, unmistakably, happening that even the OBR cannot deny it.

I believe the time has come for there be a public investigation - a formal public inquiry, in fact - into how this could be allowed to happen. After the 2008 crash, at least the economists in Treasury and the Bank of England could plausibly claim they hadn't completely understood the relation between private debt and financial instability. Now they simply have no excuse.

What on earth is an institution called the “Office for Budget Responsibility” credulously imagining corporate borrowing binges in order to suggest the government will balance the budget to no ill effects? How responsible is that? Even the second chart is extremely odd. Up to 2017, the top and bottom of the diagram are exact mirrors of one another, as they ought to be. However, in the projected future after 2017, the section below the line is much smaller than the section above, apparently seriously understating the amount both of future government, and future private, debt. In other words, the numbers don't add up.

The OBR told the New Statesman ​that it was not aware of any errors in its 2015 forecast for corporate sector net lending, and that the forecast was based on the available data. It said the forecast for business investment has been revised down because of the uncertainty created by Brexit. 

Still, if the “Office of Budget Responsibility” was true to its name, it should be sounding off the alarm bells right about now. So far all we've got is one mention of private debt and a mild warning about the rise of personal debt from the Bank of England, which did not however connect the problem to austerity, and one fairly strong statement from a maverick columnist in the Daily Mail. Otherwise, silence. 

The only plausible explanation is that institutions like the Treasury, OBR, and to a degree as well the Bank of England can't, by definition, warn against the dangers of austerity, however alarming the situation, because they have been set up the way they have in order to justify austerity. It's important to emphasise that most professional economists have never supported Conservative policies in this regard. The policy was adopted because it was convenient to politicians; institutions were set up in order to support it; economists were hired in order to come up with arguments for austerity, rather than to judge whether it would be a good idea. At present, this situation has led us to the brink of disaster.

The last time there was a financial crash, the Queen famously asked: why was no one able to foresee this? We now have the tools. Perhaps the most important task for a public inquiry will be to finally ask: what is the real purpose of the institutions that are supposed to foresee such matters, to what degree have they been politicised, and what would it take to turn them back into institutions that can at least inform us if we're staring into the lights of an oncoming train?