I’m proud to be a “deficit denier”

The Tories have no empirical or historical basis for their hysteria over the debt.

I've spent the past year on this blog mocking and riling so-called climate-change sceptics or "deniers", so I'm amused to find myself for the first time included in a different list of "deniers". According to the Prime Minister, those of us on who are critical of his government's austerity measures, and prefer to delay spending cuts and tax rises, are "deficit deniers". Hilarious.

Let me be clear: I'd much rather be a so-called deficit denier than succumb, as the Tories and their allies in the media and the business world have, to "deficit hysteria". Those of us who oppose the coalition's fiscal sadism do not deny the existence of this country's largest Budget deficit since the war, nor do we pretend that cuts will never come. We prefer, however, to contextualise the deficit and to point out that, for example:

  1. the national debt as a proportion of GDP is much lower than at other periods in our recent history,
  2. the national debt as a proportion of GDP is lower in the UK than in the United States, Japan, Italy and other industrialised nations,
  3. the UK and Greek economies are not at all comparable,
  4. deep and early spending cuts don't guarantee the retention of our much-lauded triple-A credit rating,
  5. the deficit is a result of a collapse in tax revenues after a recession caused by the bankers, rather than Labour's "profligacy", and
  6. the best route out of debt and deficit is economic growth and fiscal stimulus rather than Hooverite cuts and premature fiscal consolidation.

This last point is perhaps the most important. I'm amazed that some senior Labour Party figures seem to have bought in to this Tory narrative of the deficit and the importance of deficit reduction.

The shadow industry secretary, Pat McFadden, said in a speech this morning that Labour's current opposition to cuts risks exposing the party to accusations by voters of "wishing the problem away".

Peter Mandelson says in his new memoir that the party's biggest mistake in its final years in office was "allowing ourselves to be characterised as indifferent to the deficit or in denial about the consequences as to what was happening in our public finances".

This is a load of rubbish. Labour figures should be at the forefront of explaining the importance of deficits in rescuing fragile economies from double-dip recessions. Labour figures should be, as David Miliband has said, making the "moral" case for deficits. Labour figures should be excavating their copies of J M Keynes's General Theory of Employment, Interest and Money.

As the economists Ann Pettifor and Victoria Chick argue, in a brilliant contribution on the Bloomberg website:

It may seem obvious that if you want to cut debt, you cut expenditure, but Keynes showed that the government finances were very different from a household budget. For him, macroeconomic outcomes were often the reverse of outcomes based on microeconomic reasoning.

Keynes was instrumental in the development of national accounts, which give us the opportunity to test his conclusions. Combining the official estimates with British economist Charles Feinstein's invaluable historical estimates permits an analysis of the impacts of fiscal policy over the past century.

They point out that there are "eight episodes over which changes in the public debt (as a percentage of gross domestic product) can be compared with those in public expenditure" and they report that "the results stand wholly opposed to the conventional wisdom". As Pettifor and Chick write:

Comparing for each episode the average annual change in the public debt as a share of GDP and the average annual growth in government expenditure in cash terms, we have results that are perhaps even more remarkable than Keynes might have imagined. There is a very strong relationship between changes in government expenditure and the public debt.

But, outside the two world wars, the relationship goes in the opposite direction to that predicted by most commentators: increases in public expenditure are associated with reductions in public debt. Very roughly, so long as there is unemployment, for every percentage rise in government expenditure, the public debt falls by half a per cent, and vice versa. This is very compelling evidence in favour of Keynes's insights.

Even Simon Jenkins -- no friend of Gordon Brown or Alistair Darling! -- argues in today's Guardian::

Worst of all for Osborne is that, were it not for the continued rise in public spending, Britain would still be in recession. The ONS was quoted today on the crucial role of government spending in the first three months of this year in underpinning the economy. Private wages have been falling by 1.9 per cent and state wages rising by 3.6 per cent. Osborne is right to assert that this dependency on government is unwise and unstable. But it is one thing to accuse the patient of being a drug addict, quite another to send him cold turkey overnight.

Everyone professes not to want a double-dip recession, yet every bit of news, from home and abroad, suggests that this is now a real prospect.

He adds:

Why the west's economic leaders seem so trapped in a pre-Keynesian time warp is intellectually intriguing. An answer recently given by the economist Paul Krugman in the New York Times is that they care more about their "institutional credibility" in financial markets than about refloating a depressed economy. They are like statesmen who prefer to rattle sabres than avert war.

Another answer, closer to home, is that politicians seek to curry favour from their immediate circle. In the crises of the 1960s and 1970s, Britain's rulers spent their time with trade unionists and businessmen. They neglected the "supply side" and generated raging inflation. Now they associate with bankers obsessed with the security of bonds, and therefore with budgetary asceticism. In this respect, Osborne is no different from Darling. Both ignore Keynes's simple insight that businessmen will not invest and the economy will not grow if there is no consumer demand for products.

Hear, hear!

Mehdi Hasan is a contributing writer for the New Statesman and the co-author of Ed: The Milibands and the Making of a Labour Leader. He was the New Statesman's senior editor (politics) from 2009-12.

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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?