Dear Ed . . .

An open letter to the leader of the Labour Party.

Dear Ed,

I am not a politician. I am a trial lawyer. We are both members of the Labour Party. We are both in the business of convincing our audience that our arguments are correct. While I have never fought a political campaign, I am, like you, in the business of undermining the analysis advanced by my opponent and presenting complex concepts so as to make them comprehensible to intelligent but often uninformed ears. As the chances of my ever having the opportunity to challenge the Conservative position in court are disappointingly low, I offer my trial strategy to you, in the hope that you might find an alternative perspective useful.

I care passionately that our party is re-elected. That will not happen until the public rejects the coalition's line that: 1) it inherited an economic catastrophe caused entirely by the previous administration having "maxed out the credit card" and 2) that it can only be addressed by extreme cuts to government spending. I fear that the electorate is a long way from that point.

The role of the advocate is both destructive and constructive. He exposes the fallacy of his opponent's case, then sets out his own narrative. He does both in a way that his audience can understand. He avoids the jargon and the acronyms and sets the context. He uses statistics but doesn't recite them.

People understand comparisons. Our recent political history – a Conservative administration for 17 years followed by Labour government for 13 years – enables some telling illustrations. Compare the parties' records on debt and deficit. Everyone knows there was a meltdown in the financial markets in 2008. Explain how much it cost them as taxpayers and how it caused a dramatic increase in both public-sector debt and deficit.

Nearly every family in the country has to control a household budget and has had, at some time, to deal with debt. Explain, in household terms, why the credit card analogy is so wrong and why dealing with debt solely by drastically cutting expenditure is so potentially disastrous. Once you have done this, then tie the threads together.

The Conservatives paint a simple picture. Their previous administration was a model of financial and fiscal rectitude. There was no deficit and no debt. Then, under Labour, spending (on the nation's credit card) increased wildly, become uncontrolled and led, inexorably, to financial catastrophe and our current level of indebtedness. To add insult to national injury, all of the money was wasted on the sort of trivia that we all foolishly buy from time to time (our friend the credit card analogy again). It follows that:

  1. Labour can never again be trusted with the national purse
  2. Extreme measures must be taken immediately to stop the irresponsible levels of expenditure and
  3. As the cuts only mean not spending money on things we don't need, they are a good thing in their own right.

Ludicrous as this caricature may be, it has considerable traction in the country. How then do we confront it?

Put debt and deficit into context

We have always had a national debt. It was neither invented by, nor accumulated solely under, the last Labour government. It has been a fact of national life for hundreds of years under administrations of every political hue, not only in this country, but across the world. Even now, in 2011, our national debt is not at historically high levels relative to our GDP or by comparison with the other major economies of the world.

It has, in fact, been considerably higher for most of our history and for there now to be an annual deficit (still less a national debt) is not therefore, of itself, a sign, or evidence, of fiscal mismanagement. Nor does it represent, of itself, a national emergency requiring an extreme response.

Myth of the maxed-out credit card

Public-sector net debt and public-sector net borrowing (as a percentage of GDP) were significantly greater in 1997, after 18 years of Conservative rule, than they were in 2008 after 11 years of Labour and just before the crisis in the financial market. Over the course of their administration, the Conservatives spent every year, on average, more than they earned. Until the financial crisis in 2008, Labour, on the other hand, was able, again on average, to balance the books.

The levels of spending (again as a percentage of GDP) were almost exactly the same in 2008 as they were in 1997. As to what the money was spent on – and contrary to popular myth – the spending under Labour in 2008 on social benefits was lower than it had been under the Conservatives in 1997, whereas the spending on other, productive items such as health and education was commensurately higher.

The NHS and state education are infinitely better resourced now than they were when Labour took power. That Labour did so while still balancing the books presumably underpinned the Conservatives' pledge, in 2008 (but now conveniently forgotten), to maintain spending at those levels.

The bailout

If it wasn't because Labour were maxing out the credit card, how then did we get from balancing the books over the 11 years to 2008 to an annual shortfall of nearly £100bn by 2011 – and a doubling of the national debt (an increase of £430bn) over the same period? Unfortunately, if a week is a long time in politics, then the market crash in 2008 must qualify as ancient history, and the sad truth is that its catastrophic contribution to the current situation no longer resonates in the public consciousness.

You can hardly blame them. The Conservative narrative has expunged the inconvenient contribution of the collapse of the banking system to our financial predicament so comprehensively, and so implausibly, it would have made a Maoist historian blush. In any event, the figures involved are almost beyond comprehension and the intricacies of both the causes of the crash and the measures taken in response to it would challenge the mind of a PhD in economics.

However, without a cogent and concise explanation of the effect of the crash on the economy, Labour will continue to attract an unfair measure of blame for its consequences.

Some straightforward propositions could hit home. The breakdown in the financial markets was a worldwide phenomenon. To stave off a collapse of the financial system, almost all of the governments in the developed world had, to a greater or lesser extent, to intervene. This caused a dramatic increase in our national debt (and annual deficit).

Hundreds of billions of pounds were spent bailing out Royal Bank of Scotland, Lloyds and Northern Rock and were pumped generally into the system The interest that we are paying every year on the money that we borrowed to do so runs to the tens of billions. At the same time, the recession triggered by the banking crash (together with emergency measures taken to stimulate the economy, such as the temporary cut in VAT) caused a slump in government revenue.

This perfect storm has challenged the economies of industrialised countries across the world and the UK has been no exception. It would have been a miracle if any economy could have ridden that storm without increasing their debt and deficit. To ascribe that inevitable effect, sustained globally, exclusively to the spending policies of the Labour administration in the UK is not only misleading, it is absurd.

The strategy

There is a seductive appeal in the Conservatives' analogy of the household with the credit card bill that must be paid off as soon as possible – and whose repayment takes priority over any other consideration. It is a simple message to which the public can relate and which, of course, provides the narrative cover for a programme of cuts at which even Margaret Thatcher would have blanched at the zenith of her power.

Unfortunately for the country, the economic fallacy of treating the deficit like a credit card debt is now plain to see as, a year into the coalition, the tentative recovery of the early part of 2010 has been stopped in its tracks, even before the cuts have really begun to bite. For that reason, the public could now be somewhat more receptive to an alternative approach. How then to explain that alternative in a compelling and comprehensible fashion?

It is safe to assume that not everyone is familiar with Keynes's General Theory, nor is a dry exposition of competing economic analyses likely to gain traction with the electorate. A more profitable avenue may lie, as the Conservatives discovered, with an analogy with the household budget. The critical distinction would lie in the characterisation of the debt.

Rather than an outstanding bill on a credit card, the UK's debt can, and should, be seen as the national mortgage which, for reasons very largely outside the control of the government, had to be increased vastly to enable the economy to continue to function.

There will be few members of the public (particularly among the "squeezed middle" to which Labour should be reaching out) who are not familiar with the extension of mortgage borrowing to meet a financial challenge: whether to fund the care costs of an elderly relative, an extension of the home to accommodate a new (or returning) member of the family, to cover a period of unemployment, or to fund a business venture. They would rightly be resistant to charges of fecklessness for doing so: for those of us without the luxury of a generous trust fund, it is a commonplace in life that one sometimes has to borrow additional funds to tide the family over during a difficult period or to get a venture off the ground that will in time generate an income.

Neither would they consider the overriding imperative in their household budget to be the immediate repayment of that borrowing. Certainly they would plan for the debt to be repaid, but they would aim to do so in the long term, over a period and a rate that the household could reasonably bear.

To apply the Conservative remedy in this context is to demonstrate its absurdity: the elderly relative would be removed from the care home, the nascent business and its assets sold off, the mortgaged property sold off and the family home sold off. The household may now be homeless with no means of generating an income, but at least the mortgage would have been paid off.

Labour has been too defensive for too long about its economic record. In the months after last year's general election, it allowed the coalition to set the mood music with its endless repetition of the mantra of the maxed-out credit card and the "inherited financial mess". It may be that a new administration would always have had the exclusive ear of the public for a honeymoon period. Be that as it may, the time has come to strike back.

The public now knows the extent of the coalition's programme of cuts and knows not only that theyse go infinitely beyond a prudent trimming of the household expenditure but that they hit the poorest hardest. It is also starting to see the folly of wholesale and arbitrary retrenchment when the economy is at its most vulnerable. It is now ready to lend Labour its ear.

Our message to the public must be coherent, comprehensible and compelling. It if is not, the public will not be giving us its vote.

John Whitting is a QC and member of the Labour Party.

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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?