A debt spiral we could have avoided

Economists simply would not accept that their model could fail

Who, five years ago, would have predicted the part-nationalisation of private banks, the UK Treasury considering abandoning its fetish of “inflation targeting”, and prudent Gordon Brown breaching the EU cap on government spending?

Well, some economists did, and five years ago the New Statesman ran a piece about their concerns.

In September 2003, I edited a book for the New Economics Foundation called The Real World Economic Outlook. It warned of "a collapse in the credit system of the rich world, led by the US, leading to soaring personal and corporate bankruptcies . . . The risks of a debt-deflationary spiral in the rich world are significant."

In a New Statesman article based on the book, I wrote: "If unemployment were to rise here, that could lead to a downward spiral in . . . house prices, making it harder to pay off debts [and] a debt-deflationary spiral.

"This threat is very real. But few economists, politicians and consumers appear to understand the nature of the risk." The cover carried a picture of a middle-class dinner party with the caption: "Coming soon. The new poor."

And so it has proved.

For more than two decades, economists operated behind an intellectual blockade where their theories calcified into an ideology that, remarkably, made no provision for systemic economic failure. Instead, powerful "security services" such as monetarists and their successors enforced strict global adherence to a theory of fantastic, always self-adjusting and self-regulating markets that could be relied upon to act efficiently. Mathematical models always allowed a return to equilibrium. There was no theory for systemic economic failure.

Those who still had time for the ideas of Karl Marx, John Maynard Keynes or J K Galbraith were denied professional posts, journal publication and media commentary. As a result, mainstream economists were not analytically equipped for near-systemic global economic failure and thus failed to alert their masters in the banks, central banks and finance ministries. They still do not fully grasp the scale of the crisis (after each of six bailouts, beginning with Bear Stearns, we were promised that the bottom had been reached and recovery was nigh).

The big US and EU bailouts treated the symptoms, not the disease. The disease is debt, and though it takes two to create debt, the bailouts helped only creditors, not debtors; banks, rather than homeowners or companies; the world of finance, rather than workers or industry. There remains a high risk of a systemic meltdown and a severe and prolonged global recession. One reason is that central banks have lost control over real interest rates. Their co-ordinated lowering of rates was followed by an immediate spike in mortgage rates. These are based on the privately set British Bankers' Association's Libor rates. The committee of bankers that raised them was serving the interests of the finance sector - not those of homeowners or companies. But high rates of interest exacerbate the disease of unpayable debt.

The very opposite is needed if we are to avoid ten years or more of sustained economic failure.

Interest rates rose because of risks posed to banks by indebted homeowners and companies, and by plummeting property prices. Bailing out banks, and not private and corporate debtors, means property prices will continue to "deleverage" chaotically and destructively.

Faced with these falling property prices, compounded by extensive fraud and deceit within the financial system, nobody can calculate the scale of outstanding financial liabilities; the probability that liabilities will, or will not be met; or the timing of such payments.

Property prices have been falling in Britain for just one year now, but have fallen for three years in the US. More disturbingly, prices in Japan (as Graham Turner points out in his book The Credit Crunch) are still falling, fully 18 years after Japan's credit bubble burst in 1990.

Only by bailing out homeowners and companies can we arrest chronic property deflation, and restore confidence and solvency to the international capital markets.

Fortunately, there is a simple, cheap policy that would address property deflation. It is based on Keynes's monetary theory, which has always been sidelined, but which he considered even more essential for breathing life into the corpse that was the global economy in the 1930s than his proposed fiscal policies.

Cheap money, ie, very low rates of interest, will help make mortgage and corporate debt repayments affordable. To achieve low rates, we first have to abandon the cross of "inflation targeting" on which the economy is being crucified. Second, the government must remove from the private British Bankers' Association the power to set interbank lending (Libor) rates. If it is to help homeowners and businesses, the government must restore to the Bank of England, accountable to society as a whole (not just the finance sector), the power to set all interest rates.

Only then can we hope to regain financial stability.

Ann Pettifor is a political economist

www.debtonation.org

31 comments

fairplay's picture

with GM foods and their control over them it will be more of the same for evermore. hybrid crops that kill all the natural vegetation of the world or at least most of it is on the cards.
the money supply controlled bu these animals is a scary thought. the food supply doesnt bear thinking about

writeon's picture

Dear Ann,

At the risk of sounding 'sexist', after reading your piece I wanted to give you big hug and a kiss, but as we are virtually standing on the deck of the Titanic and I've noticed something that looks like an iceberg over your shoulder, and the moon's out, I imagine appearing 'sexist' is the least of our worries!

Why aren't people like you in positions of real power in our society? I always thought the essence of proper education was the nuturing of ones critical sense and asking questions, not learning the accepted answers by dull rote.

Anyone with half a brain could see that the economic policies pursued were barmy, yet they were pursued with vigour and arrogance. I remember listening to Thatcher lecturing the world about economics and I just couldn't believe it. I was shocked and incredulous. How could anyone take this woman seriously when she so obviously didn't know what she was talking about! Scaling-up the wisdom acquired in her fathers shop and applying it to an entire country was close to insane. And the collosal arrogance involved floored me too. It was so dogmatic and primative and ignorant, a recipe for disaster over the longterm. But the damage being done was concealed by sleight-of-hand. North Sea oil revenues, privatisations and massive transfers of wealth from the bottom upwards.

Fundamentally the medicine is being wasted and applied to the wrong end of the system in the vain hope that it will rapidly trickle down to the rest of society. This is, I contend, a collosal mistake and will only worsen the problems we face.

In many respects I think we are potentially in a worse position than we were in the 1930's. This sounds alarmist and inflamatory, but it's what I think. Also it's important to remember that Keynes' ideas didn't really gain traction until after the Great Depression had hit so hard that even the most obtuse could see that something fundamental and systemic was wrong with Western capitalism.

writeon's picture

The question is, do we really have to repeat the Great Depression all over again before we apply the right medicine? I hope not, but I'm not optimistic, as I don't believe we have the right people in charge. Removing an entire layer of the 'ruling elite' and repacing them with better people, with fresh eyes and ideas, is probably impossible within our current economic, political framework.

The good thing about the collapse and the Great Depression was that the ruling elite was terribly weakened and lost respect, prestige and legitimacy. In the United States reform elements in the ruling-class understood that unless new methods were employed, the New Deal, one risked revolution, so better to try and save capitalism from itself than risk losing everything!

However, this New Deal strategy may not work this time. It was easier to create jobs through public works in the 1930's precisely because the overall level of technology was far lower than it is today. That's just one example. Then there is the massive level of personal debt in Britain. It's like a ball and chain around most peoples legs, turning them in close to slaves and restricting their movement.

Also we no longer really have much manufacturing industry left. No mines, no steel, no shipyards, but an awful lot of computers and services which are very vulnerable and very inflexable.

The debt blackhole vortex is probably many times the value of all the reserves of all the banks and states in the world, probably larger than the worth of all assets. If this massive debt hole collapses it'll have a tremendous effect on the world's economy. We are talking about several thousands of trillions. And if only a portion 'vanish' this will have consequences.

Finally there's the problem of whether Keynes actually worked at all, or was it the destruction caused by the second world war that really got us out of the Great Depressio? It's a scary and sobering thought in my opinion.

davidhill's picture

We have clearly ‘missed a unique chance to sustain humanity in this century by not changing our basic economic structures and allowing the present financial market system to prevail.
When one considers what the future holds, a world population of between 9.5 and 10.5 billion by 2050 (possibly even up to 12 billion), ever-dwindling natural resources to support human life and the dire effects of climate change through carbon and pollution emission, is it not clear that we have to change our economics to ‘Ethical and ‘Sustainable economics? For if we carry on with the present capitalist economic system, where the very few become rich beyond their wildest dreams and the majority are kept in relative poverty through the crumbs that drop from the rich mans table, our young and future generations to come will eventually have to endure immeasurably suffering. Indeed, governments are still presently blinded by current economic dogma and minority vested interests that do not look after the well-being of all people. Therefore we have to change to new economic systems that are sustainable and where the needs of the vast majority of the people are addressed. In this respect it is a little know fact but it only takes a reduction of no more than a 15% drop in global oil supply to bring eventually the whole of the global economy to its knees.
We have therefore to supplant the present capitalist systems and economics with ‘sustainable systems and ‘need economics before it is far too late to change. That does not mean that we do away with 'markets', as 'markets' are the only way in which trade occurs. It is how we operate those markets is the problem for sustainability and public need.
But unfortunately to allow this to happen, governments should have started the critical need to change to these ‘ethical economic structures at the start of the credit crunch and should not have supported the banking system as they have.

Dr David Hill
World Innovation Foundation Charity (WIFC)

writeon's picture

David,

You mention some unpalatable truths, relating to the massive growth in the world's population that is already built into the system and can not be stopped, that is if we rule out the return of barbarism, global warfare, plague or mass starvation. How on earth are we going to manage?

The challenge of just feeding so many people is going to be massive, yet they'll want jobs, education, homes, cars, fridges - all the stuff we have too. A world with nine billion people or even twelve and then fourteen and rising seems like an impossibility wrapped in a nightmare.

Yet politicians and leaders simply don't talk about this kind of thing, do they? It's a problem pushed into the future, for future generations to deal with. Our leaders are useless, incompetent and dangerously complacent. But isn't this about par for the course in relation to many other areas of civilization?

Fundamentally we have developed, or rather, a powerful and wealthy minority, a veritable aristocracy, have imposed an economic system on everybody else, that's close to insane. Capitalism, as it's configured today, is a kind of cult, quasi-religious in nature, something we worship. Yet we are being sacrificed on the bloody alter of the free-market like the victims of the Azteks, only we sacrifice millions and thousands of species in an ecological holocaust that's almost unrivalled in the history of our small, isolated, planet.

But without cancerous economic growth where would we be. Take Pakistan which we are pushing towards destruction. Its population is well over 160 million. At least half are under 25. They need 6% growth just to provide 4 million extra jobs a year, and this pattern is repeated all over the world.

I support markets too, but back in the marketplace, keep them out of the rest of society. I suppose we're going to have to install some kind of 'socialism' or we can look forward to an explosion of barbarism. Not a comforting thought.

writeon's picture

If we are really serious about facing and tackling the challenges we face; economic, environmental, population etc. we are going to have to somehow replace our political and economic elites with other people, one way or another, whatever it takes.

This sounds ominous, almost like a cull; but I don't see a way around it. We need new people with new values, who aren't the servants of the free-market. People who haven't been corrupted and socialized into their roles as priviliged and highly paid courtiers at the free-market, global, court.

Reluctantly I suppose I'm talking about something close to a revolution, because if we don't remove the ruling elite, people joined at the hip with voracious capitalism and steeped in its values and methods, people who love wealth and power above all else, unless we replace them and begin a programme of fundamental reforms designed to make the market and economics our servant not our master, then we are truly doomed as a civilization. We simply cannot go on the way we have been. It is impossible.

Infinite growth on a finite planet isn't feasable, and no amount of faith and belief in the God of the market - Mammon - will make it so. The invisible hand doesn't exist. It is a dangerous illusion and we are following it towards the edge of a cliff. Either we rise up, somehow, and take control, or we carry on being led towards the abyss.

gnuneo's picture

actually, infinite growth IS possible (well, in every practical sense) - goods can be made with other materials, technology can develop, and higher incomes can be spent purchasing higher quality. (for instance there are more Mercedes and less Ford in Scandinavia). With increases in productivity in capitalist partnerships (cooperatives) feeding directly back to the workforces (instead of being hived off by multi-nationals and 'owners'), then the workforce can afford to purchase better, ie more efficient in production/use items.

if there was global free trade upon the principles of 'fair trade' and 'cooperative production', then the living standards across the world would rise - and if there is a demand for fridges, than fridges will be produced from suitable, sustainable materials. There is no need for them to copy old industrial styles of lots of metal for instance.

the only hold-up is a lack of power - or more accurately, control of power. But there is a huge potential for solar power focussing from deserts, which could fully power 200 civilisations if we utilised it correctly - and again, it is entirely sustainable.

about Keynesianism - it only works when the Govt pumps money directly to small, locally owned business. And when the majority of the economy is based upon that. It works because the Govt can grab its 40% or so of every pound spent going around and around the local economy, which means the tax income also increases.

but when the Keynesian investment gets given directly to multi-nationals (for instance the big building firms, or the agribusiness sector, or to prime UK schools for privatisation), then there is no multiplier effect from the local economy, as the money just immediately leaves it. Which of course turns into a greater drain upon the tax-payer, as well as the general economy.

gnuneo's picture

last note, on the 'over-population' - the best way to cut birthrates is to increase prosperity, and ensure girls and women get a decent education. This is the only way to end runaway population growth.

ann: you are entirely correct, the Govt should have taken those £Billions and invested it creating new jobs, to boost the real world economy. You are also correct, what is important is people's incomes, as that creates the consumers the economy relies upon - 1000 people spending £60 each per week on local produce, creates more economic growth than one person buying a £60,000 sports car per week. Especially if that sports car was made abroad. (don't want to sound parochial, but that is a fact.).

"Why aren't people like you in positions of real power in our society?"

indeed!

gnuneo's picture

carl: it is undoubted that a part of the global 'Elite' do indeed believe that over-population needs to be "culled", and there are indeed plans for that in development - and quite possibly already being field tested. (HIV springs to mind).

in large part though, this is due to a lack of understanding of alternatives, and also basic ecological systems.

for instance, trying to reduce birthrates through war, epidemics, or absolute poverty (leading to starvation, lack of access to basic medicines), has in virtually every case actually *increased* the rate of population growth! If the elites understood the processes, and were serious about cutting the world's human population into sustainable levels, they would be attempting to spread global prosperity, would be enormously investing in and pushing for female education around the world, would tell the Pope to shut his bloody trap, and would be putting aid into the Grameen Bank instead of into arms.

do you not honestly realise that the 'problem, reaction, solution' model is also used to convince members of the Elite as well? You don't seriously imagine that there is a Global Conspiracy, and every member of that conspiracy is fully up to spec on every little detail do you? People are told "there is no other way", and many believe it - both in the general population and also decision makers. They actually *honestly* believe it!

what is needed is to give alternatives, so people can look at the options, the arguments, and make their own minds up. This IS what Free Speech is all about, and indeed what it is for.

once again, democracy is the way out of this mess, getting People to understand what is going on, and allowing them to make rational choices between the options. People know there are problems, what they are often unaware of is possible solutions, underlying patterns and structures, and that decision makers are often as bewildered as they themselves (but believe they can't show it).

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