A debt spiral we could have avoided

Economists simply would not accept that their model could fail

By Ann Pettifor Published 23 October 2008

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

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Tags: Economy 2008

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31 comments

Sat, 2008-10-25 00:52 — VC

gnuneo; how much oil will be required to enable global properity? I understand the basic mechanisms, that after a crisis the people have a lot of sex....so if you cull the population down to 1 billion, the population might reach 2 billion in 10 years....assuming current morbidity.

PRS model is a top down therory...the Gods may use it against each other to determin objectives/policy.

Now you are being silly.....does everyone in MI6 see the big picture? Of course not, but they all have a notion of their objectives. The fact that most have no idea of whats going on, does not hinder their fuction. Its the same in government, corporations and Freemasons. The people believe they are FREE, that they are MIDDLE CLASS (lol), that we now live in a class-less society.....there is a global conspiracy....just look at Westminister...its full of people who are nobodies....well, there is David Davis and David Icke

Look at Enron...the whistle blown by a new female employee who was not EMBEDDED (like our BBC journos) and smelt a rat. I emailed No10 over the attempted assassination of Gordon Brown...I know others understand the technology, but in general, everyone believes it was ice crystals...LOL

When you fund the political system. control the MSM, its very easy to conduct a global conspiracy...every time I make a dodgy comment to a NS article, it get taken off the main page.

Your last paragraph would never be allowed...sorry, it is allowd, they believe what they see and are told...of course its a pack of lies, so why would the ELITE give the people the reality that you suggest? Its just not going to happen.

Sat, 2008-10-25 16:40 — fla56

it is becoming tiresome to hear ongoing calls for more
money to be put into the system.

given the influence of the financial elite of course they
will be bailed out but even giving away money to any
owner of over-inflated assets such as houses is not
the answer. money is not wealth & asset inflation does
not equal growth.

the bottom line is that the system is over-indebted and
needs to deflate. the nation needs to work hard & learn
to live within its means. cheap money will just create
(hyper)inflation, punish responsible folk & postpone
the inevitable.

to stand any long term hope there needs to be
population and resource utilisation control. nuclear
fission/fusion/cold fusion/whatever may help but
there’s no such thing as a free lunch

Sat, 2008-10-25 16:46 — Douglas Chalmers

Well, that is all very interesting, Ann Pettifor, but what you have described is essentially the Boys' Club run rampant. What is worse, though, is that they have once again deified the cult of elitism and the social climbing that they fawned over has ensured that an exclusively powerful and wealthy super-class was re-created at the expense of the many.

No wonder, then, that it has all happened and in the manner it has. Such people see themselves as infallible and always right. Conversely, they only ever see faults in others and diminishing the value and worth of others is thus imperative to their modus operandi. So they have been perfect in every way and a universe unto themselves as long as things went up..... http://www.youtube.com/watch?v=efdfGeUKXuU

But falling property prices in Britain may be the outcome of the same low interst rate deflationary financial black hole as followed Japan's credit bubble in the past. Thus a carry trade in British pounds or even US dollars may eventuate to punish those who have tripped us up. Getting release from that might not be as easy as it sounds and most probably will take decades, though.

In "bailing out homeowners and companies", it is assumed that those who have already been foreclosed and repossessed or bankrupted will be abandoned. How will that "...restore confidence and solvency to the international capital markets...." when it indicates the same essential thinking and the same framework of potential for error and disaster fancifully exists in a supposed economic lifeboat when the rule is still "every man for himself", uhh?

Sat, 2008-10-25 18:37 — Conall

What to do now? Surely the first thing is to make sure that Never Again will we have a house-price bubble. Actually is wasn't a *house*-price bubble, rather an easy-credit fuelled Land price bubble. The solution: as always To tax the unearned land value increment, value which is created by Society, not the landowners. Yes, our dear old friend Site-Value Rating (instead of Council tax, stamp duty, IHT, ga-ga granny tax etc)

Secondly, ask yourself: Where did all this debt-money come from? And you know the answer only too well. All the money in circulation bar a paltry 3% is created within the private banking system (well completely private until a couple of weeks ago!). These bankster clowns, Masters of the Universe have screwed up big time. What to do about it? The extreme answer is Huber/Robertson's idea of 100% reserve banking, with the Government issuing (spending) the necessary new money into existence. Alternatively, the banks could pay interest on their debt-created money at current bank rates. Either way the past excesses could not be repeated.

C'mon NEF let's have some really 'new' thinking about the solutions!

Sat, 2008-10-25 19:13 — Douglas Chalmers

"What to do now..... let's have some really 'new' thinking about the solutions..."

You (and others) say that, Conall, but nothing you choose actually shows any way of genuinely changing anything. Its fine to point out that asset bubbles are a problem and that excesses should not be repeated. In fact, you are merely muttering as we shuffle towards the gallows.....

Nothing will change unless the license for irresponsible speculation is withdrawn - and nationalizing banks will eventually make another kind of incompetent and utterly inept mess as well. Thus we are ever caught between laziness and rampant greed. There is a way out but people don't want to change.....

A lot of the money that is being lost is from pension funds and that is because the share market is a kind of casino, not a vehicle for responsible long-term investing. That is quite separate from the collateralized debt obligations (CDO's) and the added layers of credit default swaps (CDS) for mortages and God only knows what else.

None of it has been in any way a formula for meeting the imperatives of climate change yet, along with the ridiculous war on terror, it is still all only distracting us from the main issue impacting economies through this century. The effects of rising sea levels, long-lasting droughts and super hurricanes cannot just be wished away.....

Better start thinking - and hard, uhh!

Sat, 2008-10-25 21:32 — richardgrace819

Last month it was widely reported that World population increased by 7million in August, Conservative estimate 84million per annum. In 12 years time easily in excess 1Billion. We are passed Peak oil development that features prominently in the cultivation of food crops. We really need to care for our future.

Sat, 2008-10-25 23:06 — VC

William, you are so right and this is why I have out lined the human cull above.

Sun, 2008-10-26 11:08 — teenaramg

Present circumstances provide a window of opportunity to initiate incremental changes in the process of money creation which globally could improve life in respect of finance, of the economy and the environment. In the UK we can urge the government to instruct the Bank of England to make interest-free loans (administered by the existing banking system) available for public capital projects.
In the words of a petition from the London Global Table* (shortly to be presented to parliament):
“The Petitioners therefore request that the House of Commons urges the Government to bring forward legislation to enable the Bank of England to issue interest-free loans for public, environmental and clean electricity capital projects such loans to be repaid and, on repayment, cancelled thereby halving or more the usual cost in a non-inflationary way”.
If this proposal were to be implemented it could become the thin end of a wedge that, when driven home, would marginalise the role of the existing commercial banks from national money creators** to High Street agencies of the central bank. The commercial banks would implement the provision of interest-free central bank money as loans for major capital projects but also for micro-credit, small farms and businesses, student loans and also - provided wider ownership is thereby furthered (on some sort of John Lewis or Cooperative Society model) - for private capital investment.
Anne Pettifor elsewhere (Guardian, 11-10-2008) has argued powerfully that usury - ie interest - is sinful. Others like her perhaps also believe debt, if not sinful, is highly undesirable. On the latter point, this viewpoint is unlikely to prevail against the more powerful argument that repayable debt is necessary for almost any sort of economic activity, preferably restricted to activity perceived as bringing benefits at every level.
Jasper Tomlinson
*www.globaltable.org.uk/
**The process by which banks create money is so simple the mind is repelled.

Sun, 2008-10-26 11:46 — philosopher_king

The future is too important be left solely to the current elites because they dont always listen to even well read, radical and expert opinion. i think the main difficulty during the next 5 to 10 years which is the period i expect the current crisis to last is:- the inadequacy and closed nature of our democracy. Neither of the main political parties seem able to be able to escape the strangle hold of being the standard bearer for one vested interest after another. Not only that but they seem destinied to a race to the bottom in ever increasing conservative or neo con policiies. The current rhetoric from Gordon Brown sounds good but its only superficial. We are in uncharted waters and we need new radical ideas and new people. And when i say radical i dont mean the corrupted use of the word by blairite members of the current cabinet! i cant see a debate happening this side of the election at least one involving the people who have the power to change things. Things are moving fast and appear at intelligent glance to be unimaginably grim compared to the situation last time there was a global slump. Capitalism and well and truly stuffed itself! It will take more than international conference and buying the preference shares of leading banks to get us out of this one.

tony in leicester

my point is we need electoral reform and greater democracy in our institutions.

Sun, 2008-10-26 14:45 — fairplay

reserve banking would be a sham too. it would be done through the bank of england which is.....wait for it...................................run by private banking families!! you dont think the likes of the queen and the rest of the royals along with their bankers through the ages would ever allow us serfs to be in control of our own money do you?

cant anyone see through this scam? do you people really believe this is a case of bad management? the people at the top arent as stupid as you obviously think they are

this was planned and executed with precision. there are plenty of fall guys but the main players at the top will rape and pillage everything thats left at bargain basement prices giving them even more control over our lives. face facts, theyve dumbed us down with the help of the media and now there is no fight left in us.

it doesnt matter what policies are inplemented. until we rout these despicable creatures from their ivory towers and make them suffer as we do daily nothing will change