Global Finance in Trouble 04.03.15

Neil Thomas gives a very short guide to the causes of national debt.

by Neil Thomas

In the lead up to the 2015 British General Election the leaders of all the main parties have made spending cuts a key priority, with the aim of ‘reducing the government deficit’. But since the Coalition Government began its programme of cuts from 2010 the national debt (the sum of annual deficits) has increased from £760 billion to £1260 billion. The projected deficit for 2015 is £100 billion, up from £70 billion in 2014. This provides compelling evidence that ‘austerity’ can never eliminate government deficits under conditions of economic stagnation, as cuts reduce income and spending power, which in turn lowers tax revenue.

Long term stagnation, rather than excessive government spending, is the primary cause of mushrooming national debt. There are several reasons for this, but we can put them into two categories: -1- financial liberalisation; and -2- international economic/financial imbalances. I will outline these briefly and then ask what, in turn, is the deeper cause of these two phenomena and, finally, what can be done?

To understand the first – financial liberalisation – we need to return to the 1970s and the decline of US dominance, under competition from Japan and West Germany. With mounting US trade deficits (as opposed to surpluses) the dollar began to lose value, and its government was no longer able to hold its price against gold. This marked the end of the post-war era of fixed exchange rates. But the international Bretton Woods Agreement of 1944 had given the US government the unique right to pay for its imports in dollars, rather than in the currency of the exporting country. Consequently it was able to print dollars and use them to expand its trade deficit indefinitely. The world became awash with dollars which, in turn, were freely loaned to businesses previously only permitted to borrow in their domestic currency.

So rules constraining international financial flows, which had applied during the ‘Golden Years of Capitalism’ from 1945 to 1970, were torn up and the era of ‘financial liberalisation’ was under way. By the mid 2000s we were seeing this liberalisation operating to devastating effect. East Asian countries buying US government bonds made long-term US interest rates low, while the US Central Bank (the Fed) directly reduced short-term interest rates. The resulting ‘cheap money’ was grabbed by banks and loaned to poor Americans to buy (‘sub-prime’) mortgages they couldn’t afford. Thousands of these were ‘securitised’ and sold to investors around the world and, as we all know, when US householders began to default in droves, investors – mostly banks – lost money, and in 2008 the entire global financial system threatened collapse.

When governments – including the UK – responded by bailing out their own domestic banks they became heavily indebted, and felt compelled to cut their spending: so-called ‘austerity’. Global economic contraction set in. All the reckless financial activity which led to austerity derived ultimately from the financial deregulation which had its roots in US decline in the early 1970s.

The second root cause of global economic stagnation concerns ‘international imbalances’. Again, consider the very same 1944 Bretton Woods Conference. At that critical meeting the British representative, John Maynard Keynes, argued passionately that trade imbalances were, by their very nature, contractionary because countries with trade deficits have to fund them by borrowing money and cutting expenditure, thereby lowering economic growth. His revolutionary proposals to prevent, rather than manage, trade imbalances were over-ruled by the US government.

Of course this contractionary sequence of cuts and stagnation is most striking in Greece, but we must remember that the ubiquitous portrayal of Greek debt as exceptional is misleading. For example, the relatively overlooked debt of Spain – including household, bank and corporation debt, in addition to government debt – is over five times GDP compared with just four in Greece.

In the Third World the consequences of trade deficits are even worse: since the International Debt Crisis of 1982 poor countries have been forced to borrow money from the IMF with the explicit requirement to cut spending, notably on health services. One can only hope that alternative unconditional lending by the new Asian Infrastructure Investment Bank, set up by China and 21 other countries in October 2014, will reverse this contractionary trend.

But what of the trade surplus countries? These are mostly oil-exporting countries, but also China and Germany, where trade advantage has been generated by suppressing wages. This again is contractionary. Both countries could instead increase wages and generate a virtuous circle of trade and economic growth. Unfortunately they have sacrificed global growth for their individual advantage in a stagnant world economy.

Furthermore, trade surplus countries, notably China, have invested trillions of dollars in US Treasury bonds, rather than in productive enterprises. In short, they have lent money rather than invested it. More contraction. But the rise of China also offers some hope. The growing Shanghai Cooperation Organisation, including China, Russia, India, Pakistan and Iran is developing a network of expanding investment and production outside of the Western sphere of debt and stagnation.

Investment of surplus East Asian funds into US Treasury bonds highlights the problem at the heart of global capitalism: the scarcity of alternative profitable outlets for capital. The question of whether declining profitability is an intrinsic feature of capitalism has been debated by such economists as Adam Smith, Marx, Keynes and von Hayek since the eighteenth century. Irrespective of whether it is, actual global profitability has been at dangerously low levels since the 1970s and there is no sign of its recovery.

Whether the crisis of profitability can be solved or not, a capitalist system based on money and profit must be able to sell its output. So the solution is simple in principle, if not in practice. First workers must be paid adequately. Second people with money must be taxed effectively. And finally profits must be reinvested in the economy – preferably through a publically accountable banking system – rather than siphoned off into ever more exotic, and often fraudulent, forms of speculation. These are prerequisites for capitalism’s survival. Whether they would be enough only time will tell.

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