Debt: The Last 30 Years

We are marginally less constipated than before. Ideologically speaking. Thanks in large part to Jeremy Corbyn British politics has begun to move on from the mendacious obsession with public debt being the cause of the last financial crisis (and the harbinger of future ones).

Political conservation has started to appreciate the seriousness of enormous levels of private debt, which was always the elephant in the room. The Bank of England has warned of a ‘spiral of complacency’ about growing household debt, while the IMF has cautioned that the ‘rapid growth in household debt – especially mortgages – can be dangerous’. Anthropologist David Graeber says ‘the household sector is a rolling catastrophe’. Around 17 million Britons have less than £100 in savings.  And with the BoE making noises about raising interest rates from rock bottom levels, there are worries that some mortgage-holders could default, precipitating a US-style sub-prime crisis.

The problem is that all attention is directed at one kind of private debt – personal debt. And while its seriousness should not be minimised there are other sorts of private debt that merit just as much, if not more, concern:

Personal debt is not the most extreme form of private debt

Private debt can be divided into three types – financial sector debt (i.e. banks & insurance companies), corporate debt and personal or household debt. All three have grown exponentially since the start of the 1990s. According to economist Michael Roberts, what he terms ‘global liquidity’, a combination of banks loans, securitized debt and derivatives, mushroomed from 150% of world GDP in 1990 to 350% in 2011. And while in some countries, colossal financial sector debt has declined to a degree following the financial crisis, and household debt levels fell before rising once more, corporate debt, nourished by near zero interest rates, has just snowballed over the last nine years.

According to figures released by management consultants McKinsey in 2015, all forms of private debt have grown since 2007 but corporate debt has increased by double the rate of both household and financial debt, which nonetheless rose but in a more subdued manner than before the crisis (see the graphic in this article). Government debt has also exploded as financial debt was transferred to state coffers. “Nonfinancial corporate debt remains the largest component of overall in the advanced capitalist economies at 113% of GDP,” says Roberts, “compared to 104% for government debt and 90% for household debt.”

The forms that corporate debt takes vary but one of the most common is for companies to use debt to buy back their own shares. This practice, which was illegal in the United States before 1982, increases the firm’s share price in a totally artificial manner, giving the appearance of financial health and success in the marketplace. Frequently, it also personally benefits the corporate executives who authorise it as they are paid partly in stock options. In fact the corporate sector has been the main buyer of US equities since the market meltdown of 2008, engaging in what has been described as ‘the greatest debt-funded buyback spree in history’. It was estimated that in 2017 the largest US companies would spend a record $780 billion on share buy backs, though, in reality, the forecast bonanza has apparently hit a snag.

Or possibly corporate debt takes the form of shareholder loans, the practice by which one company deliberately loads another company that they own (they are the main shareholders) with huge amounts of debt which the captive company is then obliged to pay back at high rates of interest; 15 or 20% for example. The Financial Times recently highlighted the case of Arqiva which owns 9/10ths of the UK’s terrestrial TV transmission networks and, in the three years to June 2016, paid around £750 million in interest to its controlling shareholders, payments financed by borrowing.  It is now £3 billion in debt. And that’s just one company.

Household debt did not cause the 2007-8 Global Financial Crisis

What household debt did was light the touch-paper. The nationwide implosion of the housing market in America after interest rates were raised signalled the demise of all those mortgage backed securities and collateralized debt obligations but the reason it proved so devastating for the US economy and spread the crisis around the world was because of the fatal combination of household debt with gargantuan financial sector and corporate debt. The Global Financial Crisis was sparked in August 2007 (‘the day the world changed’) when French bank BNP Paribas froze its funds because of its exposure to the mortgage backed securities of the US sub-prime market. The problem wasn’t defaulting French mortgage-holders but the effects were being felt by a French bank. BNP was one of three major French banks who were collectively overleveraged to the tune of 237% of French GDP. That level of indebtedness caused the crisis to spread to Europe as hugely indebted, and now effectively insolvent, European banks called in the loans they had made to southern European governments.

Nobody can say with any assurance what the trigger will be for the next financial crisis. It might be heavily indebted US college graduates or UK credit card borrowers or Australian consumers or Dutch mortgage holders (a country which has the most indebted households in the euro area).

But it’s equally possible that the fuse will be lit from another sector of the economy entirely – massively overleveraged corporations being unable to repay their creditors when interest rates rise, for instance. In that case, households will simply be spectators to the unfolding events.

All the focus is on personal debt because it represents a morality play

In Debt: The First 5,000 Years David Graeber points out that in Sanskrit, Aramaic and Hebrew ‘debt’, ‘guilt’ and ‘sin’ are all the same word. In modern German, the word for ‘debt’ – schuld – also means guilt. “If history shows anything,” Graeber writes, “it is that there’s no better way to justify relations founded on violence, to make such relations seem moral, than by reframing them in the language of debt – above all because it immediately makes it seem that it’s the victim who’s doing something wrong.”

The existence of enormous level of personal debt in advanced capitalist countries is a sure sign that the individual freedom these societies claim to uphold is skin deep. In reality, they are founded relations of coercion and control. To be in debt is to have someone’s boot on your neck. In the UK, high rates of personal debt are intimately related to the fact that real wages are 10 per cent lower than a decade ago. Rising personal debt is also strongly correlated to mental health problems like depression and anxiety.

From another perspective, personal debt is the symbol of our fatal addiction to consumerism, the consequence of an all-embracing need to maintain a modern lifestyle, decorated with the latest products, no matter what the cost to ourselves or the environment. Either way, personal debt unmistakably says something about the current state of society – what drives it and who is in control.

Corporate and financial sector debt, by contrast, is not only opaque, it is frightening neutral. Debt has simply become the way of doing business over the last 30 years. Debtors are frequently also creditors and companies may simultaneously indebt themselves and hoard cash. Indeed, increasing ‘leverage’ (to use the technical term) or loading debt onto captive companies (as in the Arqiva case) is often the primary means by which profits are made. No sense of shame or ‘doing something wrong’ attaches to it.

The question that should arise is why the corporate sector – financial and otherwise – has become so addicted to debt? Why is old-fashioned investment in new products or new technologies comparatively shunned?

It is possible to reduce personal debt but corporate debt is far more of an intractable problem

Theoretically it is possible to cut personal debt to more manageable and less dangerous levels.  Ending austerity, strengthening trade unions, instituting rent controls and directing efforts to raising the level of real wages should see the rates of payday loan and credit card debt diminish. I say theoretically because, interestingly, some of the highest quantities of personal debt, as a proportion of GDP, are in Scandinavian countries – nations that have impressive rates of trade union membership, collective bargaining and high personal incomes. However, those in debt in Nordic countries tend to be higher earners. In the US and UK, by contrast, personal debt often afflicts people much lower down the income scale – people who are much more likely to default given a slight change in the economic winds.

Corporate debt is a different matter entirely. The massive government bail outs of 2008 only succeeded in transferring debt from the financial sector to the state and, even then, only denting marginally the indebtedness of the banks. Corporations, whose debt had risen markedly over the previous twenty years, merely took advantage of the lower interest rate environment, to become even more indebted.

The writer and broadcaster Paul Mason says governments have to do something ‘clear and progressive about debts’. He advocates a policy of ‘financial repression’ – that is stimulating inflation and holding interest rates below the rate of inflation for 10 or 15 years as a way of writing off debt. But we can see the problems that a mild rise in the rate of inflation to the historically low level of 3% is currently causing people in the UK, with wages unable to catch up. Deliberately stoking inflation for a decade or more would surely precipitate the household debt defaults that so many people are warning about – inflation would erode the total amount of people’s debt but interest payments would still need to be met as real incomes plummeted. And if interest rates are below inflation – as they are now – the incentive for corporations to take on more debt is still there.

It is difficult to imagine how this system can gradually and progressively resolve its problems without provoking the economic collapse that everyone is so desperate to avoid.

Addendum

It's probably worth re-emphasising that when I speak about corporate debt, I'm not referring to the borrowing a company naturally needs to do to keep going and expand its operations. See - https://www.touchfinancial.co.uk/knowledge-centre/blog/4-reasons-why-successful-businesses-borrow-money

What's happening now is massive borrowing to either appear successful (share buy backs) or invest in debt to make more money. They're nothing to do with how capitalism is meant to function in the textbooks.


 

Conservative economics has failed. Will the alternatives?

So the Bank of England has revived that old chestnut of making fabulously rich people richer than before by increasing the value of their shares and property. This is allied to dropping interest rates to below their lowest ever level in history in the hope of sparking borrowing and spending.

Given that these are precisely the same policies employed in the wake of the 2008 economic crash and have resulted the slowest ever recovery from an economic downturn since the 1930s, and seen 2/3rds of households in rich countries endure lower living standards than a decade ago, I wouldn’t hold out much hope of them working a miracle this time around.

The question is, will the alternative?

On the eve of the Bank of England’s decision, 35 ‘progressive’ economists (Steve Keen, Robert Skidelsky, Herman Daly, John Weeks and David Graeber among them), wrote a letter to the Guardian newspaper, urging different monetary policies to merely inflating asset bubbles and increasing household debt. The alternatives they recommended were a definite case of hedging your bets but are worth considering. Because if they don’t work, nothing will.

1 Giving everyone some money

I can’t help but find it amusing that a major plank of an alternative economic strategy, supported by eminent PhDs across the globe and at least one famous ex-Central Banker, looks, at first glance, like it’s been dreamt up by a five year old.  Let’s give everyone some money, the theory (?) goes, and they’ll spend it and the economy will get better. Or in the words of the 35, ‘a fiscal stimulus’ could ‘fund either a tax cut or direct cash transfers to households, resulting in an immediate increase of household disposable incomes.’

Famous Pinochet-backing right-wing economist Milton Friedman dubbed this idea ‘helicopter money’, likening it to a helicopter (presumably with a big smiley face on the front) dropping money on people below (which they then scramble to pick up before their neighbours thus causing outbreak of mass brawling; possibly a metaphor for the right-wing view of human nature). Helicopter money, though, has some august advocates. Adair Turner, former chairman of the UK Financial Services Authority and director-general of the CBI, supports helicopter money. As does Ben Bernanke who was chairman of the US Federal Reserve at the time of the 2008 crash (so definitely ask him what to do).

The advantage of helicopter money (and I’m damning with faint praise here) is that, unlike Quantitative Easing, it is actually a stimulus. The flaw (one of the many) with QE was that this putative multi-billion pound stimulus got stuck with its banking intermediaries and didn’t make it out into the real economy. The BoE has augmented its latest batch of QE with an extra £10 billion which will buy the debt of companies it likes. By contrast helicopter money goes direct to flesh and blood people who are likely to spend it and, should they be inclined to save it or keep it under the mattress, another economist has said helicopter money should take the form of ‘shopping coupons’.

But helicopter money’s status as a genuine stimulus is also its drawback. Many pundits have wondered why QE, by pumping money into the economy, didn’t cause inflation. The reason seems to be that it didn’t pump money into the economy. Helicopter money, however, will. More, artificially created, money will be chasing the same amount of goods, which is the classic recipe for inflation. You might say we need some inflation as it currently just above zero. But if Brexit precipitates inflation by increasing the cost of imported goods, and this is compounded by helicopter money, then the results might go beyond the benign. And if the real incomes of people do not keep up with inflation, then the effect of helicopter money is negated in the first place.

The other problem with helicopter money is that even if its effects are not counteracted by inflation, they are ephemeral. The thinking behind helicopter money seems to be that, like a dying patient miraculously revived by the right medication, the economy will be kick started into steady growth. But helicopter money does not deal, or even try to, with any of the deep structural problems that caused economic stagnation in the first place. So, why, when its effects wear off, will the economy not descend back into the same torpor?

The argument made by its supporters is that helicopter money can be used to ride out a temporary shock such as Brexit. But the world economy, aside from Brexit (which hasn’t even happened yet), is slowing. In the last quarter, the US grew by an annualised rate of 1.2%. The EU has reduced is growth forecasts and Italian banks may need a huge bailout. Brazil and Russia are in recession.

2 Public Investment

But helicopter money was not the only prescription advanced by the 35 economists. They also argue that a fiscal stimulus ‘could be used to fund essential investment in infrastructure projects – boosting the income of businesses and households, and increasing the public sector’s productive assets in the first place’.

UK Labour party leader, Jeremy Corbyn, has promised £500 billion spending over the next ten years on infrastructure, manufacturing and new industries through a National Investment Bank (by comparison, the Bank of England spent £170 billion on Thursday alone). Shadow Chancellor, John McDonnell, says, ‘when you reach some limits of monetary policy, you reach for fiscal policy’.

But the turn from ultra-loose monetary policy to an infrastructure stimulus is not solely the preserve of the Left or ‘progressive’ economists. In the US, Donald Trump, when he is not pledging to repeal bank regulations or institute tax cuts for the rich, advocates repairing the country’s crumbling infrastructure - bridges, roads and the power grid – in an effort he compares to Roosevelt’s New Deal of the 1930s. He claims it could create 13 million jobs.

Commentators suggest this ‘could end up moving him left on the political spectrum because of the massive amount of government spending his plan would entail’. But this shouldn’t come as a shock. The Nazis, who were quite right-wing all told, were implacably hostile to austerity’s 1930s vintage and in favour of public works. “Hitler had already found how to cure unemployment before Keynes had finished explaining why it occurred,” said 20^th century economist, Joan Robinson.

The question now is: can infrastructure spending revive an economy in the doldrums in a way that conservative economics cannot and evidently doesn’t want to?

Public investment has fallen precipitously in both the UK and US since the crisis. The argument in its favour is that it can substitute for private investment which itself plummeted before 2008, never really recovered and is falling again. Corporations are currently sitting on trillions of dollars and pounds they are not investing.  Declining private investment such as this is a sign that another recession is on the cards.

There are undoubtedly things that need doing. Aside from crumbling American bridges, there is crying need for more public housing in the UK. Corbyn promises to build a million new houses, half of them council homes (by contrast New Labour built a princely 7,870 council houses in 13 years). Public investment would create jobs and bolster private sector supply chains.

But in an era of huge superfluity of private capital seeking investment opportunities, there is also a real danger that public investment will merely subsidise the private sector to do things that are not needed. One economist, Harry Shutt, calls this ‘Capitalist Luddism’, manifested in ‘white elephants’ such as ‘the building of roads and bridges to nowhere in Japan, “ghost cities” of empty apartment blocks in China and airports in Spain that have never opened’. In this sense, the use of taxation to manufacture profit opportunities for the private sector, which has grown massively over the last quarter of a century, will expand even more. This is otherwise called ‘corporate welfare’.

Because a turn to public investment does not answer one glaring question – why is the private sector on an investment strike in the first place? A Marxist answer is that profit has a tendency to decline over time and that investment opportunities are not currently profitable enough, so corporations are sitting on their profits. Another explanation has that, as a result of technological change, the need for investment capital has been drastically reduced, so capital has shifted into financial speculation and away from ‘organic growth’. A Left Keynesian/Marxist perspective says that, as a result of capitalists grabbing a larger and larger share of GDP growth, the distribution of wealth has been become skewed so new investment is put on hold because there is no expectation that people will buy new products.

One Marxist economist, Michael Roberts, follows this situation to its logical conclusion - the only way to restore profitability is through a mass destruction of existing capital value. “Of course, this will be at the expense of everybody’s jobs and livelihoods, because we’re talking about human beings losing their jobs as a result of the closing down factories and businesses, mergers, selling off the assets, displacing workers and reducing the overall level of production to reach higher profitability,” he says. “A slump, maybe a series of slumps, can do that. Until then, we’ll continue with this depression.”

The 2008 crash, had it followed its natural course, would have resulted in such a mass destruction of capital value. However, it was arrested with huge bail-outs, followed by the flooding of the world economy with masses of confected money in the form of Quantitative Easing. George W Bush got his wish - the sucker did not go down.

There are many things to like in Corbynism, most obviously a strange humanitarian insistence that public policy should aim at benefiting ordinary people, not just at safeguarding the health of elites. But in its reliance of public investment, it does not have a solution to what really ails 21^st century capitalism.