Monday, 8 August 2011

Debt & Austerity


Debt is the common denominator in the crises facing the US, Europe and most of the major capitalist countries. But debts are a problem because of the pervasive and intractable nature of the global crisis. Governments now find that the extraordinary measures they took to boost growth after 2008 are no longer working. This is why their policies will now take a more aggressive turn towards austerity.

Private debt drivers


Although the focus of government policy measures in most countries is to curb public spending, the crisis did not start out as a government debt crisis. Private sector debt is much bigger than government debt in every country outside Japan, and its growth has also been faster. A McKinsey study shows that from 1995 to 2007 (the year before the crisis struck), the stock of private sector debt in 79 countries rose from $42 trillion to $107 trillion.[1] The volume of outstanding public sector debt was smaller and it increased less rapidly, from $13 trillion to $30 trillion. But in the next three years to the end of 2010, public sector debt grew more quickly as the state took on private sector liabilities to try and bail out the system. It jumped by $11 trillion, while the private sector debt pile rose by another $9 trillion.


Chart 1 gives a snapshot of global debt at the end of 2010. The numbers show the size of the outstanding debt as a percentage of GDP in each country or region. Each bar shows the division of the debt into (bank) loans, private sector bonds and public sector debt securities. Two things come out clearly from the numbers.


Firstly, the relative size of the total outstanding debt in the richer countries is much higher than for poorer countries. For the US, Japan and Western Europe, the totals are between 330% and 390% of GDP. By comparison, China, India and other developing countries have debt levels below 200% of GDP, and even less than 100%. McKinsey’s report argues that it is because the poorer countries have less developed capital markets; the more important point is that they have been far less dependent on credit-fuelled growth than the rich ones. The rich countries’ dependence now sees them drowning in debt.


Secondly, only in Japan is public sector debt the largest component of the total, reflecting that country’s decade-long stagnation. In the US and Western Europe, private sector bonds (issued by both financial and non-financial companies) and loans (both securitised and non-securitised) are much larger than public sector debt. A similar pattern is found elsewhere. While public sector debt might have been an important driver of the latest debt crisis for some countries, the data show that this is not true for most countries and regions.



Chart 1: Global debt outstanding at end-2010 as a percentage of GDP

Source: Author’s calculations based on data in ‘Mapping global capital markets 2011’, McKinsey Global Institute, August 2011.


In the early 2000s, major countries cut interest rates to try and offset stagnating growth. Private capital then began a credit-fuelled boom, but this turned to bust in 2008 as it became clear that the debts could not be repaid. The US sub-prime fiasco was the main trigger, but the reason that the crisis spread so dramatically around the world was that many countries were already vulnerable from their own versions of the credit boom, even if they had no exposure to the defaulting US mortgage securities. Credit expansion and speculation had been on a huge scale, so governments were forced to take on private sector debt liabilities or risk a ‘systemic problem’ - the problem that the capitalist financial system could no longer function. The ‘unsustainable government debts’ result from the crisis of private sector capital accumulation.

Running on empty


The crisis has trashed many totems of ‘free market capitalism’. Major financial companies were nationalised, while central banks abandoned conservative policies, bought junk, discarded their sacrosanct inflation targets and slashed interest rates. Global growth recovered somewhat after 2009, but the main impact of these policies was to boost stock market and commodity prices, not investment. In 2011, growth in the major capitalist countries has more or less ground to a halt and equity markets have slumped again. But governments now find they have now run out of options to boost their economies, either through monetary policy or through more government spending.


On monetary policy, interest rates are already close to zero in the US, UK and Japan, and only 1.5% in the euro countries. Central banks have also tried to boost their economies with ‘quantitative easing’ – which means buying junk assets from the private sector and financing government debts directly with central bank money creation. Just three or four years ago, such policies would have been described as debasing the currency, risking hyperinflation or acting like a dissolute Latin American dictatorship.


The Federal Reserve has $900bn of mortgage-backed securities on its balance sheet (as well as $1.6 trillion of US Treasury debt).[2] The Bank of England has a scheme to buy up £200bn of assets in its smaller version of ‘quantitative easing’,[3] while the European Central Bank bought €60bn in covered bonds from private banks, €74bn of government bonds from Greece, Ireland and Portugal, and has other exposures to asset backed securities and commitments to fund national euro money markets.[4] Today (Monday, 8 August) the ECB bought Italian and Spanish government bonds to try and stem the contagion. There is no reason to believe that these schemes will do anything other than slightly postpone the day of reckoning. Japan has run its own version of zero interest rates and quantitative easing since 1999, with no escape from prolonged stagnation and high debt levels.


Neither is there any way out of the crisis through increased state spending. This is a time-honoured policy recommendation from social democratic politicians and Keynesian pundits. But today public sector debts are so big that it is laughable to suggest that more spending would do any good. McKinsey’s report notes that government debt now equals 69% of global GDP, a dramatic jump from 55% in 2008. This is why, in the UK, the most that the Labour opposition can argue is that planned government spending cuts should be scaled down. In the US, one day after Congress reached a deal on raising the borrowing limit by an initial $400bn, 60% of the extra limit level was used up! It is little wonder that the US credit rating was downgraded.

Debt reckoning


A credit boom drove capitalism’s escape from stagnation at the turn of the millennium. This built a shaky edifice of debt, towering over the whole system. There is no pre-determined point at which the edifice will collapse, but the higher it gets, the more vulnerable it is to the slightest jolt. Governments have tried to prop up the structure, but now the debts have to be reduced or the system will topple. Extending further credit does very little to spur capitalist growth, and debts would just continue to grow faster than the prospects of paying them back. This should not be surprising, since the dynamic behind the rise in debt levels in the first place was the deteriorating profitability of investment.[5] Conditions for profitable capital accumulation need to be restored before extending any more credit will have a significant effect. This leaves two issues for capitalism to address, and for the rest of us to recognise and deal with.


First is what to do about the existing debts. Either the debtors pay in full, or the creditors accept that they will get less back than they bargained for. A ‘nobody pays’ solution does not exist. If the creditors forgive the debts, then they will take the hit, or current and future taxpayers will when the government bails out the financiers. If the debtors have to work harder to earn extra income, or sell their assets to generate cash to pay off their obligations, then they pay instead. That is it. All the theatrics, involved discussions and details of negotiations to ‘solve’ the debt crisis are simply about who will pay, how much and when.


Second is how conditions for profitable accumulation can be restored. The two classic mechanisms are the destruction of capital values and the increased exploitation of the workforce. Capital values can be destroyed through a collapse in asset and commodity prices. Those capitalists left standing can then buy means of production cheaply. Any new profit extracted is then measured over a smaller capital outlay, raising the rate of profit. A similar effect can be achieved by the political seizure of productive assets in other countries. This can risk conflict between rival powers, but that stopped neither the imperial adventure in Iraq, nor the latest in Libya. The other key mechanism for restoring profitability, increased exploitation of the workforce, is under way already. In many countries, real wages are falling as nominal wages rise less than inflation[6] and as companies impose onerous productivity deals.


Today we see a third important mechanism: the elimination of ‘waste’. By this I mean expenditures that capital can do without - those which do not directly contribute to profitability, either now or in the near future. Why bother educating workers when there are plenty of skilled and educated ones available already? Why bother to provide more than the absolute minimum of health and welfare services? In the public sector that is at the forefront of government spending curbs, a resetting of wages and conditions is under way, as well as cuts in jobs. In the formerly protected professions – both inside and outside state employment – the logic of capital will now aggressively ask: what’s the point of your job? There will be fewer state subsidies and less institutional protection for professional employment, and, ultimately, a proletarianisation of broad sections of the middle class. The latest example of this trend comes from Italy, whose government is coming back early from its summer holiday to implement austerity measures. These include a constitutional change that would force ‘closed professions’ to liberalise services, plus a ‘speeding up of welfare reforms, and other structural reforms designed to boost Italy’s stagnant economy’.[7]


Not many people think that life is easy, or that they are having a great time. But whatever they think now, the logic of the profit crisis demands a new wave of austerity as much as it will bring other forms of destruction in its wake. If the details of the debt piles in different countries are any guide, those living in the richer countries will feel the biggest shock to their living standards. So much more the pity then, that there are no anti-capitalist forces in these countries ready to counter the attack; and so much more the risk that the crisis of capitalism will be blamed on something else.

Tony Norfield, 8 August 2011


[1] Figures calculated from a chart in ‘Mapping global capital markets 2011’, McKinsey Global Institute, August 2011, p2.
[2] See ‘The Real US Debt Problem’, 26 July 2011 on this blog.
[3] In the event, from 2009, the BoE only bought only some £2bn of private sector assets, compared to £198bn of government bonds. However, it has kept interest rates unchanged at 0.5% since March 2009, despite its targeted measure of inflation (CPI at 2%) having been breached every month from December 2009, reaching as high as 4.5% - a negative real interest rate on this measure of 4%!
[4] There is a debate on the size of the ECB’s total exposure to potentially toxic assets, which some argue is in excess of €800bn. For example, see Der Spiegel, ‘Europe's Central Bad Bank’, 6 June 2011, which also notes that the ECB considers as eligible security for collateral a Portuguese bond that matures in roughly 8,000 years on 31 December 9999! The specific numbers in the text above are taken from ECB reports to July. The ECB’s reports do not give many country or asset details of its exposures.
[5] See ‘Anti-Bank Populism in the Imperial Heartland’ 5 July 2011 on this blog for details of the trend in US profitability and its link to the credit boom.
[6] Central banks in the US, UK and Europe are happy to ignore the higher-than-target inflation rates as long as there is no sign that wage growth will respond to the higher cost of living and real wages fall. Signs of rising wage demands were the reason the ECB raised interest rates in April and July this year.
[7] See Financial Times, ‘Italy agrees to liberalise economy’, 5 August 2011.

3 comments:

Anonymous said...

But isn't public debt good as long as it goes to fuel growth i.e., This goes into investment which provides returns and helps in growing economy.

Tony Norfield said...

The debt grows as a function of problems in private capital accumulation, and more public debt, after a point, will have less and less effect in fuelling growth. Instead, it only causes more trouble by creating a debt funding crisis. This is the experience of all major economies in recent decades. The origin of the problem of inadequate demand is inadequate profitabiity; it can't be solved by boosting demand. Hence the general reaction against expansionary fiscal policies policy now - though not consistently, since the alternative is to press ahead with austerity that hits demand. See my other articles on this blog, including 'Capitalist crisis, Keynesian delusions' for more details.

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