These questions invite binary “Yes” or “No” responses. More considered approaches exist. We need to consider the economic consequences of debt repayment, structural and attitudinal causes and contributions, responsibility for debts both particular and general, beneficiaries and losers, and, how they may be prevented in the future. Also, can such enormous debts be paid?
This requires analysis and accurate, accessible language. In Economics and Finance, that which has different labels is sometimes not significantly different and that which is under one label has significant differences. For example, money consists mainly of credit creation since loans create deposits and loans are debts.
Debt is a form of relationship: financial activity connects and affects people.
The placing of relationships on a continuum going from symbiotic to parasitical is most informative. (Clarity-opacity, clarity-deception, knowledge-ignorance continuums/continua are important here too.)
Most people live and work in what can be labelled as the “real economy” where goods and services are produced and used, tangible capital formation occurs, labour is hired, productivity is boosted and most productive income consists of wages and profits. This is the bit of the overall economy which creates income and surplus. These can be referred to as “earnings.”
A few live and work in what could be labelled as the “financial economy” which is primarily associated with the acquisition and transfer of credit, real estate, financial instruments, insurance and the like. The “wealth” used by this bit comes from the “earnings” of the real economy. It is derived, indirect “wealth”. If it cannot get such from the “real economy”, it has none. And the “real economy” does require credit/debt.
It might appear that it is in the interests of the “financial economy” and the “real economy” to have a symbiotic relationship through which the “real economy” is buoyant and the “financial economy” securely sustainable and long term sustained. It might also appear that government would want the same symbiosis to provide a healthy tax basis and to benefit the generality of the population whose interests they have a duty to protect and are paid to protect.
Alas, it is not so.
Following the 2008 crash, “Faced with a choice between saving the “real” economy by writing down its debt burden or reimbursing the banks (and ultimately their bondholders and counterparties) for losses and defaults gone bad. The policy response of the US and European governments and their central banks was to save the banks and bondholders (who incidentally are the largest class of political campaign contributors). This policy preserved the remarkable gains that the “One Percent” had made, while keeping the debts in place for the”99 Percent”.” (Finance is not the Economy: Dirk Bezemer and Michael Hudson)
Is the current post 2008 policy of “Austerity” aka “Unanalysed Debt Repayment Intention” a continuation of this policy?
The general cause of the 2008 crash was the parasitic relationship of the “Financial Economy” with the “Real Economy”, for which Government and the Mainstream Media also have a significant responsibility. Another factor was/is a general deficiency in the understanding of the practices, theories and language of economics and finance.
What and how much has changed to prevent another?
* Steve Trevathan is chairperson of Lyme Regis and Marshwood Vale Liberal Democrats.
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35 Comments
Could we have a translation please ?
To call the financial sector “parasitic” because it depends on payments from others is like calling public services “parasitic”.
Also, the logic of those against financial services, even separating it from a so-called “real economy”, is to go back to the Gold Standard, eliminate mortgages, insurance policies, loans, pensions and investments and go back to surviving of piles of hard currency stored in a bank vault.
Financial advisers provide valuable tax, insurance, mortgage, investment and pensions advice. We can’t just demonise all this as “parasitic”. It is “the way back to the cave”, to quite Professor Brian Cox on being anti-expert.
It is a myth to say the US and European governments “saved the banks”. They saved our life savings and pensions which the banks were holding. Remember the queue outside Northern Rock?
To claim “The Banks” were saved (and not all of us) is a comforting delusion for those who need a simple demon to point to and who see themselves as St. George.
The problem with austerity is that it always disproportionately hits the folk at the lower end of the scale more than the 1% and the Philip Greens of this world who can become non-doms etc.,
Until the Lib Dems get real about that they will never have a convincing economic policy to present to the electorate. Whatever Clegg may say now, he failed to convince the electorate that he understood this. His book is not so much a mea culpa. more a mea self justaficio – hence 30% to 8% in the polls.
No, it isn’t working for most people and can’t work because it takes money out of the economy. It’s really very simple, no matter how rich one person is they are still not actually spend day to day what thousands or millions do. The point being that austerity is one of the things that adds downward pressure on people’s ability to spend which means that the housing market stagnates and the prices of goods have to drop etc. This is why you end up with towns full of pound shops and discount supermarkets. Also because people who advocate austerity tend to advocate low taxation to compensate the infra structure starts to crumble. Then more pressure is added because to compensate for lower spending power more people are required. The point is that Free movement of labour, low taxation and falling livings standards are the by products of adopting right-wing economic models when in truth most socially liberal and progressive countries tend to go for high wages and higher taxation.
Thank you for your interest and comments!
Here’s an attempt at a brief metaphorical translation! (The “real economy is the golden goose.)
If you starve the “golden goose” you will get fewer eggs.
(Don’t kill the goose that lays the golden eggs!)
Best wishes!
Steve Treveth, funny how for New Labour their “golden goose” was, the City!
I rest my case on the fallacy of this “financial services are parasitic” argument.
The cause of the 2008 bank crash was the excessive lending by banks to people and companies who were unable to keep up the repayments.
The value of the properties secured against the loans turned out to be lower than the debts. Consequently bank losses wiped out their equity capital and they would have been bust without a rescue by a stronger bank (like Lloyds of HBOS) or by a government injection of equity (eg RBS).
A consequential issue was the inability of the insurers to pay out on credit insurance claims when the banks’ bad debts materialised.
The solution is more prudent lending and for banks to hold more equity capital relative to their loans. This is what has happend but expect the same mistakes to be made in future decades.
A better question might be is austerity just a myth? From ukpublicspending.co.uk/recent_spending:
“UK public spending hit £200 billion in 1990 and £284 billion by 1995. Increases in public spending were modest in the late 1990s, reaching £338 billion in 2000. The early 2000s showed an acceleration in spending, breaching £500 billion in 2006. Then the financial crisis of 2008 took over, boosting public spending over £600 billion in 2009. Increases in public spending have moderated in the 2010s, but spending is expected to breach £800 billion in 2018. Viewed as %GDP, UK public spending shows a significant increase in the early 1990s……A decline in spending took place in the late 1990s…..to 34.6% of GDP by 2000. A modest increase in public spending started in the early 2000s, reaching 39% of GDP in 2007. Then the financial crisis of 2008 took over and boosted public spending to 45.47% of GDP in 2010. Steady declines in public spending are estimated for the remainder of the 2010s.”
So the fabled cuts are not that great and just reflect that we overspent beforehand when debt-inflated GDP was just assumed by the ‘experts’ to be earned income. A sensible government would have put the money aside for a rainy day. But hey they firmly believed the boom-bust cycle was over, based on hubris and shonky models.
I disagree with Barry about bank bailouts. It would have been far cheaper to guarantee savings and pensions thanks to fractional reserve banking meaning that loans were hugely greater than reserves. Banks were bailed out purely on the premise they would continue lending that money to businesses. In fact they didn’t, instead they just used it to continue speculating/gambling as before.
The simple and unequivocal answer, for Govt Debts in their own currency only, is NO!
When asking these kind of rhetorical questions it is usual to supply some kind of answer and explanation for that answer. But I have read the article 3 times now and I’m none the wiser about what the author actually thinks.
The reason that Government debts don’t have to be repaid is because they are issuers of currency. They can issue as much as they like and borrow back as much as they like from everyone else. They have to assume a technical debt so that we can all have financial assets in that currency. If they overdo it they’ll create too much inflation. If they underdo it the economy slides into recession.
According to some political pundits the post war generation should have been financially crippled having to repay war debts. The reality was different. We’d never had it so good. We were the lucky generation.
Each generation lives on what it can produce in its own economy. We can’t send anything back in time to repay the debts of previous generations, and barring some bizarre technical advance, neither will future generations. So this inter-generational argument (ie creating a condition of debt slavery for our grandchildren) is essentially bunkum.
Government debts are an essential part of the financial system.
Our party has to get to grips with economic theory because without a sound economic basis for policies to create the sort of society we want, we will laughed at. OK we’ll be laughed at anyway, but those in the know will start to treat us more seriously.
We need a new Keynes as well as a new Beveridge because David Raw is right. Over the years since Thatcher first arrived austerity has hit those at the bottom of the pile of our Western society. The structurally unemployed are left to fester, the walking sticks of the disabled have been kicked away and our world has become a much harsher place. No wonder so many people voted for “how it was before” in the EU referendum.
Barry is right, those of us with life savings and pensions were saved by propping up the banks, but the very low level of interest rates is affecting small savers badly while the wealthy are getting richer by the second. I also agree with Glenn: to have a thriving economy you need a large middle class who want to spend money on goods and services, partly to display their wealth but also to make their lives more comfortable. Looking at the years of aristocratic power, wealth was in the hands of a few vastly privileged people while the large majority lived in poverty. It was only with the rise of the middle classes that capitalism flourished.
I think our present tax and benefits system is leading towards the return of the aristocracy with all of the problems that brings including social unrest and revolution. This time there will be a much larger middle class but with reduced spending power as the cost of basic purchases like housing and white goods takes up most of their income. The vast majority living in poverty are likely to have a better standard of living than before, but I don’t think that is guaranteed because their homes won’t be maintained, even their present income doesn’t pay for heating and eating so this problem is likely to get worse and if they are ill they may be healed by an overstretched NHS but will lose earned income.
This is the opposite of the kind of society we want as Lib Dems so please will those who have commented knowledgably about economics, as well as Steve of course, please, please offer themselves as members of the economic policy working group. It’s time for a new Liberalism!
The UK Government does spend a significant amount of money on debt interest. Even if you exclude the money it owes itself via QE, the net cost of servicing UK Government debt was about £30 billion in 2015. That’s a lot, and can get bigger if Government debt grows and/or interest rates rise. So you can’t pretend Government debt isn’t real, or somehow doesn’t count.
Good article, and whilst a noneconomist like me can’t pretend to follow everything – If you just go off and demand a translation, then you’re really not trying hard enough to justify an involvement in politics!
“Most people live and work in what can be labelled as the “real economy” where goods and services are produced and used … A few live and work in what could be labelled as the “financial economy””
Yes, but (as I’m sure the author is aware), the capital value of the “real economy” – things like stocks and shares, which represent real productive assets – is in fact dwarfed by the capital value of the “financial economy” – the instruments of speculation such as credit-default swaps, collateralised debt obligations, etcetera, all the clever schemes which caused the 2008 crash. And will probably causes future crashes, too.
https://www.amazon.co.uk/Economic-Price-Having-Lasting-Prosperity/dp/1444757121/ref=sr_1_1?s=books&ie=UTF8&qid=1473076568&sr=1-1
@Nick Baird,
The yields on 2 year, 10 year, and 30 year Treasury bonds (gilts) is about, 0.1%, 0.7% and 1.3% respectively. That’s not at all excessive or in any way a problem for Govt to pay.
Theoretically the government could force these down to zero or even into negative territory by introducing more QE. QE is really just a way of government creating its own money interest free. Governments, unlike you and I, can choose interest rates to be whatever it likes them to be.
But this would mean that pensioners would get nothing, or even less than nothing, in their National Savings accounts. Do we really want to do this?
Although £30 billion sounds a lot, it is essentially money which is going out into the economy and is capable of being spent. And we do need more spending.
The GDP is approx £2.1 trillion. Which means we £2.1 trillion of spending to keep the economy going.
Aren’t there two aspects to austerity? Government borrowing and spending by everyone?
It is possible for government to borrow less and for more money to circulate if people and companies spend money in the bank or borrow low interest rate money.
@ Barry Snelson,
“It is a myth to say the US and European governments ‘saved the banks’. They saved our life savings and pensions which the banks were holding.”
Is it ? The second sentence cannot be used as a justification for the first. The US and European governments indeed did save their banks. Except for Lehman Bros and one or two others perhaps!
They could instead have saved pensions and life savings directly, but still let the banks go bust, in the same way as did the Icelandic government. They’d simply have issued everyone with a Government cheque from proceeds QE rather than giving it to the banks. It would have been a good deal cheaper than the £375 they ended up spending!
I have to accept that there were good arguments for doing it the way Govts did. And they’d have been made forcefully by the banks themslves. They needed their bacon saving and they knew it only too well!
Just a few orders of magnitude out! Should be £375 billion!!
PeterM
You seem to be suggesting the solution to all our problems is to spend a lot more borrowed or just created-out-of-thin-air money and don’t worry about paying any of it back. This is often called ‘Voodoo economics’ or ‘helicopter money’ and such thinking is what brought about the debt bubbles and subsequent financial crisis in the first place. Surely you can do better than that!
My thanks to all who have commented, especially to those who have taken the time and effort to do so at length!
Thought and discussion on economics and finance appear to be crucial for our World, Nation and Party. These could lead to information and discussion papers from which a small set of clear and concise policies could be developed. This
might provide some commonality of assumptions and premises.
We also need to work on the language of economics/finance for if there is obscurity of language their is little/no chance of clarity and effectiveness of policy.
This brings us to the roles of the mainstream media and government in keeping us accurately informed on these matters.
Far too much seems to be encrypted in language and concept.
“The price of economic-financial well-being is eternal vigilance”.
Eddie Sammon – the article misstates the point about “parasitic”.
The distinction shouldn’t be between productive and services or financial but between ‘inclusive’ and ‘extractive’ to use the language of Acemoglu and Robinson’s excellent book.
Inclusive’ means roughly working towards the greater good of all, extractive means just taking for private / sectional advantage.
The City / Wall street are mainly now extractive, financing speculation but not industry and so on.
Not everyone in the financial sector is like that – it’s a case of if the cap fits – but I fear most are.
The thing about debt is that it has to be supported by an expected future cash flow. For a mortgage that’s future income, for factory machinery it’s profits on the future sales it enables.
Speculation doesn’t create future cash flows – only winners and
losers which is wholly different (see earlier comment).
Despite this banks are incentivised to finance speculation because it’s hugely profitable and the inevitable collapse comes only after several years when those responsible have retired as millionaires.
Any detective worth his salt would create a timeline of the crime and here the key insight is that the money was already lost BEFORE 2008 though the loss only crystallized AFTER 2008.
Austerity is all about who should bear the losses. The financial oligarchs don’t want to (!!!) and are sufficiently powerful given the weak liberal /left to get away with it
Gordon, maybe I’m wrong, but I see speculation as good for society because it creates more accurate pricing. If people can borrow to buy then arguably they should be able to borrow to sell (called shorting, for those unaware).
I also think asset-allocation in investment management is good for society because it ensures as best as possible that capital is being put to use which will benefit the overall economy.
I don’t believe in the Efficient Market Hypothesis (not at the extreme end anyway), I’m just saying overall I don’t see a lot of these activities as bad. Regards
I never saw the financial crash as being about speculation as such. What it seemed to be about to me is the tendency of debt to look like profit on the books until it is recalled and it turns out that a lot of people were not earning enough money to pay up.
To me it seems like governments are using austerity to shift the balance from public debt to private debt and are trying to re-inflate a bubble dotted with pinholes. I dunno. I’m not an economist, but that’s what it looks like to me.
Eddie Sammon – what the financial markets are largely up to has become very divorced from the business of ‘price discovery’ to get more accurate prices and also from the entirely proper activity of asset allocation within a portfolio of investor’s funds.
Tellingly, it is widely believed that ALL significant financial and commodity markets are, umm, ‘manipulated’ by insiders at the expense of their customers. Notorious examples include Libor and forex and ‘sliced and diced’ mortgages. Participants say the gold market is entirely false.
As has been noted nothing like this would be permitted in a Nevada casino – the Gaming Commission is a far stricter regulator than HMG’s powerless appointees.
Finally, as Keynes said (I don’t have exact quote to hand but something like) a bit of speculation is like bubbles on a stream but when a casino dominates how a society allocates capital then trouble will follow.
Hi Gordon, I agree insider trading and market manipulation are too common. On another time I will elaborate what I think the problems in UK financial services are (particularly financial advice). To cut a long story short: the regulation is tough, but it’s not being enforced because it would get rid of 90% of UK financial advisers. We need a new deal, but the current situation is ridiculous.
Glenn – you’re on the right track.
Every loan has a risk of default, that the borrower will by bad luck or whatever not be able to make some or all of the repayments. So naturally the key skill in lending is to accurately assess that risk and only lend accordingly, accepting that even the most careful lender will sometimes get it wrong. And of course if they do get it wrong that might not appear for several years.
But with property one of the main determinants of price is how much banks will lend on it so there can be – and was – a general increase in prices that was unconnected from the real world and so eventually unsustainable.
The process is – or should be – limited by the supply of good borrowers but when that ran out lenders ventured into increasingly speculative territory, lending in some cases to people they knew could never repay just to keep the party going. At that point epic losses became inevitable
One of the drivers of the last crash was an irrational belief that either house rising house prices would carry on rising, or that the speculators would be clever enough to spot the crash in advance and get out before they got hurt. Both were wrong.
With house prices rising strongly, mortgage lenders didn’t care too much how credit worthy mortgage applicants were. As long as they met the repayments for long enough that the house became worth significantly more, it didn’t matter. If the borrower then defaulted then either the lender could repossess the house and sell it for more than the mortgage value, or the borrower would sell it first and pay back the loan plus termination fees.
It was a way for banks to cash in on rising house prices, and it worked out great for everyone right up until suddenly it didn’t.
We hear of public sector debt as an enormous sum that has to be paid at some point in the future. In fact it is made up of a plethora of treasury bonds that are constantly being paid and re-issued, and as long as the total debt does not get out of hand (interest payments become too expensive), there is nothing wrong (what matters is the debt-to-GDP ratio, which in the UK is perfectly sustainable despite the ideological obsessions of the Tories). A lot of this debt is pension liability, so as long a we have a state pension and treasury bonds as a secure vehicle for pension saving, we will always have public debt. As the country ages and people live longer in retirement, the total debt will naturally rise, but this is being countered by a higher retirement age.
@ Andrew Toye,
You’re mainly on the right track but I should just say that pension liabilities aren’t included in the National debt.
There are those who argue they should be, and further suggest the Government should put money aside to meet future commitments. However this is to misunderstand the IOU nature of modern money. It may make sense for anyone else but the issuer of IOUs to save them up for future use, but it doesn’t make any sense for anyone to save up their own IOUs.
The only way the government can meet future liabilities to a growing elderly and retired generation, is to ensure that the future economy is in in good shape and can produce enough of the real things that are needed for their support.
Thank you all again for your time and effort in creating an interesting and informative conversation!
Does anyone have any thoughts on how another crash can be prevented?
Are there any ways in which the proportions and attributes relating to the “real” and “financial” economies, can be calibrated?
@ Steve,
“Does anyone have any thoughts on how another crash can be prevented?”
Firstly we need to decide if the last crash was caused by the build up of too much public sector debt, which doesn’t have to be repaid, or too much private sector debt, which does.
If we persist in thinking that it’s the former, then there’s no hope! Too much public sector debt can produce too much inflation. That’s all. Too much private sector debt can also produce inflation in the early stages as more borrowing leads to more spending. But as private debt levels build up, spending falls, and there can be a 1929 or 2008 style bust if there is a bubble in asset prices. Either the stock market or property.
PS You might want to Google Prof Michael Hudson’s work on the F.I.R.E. (Finance, Insurance and Real Estate) economy. I’m not sure I totally agree with him but he has the best academic credentials on this topic.
Earlier this year three IMF researchers published an article Neoliberalism: Oversold? I do not have the article here, only comment on it, and there is acknowledgement of the benefits of increased trade. But apparently after analysing the impact of the main policies underpinning global free markets there were some “disquieting conclusions”. Instead of delivering growth some neoliberal policies have increased inequality, in turn jeopardising durable expansion” “Is there really a defensible case for countries like Germany, the UK or US to pay down public debt?” “No”. The theory is that austerity gives the private sector confidence, In practice this did not happen. “episodes of fiscal consolidation have been followed, on average , by drops rather than expansions in output”
“Policymakers….must be guided not by faith, but by evidence of what worked”.
“That which works is true.” [Dewey]
M. Hudson is indeed an economist to heed and he is a comfortable read. “Killing the Host” is most relevant.
Here is a”gold standard gobbet” from his “Super Imperialism: The Origin and Fundamentals of American Imperialism”.
“In August 1971—[T]]he key-currency standard based on the dollar’s convertibility into gold was dead.—But instead of US citizens being taxed or US capital markets being obliged to finance the rising federal deficit, foreign economies were obliged to buy the new Treasury bonds. America’s cold war spending thus became a tax on foreigners. It was their central banks who financed the costs of the war in Southeast Asia.”
@Steve,
Michael Hudson has some interesting ideas, but I can’t see how his statement that “foreign economies were obliged to buy the new Treasury bonds” can be right. The Americans didn’t force anyone to buy their bonds.
If countries wished to conduct balanced trade there was no need to buy any bonds. The need only arose when they wished, like Germany, to supply the Americans with more goods and services than they received in return. The Germans wanted to build up this store of US dollars in the form US Treasury bonds. It was entirely their choice.
@pm 2001 Thank you for your interesting comment re Mr Hudson.
If he is incorrect, does this affect the validity of his general comments on the international consequences of the “off gold ” action of Mr Nixon in1971? If so, to what extent?
Best wishes!