An Acute Global Shortage

Pub Philosopher writes:

About 350 people turned up to yesterday’s Rally Against Debt. The protesters were complaining about the high level of government debt being passed onto our children and demanding further public spending cuts to reduce the deficit, and thus the debt, more quickly. I know a couple of people who went along. I didn’t join them though. Why not? Because protesting against high public debt is really silly. Debt always increases during recessions and drops during periods of economic growth. We had high public debt after the two world wars and the great depression, which was reduced by the subsequent long period of economic growth. It then went up again in the 70s and early 80s, down again with the late 80s boom. It shot up again with the crash of the late Thatcher and early Major years, then down during the growth period under Ken Clarke’s chancellor ship and that of Gordon Brown in his frugal years. Finally, it shot back up to the levels of the postwar period when the UK, like everywhere else, experienced the worst financial crisis since the 1930s.

How much of this was Gordon Brown’s fault? Not much of it. His spending spree made things a bit worse but every other western country has seen its public debt soar. That’s what happens in recessions. GDP goes down, tax revenues reduce and governments borrow more to keep public services running and pay increased the welfare benefits brought about by greater unemployment. When the economy grows again, the reverse happens. No government has ever cut its way out of debt. Reducing spending helps but growing economies and increased tax revenues are more important. Even Sweden’s legendary escape from high public debt in the 1990s was achieved as much by growth as by cutting spending.

So protesting against debt in the wake of a recession is pointless. High public debt is just what happens during recessions. It’s unpleasant but inevitable. You might as well protest against the snow. But, if debt is inevitable during recessions, should governments attempt to pay it all off during boom times? This is where it starts to get really interesting. A couple of articles I found during the Twitter discussion on the Rally Against Debt offer a different perspective from the debt-is-all-down-to-feckless-governments line. Chris Dillow reminds us that, without public debt, the pensions and insurance industries would be stuffed. There are not enough private investment opportunities that offer the stability and guaranteed income provided by government bonds.

"Pension funds and insurance companies – who hold £294.1bn of the £994.9bn stock of gilts - would then face an acute shortage of long-term sterling safe assets. They could not transfer into corporate bonds, as this market is just not big enough. Nor would cash be a good alternative, as this carries reinvestment risk – the fact that you can’t be sure of its future returns. And of course equities and commodities are just far too volatile. (Anyone who thinks gold is a safe store of value is just a prat.) Worse still, fund would face a terrible shortage of inflation-proofed assets – as hardly any private sector companies issue index-linked debt. Institutions which have long-term liabilities – such as pension and insurance companies – would then be in a terrible mess. They would not have the assets which offer a safe match for their huge future liabilities."

So pension funds, insurance companies, banks and other investors need to lend money to governments to maintain some stability in their portfolios and to hedge against their more volatile risks. If states stopped borrowing money, the financial services industry would have a huge problem. Which is why, if they suggest paying off their national debts, governments are soon ‘persuaded’ to do otherwise. Someone who understands this very well is former investment banker Frances Coppola, whose blog I discovered yesterday and who is going straight onto the blogroll. Here, she describes how Australia was discouraged from paying down its debt:

"I read a fascinating post today by the excellent Australian blogger billy blog. In it he notes that even when the Australian government was running surpluses between 1996-2007, the international financial institutions pressured it to continue issuing debt – and it gave in to them. During that period the Australian government issued more debt than it needed but didn’t actually use the proceeds in any way that benefited the people of Australia. This intrigued me. Surely when a government is running a fiscal surplus it will pay off debt, won’t it? Well, apparently not. Why not?

Billy answers his own question at length in the blog, but to summarise here – the government continued to issue debt because the international financial markets needed it for liquidity. It had nothing to do with the people of Australia and everything to do with providing risk-free funds to speculators. And the taxpayers of Australia paid interest on that unnecessary debt."

Why would a democratically elected government borrow money from international financiers when it didn’t need to?

"Well, it’s all about the power of the big international financial institutions, and in particular the credit rating agencies, the IMF and the World Bank. Governments are terrified of them, and with good reason. The same institutions that want spending cuts to reduce deficits also want governments to issue debt. You might think this is an extraordinary example of doublethink on the part of the international institutions, but it isn’t really. Government debt is only useful to financial institutions if it is low-risk. Countries that run deficits are riskier than those that don’t, so the safest debt is of course that issued by countries that don’t run deficits – and they want lots of that debt, whether or not the country itself needs it.

To these institutions, the issuance of public debt has nothing whatsoever to do with deficit financing or public investment: its sole purpose is to ensure a plentiful supply of highly liquid, virtually risk-free funds for international speculation. So the international institutions apply immense coercive pressure to governments to reduce or eliminate deficits, thus reducing risk, while maintaining debt issues, thus ensuring liquidity in the international financial markets. Hence the Australian government’s bizarre behaviour."

The money men don’t want governments to run deficits that are so high that their debt becomes risky. That would defeat the object of investing in sovereign debt. The whole point of state debt is that it is low risk and provides stable investments. On the other hand, they don’t want governments to drastically reduce their levels of debt either because then there would not be enough state debt in which to invest. So the financiers bully governments that run high deficits for too long but they also bully governments that don’t issue enough debt. The point of state debt, therefore, is not to provide public services or welfare. The financiers couldn’t give a toss what governments do with the money they lend. No, whole the point of state debt is to feed the hungry beast of international finance.

The pensions industry provides an interesting case study. Go back a couple of decades and many governments of western countries provided state funded index linked pensions. Since then, many of these have been abolished or scaled back and replaced with private pension provision. However, the private pensions are still funded by the state in the form of interest payments on the bonds bought by pension funds. It’s rather like a PFI scheme. The people still get the benefits, after a fashion, and the state still pays. But, along the way, a few rich people get very much richer.
Some of the protesters at yesterday’s rally described the public debt as a giant Ponzi scheme but it’s actually more like a giant PFI scheme. The state borrows money from financiers and uses it to provide various services and pay welfare benefits. But that’s just by-the-by. The real point of the scheme is to provide a source of stable investment funds and to transfer wealth from a large number of taxpayers to a small number of very rich people.

Why wasn’t I at yesterday’s rally? I’m as uncomfortable as the next man with the level of state debt we now have but simplistic answers like more spending cuts ignore the causes of the problem. The Rally Against Debt took place outside the Houses of Parliament but that’s not where the real power lies. The strings are being pulled from the City and Wall Street and from small secluded offices all over the world by people we have never heard of. As Frances Coppola says:

"No international institution should coerce a democratically-elected government into taking actions that hurt its citizens, and no democratically-elected government should allow international institutions to dicate how it should run its economy. And above all, democratic governments should support each other in standing up to the demands of the international institutions."

But for that to happen we’d need politicians with balls. At the moment, there is an acute global shortage of such people.