Twilight of the investors

     A striking symptom of the unending global financial crisis (GFC) has been the announcement by Union Bank of Switzerland (UBS) on 30 October of 10,000 staff redundancies across its world-wide operations – almost 20 per cent of its existing personnel. In London, where some 3,000 of these lay-offs have occurred, the development has been made all the more dramatic by the fact that many of those affected only learned of their fate when they arrived at the office to find that their passes had been disabled and they were given a letter informing them of their suspension on full pay (pending termination) before being escorted off the premises by security staff. According to press reports the reason for this seemingly brutal procedure was the management’s fear that, should these individuals be allowed further access to their computer terminals they might feel they now had nothing to lose from engaging in reckless trading, either in the hope of making one last killing for themselves or else, out of spite, to saddle the bank with massive extra losses. Such worries seem all too understandable in the light of the current fraud trial of an ex-UBS London trader in connection with a loss of $2.3 billion allegedly resulting from his dealing, although the defendant claims his bets well above the defined risk limits were placed with the encouragement of his superiors.

     Nothing could better symbolise the terminal decadence of the financialised capitalist economy than this sordid episode. It demonstrates graphically both the climate of dishonesty and mistrust now pervading the investment banking industry and its utter abandonment of any notion that it exists to support economically viable productive investments in favour of a purely parasitic casino culture. While some might suggest that this tendency is somehow attributable to a spontaneous outbreak of moral decay – whether in the financial sector or more generally – such a claim would be no more plausible now than when it was used to explain the Enron and numerous other financial scandals that occurred before and after the bursting of the “dotcom” bubble over 10 years ago. Indeed that event can now be seen to have marked the ending of the prolonged global stock market boom that began in the early 1980s, as equity prices have been declining or stagnating ever since and in real (inflation-adjusted) terms now stand far below their peak in 2000.

     Rather what is now becoming inescapable is the ever greater impossibility of making sufficient returns on investment – as reflected in the level of operating profits relative to capital employed – to satisfy the competitive markets other than by reckless gambling, a requirement made inevitable by the classic cyclical implosion of the corporate sector under the weight of excess accumulated capital. This perception is reflected in a recent report in the Financial Times (8 November) that a number of City institutions have pronounced that the “cult of the equity” is dead or dying, claims that echo an earlier FT article by Samuel Brittan – The End of the Cult of the Equity (2005).

     This recognition is also mirrored in the declining share of equities in the total investment holdings of UK pension funds which, at under 40 per cent, is now below that of fixed interest securities (bonds) for the first time ever. This does not mean, it should be stressed, that bonds are viewed by the market as an attractive investment, but rather that they may be preferred by pension funds desperate for the higher yield offered by speculative, but correspondingly more risky, “junk” bonds – or else simply that bonds in general may be thought less likely to experience a sudden collapse in value such as that which affected equities in the 18 months to 2009, when the benchmark S&P 500 index fell by almost 60 per cent. However, given that the market price of corporate bonds is ultimately just as dependent on the value of the underlying assets as are equities, such a belief in their relative safety is almost certainly misplaced, as noted in yet another FT article (A false sense of security – 19 November). Likewise the high prices of many government bonds – and correspondingly low interest rates – can hardly be seen as sustainable when all the Western governments issuing them are essentially insolvent and can only maintain such market valuations by virtue of money printing and other blatant forms of manipulation.

     The implications of these developments are momentous, though little understood outside a rather small circle of the more clear-eyed market observers and investors – not least because of the huge vested interest in sustaining public belief in the continued viability of long-term investment in the market. The size and power of this vested interest has been growing over the last 60 years, ever since Wall Street (followed by the City of London) began to promote the idea of the benefits of saving through investment institutions such as mutual or pension funds. Its genesis, it should be noted, coincided with the post-World War II economic boom giving rise to unprecedentedly rapid sustained growth in the 1950s and 60s. Once this came to an end with the onset of the first global post-war recession in 1974-5 it might have been suspected that the “cult of the equity” would have a limited shelf life. By that time, however, the economies of the US and much of the industrialised world were already too closely tied to the fate of the overly powerful financial sector – on which the livelihoods of many millions had in any case come to depend – for there to be any question of calling this model into question. Instead it was determined, if only by default, that policy would be directed towards maintaining the value of financial securities and the buoyancy of financial markets at all costs.

     Over the subsequent four decades the constant refrain of official propaganda has been that prosperity would be revived – and reflected in steadily rising stock market values – if only appropriate policies of market liberalisation (including globalisation) were pursued, thus supposedly permitting renewed growth of investment and output (GDP). The fact that, despite the general implementation of such policies, the sustained recovery in growth has persistently failed to happen has been constantly glossed over by mainstream commentators as well as governments – even to the point of ignoring or denying the reality of a steady long-term decline in real global GDP growth rates since the 1970s. At the same time, as in previous world financial crises – such as that precipitated by the Wall Street Crash of 1929 – an increasingly dominant part has been played by speculative investment, which essentially means the buying and selling of existing assets rather than creating new productive capacity. Such activity – defined by defenders of the status quo as “wealth creation” but more aptly characterised by Lord Turner of the Financial Services Authority as “socially useless” – has been greatly facilitated by the great liberalisation of financial markets that has occurred since the 1980s. Indeed it was precisely thanks to this liberalisation – involving the removal of restrictions which had been put in place in the 1930s to prevent the very type of dangerous risk taking that had led to the Wall Street Crash – that the global stock market boom of 1982-2000 was able to happen in spite of persistent stagnation in output.

     Ignoring these growing symptoms of economic failure and systemic dysfunction since the 1970s, propagandists for the ruling élite, particularly under the Thatcher régime in Britain, have promoted the idea of “popular capitalism” and a “property-owning democracy”, concepts that were quite easy to sell politically in the 1980s as the sustained stock market boom was taking hold and belief in more state-centred ideologies was weakened – not least by the terminal failure of the Soviet model. However, since the start of the new century, which coincided with the end of the market boom, it has become more and more obvious that investing in financial securities of any kind offers no secure route to a prosperous retirement for anyone – all the more so as the world is faced with many years of global economic stagnation before its huge debts can be unwound or written off.

     The reality of bleak investment prospects was evidently grasped – even before the onset of the GFC in 2008 – by the Pensions Commission reporting to Britain’s Labour government in 2005 on how to resolve the mounting “pensions crisis”. For it was forced to recognise that the sacred promise of the private funded pensions industry – that it could guarantee an adequate level of retirement income to contributing individuals – was soon to become a thing of the past. Yet rather than drawing the obvious inference – that the model of funded pensions was always doomed to failure and was thus an idea whose time should never have come – the Commission felt politically compelled (in the interests of the City institutions) to pretend that people should still be encouraged to save for their retirement through funded schemes, albeit ones that would offer no guarantee of any level of pension. At the same time the Commission was forced to recognise that non-funded (pay-as-you-go) pension schemes such as the vast majority of occupational schemes in the public sector were inherently more viable than funded ones, although subsequently successive governments (egged on by the City and with little resistance from the unions) have done their best to undermine them.

     As the global outlook darkens further, both market players and the authorities are becoming ever more shameless and irresponsible in their efforts to avert systemic collapse by rigging markets – through “quantitative easing” (money printing by any other name), manipulating LIBOR, stock markets and energy and other commodity markets – or turning a blind eye to other forms of fraud (mis-selling of payment protection insurance and interest rate swaps). Yet this struggle to hide the reality of a generalised collapse in the market worth of corporate assets – and indeed of the entire capitalist profits system – is now increasingly revealed to be as futile as it is criminal. Hence, as investors become an endangered species, thousands more City traders may well already be wondering, as they leave their office in the evening, whether their passes will still work when they return the next day.

21 November 2012

Energy: The Ultimate Case of Capitalist Dysfunction

In the last instalment we described how since the 1970s the capitalist economic model has become progressively more maladjusted in a world of transformational technological change which is tending to make it as obsolete as the feudal model based on pre-industrial technology became at the start of the Industrial Revolution two centuries ago. However, a glaring difference between the situation now and at the start of the 19th century is that throughout the world the class with a vested interest in the survival of the existing (capitalist) order is still overwhelmingly dominant, whereas 200 years ago the then ruling élite (the landed aristocracy) were increasingly being challenged by the rising bourgeoisie.

Because of their continued dominance – based on their disproportionately huge share of global wealth and income – this group still retains almost total control of the political agenda via its virtual monopoly of the mainstream media (even though this position is now being progressively eroded by the growth of the internet and social media), not to mention the persistence of corrupt structures of political party funding and lobbying which ensure that money talks loudest in public discourse. Hence it is all too easy for big business to disseminate propaganda favouring its interests in the channels that most strongly influence public policy.

Thanks to this influence it has been possible for the very substantial vested interest comprising the global energy industry – representing not only the major oil companies but leading OPEC states as well – to conduct a sustained campaign of misinformation to try and discredit the overwhelming scientific evidence that man-made global warming – resulting primarily from exponentially growing consumption of fossil fuels – is a reality which may pose an existential threat to human society in much of the planet. While the strength of the evidence is such that this campaign of denial has only been partly successful, it has undoubtedly had the effect of sustaining a high degree of “climate change scepticism” among the global public, thereby weakening and delaying moves towards radical change in the pattern of energy use.

Furthermore, to the extent that the giants of the energy industry – and the rest of the traditional corporate sector (including big finance) – have found it necessary to “go green”, by promoting low-carbon forms of energy supply, they have not done so in ways best designed to serve the public interest. Thus rather than support policies designed to limit or phase out particular types of operation, such as coal-fired power generation, corporate interests have given priority to the seriously deficient mechanism of “cap-and-trade”, based on the idea that it is possible to reduce global production of carbon emissions by means of a market mechanism, namely trading in permits to pollute within an officially mandated emissions ceiling. Although this system has had some marginal benefits – mainly in facilitating investments that limit the growth of emissions in developing countries through the Clean Development Mechanism (CDM) – the overall experience of carbon trading to date (largely confined to the European Union) suggests it is highly unlikely to lead to significant reductions in emissions or promote the most cost-effective choices. Indeed it has been shown there is a danger of it having precisely the opposite effect if the incentives are badly calibrated. An example of this is provided by a widely used coolant gas whose by-product in the form of a waste gas resulting from the manufacturing process produces a massive amount of global warming – the destruction of which is accordingly assigned an extremely high value in terms of carbon credits saleable on international markets under the CDM. Hence the unintended result of this incentive has been a huge increase in output of the coolant gas in China and India – far beyond the demand for it simply in order to make profits from the excessive credits available on the harmful by-product (see Profits on Carbon Credit Drive Output of a Harmful Gas by Elisabeth Rosenthal and Andrew W. Lehren. New York Times, 8 August 2012).

Such counter-productive distortions illustrate the perverse rationale of the global ruling élite in trying to ensure that any new initiatives or activities aimed at limiting potentially harmful forms of production and consumption must as far as possible be designed to provide opportunities for the investment of profit-seeking capital and should extend rather than restrict the scope for market trading of assets and resources.

But arguably the most pernicious way in which the profit-maximising model works to subvert and defeat the public interest in the effort to rationalise global energy production and consumption is its tendency to promote those investments and technologies which are the most profitable for the private sector but which constitute the least cost-effective allocation of resources from the public’s perspective. This is reflected in the extent to which publicly supported programmes of research and investment (heavily influenced by corporate interests) tend to

  1. Give low priority to supporting energy conservation – notably in respect of the design and refurbishment of buildings – which has the potential to meet up to half the requirements for emissions reductions in the industrialised world by 2050 at a far lower capital cost than would be absorbed by investment in renewable energy sources on a scale sufficient to achieve the same outcome. (This problem has clearly been exacerbated by the privatisation of so many energy utilities, giving them a vested interest in expanding rather than restricting demand – as confirmed by the fact that the utilities most effective in supporting energy-saving investments in industry are those which, as in Canada, have remained largely in public ownership);

  2. Prioritise those forms of renewable / low carbon energy production that require relatively high levels of capital investment, thus providing outlets for the maximum amount of excess capital (surplus value) which will otherwise continue to weigh down corporate balance sheets and financial markets. The advantage of such outlets to investors is that the public interest in curbing carbon emissions is seen to justify high levels of public subsidy to energy utilities. This explains why the strategy of the UK and other OECD governments puts heavy emphasis on conventional nuclear and wind power despite – or perhaps precisely because of – the fact that they not only absorb high levels of fixed investment but are of such doubtful cost-effectiveness at market prices that projects can only be undertaken with the aid of a more or less indefinite state subsidy guaranteeing investors’ returns. (To the implied extra financial costs, moreover, must be added the environmental costs associated with both wind and nuclear power, which may be huge if scarcely quantifiable).

The criminal irresponsibility of pursuing such damaging strategies is apparent once it is understood that far more rational and efficient approaches to providing for future energy needs – while at the same time meeting the challenge of global warming – are increasingly available. Yet the existence of such options could scarcely be grasped from information provided by the mainstream corporate media; hence there is little awareness of the potential benefits to the planet, to consumers and to taxpayers alike from applying alternative technologies that have lately been developed. These should include:

  • Design / adaptation of buildings (to be encouraged through regulation and / or fiscal incentives) so as to make them self-sufficient in energy for space and water heating. This would be achieved both through a) extraction of heat from the sub-soil (geo-exchange) and b) improved building materials and insulation;

  • Development of small-scale electricity generation based on local / domestic installations (mainly solar), largely eliminating fossil-fuel dependence for power generation as well as minimising distribution costs (expensive national grid networks would become increasingly redundant);

  • Improvements in energy storage systems – batteries, hydrogen-based fuel cells using renewable energy – which could also render electric-powered transport systems much more competitive.

The adoption of such economically and socially desirable technologies would be greatly accelerated if more official support were provided to enhancing their commercial competitiveness. Given the active (if covert) hostility to such innovation from the existing corporate sector – for the reasons mentioned above – this would require the allocation of public resources to properly targeted research and development along with appropriately designed incentives to users – e.g. tax breaks for the capital cost of retro-fitting buildings for geo-exchange. The cost of such support would be a small fraction of that currently being devoted annually to subsidies to nuclear and wind energy.

While the overall scale of potential savings – in terms of reduced expenditure on investment in infrastructure as well as fossil-fuel consumption – is difficult to quantify a priori, particularly bearing in mind the continuing rapid pace of innovation, it is likely to be vast, especially once the qualitative benefits to the environment are factored in. One such saving might be the cancellation of the proposal for the mandatory installation of “smart meters” in all homes in the European Union projected to start in 2014, the benefits of which will probably far exceed the costs of at least 150 billion as consumers become less and less dependent on mains electricity supply thanks to the type of changes in supply sources outlined above. This prospect is of course what terrifies the existing energy corporates the most, which is why they and their political allies will continue striving to distort the debate with misinformation so as to foist wasteful investment and excessive use of fossil fuels (not to mention uranium) on the public for as long as possible. Equally, for those who have long sought to place some check on the enormously opaque and unaccountable power of the global energy conglomerates and OPEC this gathering revolution in the sector represents a welcome opportunity to advance economic democracy by empowering consumers and local communities alike.

14 August 2012

The tide of history and capitalist denial

Marx and Engels famously explained in the Communist Manifesto (1848) that the emergence of capitalism – or as they then called it “the bourgeois mode of production” – as the dominant economic model during the Industrial Revolution was the inevitable result of the adoption of new technology (steam-powered mechanisation) which totally superseded and marginalised pre-industrial technology. Although not all their contemporaries welcomed this development as much as they did – as a transition to the proletarian revolution they eagerly anticipated – few then or since have seriously disputed their analysis of how it came about.

Despite this implicit general recognition that capitalism became dominant largely as a result of a technological revolution some 200 years ago the ruling global élites of today – and the vast majority of economists and analysts directly or indirectly in their pay – seem unwilling or unable to draw the moral of what this implies for economic development in the 21st century. Hence they are apparently refusing to recognise that what the first industrial revolution did to the handloom – or indeed the “second” industrial revolution of a century later did to horse-drawn transport – the so-called Third Industrial Revolution of today has begun to do to the established manufacturing and other technologies inherited from the post-World War II era or earlier.

In fact this seeming resistance to change cannot be ascribed to today’s leaders of capitalism being either insensitive or ideologically resistant to technological change. Indeed it is their proud claim that the capitalist economic model has been the most crucial factor in bringing to fruition the unprecedented advances in human wealth and welfare made possible by technological change in the last 200 years. On the other hand they have long been aware that technological innovation is very much a two-edged sword from their perspective, threatening the viability of existing investments while at the same time offering outlets for investment in new products. That is why large corporations have always sought to control and (if necessary) restrict the rate of innovation in such a way as to maximise the rate of return on both their existing and new investments. Their ability to do this was for a long time enhanced by the fact that ability to compete in many areas of manufacturing still depended on large-scale mass production, requiring substantial capital investment – a reality which constituted a serious barrier to the entry of new competitors. Such was the basis of the model of corporate management dubbed the “planning system” by J.K. Galbraith in the 1960s, which enabled multinationals such as General Motors to maintain global market dominance throughout the immediate post-war period and beyond.

Increasingly since the 1980s, however, this privileged position of traditionally dominant global corporations has started to crumble in the face of competitive forces they can no longer control. While there are diverse factors contributing to this tendency, none has been more significant than the accelerated pace of technological change involving electronics, digitisation and advanced materials (such as carbon fibre). This is because

  1. The new technologies often require relatively small amounts of investment in fixed capital (compared with traditional factories based on mass production). Hence existing producers heavily invested in older technology tend to be more vulnerable to competition from start-ups which correspondingly find fewer barriers to entry.

  2. The speed of innovation can be such that investments in new technology are increasingly perceived as too risky – i.e. liable to be rapidly superseded by the latest “new thing” – particularly as the rate of return demanded by investors has been pushed ever higher by the cyclical forces of the competitive globalised market.

The effect of these forces has been to drive the investible funds of capitalists away from the dwindling opportunities in productive investment in favour of either a) purely speculative investment (e.g. the mergers and acquisitions boom facilitated by the great financial liberalisation of the 1980s or the more recent real estate and other bubbles much assisted by the repeal of the US Glass-Steagall Act in 1999) or b) investment in utilities or public infrastructure where competition is typically limited and high returns can be more or less assured by collusion with “captured” state regulators. These distortions, underpinned by the “moral hazard” stemming from states underwriting the financial sector as “lenders of last resort” and the political corruption enabling private investors to plunder the public sector at will, have been behind the huge misallocation of resources leading to the ongoing implosion of the financial markets since 2008.

In considering how the world is to emerge from this disaster we must look beyond the immediate problem of the financial crisis, which can only end – as argued in the first instalment of this blog – with generalised debt default and mass destruction of capital values. In order to prevent such a calamity ever occurring again it will be necessary to ensure that a future economic model is structured so as to avoid recreating the unnecessary and distorting treadmill of mindless accumulation which has brought us the ultimate capitalist catastrophe. At the same time we must respond to the ever more pressing need to limit, if not reverse, the threat to the biosphere posed by the compulsion perpetually to expand production and consumption – on a finite planet with a still exponentially rising population – inherent in the existing capitalist model. Fortunately the possibilities opened up by recent technological advances – including those referred to above as the “Third Industrial Revolution” – give us the chance to meet the needs of the world’s population at much lower cost and with less use of scarce resources than at present.

Yet while this is good news for the planet and the global community as a whole, it is clearly bad news for those still dominant groups who would restore a world of capitalist “business as usual”. Naturally their central preoccupation remains to maximise the opportunities for investing their capital at an acceptable rate of return. But as such opportunities continue to shrink – not only under the impact of changing technology but because the financial sector’s scope for reckless speculation has inevitably been curbed in the wake of the crisis – the perception has grown that almost the only promising outlets are ones in public infrastructure (whether nominally privatised or not) where competition is limited and / or the level of returns can be effectively guaranteed by state subsidy. Quite apart from the potential added burden to taxpayers at a time of extreme fiscal stringency, such pressures are clearly tending to result in huge misallocations of resources compounding those that have already brought the financial sector (and the entire global economy) to its present ruinous pass.

The main manifestations of this tendency since the bursting of the real estate bubble in 2007 have been in the form of investment in public infrastructure of all kinds, involving private sector capital underpinned by state subsidy or guaranteed revenue streams. Perhaps the most conspicuous recent example of this in Britain is the proposed high-speed railway (HS2) intended to link London and Birmingham – projected to cost well over £30 billion – the economic viability of which is extremely doubtful. Yet the world is already littered with similar white elephants – including several airports in Spain which will never open and roads and railways to nowhere in Japan and China.

Nowhere have the distorting effects of this tendency raised bigger threats to the public interest – both financial and environmental – than in the energy sector, as it struggles to come to terms with the demands of the low carbon economy of the future. This issue will be addressed in detail in the next instalment of this blog.

Set against the historic trend of technological evolution as described above, such perverse acts of waste and vandalism increasingly appear like desperate attempts to resist the tide of history. The next 10 years will be crucial in determining whether this struggle ends in ruinous global conflict and catastrophe (casting doubt on the survival of the human species) or the beginnings of a new era for global society in which new technology is at last allowed to benefit the community as a whole – both in terms of adequate living standards for all and a rational and sustainable management of the earth’s finite resources – without the need for endless growth of investment and production.

2 July 2012

The Debt Disaster and Keynesian Delusions

It is generally recognised that the most intractable symptom of the global financial crisis which has gripped the world since 2007 is the huge burden of accumulated debt weighing on the economy, particularly in the industrialised (OECD) countries.

 

While the precise volume of global debt outstanding is hard to pin down – particularly if one takes account of the potentially hundreds of trillions of dollars of contingent liabilities represented by Credit Default Swaps and other derivatives (the actual amount of which can only be guessed because of the opaque nature of the markets) – it is a fact that accumulated debt (public and private) relative to GDP now far exceeds any previously recorded level. A recent report by McKinsey Global Institute (MGI) indicates that total debt (of households and financial and non-financial corporations as well as the public sector) in the 10 largest developed countries (USA, Japan, Germany, France, Italy, Spain, Canada, Australia, South Korea and UK) had risen to an average level equal to at least 300 per cent of GDP by mid-2011 – which is close to double the average ratio prevailing in 19901 , and much greater than anything recorded earlier It is important to note, moreover, that public sector debt accounts on average for no more than about 30 percent of the total debt outstanding – although in most cases its share has sharply increased since 2008 because of the need to bail out insolvent banks (virtually all in the private sector). This aspect of the MGI findings is all the more significant in that it serves to emphasise (if inadvertently) that the deepening fiscal crisis of states is mainly a symptom of the insolvency of the private financial sector, which had been allowed to run up unsustainable mountains of debt prior to 2007, only to dump them in the lap of the state in its capacity of “lender of last resort”. This poses in stark relief the reality that these massive bad debts have now brought the states themselves to the brink of insolvency, with nobody to bail them out as they have bailed out the private sector.

 

 

At the same time the cost of servicing all this debt at anything like a commercial rate of interest is also at record levels relative to GDP and is far beyond the capacity of the economy to meet it without either reducing most of the population to absolute destitution or inducing total financial collapse – although for the moment this problem is being substantially concealed by the artificial suppression of interest rates.

 

 

With the global economy in this state of debt paralysis mainstream economists are virtually unanimous in asserting the need for a revival of economic growth in order to generate the resources needed to pay down debts to a more sustainable level. Most of them also recognise that the orthodox recipe of cutting public spending to achieve this end will – as even the IMF has conceded – be self-defeating in that it is bound to be negative for growth and thus result in even higher public sector deficits and debt – as has already happened most conspicuously in Greece. Hence they see the only alternative as being to expand public borrowing and indebtedness further in the short term so as finance expansion in investment and output (and employment), while at the same time maintaining interest rates as low as possible with a view to encouraging consumers and businesses to spend – on the supposition that, in line with Keynesian theory, such extreme fiscal and monetary laxity will induce the required GDP growth.

 

 

Yet, as has been obvious since the start of the crisis in 2008, such a strategy is doomed to fail by the reality that a) in a situation where levels of public debt are perceived by the markets to be too high in relation to the capacity to service or repay them, further increases in public borrowing must tend to raise the effective interest rate demanded by the bond markets on government debt – because of the increased risk of default – thereby pushing states closer to insolvency, while b) most consumers and businesses are already “maxed out” on debt and thus need to “deleverage” (cut their indebtedness) rather than borrow still more.

 

 

In their desperation to escape from this impasse the authorities in the US and the UK have since 2009 started to employ a radical and high-risk stratagem – never explicitly pursued by any industrialised country until Japan began to adopt it in 2001. This is the practice of monetising public sector debt with currency electronically created (printed) by the central bank – i.e. to buy up government securities such as US Treasury Bills. This mechanism – officially called “quantitative easing” (QE) – is justified by the authorities as a means of averting the risk of deflation, which could easily lead to outright slump, in a situation where the official benchmark interest / discount rate has already been set at close to zero and therefore cannot be reduced any further. It is hoped by the governments concerned that this process of debt monetisation (printing extra money by any other name) will stimulate effective demand in the economy by expanding the money supply – even though the earlier Japanese experiment along these lines had no such positive impact. What is not stated is that QE is also seen as vitally necessary in order to support the market price of government bonds, thereby keeping down the effective interest rate on them. Failing this artificial support, it would be impossible to conceal from market investors that the unprecedented level of indebtedness throughout the economy (see above) must call into question the solvency of all borrowers, both public and private. Once that happens (as sooner or later it must) the market rate of interest on all debt securities will rise to unsustainable levels as investors perceive the soaring risk of default, precipitating mass bankruptcy, financial collapse and the probable breakdown of civil order.

 

 

     The failure until now of the Eurozone authorities to resort to QE – mainly because of German refusal to accept such an unorthodox and potentially inflationary policy – is the main reason the Euro area has seemed on the brink of financial collapse since late 2011. By early February 2012, however, it is apparent that – under the influence of a new and more permissive President of the European Central Bank – mechanisms have been devised for making available liquidity to the many Eurozone banks in desperate need of it, even if there has thus far been no explicit adoption of QE. This has eased some of the pressure both on the banks and on similarly insolvent member state governments who would otherwise only be able to cover their soaring budget deficits by borrowing at impossibly high market rates. However, the threat of a sovereign debt default is still ever present, most obviously in the case of Greece, where in fact such an outcome now appears inevitable – and imminent.

 

 

     Those economists, still the overwhelming majority, who hold out some hope that such “extraordinary measures” can facilitate a revival of growth and living standards choose to disregard or play down the significance of the unprecedented burden of debt weighing on all sectors of the world’s major economies. Many of them point out, quite correctly, that public debt in these countries has on numerous occasions in the past been much higher than it is now (e.g. in the UK in the 1940s and 50s) and that this did not prevent them paying down such debt to more normal levels at the same time as permitting a rise in average real incomes. What such die-hard Keynesians ignore, however, is the grim reality that a) overall debt (mainly in the private sector, as noted above) is now at totally unprecedented levels and b) that – in contrast to the situation in the past (such as 50 years ago) there is no prospect of debtor countries growing their way back to solvency, not least because already crippling debt service liabilities severely restrict the scope for expanding consumption and investment.

 

 

     The only (slender) hope for the ruling establishment is that QE, by keeping real interest rates negative – i.e. below the rate of inflation – will enable them gradually to shrink the debt burden in real terms down to a more sustainable level. The problem meanwhile with such “financial repression” is that, as the UK Coalition government has already discovered, it has the effect of squeezing the incomes of savers and the lowest paid (already stretched to breaking point by recession and fiscal austerity) while favouring debtors whose profligacy is rightly perceived to have caused the crisis. It is thus likely that such an approach will prove as politically intolerable as it is economically unviable.

 

 

     As such realities dawn on mainstream economists and political leaders alike it may be hoped that more of them will soon feel forced to confront what is for them a still more intolerable necessity: the inevitable write-off of all the massive bad debts crippling the world economy and the consequent destruction of capital values on a vast scale. Whether such an outcome would signify the end of capitalism may be debatable. What cannot be doubted is that it would entail drastic and urgent restructuring of the economic order along more collectivist lines and a consequent curtailment of the power as well as the wealth of “the 1 per cent” – or else a cataclysmic global upheaval at least as destructive as World War II. If, as seems all too likely, the latter course is chosen, it may well be doubted whether our species could survive such an apocalypse.

 

 

 

6 February 2012

 

 

 

1McKinsey Global Institute, Debt and deleveraging: Uneven progress on the path to growth

. January 2012