Posted on 4-11-2003

Debt's Long Shadow
From People's News Agency (PNA)

The reckless financial policies of leading western powers in the last two
decades make it likely that the next seismic debt crisis will be in
America, not Argentina. It can be avoided, says Ann Pettifor of the Real
World Economic Outlook, only by serious efforts to bring regulation and
balance to the international economy.

Jubilee Research at the New Economics Foundation (NEF), the team that
spearheaded global awareness of a third world debt crisis released
provocative new research in September 2003 which argues that the "first
world" is approaching a major debt crisis. These findings appear in the
first of NEF's annual reports on the global economy, Real World Economic
Outlook - which shadows the IMF's annual World Economic Outlook.

The report predicts that a giant credit bubble, created by central bankers
and finance ministers (the engineers of decades of "easy money") has now
reached a "tipping point". This point - at which the "bubble" of financial
assets exceeds GDP by 9 times - has triggered financial crisis elsewhere.
Another "tipping point" would be a rise in interest rates - not unlikely
for economies like the US and UK which have Massive Foreign Deficits.

The financial system: unbalanced, unfair, unsustainable

On a global level, there is $100 Trillion of Debt outstanding, but only
$33 Trillion of income with which to repay those debts. Even the drastic
recent stock market falls have barely dented the credit superstructure.
When this credit bubble bursts in the United States and Britain, it will
be middle-class consumers that will first bear the brunt of the financial
crash. That will be unjust and unfair, because American and British
consumers have been actively encouraged in their borrowing by the
financial deregulation policies of both central bankers and governments.
Moreover politicians and bankers have watched as dutiful and compliant
consumers have propped up these two big economies - helping to keep the
global economy afloat. They will be rewarded for their heroic efforts by
Bankruptcy, Losses, Liabilities, and Personal Anguish - which will extend
some time into the future. The impact of a collapsing credit bubble will
reverberate around the world, and hurt the poorest most.

The crisis will be exacerbated for individual consumers, because the end
of the credit boom will take place in a deflationary environment.
Deflation is in part a consequence of the policies of central bankers and
finance ministers for opening up markets, and clamping down on wages and
prices. Deflation is good for lenders, but bad for debtors. This is
because the value of debts rises in real terms in a deflationary
environment. This is in contrast to inflation, which ultimately erodes the
value of debt.

A financial crisis under debt-deflationary conditions will be catastrophic
for many debtors. It will also be grossly unjust and unfair, because while
central bankers and finance ministers have clamped down on Prices and
Wages - they have used the credit bubble (borrowing) to inflate asset
values (stocks, bonds, and property) to extraordinary heights. On the
whole, it is the Poor and the Middle classes that rely on wages and
salaries-while the rich derive their incomes from wealth. However, while
the rich have been getting richer, they have not become indebted. Nor are
they using these assets to spend and boost the economy. Instead, on the
whole, they are standing by while their assets rise in value.

The Poor, by contrast, have watched as their Wages and Salaries Declined
as a share of GDP, and have had to borrow to compensate for these losses.
By doing so, they are providing a service to the rest of the economy, and
helping asset prices stay high.

Winston Churchill's storm warning

The team producing Real World Economic Outlook warns that the coming
"first world" debt crisis will resemble the debt crisis of the 1920s -when
bankers and politicians embarked on a similar experiment of "globalising"
and deregulating capital. Then, as now, their liberalisation of capital
markets and reckless inflation of credit encouraged massive borrowing.
Then as now, the burden of resulting debts fell most heavily on the middle
classes and poor. Winston Churchill, in his book about that period, The
Gathering Storm, described it well: "The year 1929 reached almost the end
of its third quarter under the promise and appearance of increasing
prosperity, particularly in the United States. Extraordinary optimism
sustained an orgy of speculation. Books were written to prove that
economic crisis was a phase, which expanding business organisation and
science had at last mastered.

"We are apparently finished and done with economic cycles as we have known
them"-- said the President of the New York Stock Exchange in September
1929. But in October a sudden and violent tempest swept over Wall Street.
The whole wealth so swiftly gathered in the paper values of previous years
vanished. The prosperity of millions of American homes had grown up a
gigantic structure of inflated credit, now suddenly proved phantom. Apart
from the nation-wide speculation in shares which even the most famous
banks had encouraged by easy loans, a vast system of purchase by
instalment of houses, furniture, cars and numberless kinds of household
conveniences and indulgences had grown up.

All now fell together.

But yesterday, there had been the urgent question of parking the
motor-cars in which thousands of artisans and craftsmen were beginning to
travel to their daily work. Today the grievous pangs of falling wages and
rising unemployment afflicted the whole community, engaged till this
moment in the most active creation of all kinds of desirable articles."
If we substitute "the urgent question of parking motor-cars" with the
"urgent question of parking SUVs", Winston Churchill could be writing in
2003.

A cycle of illusions

How did we get into this mess?

Real World Economic Outlook challenges standard explanations for the
launch of the "globalisation" experiment. We contest the view that
deregulation of capital flows - the very core of the globalisation project
- was brought about by a form of "spontaneous combustion" caused by new
technology. Nor do we share the view of many activists that globalisation
is "corporate-driven". Instead, we argue, globalisation was triggered by
Elected Politicians, and Central Bankers, in both the US and the UK. In
the post-Vietnam war era, led by Richard Nixon and later Ronald Reagan,
these politicians sought ways to avoid making the "structural adjustments"
necessary to the American economy if debts incurred by foreign wars were
to be repaid by US taxpayers.

Rather, these politicians preferred to disband the existing system of
paying off debts by exchanging gold, and opening up capital markets, so
that the US could borrow to pay off its debts. This new arrangement also
allowed them to print the money in which they paid off those debts (unlike
poor countries which have to repay debts in foreign currencies like
dollars or sterling). British politicians and central bankers were only
too happy to act as US intermediaries in the capital markets. Together
they constructed a new financial architecture that effectively obliges
central banks of both rich and poor countries to lend to the US - by
buying US treasury bills (debt). It is US Treasury Bills that have now
effectively become the World's Reserve Currency - where once that reserve
currency was neutral (gold).

It is this international financial system that makes the US administration
so arrogant in its refusal to "adjust" its economy by cutting spending and
pay its way - as poor, Indebted Nations are required to do by the
International Monetary Fund (IMF). (The IMF's double standards in its
dealings with poor countries on the one hand, and the US on the other, are
breathtaking). It is this financial system which makes US financiers so
confident that the rest of the world will continue to finance their
nation's extravagant spending binge.

In the words of David Goldman, head of debt research at Banc of America
Securities: "America is at little risk for the foreseeable future, simply
because the world's capital has nowhere else to go" (Wall Street Journal,
13 August 2003).

The day of reckoning

The Real World Economic Outlook challenges that view. There is now a
growing consensus that the vast build-up of household, corporate, state
and foreign debts of the US is not sustainable. Some central banks are
already switching out of US Dollars and into Euros. When capital flows
shift away from the US, and there are recent signs of this happening, Alan
Greenspan may have to raise interest rates to attract Capital back into
the US to fund the growing federal, state and foreign deficits. Indeed,
the bond markets seem to be signalling that they expect this to happen
quite soon. When interest rates begin to rise again, when debt costs soar
both for corporates and households, when defaults and bankruptcies
increase more rapidly than now - then the "tipping point" will be reached.

The latest official US government statistics show that mortgage debt rose
in the previous year by a staggering $700 Billion, to $6,219 Trillion, in
the first quarter of 2003. That is double the increase in the 1990s. At
the same time, personal bankruptcies in the US rose in the last quarter by
9.0% more than in the same period in 2002; business bankruptcies in two
successive quarters rose by 5.9 Samuel J.Gerdano, executive director of
the American Bankruptcy Institute said as far back as May 2003: "Today's
new bankruptcy record is continued evidence that U.S. households continue
to struggle with the burden resulting from consumer debts incurred in the
1990s".

Avoiding the next great crash

For some, therefore, the day of reckoning has already arrived. When it
arrives for the millions more that are dutifully and heroically borrowing
and spending, and thereby propping up the economy, great pain and anguish
will be inflicted on individuals, businesses, their workers, families and
communities. The consequences for the rest of us, and particularly for
those in the poorest countries, are frightening.

Real World Economic Outlook calls on governments and central banks to take
3 Measures to take responsibility for their Reckless Deregulation of
finance.

First, We call on them to re-regulate international capital, by bringing
back exchange controls. (It has been done before, and can be again.
Capital was re-regulated in 1944,at Bretton Woods, after the
"globalisation" experiment of the 1920s that created a giant credit
bubble, which led to the crash of the 1920s and 1930s).

Second, We call on them to rein in the "easy money" of reckless lending
and borrowing; to return the economy to scale.

Third, We call on governments and central banks to compensate those
consumers now dutifully propping up the US and the UK economies. But we
argue that this should not be done by taxing the middle classes, but by
obliging the rich to share some of the incredible gains that economic and
political leaders have allowed them to make over the last two decades.

Our World has been turned Upside Down. It is time to put it right again.