The Financial Crisis of 2007/8 was a crisis of private debt. It only became a crisis of public debt when states around the world made the taxpayer guarantor for this debt and bailed out banks. However, since then conversation and policy has focussed almost exclusively on public debt, as if this were the source of the crisis. This has seen devastating impacts on public services, and public perceptions on the welfare state. In doing so, the government is not solving the financial crisis, but causing it.
Public Debt before and after the Financial Crisis
In the last year before the Financial Crisis, public spending in the UK stood at 41% of GDP and national debt was just 44.1% of GDP. This was consistent with the level of debt and public spending as a proportion of GDP for around the last fifty years.
Running budget deficits has also been a pretty regular feature of UK economics. The Conservative government ran deficits between 3.9% and 50.9% between 1990 and 1997. The incoming Labour party returned the budget to surplus into 2002.
Labour argue that these deficits were cyclical rather than structural. This means that they created a deficit to invest in programmes that would release an economic benefit later. So, a cyclical deficit would look like a mortgage – the average mortgage holder’s account would look in deficit if their mortgage were taken into account, but also counts as an asset. A structural deficit would look more like an overdraft, it’s simply there to cover the fact that what is being spent is more than what is being earned.
Whatever the reality, the deficit was not increasing the national debt, and public spending as a percentage of GDP was no higher than it had been under previous governments. Therefore if there were criticisms of Labour’s spending programme, it cannot be laid at the door of domestic public spending.
This is no defence of Labour’s fiscal approach however, but we do need to make sure we criticize the proper things, and the welfare state was not the issue.
According to the National Audit Office, the Bank Bailout increased the National Debt by £1.5trn. That means in one month in 2008, the (non-fiscally adjusted) national debt jumped to 138.7%. Since then this figure has risen and fallen by 10% in either direction. More worrying is as austerity policies kill off investment, consumer spending and economic growth, the net national debt figure has actually risen 30% since 2008, and 22% of that has occurred under the Coalition government.
Public spending has remained fairly constant throughout this time, rising 3% as a proportion of GDP under the Coalition.
This level of national debt and deficit have not been seen in the UK since World War II. But the entire welfare state was built and rolled out while reducing the national debt and the deficit. The UK can more than afford its public spending as less than half of GDP. What it cannot afford is the Corporate Welfare State on top of it.
Private Debt before and after the Financial Crisis
While public debt rose after the crisis, private debt rose exponentially prior to the crisis and was its ultimate cause. Economist Steve Keen rails against mainstream neoclassical economists’ insistence on ignoring private debt as a factor in a future crisis.
We need to distinguish two kinds of private debt. The first is consumer debt: that debt carried by individuals in the form of loans, credit cards and so on. The second is corporate debt: that debt carried by private entities (businesses, corporations, etc.).
Consumer debt rose by 158% in the ten years between 1999 and 2009. Did the UK consumer go on a self-indulgent spending spree for this decade? Not quite. You see, during the same period, house prices went up 130%, a loaf of bread went up 147%, and a litre of petrol went up 42%. Wages rose just 13.6%. Consumer debt was used to conceal the fact the wages were failing to keep pace with a fast rising cost of living.
This issue contributed to the Financial Crisis when overburdened debtors in the US failed to meet their mortgage payments, effectively kicking over the first domino. So how does Austerity deal with this problem? It makes it worse.
Austerity policy is only driving down wages further, in fact workers are being asked to accept further wage cuts to hold on to their jobs, which is only exacerbating consumer debt. The level of family debt rose by another 50% just last year, hitting £1.4trn by February this year. This is significantly faster than its already dizzying rise in the previous decade.
Corporate Debt is a whole other matter. Financial Services corporations have effectively begun printing their own money by inventing financial instruments which turn debt into assets. The problem is, the assets are used to create paper profits for corporations and individuals, while the debt is simply ignored until it explodes, as it did in 2008, and then passed over to the taxpayer.
By 2004, UK Banks were creating £500bn a year this way, they created £567bn in 2007 as the crisis was at their door. To put this figure in perspective, the entire national debt in 2007 was £501bn. Corporations created the same amount of debt based money in a year, as the UK’s entire national debt. This has totally screwed up the money supply, with the Bank of England creating only a tiny fraction of the money in circulation.
The Derivatives market that capitalises on this debt based money, by turning consumer debt into investment vehicles, caused the Financial Crisis. This market encourages fraudulent, reckless and predatory lending to consumers who cannot repay, as by creating the debt the organisation can print money.
The Government is Fixing Problems Which Don’t Exist
The UK Government is fixing problems which don’t exist, and by doing so is worsening the problems that do.
The Financial Services industry as a whole and the Derivatives market in particular remain unregulated and derivative debt has now grown to $700trn (ten times the GDP of the entire planet). There is no way any state or combination of states could ever pay this down in a future crisis.
The bankers personally responsible for the crisis have not been held accountable in a court of law. Indeed, many of them now hold senior responsible positions in economics, academics and government.
What Solving the Crisis Might Look Like
To tackle the causes of the Financial Crisis and restore the UK economy to a sustainable footing, we would need to do almost the exact opposite of what the government is doing today.
Break up the big banks into many smaller ones which could fail in future and not devastate the wider economy.
Make it illegal for a bank to be both a retail bank and an investment bank.
Hold individuals responsible for the Financial Crisis accountable in a court of law, sending a clear signal that people will not be allowed to profit by destroying their companies and the wider economy.
This was what the government publicly committed to ahead of the Vickers Report but watered down proposals to such an extent that they will not reduce the banking sector as a proportion of GDP, they will not separate casino banking from retail banking, they will not outlaw derivatives trading or the commercial money supply.
Introduce legislation increasing the minimum wage to the living wage. This would support the reduction of consumer debt, an increase in consumer spending, and decrease the income equality gap.
Cost of Living
Introduce price control measures on items on the UK Essentials Index. By reducing the cost of the essentials, the consumer budget has more room to accommodate saving and pension contributions that will take the pressure off public finances as they age, and to avoid debt. There would be losers in this plan, but that GDP is already gobbled up by the impacts of what is being sold. GDP at the cost of personal and corporate debt is short termist and creates unsustainable and unstable economic circumstances.
Abandon neoclassical economics. The dominance of this model is dangerous. When ‘economists’ are produced on panel shows, news interviews and government working groups they are always neoclassical economists. Keynesians or Friedmanites, they are of the same school. This school of economics uses models to forecast economic performance which do not even include debt, money or time as factors. These economists contributed to the Financial Crisis by endorsing the behaviour or the Financial Services industry and governments who deregulated them. They also not only failed to foresee the Financial Crisis, but actually said it was impossible. To continue to seek answers from this community when they have so clearly been proven wrong, is utter folly.
Why Doing Nothing is Not an Option
It is not that our government are not aware of the alternatives to Austerity, it is that they are actively opposing those alternatives. The public debt crisis in the UK is as a direct result of the private debt crisis, and our government has no answer for that. Therefore we can only predict years of crushing austerity, rising unemployment, rising consumer debt, rising corporate debt and a continuing and deepening crisis. It is not enough for us to wring our hands and wait for the good times to roll again. Without significant public intervention to stop this process, the good times will never roll again for those outside the 1%.
Positive Money – a great way to learn more about how money is created and how you can change your own behaviour to make a difference.
Steve Keen at LSE – this is 30mins which will change your life. Steve Keen explains why our current economics simply does not work.
Move Your Money – take your money out of the big banks which are causing the crisis.
The People’s Assembly – join the campaign to end the democratic deficit caused by all our main political parties adopting the same flawed economic policy.
The 99% Rise Against Austerity – protest Austerity on May 4th and make your opposition visible.