The cause of the slump is still misunderstood
January 25th, 2012The news that the public sector net debt has now passed the £1 trillion mark isn’t really news since it’s long been on track to reach £1.4 trillion by 2014. What is far more disturbing is that the government, in its obsession to cut the public sector deficit regardless, has completely ignored the impact this is having on the private sector deficit in driving the slump. The government’s answer to drooping demand and consequential languishing growth is to pump colossal amounts of new money into the economy via so-called quantitative easing (i.e. printing money), first £200bn under the Labour Government and now a further £75bn under this government, but it has had virtually no impact at all in stimulating growth, either here or in the US, because the lack of base money (M0 in the jargon) is not the cause of the crisis. The real problem is what is happening to private sector debt.
It is extraordinary that, according to the first forecasts of the newly formed OBR in 2010, the government was expecting the level of private household debt, already £1.57 trillion, to rise to a staggering £2.13 trillion by 2014-5. It should be emphasised that this was not something they feared would happen or were simply allowing to happen, but rather it was a deliberate aim of monetary policy that it should happen. The plan was that the deficit provided the perfect excuse to squeeze the public sector, shrink the Welfare State, but ever-increasing private household debt would provide the extra demand to maintain at least some modestly decent growth. The opposite has happened.
In the private corporate sector deleveraging (i.e. paying off debt) has gathered pace because the corporates are sitting on mountains of cash (at least £70bn) but not investing because demand is being squeezed. Equally in the private domestic sector households are being forced to pay down their debts and cut their consumption as rapidly as they can as the only way to get by. The effect is massive private debt deflation, which is the real cause of the slump.
The debt deflation forces are far larger today even than those that caused the Great Depression in the 1930s. In the 1920s private debt rose by 50%; in the decade to 2009 it rose by 140%. The debt-to-GDP ratio is still much higher in both the US and the UK than when the Great Depression began. The only way to stop the slump, before it bottoms out with incalculable damage in joblessness and loss of national output, is to restore that level of private demand. There are two ways to do that. The better by far would be a jobs and growth strategy which would begin to pump demand back into the private sector. The other is (as in Greece) to write off a high proportion of the private debt and make the banks take a ‘haircut’ as a penalty for seeking to grow rich by showering the populace with mountains of irresponsible and unsustainable loans.
January 26th, 2012 at 12:02 am
Interesting, I didn’t know that the UK private sector had deleveraged so profoundly – the same sort of thing has happened in the USA too.
January 26th, 2012 at 12:16 am
the UK private sector has deleveraged a bit (only a few %), but thats enough to cause a slump as before 2008 UK economic growth was entirely based on increasing debt (and still is, based on the government’s assumption that private debt will INCREASE).
However, we’ve stolen just about all the wealth available from the future so now we can look forward to a future minus the wealth we’ve greedily stolen. Enjoy!! (or should I say ‘endure’?!!)
January 27th, 2012 at 12:43 am
thought more on it -
If business is able to massively raise its cash assets and yet they are refusing to invest. Perhaps the best policy response is to hike corporation tax?
higher corporation taxes will make companies more nervous of showing profit, and should encourage early-reinvestment, including expanding workforce.
January 27th, 2012 at 7:45 pm
If “the private corporate sector deleveraging (i.e. paying off debt) has gathered pace because the corporates are sitting on mountains of cash (at least £70bn) but not investing”, and the Government is reducing it’s spending (or at least slowing it’s deficit spending) then won’t the money supply shrink ?
This – I guess; will further reduce demand and further reduce investment. The Government will have to adopt some form of FDR style “New Deal”, or start a massive War to justify greater Government Borrowing?
I expect we might see more Quatitative Easing – QE3 perhaps ?
January 28th, 2012 at 1:28 am
“The plan was that the deficit provided the perfect excuse to squeeze the public sector, shrink the Welfare State, but ever-increasing private household debt would provide the extra demand to maintain at least some modestly decent growth. The opposite has happened.”
If this was the plan, why have the Coalition done _nothing_ to directly encourage growth of the private sector?
I rather suspect there was a secret plan.
We are buckling down, slowing reducing the deficit and waiting for the Euro storm to pass.
“The other is (as in Greece) to write off a high proportion of the private debt and make the banks take a ‘haircut’ as a penalty for seeking to grow rich by showering the populace with mountains of irresponsible and unsustainable loans.”
The banks are as broke as the rest of us — well they will be when Greece and Portugal inevitably default.
As you said, the only money around is in the bank accounts of the corporations. And they’re not crazy enough to spend it.