Britain’s Private Debt Problem

It is the 10 year anniversary of the financial crisis and politicians are again ignoring the drivers that caused the biggest financial meltdown since 1929. When there’s too much private debt or credit in any financial system and when it increases too quickly it always leads to financial instability. It is the volume and pace in which credit grows that links the crashes in the roaring 1920s, the so-called ‘Japanese economic miracle’ in the 1980s, the US crash in the early 2000s, and of course the Great Financial Crisis of 2008.

On the latest episode of Renegade Inc, anthropologist and writer, David Graeber, said the great secret they don’t want you to know about is that the central logic of sectoral balances lends itself to private debt.

“If, under austerity, you’re constantly cutting government debt and government deficits, eventually this will have an effect on increasing private debt,” he said. “This is kind of the great secret they don’t want you to know. There’s this kind of mystical formula where you’re supposed to think that if the government balances its budget, that’s going to make it easier for us to balance our magical correspondence between the two. But in fact they have an inverse relationship.”

Imagine that every year the government taxes you 100 pounds. You have 100 pounds more, and you have 100 pounds less. Similarly if it borrows money and spends its 100 pounds in debt, then there’s a hundred pounds more floating around in the household economy.

“Ultimately these things always balance essentially if the government is taking more in and putting less out,” says Graeber. “There’s less money in the household economy, people have to farm more. So it just makes sense that austerity will actually mean that private debt levels will go up. And indeed that is precisely what happened.

“If you look at the charts, if you look at 2015, they were predicting modest levels of deficit in the household sector. But they’re also saying ‘well, you know, that could be offset because there’s going to be a lot of corporate borrowing.’”

“When I was looking at the numbers I noticed something else. When you’re looking at these charts, the numbers are meant to mirror each other. The old chart and the new chart should have exactly the same number up top that exists on the bottom, that is until you get up to the projections on this latest one. If you look at the projections, they don’t actually match. The numbers literally don’t add up. So I talked to some of my economist friends, I talked to Steve Keen, for example, and I talked to some other people and said: ‘Am I seeing what I think I am seeing? Is this actually not adding up?’, and they said ‘oh yeah that’s right.’ Nobody had noticed it. “

Lord Turner told Renegade Inc that he is 99% sure the projections were “a cock-up not a conspiracy”.

“You know it is odd, if these are the figures that we’re looking at, sectoral balances that you know don’t add up, because anybody who’s taught undergraduate economics knows that when they do national income accounting, there are four sectors which have to balance to zero.”

Lord Turner said it’s important to look not just at the UK but at all the advanced economies together,  private debt as a percentage of GDP increased dramatically from about 50% of GDP in 1950 for all the advanced economies on average, to 170% by 2008, primarily in the household sector.

“The household sector and commercial real estate – primarily to buy property – that’s where the big increase in debt was,” says Lord Turner. “That really put us in a position where when we then had a financial crisis in 2008, there was so much debt around that a lot of people were trying to pay down that debt. Corporations were trying to pay down debt. Households were trying to pay down debt. And that put the economy into recession. And in that recession the only thing that kept the economy going were large fiscal deficits because that’s the only thing that’s going to keep the economy going.

“At the core of the modern economy we have had this sort of gradually increased global economy.  It is very very important to take a global point of view.  Let me give you an example. Whenever you talk about debt in Germany and say ‘we’ve got a problem of an economy which is too dependent on the creation of private debt’, Germans will say – ‘not us. I mean, that may be your problem that’s that’s not our problem. You know, we’re good people who pay back our debts.’ But actually the German economy has been as much driven by debts as every other economy. It’s just their debts are in other countries.”

“Germany runs this huge current account surplus. It exports more than it imports to the extent of 9% of GDP. And before the crisis of 2008 that was only possible because of unsustainable debts being piled up in Spain and Italy and Ireland etc. And since the crisis it’s only been kept going by this enormous debt explosion in China.

“So at the core of the global economy there are some really unresolved issues about our reliance on debt and – bluntly – economics. A lot of mainstream economics has not given us a good set of tools to understand that.

“Most crucially it tends not to concentrate on where does debt and money come from. And money is primarily created as a by-product of debt.”

Most of the money – or money equivalents – that exist in a modern economy exist because a bank lends you money, and in lending money, it creates money. That was well understood by economists before about the 1960s. In the late ‘60s, early ‘70s, money creation is almost written entirely out of economic textbooks which fails to provide a really insightful account of where money comes from.

Lord Turner refers to this development in the field as ‘physics envy’, a desire to write economics in a highly mathematical fashion.

“Some economists were guilty of taking reality out of their equations in order that they could have equations which elegantly solved something which the peer-reviewed academic journals said was brilliant,” said Lord Turner. “That may seem a very odd thing to do but intellectual processes are often driven by their own internal dynamic between what gets you reward as an academic, between the desire for elegant solutions per-se and if in the course of that you have to make assumptions upfront which are clearly nonsensical, sometimes people do that.”

David Graeber said it’s important to take into consideration the fact that that this also occurs in politics.

“Politicians find that certain formulas really work out and the austerity line seems to win votes,” he said. “It’s a sort of moral argument that I want to do something to pitch-in. I want to be able to sacrifice for the sake of our children, responsibility, balancing the budget. I have to balance my budget and the government theirs.

“And they found that to work to some degree, and the economists who provide them numbers seem to reinforce what they want to say anyway, are found to be a factor.”

Lord Turner called for the need to “be careful” on the austerity debate.

“I think we’ve overdone austerity because, in the aftermath of this huge private debt creation it was inevitable and necessary that we ran large public deficits in order to balance the economy.

“And I think indeed the failure to do that back in 1929 to 33 is one that things turned to the crash of ‘29 into a complete political disaster, particularly in Europe. But one mustn’t leap to the other end and say there are no limits to what you can do on public expenditure because the fact is you can create problems in an alternative fashion.

“If you were to simply end up with large deficits and if you were to effectively ‘monetize’ that by the central banks supporting them, then under some conditions you can create excessive inflation which causes harm, which is what happened in Weimar in the early 1920s.”

Lord Turner says austerity gets confused in more ways than one, depending on how the argument is used.

“The fact that large public deficits can be overdone – and they clearly can be overdone – then terrifies some people because they then have to discipline it. How do you make sure that we run public deficits which are useful, but not too much? In order to try and make that argument people then latch on to simple analogies like ‘the private budget’. They’re trying to make it work for the individual because they’re sort of terrified that that’s the only argument somebody will understand, that if you didn’t have that it would run out of control.

“We have a problem here that the amount of money that can be created is limitless, right? It can be limitless, created by governments running deficits and monetising them. It can be limitlessly created by a private banking sector creating it. And we need ways of controlling intelligently, both of these. The big problem we had before 2008 is that we had developed an ideology in which we thought that the public creation of money was uniquely evil and dangerous and that the private creation and money would always be just fine because however much money the private sector created, it would create the correct amount because it was the clever free market.

“We actually have to realize that both of these can be dangerous.”

Lord Turner says once you create all of that debt, and  start to deleverage to address the imbalance, the only way to do that is if you simultaneously allow public debt to increase.

“ I mean if you could achieve that deleveraging without letting the public debt go up, we would have just tanked the economy into a deep 1920s style recession,” he said. “But now we’ve got high public debt and we’ve got to work out what to do about that. What’s the appropriate approach to that? So the easy thing to say here is we should have been much more worried about the upswing of the cycle.”

The great failing of economics at the time was the perception that that this was of no particular importance.

“Let’s be clear,” said Lord Turner. “By far the biggest proportion of private debt is lending against property. That’s 90% of this story. This is household mortgage debt and commercial real estate debt. That’s what drives that.

“We live in a property owning democracy.”

David Graeber is calling for a public inquiry into the system that has lumped populations with huge volumes of private debt, as a supplement for a government and economy that prioritises the needs of its population.

“In the early stages of this take off, what people thought they were doing was making it easy to extend a property owning democracy because it was easier to get mortgage debt. And in the early stages of that process, that was probably right,p up to a point. The easy availability of mortgage debt enables somebody who does not come from a rich family to borrow money to buy a house and easier mortgage debt in the ‘70s and ‘80s probably helped spread property owning.

“Ironically what then happens is that when it becomes too easy, it actually undermines the growth of the property owning democracy. It undermines it because the sheer ease with which debt is available pushes house prices to such a level that only people who do have a parent who can be the Bank of Mum and Dad to give them a deposit could possibly afford it. Which, by the way, I think relates to David’s work on the long-term history of debt.

“If you look at the origin of extreme inequalities in society we go back to the agricultural society is what you get is relatively small differences in things like luck, the luck of the harvest, the luck of whether your piece of land produced a good harvest or not. Produce an environment where the richer farmer lends money to the poorer farmer, run it forward for six generations and this guy’s a feudal overlord and that guy’s a serf.

“Debt can – unless we’re careful – generate a self-reinforcing inequality because it gives huge opportunities to the people who already have some wealth which they can use to borrow money. And for people who don’t have it, the interest rate go up and it removes from them given the wealth that they’ve got.”

David Graeber says that the main argument when the crash happened was: ‘why didn’t you see this coming?’

“You could make the argument that they didn’t have the tools at the time, they didn’t understand the relation of private debt and the financial instability risk. Now they do. And that’s why I’m asking for public inquiry. Come on, we’re not going to make the same mistake, this time with our eyes open.”

Watch the full episode above to understand the true relationship between austerity and private debt and their relation to every financial crisis in history, and the one that is – very likely – on the horizon.