Figure: UK Debt by sector – debt has increased hugely in the financial, household and business sectors, whereas Government debt has not increased so much.
(Source Haver Analytics, McKinsey Global Institute)
Debt as a whole is increasing exponentially and a debt fuelled economy is unstable and unpleasant to live in.
Some financial definitions
Debt is simply a sum of money that is owed. Because it is a claim on money it can also be seen as a claim on work to be done in the future.
Credit refers to the transfer of money, or other property, on promise of repayment, usually at a fixed future date.
Inflation is a rise in the general level of prices of goods and services in an economy over a period of time. Money buys fewer goods and services, so money lowers in value.
Inflation as a form of Government backed robbery
Inflation is a result of the amount of (debt) money in an economy and has a huge effect on ordinary people (though we may have become used to and accepting of it).
- In 1970 the amount of money in circulation in the UK was £25bn and started to increase dramatically. Now it is £2,185bn. 3% of this money is notes and coins. 97% is composed of digits in computers, which refer to debts that people and companies have (and credit registered to those they owe the money to).
- Since the 1970s the level of personal debt in the UK has multiplied dramatically. UK mortgage debt in 1970 was £10bn. By 2011, mortgage and credit-card debt had risen to £1,450bn.
- There has been massive inflation in most people’s biggest item of expenditure: the cost of housing. Those who bought early or who inherited property have benefited. For others homelessness, negative equity or an inability to repay are increasing problems.
- There was little or no inflation in the US for about 280 years from 1665 to 1945, except when wars were fought.
- Inflation doesn’t have to exist, it is a result of Government policy and the policy takes value from the ordinary citizen.
- From 1945 inflation has been causing prices to increase year on year (exponentially).
- Ongoing, damaging inflation is linked to how money is created (using a “FIAT” system, where money has no intrinsic value, it isn’t backed by reserves of gold and money creation is not kept in a healthy check). Inflation is also linked to the maintenance of high levels of war apparatus.
- Debt and inequality are linked, because interest on debts flow from those that need to borrow to those that have money to lend or are allowed to create money. This concentration of wealth has caused the present extreme inequality (see Distribution).
Why is there so much debt around?
The simple answer is that this is a policy decision by neo-liberal based governments. Debt means you are paying interest to someone, who is therefore benefiting. Developing nations have been coerced into adopting these policies and most ordinary people don’t understand the dangers of a debt-based economy.
People have been encouraged to feel invested in the system. If you are on the property ladder and your house rises in value or you have shares that go up in value, you may appear to be benefiting. However, the system isn’t designed to benefit the ordinary person in the long term. Asset prices are crashing; savings and pensions have become worth very little.
The chart above shows that the huge rises in debt in the economy are due to privately held debts; the largest being with financial institutions, then households and in other businesses. Government debt hasn’t increased anything like to the same degree and much of this public sector debt is a result of bailing out banks (instead of letting them go bankrupt). So why are we being told we have to cut spending on the most vulnerable in our society? It’s a political choice.
Money creation: Virtually all money is created when banks type figures into the accounts of people and companies (allowing them to send cash into circulation) and charge interest on this debt. This gives banks the incentive to increase the money supply exponentially. Banks prefer to provide loans for assets, such as property, that can be repossessed should the debtor default (rather than for funding the productive sector or real economy. Only 8% of money received by banks from the Government has been loaned to the productive sector).
A small, useful role for debt and credit as a preferable alternative
Debt has its place. It would play a minor role in a functioning economy. If a company wants to expand or increase its productivity, it can take on debt for a limited period to fund an investment. If a person wants to buy a house, they can take a loan from a local building society, based on the savings of local investors. Caution should be exercised when loans are offered, to assess whether a person or company will have the ability to repay.
Societies with high levels of trust at a local level are based on credit, where for example, a local baker might pay the wheat seller for the wheat at the end of the month, when she has made her income from selling enough bread.
When is Debt a bad thing?
‘Interest’ and ‘charges’ are the money you pay on top of your original loan. (They are often just collectively called “interest”, but there is a difference between specific fees and charges and actual interest, which is money paid on top of the loan to the organisation you owe the loan to). The charges are justified by the work required to assess the risk of the loan, insurance against the risk and inflation (when money becomes worth less over time). In our current economies, an interest payment is added on top, which can be a huge % of the loan made, especially in the case of some credit cards.
This form of interest has been seen as an evil in many societies and outlawed. (Islam forbids lending with interest even today, while the Catholic Church allowed it from 1822 onwards, and the Torah states that all debts should be erased every 7 years and every 50 years (in the Jubilee year, as described in the Book of Leviticus)). In recent years, behind the scene lobbying by financiers allowed the caps on interest rates to be removed. Whilst other charges are reasonable to insure against risk, for inflation etc, in a Just Economy interest payments would be disallowed.
Easily obtained loans drive up the value of property. Rather than one salary being needed to buy a house, two salaries are needed and for longer repayment periods. People’s life choices are made based on the need to repay debts or to get on the property ladder, rather than what they want to invest their time in. Debt-based economics lead to inflation, the value of money declines (so savings become worth a lower amount) and we need more money to buy the same amount of things. We have become debt slaves and the usury classes are living off the interest we pay.
Debt is taken on more easily by larger companies (who can write off some of the interest against tax payments. This is often done through dubious tax avoidance mechanisms). Larger companies have to go after larger markets, by force of their size and out of necessity when carrying debts. Economies of scale are pursued mercilessly and are often environmentally destructive. They favour regional and global expansion over local production.
Debt fuelled economies simply must have economic growth or they slide into recession. This is because, as the graph at the top shows, all sectors are burdened by debt on which interest must be paid, so the whole economy must produce not only the goods and services required, but a margin on top from which interest can be paid. This isn’t feasible and so debts grow and the interest owed gets higher. So not only is growth required, but growth must increase year on year. This just isn’t sustainable or logical. Individual companies cannot be satisfied with simply delivering a good local service. A debt-fuelled expansion by a competitor from further afield is always likely. Everyone is chasing smaller margins and economies of scale. This does not on the whole benefit the consumer.
Debt based economies lead to ridiculously wasteful food systems, breakable, disposable goods, quantity over quality in goods and services, hugely increasing pressure on transportation and the general feeling we all carry: of being spread too thin.
Consider this madness: in 2004, using climate changing transportation, the UK imported and exported the following:
17.2million kgs chocolate wafers 17.6million kgs chocolate wafers (to and from France)
1.5million kgs potatoes 1.5million kgs potatoes (to and from Germany)
£310m of beer £313m of beer (internationally)
(See The UK interdependence Report 2006, NEF, for the longer list)
Government deficits and debt
Government plays a crucial role in the economy and should not be likened to a householder running up a credit card bill that needs to be paid off (this false perspective is frequently deployed to gain backing for an agenda to cut welfare and public spending).Through taxation, our Government is able to take a portion of our collective wealth and deploy it for collective public benefit.
Government deficit is the difference between taxes collected and public sector spending in any one given year. Government debt is the collection of liabilities that the Government has, such as bonds it has issued and pensions it is due to pay. Interest must be paid on these liabilities. The current mantra is that we have to reduce Government debt by reducing the annual deficit. Government debt has hugely increased by bailing out the banks and yet the most vulnerable in society are now paying for this. It is worth considering:
- The annual deficit could be reduced by collecting taxes that are evaded, avoided or left unpaid (collectively known as the “tax gap” and estimated at £120bn annually. UK taxes collected in 2011/12 were £548bn, the UK budget deficit in 2012 was £170bn)
- Government doesn’t have to fund itself by taking on debt. It could chose to issue credit, in other words create money, and spend it in a responsible way, to keep up with economic growth through desirable economic activity (genuine efficiencies and new technologies).
- Government can spend money into the economy. This allows more money to circulate and could take us out of a stagnant economy (in which the work that needs to be done isn’t able to get done, because there isn’t the money to pay for jobs). A Green New Deal has been proposed to spend money on transforming our society into a more sustainable one (renewable energy, energy-saving measures etc).
- Government debt can be reduced by a Jubilee Debt in which some of the toxic debt we took on through the financial crash would simply be cancelled. (More on these solutions in Future).
International Financial System
- The trade and speculation in money, derivatives and currency values has resulted in a ‘virtual economy’ outstripping the real economy.
- In 2010 the value of goods and services produced – the real economy – was about $60 trillion. For the virtual economy it was $1550 trillion. (This includes trading of financial derivatives and foreign currency transactions).
- Bad practice is encouraged by the bonus culture and lack of regulation of the financial sector. The financial sector is a heavy user of secrecy jurisdictions (tax havens) where it can do things that are illegal elsewhere. Financiers can create huge complexity within transactions, so that it isn’t clear what is being signed up to. (The jargon is rich here, collatoralised debt obligations, credit default swaps, money laundering, Libor, etc and some of the details are complex. The links below give more insight, but the basic facts are that the system has been set up to benefit financiers and there has been a lot of cheating.). This is often called the shadow banking sector.
- The free flow of capital across borders encourages capital to move to low-tax locations. Companies relocate to low-wage countries and the nation’s essential services are taken over by overseas enterprises. Corporations can play one poor country against another to reduce wages further.
- International cooperation is essential, but globalised finance makes it difficult for governments to introduce policies for their own people.
- International finance gambles on the price of commodities (such as wheat or cocoa) and this can hugely inflate prices. Since 2008, 115m more are hungry in the world (925m in total) and there have been riots over the price of food.
Debt fuelled economies have to keep growing (hello- in a planet that doesn’t get any bigger?) and they rely on cheap energy, especially oil. The neo-liberals want to overcome our debt crisis by getting back to economic growth, but the cheap energy is gone; climate change and demographic shifts are costing money, so their plan is doomed to fail. Depletion looks at how we are reaching the end of cheap oil whilst running down other resources and increasing pollution… it’s time to get real about climate change too.
Robert Peston’s book, “Who Runs Britain?” is a good overview of both the characters involved in the financial crisis and the mechanisms involved in setting up the problem.
Robert Peston also examines the wealthy and their techniques in a documentary: “Super Rich: The Greed Game” He concludes that the idea that rich people getting richer helps us all, is not correct!
The Grip of Death by Michael Rowbotham is a compelling read on how debt based economies favour Multinational companies over smaller local companies, quantity over quality, environmental destruction and the feeling of being on an insane treadmill!
Positive Money is a campaign to bring money creation back into the hands of government. They have good cartoons and videos to explain how poor monetary policy affects our lives.
It’s really worth checking out these experts in debt, talking about debt crises and solutions: Steve Keen with the Renegade Economist and on the BBC calling for a cancellation of Debt and his blog. Ann Pettifor talking to Renegade Economist. These are the economists who predicated the crash and were ridiculed for doing it. Michael Hudson is also very much worth checking out.
The excellent Renegade Economist has also released a film called the Four Horsemen questioning the whole system.
The Inside Job film tells the story of the financial crisis.
Including Banks and Credit in Macroeconomic models: Slideshow from NEF