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While the politicians flounder over masks and testing kits, economists are worrying about the shape of the coming recession, and the danger of a global debt crisis once that’s over.
There are three kinds of outcome to the current slump in output. If the disruption is only physical, and most companies stay solvent thanks to government bailouts, the global economy will suffer only a V-shaped recession, with growth bouncing back by Christmas.
If, on the other hand, there are severe financial aftershocks, necessitating the emergency bailout of banks, insurers and major corporations, as in 2008, the recession will be long and “U-shaped” – and the debts incurred by the end of it will be even higher.
Finally, there’s the dreaded “L-shaped recession” where it takes years for the economy to come back, and at some point the government itself goes bust.
We know how to achieve an L-shaped recession because we have the textbook example of Greece. In 2010 the country’s annual economic output was $300bn; by 2015 it was $200bn and – though it recovered slightly due to the eurozone stimulus after 2015 – Greece will be lucky if it reaches $200bn this year.
To produce an L-shaped recession, governments have to impose austerity on an already busted economy. And that, unfortunately, is what large parts of the European political establishment intend to do.
Last Thursday at an “emotional” three-hour virtual summit, the Italian and Spanish prime ministers pleaded with the rest of Europe to launch a “corona bond” – an IOU issued collectively by eurozone governments, to spread the burden of supporting businesses, hospitals and failing companies across the borders of Europe.
The Germans and the Dutch told them in no uncertain terms to get lost. Instead they want the countries under stress to use the European Stability Mechanism, which supplies emergency funding now in return for austerity later. And as Greece found out, that austerity is non-negotiable.
The dilemma may prove existential for the euro project. And yet Europe’s rigid rules, and the mule-headed response of Berlin and The Hague, only serve to dramatise the long-term shortage of options across the entire world.
Since the 2008 financial crisis, the combined debts of companies, households and governments have risen by $72trn Across the G7 countries, government debts now total an average of 118 per cent of GDP – a figure that is now rising rapidly as GDP slumps.
To put that in historical context, even after four years of breakneck mobilisation during the Second World War, the US’s debt only hit 120 per cent of GDP – and it was able to halve that ratio in the space of ten years as the postwar economy boomed. The developed world, by contrast, is entering a war with coronavirus while already carrying wartime levels of debt.
There are only five ways of reducing a debt pile of this magnitude: inflation, currency manipulation, taxation, austerity or write-offs. All of them involve an element of class struggle and inter-state competition.
After the Second World War, the US was able to erode its debt-GDP ratio through a sharp inflation spike; through forcing domestic savers to hold government bonds; and through making real interest rates negative – which, as economists Carmen Reinhart and M Belen Sbrancia pointed out in an influential paper, acted like a tax on wealth.
Though real interest rates are already negative, thanks to 11 years of quantitative easing by central banks, that won’t be enough to start eroding debt. To work today, the old US strategy, known as “financial repression”, would require governments to limit savers’ ability to move money out of the country, to actively stimulate inflation – including real wage growth – and to boost productivity.
For political elites attuned to the free flow of capital, to a low-wage economy and historically low taxation of companies and rich people, none of this is palatable. So we are now likely to hear a growing chorus of politicians saying “we can't let future generations pay for this”.
Though they will turn the money taps on now, to avoid the bankruptcy of airlines, auto manufacturers and banks, it will be working people and their families who are made to pay, once again, through yet another decade of austerity. It’s as if politicians haven't understood a single word of history from the early 1930s. After the Wall Street Crash of 1929, free-market ideology told politicians – from Herbert Hoover in the US to Heinrich Brüning in Germany – to cut public spending and slash wages, even as the economy went into freefall.
Then, as the crisis worsened, the rival governments of the developed world began to default on debt payments, war reparations and ultimately on the global currency system known as the Gold Standard. In the process they managed to plunge half of Europe into fascist or authoritarian dictatorships, and, eventually, the whole world into war.
We, thankfully, are a long way from that. But the situation is fragile. First, because the real economy on which $253bn long-dated debt has been accumulated is not that strong. Second, because while banks have seen their risks reined in due to post-2008 regulation, corporations have been gorging themselves on borrowing, especially as the economy slowed down during 2018-19.
As their profits slump and supply chains freeze, corporate credit ratings are being downgraded, causing the people who lent the money to scramble for cash held in dollars. Of particular concern, says the Institute of International Finance, is the oil and gas industry: oil prices are slumping due to a price war, while the industry is notoriously light on ready cash.
What we’re seeing today is a combined attempt by treasuries and central banks to solve this problem on the cheap. The Federal Reserve, the Bank of England and the European Central Bank have injected money through two channels. There’s an instant-hit form of quantitative easing going on: instead of gradually buying safe debts from banks, the central banks are suddenly buying up a lot of debts at once – some of them pretty risky.
Meanwhile, the Fed has launched an unprecedented “swap line” operation: this means providing ready cash to other central banks so that they can supply money to banks and companies in the form of dollars, avoiding the kind of currency runs and capital flight the Bank of England had to face two weeks ago.
At the Treasury level, much of the money pledged is not actually new spending or tax cuts: it is taxpayers’ money placed notionally at risk by providing soft loans to banks and big corporations, as the Chancellor Rishi Sunak has done to the tune of £330bn.
In the UK, if things go right, the Bank of England ends up holding a large amount of government debt, the government debt increases, but major corporations still exist with their workforces intact. It is then – in the UK as in Europe – that we have to bite the bullet and reject austerity. Austerity is what’s depleted the NHS. Austerity is – as Michael Marmot’s research shows – what is driving the diseases of poverty that make coronavirus more deadly: obesity, heart disease, lung disease and type 2 diabetes. Austerity is what ripped out the heart of small-town communities now awash with xenophobia and hopelessness, and led to dramatic regional dislocation.
Contrary to the neoliberal mantra, we must let future generations pay. You do that through borrowing and through the central bank creating money to buy the debts. It’s not pretty – and as I’ve explained elsewhere, it’s a signal of capitalism’s long term non-viability – but it’s what we have to do.
We must also make today’s rich pay – by forcing tens of trillions' worth of money out of the offshore finance system and into taxable deposits and investments. With the defeat of the Osborne-Cameron wing of Conservatism I am hopeful that – for all its faults and failures - the Johnson wing can be forced to reject a Eurozone-style switch to austerity once this is over. But I am not confident the global system will hold together.
Because the lesson of the 1930s is not just that you need to avoid austerity. It is that you need global leadership. The historian Charles Kindleberger outlined five measures a global power has to take in a crisis of this kind: maintain a relatively open market; provide long-term lending; create and police a stable system of exchange rates; coordinate the macroeconomic policies of major countries; and provide liquidity. The Depression happened because the UK couldn’t, and the US wouldn’t, do these things.
Today, global leadership is almost entirely absent. The central banks are coordinating their response, but governments are not: the Eurozone seems prepared to risk disaster, the UK has forfeited its international leverage during the Brexit process, while the US is led by a clown, whose chosen mission in life is to take a wrecking ball to the global order.