Broken banking system is keeping growth at bay
Last weekend’s election results in France and Greece, we’re told, show that eurozone voters want “growth, not austerity”. In the UK, too, the deficit-cutting coalition government is being widely castigated for “lacking a growth policy”. In reality, though, “growth versus austerity” is a false and dangerous dichotomy, a misleading policy choice that has been formulated and fed to electorates in Britain and elsewhere by opportunistic politicians and their pet intellectuals.
“Economic growth” isn’t a decision a government can opt for. It is, instead, an outcome – an outcome we want and need, and which can be achieved in a variety of ways, none of which is guaranteed. There are, on the other hand, many ways to guarantee that growth won’t happen. One way is for country to borrow and spend far beyond credible limits so that, in the end, bond markets refuse to roll over their sovereign debts. Growth won’t happen in the midst of a creditors’ strike, when sovereign bond markets are in meltdown and interest rates spiraling out of control.
Similarly, growth won’t happen when there is capital flight and soaring inflation, the result of a plunging currency, after a nation has printed so much money that global investors, sick and tired of asset debasement, ultimately cut that country loose. Growth won’t happen, either, when there is civil unrest, the result of governments being unable to pay basic bills because credit markets have collapsed. While there are few certainties in economics, the above no-growth scenarios, however harsh, are backed by decades, centuries even, of historic evidence, to say nothing of common sense.
In that aftermath of this Franco-Greek revolt, the eurozone, despite numerous bail-outs over several years, has plunged back into crisis. Some of the world’s most advanced nations are now, once again, flirting with a creditors’ strike. Sovereign bond chaos, already seen on the “eurozone periphery” of course, has only been averted in some larger Western European economies – the UK included – because central banks, in an unprecedented move, have expanded base money three-fold, then hoovered-up reams of government debt.
This is the reality. Some may quibble with my tone. But no-one, if they have the most elementary understanding of financial markets, can deny these facts. And yet, despite the fragility of our predicament, we still hear claims that extra government borrowing is the answer, that raising sovereign debt even more than it’s already set to rise, will help us handle the record debts we face. Let us spend more, the Keynesians say, and our problems will be solved. Let us further expand already escalating state borrowing because “austerity” isn’t working.
This is, like motherhood and apple pie, an easy message to sell. As such, there will always be craven politicians, and court jester policy-wonks who will line-up in order to sell it. It falls to the grown-ups, then, to insist on the truth, however uncomfortable that truth may be. For the truth is that austerity, for all the hardships and injustices involved, is working in one crucial regard, the importance of which trumps all others. Austerity is working because, without it, UK and eurozone sovereign bond markets would be in utter chaos, making our situation far, far worse than it currently is.
Last week, Christine Lagarde, her eye firmly on the French electorate, also criticized the “growth versus austerity” debate. The International Monetary Fund supremo did so, though, while urging Europe to move away from the “Merkozy” model of deficit-reduction. “Fiscal austerity holds back growth, and the effects are worse in downturns”, observed Lagarde, calling for a more gradual pace” of adjustment.
In an ideal world, Lagarde is right. In the real world, many Eurozone countries, and the UK too, have lost the ability to choose how quickly we return to a sustainable fiscal path. Given the extent to which we’ve already borrowed and spent in recent years and decades, the speed of our economic adjustment is no longer ours to decide. That is the reality our “leaders” ignore. Western Europe’s debts are so high that our democratic freedoms have been severely compromised – and that, I’m afraid, is that.
If we don’t adjust fast enough to appease our creditors, then a cataclysmic adjustment will instead be imposed on us. Many large European economies are now reliant on the totally unsustainable combination of QE and international bail-outs to prop up sovereign bond markets and keep the wolf from the door. The Chinese government, meanwhile, is so sick of Europe’s woes, and money-printing, that it’s refusing to buy more eurozone bonds. What more evidence do we need that we’re not moving quickly enough?
Yes – the bond markets can see that adjustment takes time and extreme policy measures may be justified. But that argument only holds for so long, and only if the time is used to implement genuine reforms, and if the liquidity injections facilitate necessary adjustments and structural change. In the eurozone and UK, though, the time we’ve bought, and the QE we’ve implemented, has been used not to accommodate change, but to kick the can of tough reforms ever further into the future. “Growth, not austerity” is merely the latest manifestation of that self-same can-kicking.
There is no choice between growth and austerity. This posing of this false dichotomy reflects, instead, the ideological, almost tribal nature of the Western world’s policy debate. The real choice is, in fact, between two forms of crisis-management – that taken by Sweden on the one hand and Japan on the other.
The reason the UK and much of the eurozone has slipped back into recession has nothing to do with a “lack of demand”, as the Keynesian dinosaurs assert. A bit more government spending here, an “enterprise scheme” there, may buy-off the odd interest group. But such measures are mere political parlour games, doing nothing to decide our economic trajectory and having zero impact on growth – unless, of course, the extra spending they entail tips international opinion over the edge and our bond markets totally seize, forcing us back into a deep, Lehman-style, slump.
Western Europe is failing to grow quite simply because the banking system remains broken. It remains broken because, as this column has repeatedly asserted, massive, unaudited liabilities continue to lurk within banks’ off-balance sheet vehicles, ensuring that the inter-bank market remains paralyzed by fear of counter-party risk. As such, lending languishes at rock-bottom, with credit-worthy firms and households starved of the working capital that is the very essence of economic progress. That’s why we have no growth.
During the early 1990s, faced with a similar situation, Swedish leaders had the foresight to force their busted banks to reveal their losses, using a combination of “full disclosure”, write-downs and a “bad bank” to re-boot credit markets, which in turn got the economy moving. It was a text-book credit-lock escape, but no less courageous for that.
Japan, of course, took a different route. Bogged down by institutional torpor, and a cultural “fear of failure”, the Japanese dealt with their 1990s credit-crunch by sticking their collective head in the sand – which is where it remains, almost 20 years on. The “zombie bank” – leeching from society, dragging down the rest of the economy – may have been invented in Tokyo, but it’s now increasingly to be seen in Madrid and Paris, Frankfurt and London.
So forget “growth V austerity”. The question is do we follow Schumpeter or Marx, Sweden or Japan? That’s the real policy dilemma we face.