Central bank tales

Britain’s debt  increased from about 3.5 times the amount of GDP to seven times from 1998 to 2008 [EPA]

London, UK – I am as big a fan of taking the historically informed and long view as anyone, but there’s a problem with these explanations. They don’t explain very much. “People have always been idiots” and “Idiots always mess things up” might be useful rules of thumb, but they do not tell us very much about the specifics of what’s been happening in the economy for the last 30 years. Indeed, I am inclined to think that the popularity of these stories in the major media has something to do with their polite uselessness. No one who matters is going to get upset if you start pointing the finger at human nature. The current mess is everyone’s fault, so no one in particular is to blame.

Serving, as opposed to retired, central bankers cannot get away with world-weary musings about man’s timeless folly. They have to be a little more specific. And what they say matters. To a remarkable extent the central bank version serves as a kind of intellectual gold standard. A British commentator or journalist can take what the governor of the Bank of England says, change the word order a little and send it to their editor without fear of challenge.

So what does the current governor, Mervyn King, say caused the economic crisis? In a speech in Liverpool last month King gave a condensed version of The Bank of England Explanation. And, yes, I am trying to make what he said sound like the worst thriller Robert Ludlum ever wrote. Anyway, what does King think is at the root of all our current woes – the stuttering global economy, the Euro crisis, and Britain’s particular cocktail of low growth and high unemployment? King finds the origins of the current mess in the financial sector and he is emphatic that “four years into the crisis it is surely time to accept that the underlying problem is one of solvency not liquidity – solvency of banks and solvency of countries”.

Government and consumers have borrowed too much, in other words. This is an interesting admission and a fairly remarkable one, given what it tells us about the ability of independent central banks to maintain financial sector stability. But King is even more interesting when he sets out “the causes of the unsustainable build-up of debt in Europe and elsewhere”. There was, he says, a “continuing imbalance between those economies running large current account surpluses and those running large current account deficits”. Capital flowed from Asia into the United States, the United Kingdom and elsewhere to finance “unsustainably high levels of consumption” in both the public and the private sector.

Now there’s no doubt that trade imbalances played a part in the buildup of debt in the UK, the US and other countries. And some of the money that flowed back from creditor nations was used to fund public and private consumption. But the plot of The Bank of England Explanation has a hole in it. King fails to note that the Asian tigers didn’t provide the capital for the vast bulk of credit expansion in the West. This is an important omission.

In Britain a reliable authority tells us that in the decade before 2008 “the indebtedness of the financial system doubled”, from 3.5 times GDP to more than 7 times GDP.

(The reliable authority is, of course, Mervyn King.)

UK GDP in 1998 was around £0.87tn. By 2008 it had increased to around £1.4tn. So, financial sector indebtedness rose from about £3tn to nearly £10tn in 10 years. The Asians lent the British some money, for sure. They did not lend our banks £7tn, more than twice China’s total GDP in 2008. Avid consumers though we may be, we didn’t buy that many flat screen televisions.

So if our appetite for imports wasn’t a major cause of the UK’s growing indebtedness, where did all the money come from? Some of it came from rich Western investors. As income inequality grew, the people who like to think of themselves as winners lent the people they privately call losers the money they needed to pay for increasingly expensive housing, household bills, transport, education, healthcare and so on. Productivity was growing. But the rich were capturing a larger and larger slice of national income. Easy credit was what the rest of us had instead of pay rises. Some of the money went on cartoonishly big cars and irritating electrical gadgets. Most of it didn’t.

Creating debt

The other source of credit expansion is a little more arcane. Banks have rarely noticed power to create money in the form of debt. Banks used this power to lend money to purchasers of residential and commercial property, thereby inflating an asset price bubble. This new money was lent back to the banks, increasing their debt levels. The banks also lent more and more money to one another to finance speculation, creating trillions in new debt.

This is the key point to bear in mind. The consumption of imported goods from the hard-working regions of the world accounts for only a tiny fraction of the UK’s total debt growth.

Under the benign gaze of Mervyn King, private banks created heaps of new money in the form of debt. This conjuring up of money is a central cause of the banks’ insolvency and hence of the economic crisis. Once we grasp the role that income inequality and money creation by banks played in the crisis we can begin to see how our current problems can be addressed in both the short and long term.

We don’t have to become more like the Chinese to set the economy back on track. This is good news for anyone who doesn’t want to live in an authoritarian regime where an unelected elite lord it over an ill-informed and depoliticised population. Central bankers probably have more mixed feelings.

After decades of enthusiastic tax avoidance and evasion, asset price inflation, and general chicanery, the rich have more money than they know what to do with. This is not an empty figure of speech. There aren’t enough profitable investment opportunities in the real economy to soak up the money in private hands – all those bonuses and dividends and ill-gotten gains.

The tax system must recognise the needs of the nation as a whole and transfer this idle wealth to those who will either invest it sensibly or spend it into circulation. This is necessary even if it means dismantling the offshore archipelago that constitutes Britain’s latest gambit in the game of empire. If governments have been spending more than they take receive in tax, it is time to start taxing the rich again.

In the longer term, we cannot continue to allow private banks to create new money out of thin air. The supply of debt is too important to be left in the hands of institutions that have proved hopelessly unequal to the task. By all means let private lenders fund innovation. But they cannot be permitted to blow asset bubbles or fund speculative Ponzi schemes. The central bank must become the transparent overseer of a system of credit that responds to the stated needs and wishes of the people who must ultimately foot the bill.

That would be everyone, by the way.

Dan Hind worked in publishing for a decade and is the author of two acclaimed books: and

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The author would like to thank the Tax Justice Network for their help with this article.

The views expressed in this article are the author’s own and do not necessarily reflect Al Jazeera’s editorial policy.