Originally posted at Der Spiegel,
Prison of Debt Paralyzes West
By Cordt Schnibben
In the midst of this confusing crisis, which has already lasted more than five years, former German Chancellor Helmut Schmidt addressed the question of who had "gotten almost the entire world into so much trouble." The longer the search for answers lasted, the more disconcerting the questions arising from the answers became. Is it possible that we are not experiencing a crisis, but rather a transformation of our economic system that feels like an unending crisis, and that waiting for it to end is hopeless? Is it possible that we are waiting for the world to conform to our worldview once again, but that it would be smarter to adjust our worldview to conform to the world? Is it possible that financial markets will never become servants of the markets for goods again? Is it possible that Western countries can no longer get rid of their debt, because democracies can't manage money? And is it possible that even Helmut Schmidt ought to be saying to himself: I too am responsible for getting the world into a fix?
The most romantic Hollywood movie about the financial crisis isn't "Wall Street" or "Margin Call," but the 1995 film "Die Hard: With a Vengeance." In the film, an officer with the East German intelligence agency, the Stasi, steals the gold reserves of the Western world from the basement of the Federal Reserve Bank of New York and supposedly sinks them into the Hudson River. Bruce Willis hunts down the culprit and rescues the 550,000 bars of gold, which, until the early 1970s, were essentially the foundation on which confidence in all the currencies of the Western world was built.
Creating Money out of Thin Air
Until 1971, gold was the benchmark of the US dollar, with one ounce of pure gold corresponding to $35, and the dollar was the fixed benchmark of all Western currencies. But when the United States began to need more and more dollars for the Vietnam War, and the global economy grew so quickly that using gold as a benchmark became a constraint, countries abandoned the system of fixed exchange rates. A new phase of the global economy began, and two processes were set in motion: the liberation of the financial markets from limited money supplies, which was mostly beneficial; and the liberation of countries from limited revenues, which was mostly detrimental. This money bubble continued to inflate for four decades, as central banks were able to create money out of thin air, banks were able to provide seemingly unlimited credit, and consumers and governments were able to go into debt without restraint.
This continued until the biggest credit bubble in history began to burst: first in the United States, because banks had bundled the mortgages of millions of Americans, whose only asset was a house bought on credit, into worthless securities; then around the globe, because banks had foisted these securities onto customers in many countries; and, finally, when these banks began to totter, debt-ridden countries turned private debt into public debt until they too began to totter, and could only borrow money from banks at even higher interest rates than before.
At the moment, the world has only one approach to getting out of this labyrinth of debt: incurring trillions of even more debt.
What does all of this have to do with Bruce Willis and Helmut Schmidt? Willis rescued the world's gold and, with it, the illusion of the good, old world. Schmidt, as Germany's finance minister in the 1970s, set the debt spiral in motion and fueled the illusion in Germany that countries could go into debt, and that this was good for everyone.
When Schmidt's predecessor, Karl Schiller, resigned from the government in protest over 4 billion deutsche marks in new debt, he said: "I am not willing to support a policy that creates the impression, to outsiders, that the government pursues the motto: After us comes the deluge."
Schmidt incurred 10 billion deutsche marks in new debt. Inspired by crisis economist John Maynard Keynes, the German government believed that economic stimulus programs would stimulate growth, but only under the condition that the debt was to be brought down again in better times.
This economic policy was known in Germany as "global regulation." As finance minister, and later as chancellor, Schmidt took advantage of the oil crisis to drive up the government deficit with economic stimulus programs. When Schmidt stepped down in 1982, annual government spending tripled in comparison to spending in 1970, reaching the equivalent of €126 billion ($161 billion), and the public debt increased fivefold, to €313 billion. By today, the combined debt of federal, state and local governments has climbed to more than €2 trillion.
A Human Debt Gene?
From today's perspective -- leaving aside all the effusive rhetoric about Europe -- the introduction of the euro is nothing but the continuation of debt mania with more audacious methods. The euro countries took advantage of the favorable interest rates offered by the common currency to get into even more debt.
Can all of this be blamed on some sort of human debt gene? Is it wastefulness, stupidity or an error in the system? There are two views on how the government should use its budgets to influence the economy:
- the theory of demand, established by Keynes, advocates creating debt-financed government demand, which in turn generates private demand and produces government revenues. In other words, building a road provides construction workers with wages. They pay taxes, and they also use their wages to buy furniture, which in turn provides furniture makers with income, and so on.
- The other view, supply-side economics, is based on the assumption that economic growth is determined by the underlying conditions for companies, whose investment activity depends on high earnings, low wages and low taxes. According to this theory, the government encourages growth through lower tax rates. In the last few decades, the frequent transitions of power in Western countries between politicians who support supply-side economics (conservatives, libertarians and now some center-left social democrats) and those who advocate Keynesian economics (social democrats) has driven up government debt. When some politicians came into power, they reduced government revenues, and when they were replaced by those of the opposite persuasion, spending went up. Some did both.
When the debts of companies and private households are added to the public debt, the sum of all debt has grown at twice the rate of economic output since 1985, and it is now three times the size of the gross world product. The developed economies apparently need credit-financed demand to continue to grow, and they need consumers, companies and governments that go into debt and put off the financing of their demand until some time in the future. Of its own accord, this economic system produces the compulsion to drive up the debt of public and private households.
Governments delegate power and creative force to the markets, in the hope of reaping growth and employment, thereby expanding the financial latitude of policymakers. Government budgets that were built on debt continued to create the illusion of power, until the markets exerted their power through interest.
Interest spending is now the third-largest item in Germany's federal budget, and one in three German municipalities is no longer able to amortize its debt on its own steam. In the United States, the national debt has grown in the last four years from $10 trillion to more than $16 trillion, as more and more municipalities file for bankruptcy. In Greece, Spain and Italy, the bond markets now indirectly affect pensions, positions provided for in budgets and wages.
A country isn't a business, even though there are politicians who like to treat their voters as if they were employees. Politics is the art of mediating between the political and economic markets, convincing parliaments and citizens that economic policy promotes their prosperity and the common good, and convincing markets and investors that nations cannot be managed in as profit-oriented a way as companies.
After four years of financial crisis, this balance between democracy and the market has been destroyed. On the one hand, governments' massive intervention to rescue the banks and markets has only exacerbated the fundamental problem of legitimization that haunts governments in a democracy. The usual accusation is that the rich are protected while the poor are bled dry. Rarely has it been as roundly confirmed as during the first phase of the financial crisis, when homeowners deeply in debt lost the roof over their heads, while banks, which had gambled with their mortgages, remained in business thanks to taxpayer money.
In the second phase of the crisis, after countries were forced to borrow additional trillions to stabilize the financial markets, the governments' dependency on the financial markets grew to such an extent that the conflict between the market and democracy is now being fought in the open: on the streets of Athens and Madrid, on German TV talk shows, at summit meetings and in election campaigns. The floodlights of democracy are now directed at the financial markets, which are really nothing but a silent web of billions of transactions a day. Every twitch is analyzed, feared, cheered or condemned, and the actions of politicians are judged by whether they benefit or harm the markets.
The attempt by countries to bolster the faltering financial system has in fact increased their dependency on the financial markets to such an extent that their policies are now shaped by two sovereigns: the people and creditors. Creditors and investors demand debt reduction and the prospect of growth, while the people, who want work and prosperity, are noticing that their politicians are now paying more attention to creditors. The power of the street is no match for the power of interest. As a result, the financial crisis has turned into a crisis of democracy, one that can become much more existential than any financial crisis.
An Unequal Battle
The one sovereign stalks the other, while the pressure of the markets contends with the pressure of the street. In Europe, in particular, this has become an unequal battle. Since Jan. 14, 2009, when Standard & Poor's downgraded Greek government bonds, the markets have determined the direction and pace of European integration. They want bigger and bigger bailout funds, they want to safeguard their claims, they want a European Central Bank that buys up government bonds indefinitely, they want slashed government budgets, they want labor market reforms like the ones in Germany, they want wage cuts such as those in Germany and, at the same time, they want these incapacitated countries mired in recession to offer the prospect of healthy growth.
And this is happening in a Europe in which the sovereign nations don't truly know how much Europe they really want. The people who govern Europe don't know either, which puts them at the mercy of the markets. They have no common model for Europe, and they suspend the most basic democratic ground rules to remain capable of acting. They have to use tricks and bend agreements to prevent the euro from breaking apart.
The gulf between those who govern and those who are governed, a problem in any democracy, is complicated in Europe by the mistrust between Europeans and bodies that seek to tame the crisis in their name.
The actions of governments also generate mistrust. The German government, in particular, has more confidence in the markets than in the governments of Europe's crisis-ridden countries, and it finds the power of interest rates more convincing than promises of reform. Mistrust also stems from the relationship between governments and their voters, so much so that it's become common to delay important decisions until after elections and to keep them out of campaigns. There isn't much confidence in the economic judgment of the people. If lawmakers can hardly understand which bailout funds they are voting for, how many billions they are pushing in which direction, how great the risk of inflation is, what terms like target, derivative, leverage and securitization mean, how much can citizens be expected to comprehend? A citizen who hopes to understand the underlying problems of the euro crisis would, at the very least, have to read the business sections of major German newspapers like the Süddeutsche Zeitung or the Frankfurter Allgemeine Zeitung every day. Watching one talk show a week isn't enough.
Even Good Debt Needs to Be Serviced
The democratic decision-making process reaches its limits in this fundamental crisis, but even in the decades when debt was being accumulated, it was clear that democracies have a troubled relationship with money.
There was always justification for new debt. The catchphrases included things like more jobs, better education and social equality, and the next election was always around the corner. Debt was justified at the communal level to expand bus service or build playgrounds, at the state level to hire more teachers or build bypasses and, at the federal level, to buy tanks and fund economic stimulus programs.
There is good debt and bad debt, but even good debt needs to be serviced constantly. A closer look at which countries acquire and pay off debt, and to what degree, reveals unsettling correlations: The more often governments change and the more pluralistic they are, the faster the debt increases and the more difficult it becomes to pay if off. The more democracy, the looser the money. The only place money gets even looser is in dictatorships.
To hold an administration responsible for the debts of its predecessors, there are debt limits in democracies. In Helmut Schmidt's day, for example, there was a provision in the German constitution stipulating that total debt could not exceed total investment. In Europe, the provisions of the Maastricht Treaty, which is aimed at ensuring the stability of the common currency, limit the amount of debt a government can accumulate to no more than 60 percent of gross domestic product.
Debt Limits Have Never Worked
So far, such debt limits have never worked in any country. Under new laws in Germany, the federal government, starting in 2016, will only be allowed to incur new debt amounting to 0.35 percent of GDP. The euro countries have agreed to a similar rule, but it can only take effect if all national parliaments agree.
In some countries, there are already sparks of resistance against the limitation of new debt. The Italian government refuses to implement austerity measures demanded by the ECB and to approve a clause stipulating automatic spending cuts. After mass protests, the Portuguese government reversed cuts that had already been announced. Spain will fall short of an agreed deficit target of 6.3 percent, with its deficit actually predicted to come in at 7.4 percent. Euro-zone countries are in fact not allowed to incur new debt of more than 3 percent of GDP.
What makes those hoping to clean up budgets in the crisis-ridden countries skeptical is the downward spiral triggered by such drastic budget cuts, structural reforms and wage reductions. Private and public demand is sinking while the economy shrinks, leading to higher unemployment, less government revenue and higher debt. In Spain, after four austerity packages, the unemployment rate has increased from 8 percent in early 2007 to 25.8 percent today, while the country's debt ratio has doubled. In Portugal, unemployment has gone up by close to 100 percent in four years, with the debt ratio increasing from 72 to 114 percent. In Greece, after budget cuts amounting to more than 10 percent of the country's total economic output, unemployment has almost tripled and the debt ratio has risen from 113 to 160 percent.
These horrific numbers are not just driving people into the streets, but are also creating conflicts between politicians and economists. There it is again, the old dispute between the supporters of supply-side and Keynesian economics. Only when budgets have been balanced, taxes are low and wages are brought down can growth return, says the one side; those who cut public and private demand so radically are driving countries into recession and driving debts up instead of down, says the other. Average growth in Europe has declined continuously and was only 1.4 percent in 2011, while the economy is expected to shrink this year.
For many debt-ridden countries, growth is one of four possibilities to reduce debt. Balancing budgets through cuts and tax increases is another. The third option is a debt haircut, which means declaring bankruptcy and no longer servicing at least a portion of debts. The fourth path is inflation, that is, allowing the debt to melt away on the quiet at the expense of savers and consumers. But three to four percent inflation can hardly be justified politically in Germany, although the prospects are better in the United States and other countries. For this reason, and in response to German pressure, European countries are now trying out tough austerity programs.
A European Depression and a Pending Japanese Disaster
Because governments are in disagreement, bodies are taking their place that are turning into ersatz governments: the central banks.
The ECB's decision to buy up unlimited amounts of the sovereign debt of European countries is a replacement for political solutions for which there are currently no majorities in the governments and parliaments of euro-zone countries. The decision by the American Federal Reserve Bank to inject hundreds of billions of dollars into the markets again to stimulate economic growth results for the inability of Democrats and Republicans to agree on a compromise between limiting debt and economic stimulus programs. Printing money -- or betting hundreds of billions once again -- is the last desperate response on both sides of the Atlantic.
What began four years ago with the bursting of a credit bubble in the mortgage market is being combated with more and more new debt in the trillions, thereby inflating the next, even bigger credit bubble.
The fresh trillions circle the world in the search for yield, but only a small part of the money flows into the real economy, where investments in new production plants produce lower returns. Instead, the trillions slosh back and forth, from one financial market to another, from the foreign currency market to the commodities market, and from the gold market to the stock market and back again.
Because these trillions are not reaching the real economy, the risk of inflation is currently smaller than Germany's central bank, the Bundesbank, and its president would have us believe. But every saver and everyone with a life insurance policy pays for the central bank's low interest-rate policy with low interest rates. When central banks keep interest rates close to zero for long periods of time, which they have done for years, they disadvantage ordinary savers and favor major investors, gamblers and banks, which can borrow at low rates and invest the money elsewhere at a profit.
Blaming the Banks
Who and what has gotten the world into such trouble, and how can it extricate itself again? Not surprisingly, former Chancellor Schmidt blames investment bankers, the managers and bankers who flooded the world with worthless securities and long speculated on the sovereign debt of crisis-ridden countries, and who hedged their risks, which were much too high, with far too little capital and therefore had to be rescued with taxpayer money. Banks are still the focus of all problems in the financial markets. They still have to be supplied with money, and they still pose a threat to the system.
And those who allowed them to become so powerful are all those politicians and governments that gave the financial markets so much freedom, often socialized the risks, incurred too much government debt, and allowed the municipalities, states and countries to become so irresponsible. "The market" is not some group of experts, nor is it the last resort of collective reason. It is an orgy of irrationality, arbitrariness, waste and egoism. "Democracy" is not some event involving citizens, or some celebration of altruism and far-sightedness, but rather the attempt to bundle diverging interests into decisions in a way that's as peaceful as possible.
Together, the market and democracy are what we like to call "the system." The system has driven and enticed bankers and politicians to get the world into trouble, or least one could argue that if they too weren't part of the system. And we could sweep it away if we had a better one.
Instead, we are left with an undisguised view of the system. One of the side effects of the crisis is that all ideological shells have been incinerated. Truths about the rationality of markets and the symbiosis of market and democracy have gone up in flames.
The Problems of Modern Capitalism
The European depression is only prelude, with the Japanese disaster waiting in the wings. The country's debt-to-GDP ratio is 230 percent, and the government is dependent on the opposition approving the issue of new government bonds. Lurking behind it all is the American abyss, the debt drama of the next few months, the showdown and duel between Democrats and Republicans over which party can blame the other one for a national bankruptcy.
And then, finally, we have a clear view of the three biggest problems in finance-driven, democratically constituted capitalism:
- First, how can a debt-ridden economy grow if a large part of demand in the past was based on debt, which is now to be reduced?
- The second major problem of modern capitalism is this: How can the unleashed financial markets be reined in again, and how should the G-20 countries come up with joint rules for major banks, which are their financiers and creditors, and for markets, which punish and reward these countries through interest? How much freedom do financial markets need to serve the global economy as a lubricant, and what limits do they need so that banks, shadow banks and hedge funds do not become a threat to the system?
- Third, how do governments mediate between the power of the two sovereigns, how do they reestablish the primacy of citizens over creditors, and how does democracy function in debt-ridden countries? How can politicians react without burdening countries with more debt, and how can they reduce that debt? In fact, how can they even govern anymore in this prison of debt? In the past, future revenues were mortgaged, in municipalities, states and the federal government. This now makes it difficult to structure the present and the future. Today only about 20 percent of the federal budget is truly politically available, as compared with 40 percent when Schmidt was still in office.
It is always only at first glance that the world is stuck in a debt crisis, a financial crisis and a euro crisis. In fact, it is in the midst of a massive transformation process, a deep-seated change to our critical and debt-ridden system, which is suited to making us poor and destroying our prosperity, social security and democracy, and in the midst of an upheaval taking place behind the backs of those in charge.
A great bet is underway, a poker game with stakes in the trillions, between those who are buying time with central bank money and believe that they can continue as before, and the others, who are afraid of the biggest credit bubble in history and are searching for ways out of capitalism based on borrowed money.
Translated from the German by Christopher Sultan