Borrowing was both the shaky foundation of global growth and the cause of its collapse.
It started with a bust and it ended with an even bigger bust. In between was sandwiched an unsustainable boom. Banks have been humbled. Economists have been found wanting. Geopolitical power began to shift from west to east. That was the noughties that was.
It barely seems five minutes ago that policymakers were fretting about the possible -- and, as it turned out, entirely illusory -- effects of the millennium bug. Policy was loosened to prevent any deleterious effects from a global computer meltdown; the result was to pump even more air into the dotcom bubble.
Britain, hard though it now is to believe, was one country that avoided the recession which followed the realisation that most of the overhyped internet companies were duds. Gordon Brown had been stingy with public spending in the late-1990s, building up a sizeable fiscal war chest in the process. When the crisis broke, he was able to behave in a classic Keynesian way - boosting growth through higher investment and lower taxes.
These were the days of “prudence for a purpose”, of “no return to Tory boom and bust” and of “building a platform of stability”. With the economy likely to contract by 4.75 per cent this year (a post-war record) and borrowing on course to hit 12 per cent to 13 per cent of GDP this year (a peacetime record) it all seems a very long time ago.
[Opposition finance spokesman] George Osborne, understandably enough, is loving it. Mr. Brown made mincemeat of a succession of shadow chancellors, taunting them with the contrast between the strong growth and healthy public finances under Labour and the humiliation visited upon John Major’s government on Black Wednesday.
There were none of the sterling crises that had marked every previous Labour administration. Nor could the Conservatives make their traditional accusation against Brown -- that Labour governments, sooner or later, ran out of money.
There are no such constraints now. Osborne responded to Friday’s news that the Treasury had to borrow more than £20bn last month to balance the books by accusing Brown of “maxing out on the nation’s credit card.” The looming fiscal squeeze does reflect the fact that Labour has run out of money.
It is, however, unfair to assume that Britain is alone in its budgetary difficulties. The U.K.’s overreliance on financial services as a source of both growth and tax revenues means the deterioration in the public finances has been more marked here than elsewhere, and from a worse starting point. Brown, crucially, failed to replenish his war chest after the loosening of policy earlier this decade.
But the crisis of the past two-and-a-half years has exposed vulnerabilities across the entire global economy. During the fat years in the middle of the decade, clear warning signs of trouble ahead were ignored. Ultimately, the global imbalances did matter. Ultimately, the build-up of personal debt did matter. Ultimately, the willingness of banks and other financial institutions to take ever bigger risks in search of high returns did matter.
The economics profession thought otherwise. It built sophisticated mathematical models showing that markets could not be wrong. Despite the fact that Wall Street and the City of London seemed to be dominated by headstrong young men with far too much money and far too little sense, the chance of a catastrophic blow-out was viewed as alarmist nonsense. When the meltdown occurred, there was a sense of utter disbelief. Chuck Prince, the (former) boss of Citigroup, captured the mood when he said, a couple of weeks before the crash, that while the music was playing he would carry on dancing. If prices in the markets were not signalling problems, how could there possibly be any?
The fact was, however, that trouble had been festering for the past 15 years, and intensified during the noughties. After the collapse of communism, industrial production migrated to Asia, and China in particular. Britain and the United States saw a hollowing out of manufacturing and a concomitant growth in the relative importance of their financial sectors. Producers in Asia (and parts of Europe such as Germany) ran trade surpluses while the Anglo-Saxon economies ran trade deficits. Surplus countries bought assets in debtor countries; the money churning through New York and London kept the dollar and the pound strong, made imports cheaper and allowed policymakers to keep interest rates low. Consumers found their incomes went further and they could borrow cheaply. They spent like it was going out of fashion.
Yet there was a dirty little secret about this supposed perpetual moneymaking machine. It required debt — and lots of it -- to work. The real story of the noughties is that of how borrowing was used to plaster over the deep structural problems of modern global capitalism. We have almost reached the end of that road, but not quite.
Dhaval Joshi, the economist at RAB Capital, describes it well when he says that this has been the decade of three borrowing booms. It began with corporations racking up debt during the irrational exuberance of the dotcom bubble. Alan Greenspan dealt with the recession that followed by leaving interest rates low enough for long enough that there was then a boom in borrowing by households, leading to a housing bubble.
When that bubble burst, governments had a choice. They could sit and watch a severe recession worsen as companies and individuals repaired their finances by paying off their debts, or they could borrow more themselves. They took the second option, allowing budget deficits to take the strain as growth collapsed and unemployment rose. That was true in the west, but it is also true in the east. China, which perhaps has more to fear from recession-generated political unrest, is the world’s top borrowing nation.
There are three big lessons, Joshi says. The first is that debt-driven growth is eventually unsustainable. To generate growth from borrowing, you have to borrow more year in, year out. The second is that borrowing binges lead to asset booms, which investors seek to rationalise using arguments such as “a new paradigm” or “a wall of money.”
The final lesson is that the point of maximum danger in any borrowing boom is when borrowing starts to slow, not when it stops. “However much you borrow and spend this year,” Joshi says, “if it is less than last year, it means your spending will go into recession.”
This is an important point given the current state of the global economy. Governments are coming under intense pressure to rein in their borrowing; some countries, Ireland most notably, have already taken steps to do so.
Policymakers are hoping a renewed appetite for debt by firms and households will enable governments to cut borrowing without causing a second leg to the recession. This looks like a flawed strategy. It would be rebuilding the global economy on the same jerry-built foundations that caused the crisis in the first place. It also flies in the face of reality: there is precious little evidence that the private sector has any great desire to load up with lots more debt.
Instead, governments may have to face up to a stark choice. They can carry on borrowing more, thereby accepting that public sector deficits will spiral. Or they can respond to the pressure from the financial markets and start borrowing less. The latter seems the likeliest, but it would all but guarantee a double-dip recession during 2010. — © Guardian Newspapers Limited, 2009