Reinventing Prosperity. Graeme Maxton
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than before they started their borrowing spree. But when they are unable to borrow more, spending is forced down—and to a lower level than before the borrowing began. The difference—that is, the reduction—equals the amount the borrower has to pay in interest and in repayment of the loan. Borrowing simply makes it possible to increase consumption above what is sustainable for a limited period of time. It cannot lift the rate of consumption in the long term.
We can look at the debt phenomenon another way. The increase in debt meant that the poor (and their consumption) were funded by the rich, whose savings were loaned through the banking system. In effect, the rich boosted their incomes by paying the poor less than before (and making them work longer hours into the bargain). They then became richer still by lending the poor the profits, in return for interest. So it is not just rising business profits and lower taxes that have benefited the wealthiest segments of society. Nor is it purely falling wages and rising unemployment that have blighted the poor. The great borrowing binge of the last three decades has also greatly widened the gap between rich and poor by increasing the flow of money to the rich.
The combined effect of these trends is startling. Instead of three decades of economic growth improving average living standards, as economists said it would, it has led to a decline in living standards for vast numbers of people. Rather than creating jobs and narrowing the gap between rich and poor as expected, millions of people in the rich world are being thrown back to a place they have not occupied for almost a century. In the United States, the U.K., and Ireland, the gap between rich and poor is bigger today than it was in 1917, a remarkable reversal of economic and social progress.19
It is not the same everywhere, however. The gap between rich and poor in Japan has not widened much. Nor has inequality changed much in Germany, Sweden, or much of the rest of Europe in the last thirty years, despite the hike in unemployment. Inequality has actually fallen slightly in France, Norway, and Italy, as well as in Canada, though it has risen there again since 2011. This is because the unemployed are better supported and the wealthy more highly taxed in these countries.20
This at least shows that it is possible to live in the developed world, to run an open free-market economy, to have experienced thirty years of spectacular economic growth, to have a financial crisis, to have unemployment rise, and still see no widening of inequalities.
It is possible if the extreme effects of the free-market model are properly managed.
In many other OECD countries, though, and most notably in the places inhabited by the loudest proponents of the extreme free-market ideology, the economic growth of the last thirty years has not distributed incomes and wealth more evenly. It has not created enough jobs. It has achieved the opposite.21
DESPITE ALL THIS, most rich-world economists and politicians still think that pushing for faster economic growth is a good idea. They still believe that free-market economic thinking can reduce unemployment and inequality. Like captains of a ship that has veered wildly off course and then hit a rock, they think the solution is to push the engines harder rather than to properly understand what is going on. Few have questioned the fundamental wisdom of having a lightly regulated free-market economic system, even though it has not done what it promised for so long.
Rather than trying to bring their economies into balance, rich-world governments have continued as before. As a consequence, the developed world’s economy is becoming more and more like one of those cartoon characters that has run off a cliff, legs still running furiously, despite there being no solid ground beneath them. It is riddled with financial imbalances and burdened with trillions of dollars in debts that are unlikely to ever be repaid. The entire system is off course.
Since 2008, in addition to implementing their usual economic strategies, rich-world governments have employed two especially important and unusual policies to respond to the current challenges: ultra-low interest rates and Quantitative Easing (QE),22 which just means printing money. Governments and businesses have also applied enormous psychological pressure on their citizens to continue spending, encouraging them to borrow more if necessary, to maintain economic growth. Many banks have received cash injections to strengthen their balance sheets and access to low-cost central bank funding to maintain liquidity and boost lending.
As a result, commercial rates of interest in much of the rich world are at their lowest level ever,23 with several European countries, the eurozone, and Japan offering negative rates, forcing people to pay to save (thereby encouraging them to spend instead).
The consequences of lowering the costs of borrowing like this are that bankers and the rich have gained even more. Between 2008 and 2013, commercial banks increased their profits because their margins (the difference between the rate at which they borrow and lend) rose. Many big corporations also gained, through lower interest payments, while financial investors, such as venture capitalists and hedge funds, were able to borrow more cheaply, allowing them to snap up assets before they increased in value.
Developed-world households were the main losers from the low interest rate policy, suffering $630 billion in lost interest income between 2007 and the end of 2013.24 Those living off their bank savings were hit especially hard. European banks and life insurance companies also lost out, because of the decline in interest income. Many pension funds had problems, too. As their earnings declined, some found themselves unable to meet their future commitments.
As with the wider free-market economic system, the main beneficiaries of this low interest rate policy were the wealthy, especially in the United States, and the finance industry. In effect, ultra-low interest rates increased the flow of money from those who borrow (generally, the poor) to those who lend (generally, the rich), widening inequality even more.
It is much the same with QE.
After the 2008 financial crisis, there was a risk of deflation, when average prices fall. For economists, this is a scary prospect because deflation is extremely hard to cure. When prices fall, people delay spending because they know that whatever they want to buy will be cheaper in the future. Deflation causes the economy to slow and then shrink, with nasty implications for jobs, wages, and asset values.
To avoid this risk, economists advised governments to print money, which is thought to have an inflationary effect.
Between 2008 and October 2014, the United States’ central bank, the Federal Reserve, injected between $75 billion and $85 billion into the economy every month. Cumulatively, it injected $4.5 trillion—more than a quarter of the country’s annual GDP. This was the same as adding another Australia, India, and Spain to the world economy.
The British government did much the same, injecting $500 billion, while the Bank of Japan and the European Central Bank (ECB) also printed many hundreds of billions of yen and euros—and continue to print them today, in 2016.
Together, these countries have injected so much money into the global economies since 2008 that it has been like adding another China.25 If this money was simply converted to demand and output, it would have increased the GDP of these countries by more than 25% between 2008 and 2015. Yet their GDP grew by just 11% in real terms. The rest was kept by business owners and banks, or used to boost asset prices.
Essentially, all this money was created out of thin air, by changing numbers on balance sheets. So, even to describe it as “printing money” is a misnomer—no real effort was required, and certainly no printing presses were involved. It was fed into the economy mostly by central banks purchasing government and corporate bonds, which were typically sold by private banks and other financial institutions, including insurance companies and pension funds. The process provided liquidity, and so cash flow, for these institutions and an opportunity for them to reinvest. The money did not go to the people—and certainly not to all those unemployed who lacked an income, which would have been much more effective. If they had been given the money, they would have spent it immediately—and created the demand that the economy needed.
As with ultra-low interest rates, the main beneficiaries of QE were business owners and financial institutions, who used the increased cash flow to boost their earnings. Or to put it another way, money was created out of thin air by central bankers and paid to bondholders, which allowed them