Credit-card Keynesianism - Oooooh! What a carve up!

The more avid readers amongst you may have seen in the papers that the world is undergoing a massive financial crisis, alliteratively titled the credit crunch (in Spain this title is secondary to the more easily pronounced “sub primay”). It is still discussed largely in terms of its effects on house prices (i.e. prices have dropped, but you still can’t buy a house because nobody will give you a mortgage) but this is merely the symptom of a larger malaise.

30 years ago, the UK, along with all developed countries, had an economy based on the production of goods which were then sold abroad or consumed domestically. It was recognised that the creation of physical objects was the foundation of the nation’s wealth. Today the UK economy is based on the financial sector, and it is believed that the country can survive without making anything. This change has its roots in the friedmanite economics of the New Right, it was argued that the UK should abandon policies protecting its industries, privatise steel, telecom, gas and railways, and move towards a post-industrial future. Part of this future was the massive deregulation of the City and the banks, the market was the venerated Idol of this new world; the banks and finance houses were logical actors, they would maximise their profit and the wealth they created would trickle down to the masses. Here was where it all started to go wrong.

The newly unbound promethei of The City had a marked aversion to investment in industry, it was such a dirty smelly northern thing, and they really didn’t understand it. So the bulk of their investment went into the service industries, industries abroad, or into arcane financial investments that were essentially shuffling cash from one place to another. This change appeared to work, it was luckily timed to coincide with the end of the worldwide recession of the early 80s and it led to a service boom that gave the nation the impression of great prosperity. But all the while, the country’s industrial base was being eroded. In 1997, Aneuirin Bevan’s “Island built on coal and surrounded by fish” was importing its fish and its coal. The latter could be dug much cheaper by child workers in Colombia than by grown men in the Rhondda or in my home town, Wakefield.

So the profits of this consumer boom did not trickle down as much as they should have done, if your country produces no goods, the profits from boomtime consumption do not remain in the country, they are repatriated. In this case they were repatriated to the far east, and they were used , notably, to develop the economies of Malaysia and China. Both these countries sensibly protected their national markets by insisting that foreigners wishing to set up industry there could only do so in conjunction with local partners, ensuring the cash stuck there.

So if it wasn’t coming from profits, how were we paying for our consumption? The answer is that we weren’t. The last 10 years have seen British consumers take on a massively increased level of debt, this borrowing has been used to buy imported goods. Government policy has sought to keep interest rates low in order to facilitate lending, which has taken the place of wage increases which can’t be given because of the profit flowing back to China and out of the system . This credit-card Keynesianism was based on the country’s citizens taking on ever increasing levels of debt, and continuing to do so forever. £10 (which used to actually be fucking worth something) to the person who can spot the flaw in the plan.

Yes, if you continue taking on higher and higher levels of debt, you eventually run out of money for food. But what if there was a magical asset that always increased in value, and against which money could always be lent? Yes, rising house prices were the key to it all, as long as the price of houses magically continued to rise, the banks would continue to lend, and it wouldn’t matter that you were £80k in debt because your house was worth £160k. The good returns brought by mortgages, and the amount of money sloshing around in the city with no productive place to go (because of the already credit dependent economy), meant that banks loosened their lending criteria, so people could be lent ever greater multiples of their salaries over ever greater periods of time. This in turn fuelled an increase in houseprices, feeding the perception that prices would rise forever.

So what we had was modern day version of 17th century Spain. Goods were produced in China and sold at a profit in the UK, the profit is then lent back to the UK where it is used to buy imported goods. Our system was leaking capital, so we were taking on ever more debts. In Spain there were the hidalgos and religiosos (see here) who were producing nothing, in England we had the bloated service sector who slaved everyday to actively facilitate the transfer of the nation’s wealth out of the country.

Eventually the whole structure came tumbling down because of houseprices. The US, which like Spain had undergone a similar process, realised that some of the more outrageous mortgages would never be repaid, this triggered a credit drought and a moment of sanity in which the markets realised that they had made a terrible mistake, and that housing was vastly overpriced. The magic asset had lost its mojo, and without it securing lending, the UK, Spain and US are heading to a recession. The experiment in running service based import economies has failed, if we want to keep buying., we are going to need to find something to sell.

Might I be the first to suggest cocaine?