Planet Ponzi

by Mitch Feierstein

  But it’s time to leave these thoughts. Enough of the euro and the EFSF‌—‌and enough of Greece, Ireland, and Portugal too. Readers in Germany and the Netherlands will be wondering about the implications of all this for them. It’s all very well being prudent, diligent, and competitive yourselves, but what happens when all those around you are wildly mismanaging their affairs?

  It’s a fair question. As it happens, there’s room for optimism. Canada’s banks survived the 2008–9 financial crisis just fine. They had no subprime mess, no tidal wave of foreclosures, no gigantic bank failures. The economy couldn’t be unaffected by American travails, but the effects were limited.10 It does, of course, help to have 178 billion barrels of oil under your feet.11 Except for that oil, German, Dutch, and Scandinavian policymakers today are in broadly the same position as their Canadian counterparts of 2008. Their governments have responsible fiscal policies. The economies enjoy some strong, well-managed businesses. Their citizens know that rewards come from hard work intelligently directed‌—‌and haven’t forgotten there was once a time when you needed a wheelbarrow full of cash to buy a loaf of bread. As a result, no postwar German or Dutch government has yet applied for citizenship of Planet Ponzi. Quite likely, no German or Dutch government ever will. It’s not in the genes.

  Yet these sane and stable countries are trading nations located right at the heart of Europe. Canadian banks were somewhat shielded from American contagion not simply by better regulation and an old-fashioned sense of discipline but also by a different currency. Canadian banks accepting Canadian dollars from Canadian savers weren’t particularly tempted to start investing those deposits in mortgage assets denominated in US dollars, because of the resultant currency mismatch. Many banks in Germany, however, were tempted‌—‌too tempted‌—‌to acquire ‘high-yielding’ euro assets as a way of boosting profits. The largest German banks are probably fine, but the Landesbanken (regional wholesale banks) and local savings banks may well be overextended in a number of cases.12 It’s impossible to say which banks are in trouble, because the various bank ‘stress tests’ which have been applied were all devised on Planet Ponzi‌—‌so that, for example, the European stress tests of July 2011 excluded any consideration of losses on sovereign debt portfolios. Since all banks holding sovereign debts in the troubled eurozone countries would have lost money, those stress tests were effectively meaningless.13

  Nevertheless, strong economies and well-managed governments can get through these messes. If some banks need to be recapitalized, the German and Dutch (and Scandinavian) governments will have ample resources to do so. Growth will be injured by the turmoil. Joblessness will be higher than it ought to be, growth and household incomes lower. But still. There may be rain and bad weather in Berlin and The Hague. That’s still preferable to the gales and thunderstorms that are coming to Paris, or the typhoons and worse which will visit Madrid, Lisbon, and Athens. And in Germany and the Netherlands, the government can still afford a raincoat.

  Up next: the United Kingdom‌—‌and this time, and for the first time in this book, we have some real good news to explore.

  18

  Choosing second

  There’s an old joke which runs like this. Q: Why did New York get Wall Street and New Jersey get the toxic waste dumps? A: Because New Jersey had first choice.

  Something similar applies in Europe. Both Britain and Germany are impressive in their ways. Germany is the second largest exporter of goods in the world (after China), an extraordinary achievement for a country with a population smaller than that of either Japan or the United States.1 Britain, on the other hand, has a somewhat average manufacturing sector but a quite remarkable service sector. Britain is the world’s second largest exporter of services, behind the US but well ahead of Japan, Germany, and all the emerging market giants.2 Although Britain is strong in nearly all service sectors, the global heft of its financial services sector is simply extraordinary.

  Now, there’s no question which of these two positions you’d rather be in. Having a large manufacturing sector, particularly one whose eminence is based on quality rather than price, is a gift for any economy. Having one of the world’s two leading financial centers in your country, on the other hand, is like sharing your home with a hormonal gorilla. The animal is impressive as heck, but you know you’re going to lose some china. The financial sector in Britain wasn’t as utterly out of control as its counterpart in the US‌—‌no subprime horrors, no CDOs of CDOs‌—‌but being ‘better managed than Wall Street’ is hardly a badge of managerial excellence. On pretty much every metric you care to look at, Britain has too much debt. Too much government debt. Too much household debt. Too many large and leveraged banks. Way too much mortgage debt. Even its corporations are too ready to borrow.

  Having said all that, however, Britain is still in better shape than the troubled economies of southern Europe. It doesn’t have the hideous government debt of Greece or Italy. It doesn’t have the structural rigidities of Spain. It’s still Europe’s chief magnet for inward investment. It remains a good place to do business, ranking tenth in the World Economic Forum’s annual competitiveness survey (neck and neck with the US, Germany, and Japan).3 What’s more, the country isn’t in the eurozone. Germany’s current challenges very largely revolve around how it can manage its relationships with its fiscally incontinent, low-growth eurozone partners. Naturally, Britain has extensive trading relationships with the eurozone, but its banks are at least somewhat insulated.

  The bond market, at the time of writing, is allowing the British government to borrow at just 2.3% p.a. for a ten-year bond. France borrows at 3.3%, Spain and Italy at 5.7% and 6.8%, respectively.4 Those borrowing costs reflect the market’s current estimate of risk, and are confirmed by the ratings agencies. Britain’s international debt rating is affirmed at AAA by all the major agencies (thereby placing it above the United States), and there are no rumors of looming downgrades dogging the country, which cannot be said of France, for example.

  These things are, on the face of it, mystifying. Britain’s government debt is about the same as France’s. Britain’s government deficit is worse. In the short term, its growth prospects seem equally feeble. Its banks don’t have huge exposure to either Greece or Portugal, but they do have massive exposure to the almost equally troubled Ireland. And of course, it shares house with a hormonal gorilla and there’s a lot of broken crockery littering the carpet.

  The bond markets are right, however. The ratings agencies too. Personally, I wouldn’t give Britain an AAA rating, simply because I don’t think any nation on Planet Ponzi deserves such a rating. The risks are simply too great, not just in the UK but across the board. Nevertheless, despite those debt figures, despite that horrendous deficit, and despite that gorilla, Britain is showing signs of wanting to exit Planet Ponzi. To take the pledge. To push away the bottle. In plain language, Britain is the first leading country on Planet Ponzi to show convincing evidence that it wants to return to a path of fiscal rectitude and sober banking. (Germany and Canada are largely fine on both counts, but they always were.)

  The story of Britain’s conversion to fiscal teetotalism is worth telling in some detail, because it shows what can be done. In 2009 the government deficit stood at £144 billion, an extraordinary 10.3% of GDP. The following year, that deficit rose a notch to 10.4%. Government debt, inevitably, was starting to spiral upwards. The economy shrank abruptly, by 4.9%, in 2009. In 2010, growth returned, but feebly, at a rate of just 1.3%.5

  In these ugly circumstances, an election was held in May 2010. The Labour government was, deservedly, beaten. It lost because it was seen as having contributed to the banking crisis by regulating too little and borrowing too much. Prime Minister Gordon Brown was seen as bullying and detached from reality. According to his Chancellor of the Exchequer Alastair Darling, when the global financial crisis blew up Brown predicted that it would all blow over in the space of six months‌—‌a prediction which even then seemed extraord
inarily out of touch.6

  On the other hand, the incoming government struck many observers (including this one) as underwhelming. The new Prime Minister, David Cameron, had no real experience of the private sector. He was a PR man turned professional politician. His background was privileged. He was surrounded by colleagues with similarly patrician origins. Worse still, his Conservative Party didn’t even have overall control of Parliament. It was forced to enter coalition with the Liberal Democrats, a left-leaning party of protest with no previous track record in government. Its leader, too, was a man of privilege with virtually no experience outside government. Given the vast scale of the problems facing the country, this new government seemed underweight and underexperienced. Catastrophe loomed.

  Loomed‌—‌but has not, as yet, arrived. The new government didn’t just talk tough, it actually delivered. It told voters bluntly that savage cuts were needed and that taxes would need to be raised. It set up an Office for Budget Responsibility, an independent agency to vet the government’s budgetary figures. It unveiled a spending review which promised to slash £81 billion from government spending over four years, an amount equal to 6% of British GDP. Government departments (excluding health and education) would lose an average of 19% of their budgets. American, Italian, Spanish, and French readers will want to reread that sentence‌—‌no doubt with incredulity. The British government is calmly proposing to cut (in inflation-adjusted terms) some 11% from the education budget; 25% from the Home Office budget; 20% from the policing budget; 25% from the Justice Department budget; 7% from the defense budget; 15% from the transport budget; almost 30% from the business budget; over 30% from the communities and local government budget. Alone among the major departments, health was spared any cuts in spending.7

  These figures exclude various mandatory expenditures (‘annually managed expenditures’ in the jargon), which departments have to administer. Thus, for example, the relatively small Department for Work and Pensions (with an annual departmental budget of around £7 billion) manages a huge welfare budget of between £150 and £160 billion. Nevertheless, those mandatory expenditures are also being cut. Pensions ages are rising. Welfare rules are tightening. Investment budgets are also being reduced.

  The upshot of all this is a dramatic drop in government borrowing. The independent Office for Budget Responsibility estimates that the yawning government deficit is going to dwindle almost to nothing within four years (see figure 18.1).8 Over the period covered by these forecasts, government debt is forecast to peak at 85.5% of GDP, before starting to drop back.

  Figure 18.1: What responsible government looks like: UK government revenues and spending, 2008/9–2015/16

  Source: Office for Budget Responsibility.

  There are two different ways you can look at these figures. You can look at them with Ponzi-ish eyes. You can forecast the dissolution of the state, the collapse of public order, the decay of education, the destruction of a generation. These are the kinds of forecasts which have fueled the insane levels of government spending right across the developed world. They are the kinds of forecasts which are causing politicians problems right across southern Europe; the kind which in the US prevents Democrats and Republicans from coming to any shared view of the direction forward.

  Alternatively, you can look at them with the eyes of sanity. Government revenues are holding broadly steady. Government expenditures are simply falling back to where they were in 2003–7. In 2003–7, nobody thought that the state was dissolving, public order collapsing, or a generation being destroyed. If anything, it felt as though the government could economize quite happily if it needed to.

  Nor have the politicians stopped at getting a grip on their own finances. The banks, too, are to be overhauled. In September 2011, the Independent Commission on Banking published a report into the future of the banking industry. Its precise recommendations are complex, but their essence is simple. Ordinary, routine retail banking is to be separated from the casino banking so prevalent on Wall Street and in the City of London. Consumer banking and banking for small and medium-sized companies will be housed within the ring-fence around retail banking. Those ‘fenced-in’ banking operations will be closely regulated and required to hold plenty of capital against possible losses. And so on. In effect, it’s like a British Glass–Steagall Act fitted to the needs of the twenty-first century.9 If rules like these had been in place in the US in 2008, the crisis would have wrecked Wall Street but left Main Street largely untouched.

  There are other good things in the pipeline too. The set of zoning rules which governs new construction developments has been cut down from over 1,000 pages of regulations to just 52.10 Red tape, more generally, is to be cut. The British economy labors under the burden of some 21,000 different regulations. The government has announced a commitment to reduce that burden over its time in office. A government website invites people and companies to identify which regulations they want to be junked, saying bluntly: ‘Once you’ve had your say, Ministers will have three months to work out which regulations they want to keep and why. But here’s the most important bit‌—‌the default presumption will be that burdensome regulations will go.’11 If they really mean that, it’ll be a reversal that no government in my lifetime has managed to achieve.

  Thus far I’ve been positive, so I ought to admit to a couple of doubts‌—‌serious doubts. First, I don’t think that the British government will achieve either its revenue or its spending target. Its projections are based on far too rosy a picture of economic growth. The simple fact is that if you drink a bottle of whiskey each day from Monday through Saturday, you’re going to have one hell of a hangover come Sunday. The British economy is in that position now. Past growth has been pumped up by excessive reliance on government spending and household debt. Firms need to figure out how to engineer growth in a climate that’s prudent, not Ponzi-ish. That’s not an impossible brief‌—‌Germany manages it‌—‌but it’s an art that needs to be relearned. The learning will be slow.

  Second, although the banking reforms are fundamentally sound, they are being introduced painfully slowly. The reforms won’t be complete and in place until 2019: that’s eight years from the date of the report and more than a decade from the banking crash. I can understand that measures need to be introduced properly and without imposing unnecessary costs of transition‌—‌but eight years?

  Third, despite the astonishing progress on certain fronts, there are still huge issues left unaddressed. The government has brought in no measures to constrain house prices. Since Britain is as fond of housing bubbles as it is of royal weddings, it seems crazy not to get a grip on the housing market, which lies at the heart of so many of the country’s economic and financial troubles. Additionally, household debt has become too free, too easy. The government needs to find ways of limiting further growth. The credit card economy is no way to build stability or prosperity in the long term.

  Fourth, in October 2011 the Bank of England’s monetary policy committee agreed to approve the printing of £75 billion in a vain effort to wake up the economy.12 Such policies might in theory have a positive impact if they serve to unblock the flow of credit to firms, but they’re utterly senseless to any other end. And in Britain today, firms are not seeking to take on debt (because they’re terrified of a worsening recession) and banks don’t want to lend (because they know they have capital and liquidity issues which corporate lending would only exacerbate). Indeed, there exists no credible evidence that monetary loosening has had any positive effect in either Britain or the US since the credit crisis began, while the risk of fanning inflation is already high and rising. Once again, we see academics and politicians with minimal real-world experience combining to conduct theoretical experiments with real economies. Such experiments can only end badly.

  But in the context of where Britain’s been for the past thirty years‌—‌at the heart of Planet Ponzi‌—‌it’s one hell of a good start. The US government needs to copy David Cameron’
s lead. Italy, Spain, and France should take careful notes. Even Germany, whose banking system is not as robust as it ought to be, should be watching with interest.

  And the best thing about all this? The single most positive aspect is that, with the exception of some public sector unions, everybody’s on board with the project. The Labour Party, now in opposition, has converted from fiscal recklessness to something closer to fiscal prudence. True, it wants the fiscal tightening to run more slowly than the Conservative plan. It has a tendency to oppose individual cuts without proposing other specific measures in their place. Yet right across the political spectrum, it is understood that taxes have got to be increased (but modestly) and expenditures cut.

  Indeed, compared with what I’ve seen elsewhere, British politicians have suddenly discovered a remarkable capacity for honesty. During the election campaign, there was a televised debate which saw the Chancellor of the Exchequer, Alastair Darling, go up against his rivals from the Conservative and Liberal Democrat parties. One of the exchanges during that debate ran as follows:13

  ‘Do you agree that cuts we are going to be facing will be deeper than the cuts that Mrs Thatcher had to put through Britain?’ TV presenter Krishnan Guru-Murthy.

  ‘Well, I said last week they’re going to have to be pretty deep.’ Alastair Darling MP, Chancellor of the Exchequer.

  ‘The answer is yes.’ Vince Cable MP, Lib Dem Treasury spokesperson.

  ‘The answer is yes.’ George Osborne MP, Shadow Chancellor.

  Given that the Thatcher era is etched into British political folklore as a time of dramatic budgetary cuts, this frankness is astonishing‌—‌and accurate. Independent analysts have indeed confirmed that the plans of all three parties imply a fiscal tightening much more severe than Mrs Thatcher ever achieved.