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The Default Line: The Inside Story of People, Banks and Entire Nations on the Edge

By Faisal Islam

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Economics is not meteorology. In Britain, and across Europe, the economy is not like the weather. Yet this is precisely what a long list of incompetent politicians would like you to believe. It’s an excuse.

Economics is about choices. * This story, which I have called The Default Line, is about those choices.

Right from the beginning of his tenure as chancellor, George Osborne was asked why he was pursuing austerity while the US government was not. ‘I don’t have the world’s reserve currency,’ was his answer to me in early 2011. *

In August 2010, he was at his peak – a colossus confident in his argument, bestriding government with his spending review, and displaying a missionary zeal for his fiscal plans.

He had carefully won the argument for some sort of spending cuts in advance of the election, although he had given very little detail of his plans for raising tuition fees, slashing the housing budget, cutting non-pensioner benefits, raising VAT, freezing public pay and hiking train fares.

Part of the early political strategy was to get the pain in early, and to blame it all, including the VAT rise, on Gordon Brown and Labour.

By March 2013, Britain was borrowing £703 billion over six years 2010–2016, instead of the £471 billion forecast in George Osborne’s June 2010 Emergency Budget.

The market value of Britain’s total stock of debt was £617 billion at the end of 2008, and that had more than doubled to £1.35 trillion at the end of 2012 – an increase of £741 billion. More than half of this increase (in fact 56 per cent of it) was explained by the increase in what was owed by the Treasury to the Bank of England, so that by the end of 2012 the Bank owned 29 per cent of the total debt stock of the UK. In effect the Bank of England was funding the equivalent of Britain’s entire national debt in mid-2005.

The market for gilts has basically been rigged by a monopoly buyer with access to unlimited central-bank funding.

Iceland bailed out its own people rather than the moronic foreign creditors of its insane banks. And the result, to date, is a growing economy.

Iceland’s plunge into financial calamity, and its subsequent recovery, have also turned out to be important experiments for the rest of the world – experiments involving burning bondholders, capital controls, welfare, currency regimes, financial regulation and the criminal prosecution of bankers.

Icelanders know more – much much more – about the operations of its banks than any other nation.’

Are we really to believe that none of the cronyism and fraud revealed in Iceland occurred in larger financial centres? The world has been looking at this island through a lens, but I suspect in truth that that * lens is really a mirror.

On 11 December 2001, precisely three months after the attack on the World Trade Centre in New York, the World Trade Organisation (WTO) was at the centre of an event that was to cast an even longer shadow over the twenty-first century, changing more people’s lives around the world than Osama Bin Laden’s attacks on America. Yet few know it even happened, let alone its date.

China’s admission to the World Trade Organisation changed the game for America, Europe and most of Asia, and indeed for any country in possession of industrially valuable resources.

An army of cheap Chinese labour began to produce the goods that underpin Western living standards, as China seamlessly inserted itself into the supply chains of the world’s biggest companies. Economists call it a ‘supply shock’, and its impact certainly was shocking. Its effects are still reverberating around the world, from China’s rural backwaters to the world’s most powerful central banks, and to every home in Britain.

Deng Zhi is not a slave. But he is paid less than the equivalent of what it cost to hire a slave labourer in the American South in the era of slavery. And, in effect, Deng Zhi works for you.

This is effectively a form of twenty-first century serfdom, for the benefit of factory owners, the Chinese government, and consumers in the West.

Container ships are the juggernauts of global trade. In the five years after China joined the WTO in 2001, the number of containers on ships coming in and out of China doubled from 40 million to over 80 million. By 2011, a decade after China joined the WTO, the number of containers going in and out of China had more than trebled to 129 million.

Through the 1990s, China’s production of steel had hovered at around 100 million tonnes per year. After WTO membership, it exploded to around 500 million tonnes by 2008. By 2012 it had topped 700 million tonnes. China now accounts for 50 per cent of world production. It now produces more steel on its own than the rest of the globe managed together, just ten years ago.

China’s astonishing manufacturing surge did much more than just cut prices for Western consumers and increase profits for Western multinationals. The dollars, pounds and euros that flowed in to pay Chinese manufacturers had to go somewhere, if not to the workers.

Even before the election, the men running China’s wealth funds were surprised by the inviting offer from Gordon Brown that almost everything in the UK was for sale, bar defence and media.

Think Chinese funding for a mega-city connecting Liverpool and Manchester, and you might begin to understand the ambition and the spoils that are up for grabs. This is the sort of scale of project that is required by Chinese financiers used to funding ports built on artificial islands, 30-kilometre bridges, and entire new cities.

Many of the investments China would like to make in energy, aerospace and manufacturing, are off limits in the USA, which fears that its security would be compromised. No such restrictions hold sway in Britain, however. Almost everything is for sale.

Great Britain, the nation that used to fund and build roads, railways and ports around the world, now wants the world to fund and build Britain’s own roads, railways and ports. The empire – that is, the new Chinese empire – just struck back.

In effect, consumers paid for a bailout of an industry on the grounds of environmentalism, which ended up rewarding the worst polluters most of all. Yet unlike the banks, those companies did not even need a bailout in the first place. It was the perfect example of the impact of complex ‘financialisation’ combined with vested-interest lobbying.

Will a single barrel of Kurdish oil, a single therm of Siberian gas, a single basket of Indian coal remain unburnt as a result of the scheme so far? Brutally put, no.

 If there is any point to economics, and the pursuit of growth, it should be the advancement of ordinary people.

In some countries, such as Britain, the United States and the nations of the Eurozone periphery, the argument right now is not so much about who shares the proceeds of growth, but rather who bears the burden of paying the cost for the decade of excess.

For one in six Americans – more than the population of Spain – food stamps are an alternative currency, and the number of US citizens reliant on them has nearly trebled since the turn of the century.

Those who breathlessly declared that, in the aftermath of the financial crisis, we were seeing the end of capitalism, were spectacularly incorrect. Let’s focus on the UK for the moment. If you look through the lens of Marx, then it’s pretty clear that, right now, capital has never been so ascendant over labour. Capital is capturing the returns to growth, and labour is losing them.

So there is no wage-price spiral. Workers have been tamed; labour is mute.

Something similar is happening with savings. To support their economies, nation-states such as Britain are printing money by the truckload.

But £375 billion of quantitative easing (QE) is crushing the pensions of current retirees, alongside savings income. Yet at the same time, QE has also inflated the price of accumulated wealth even further – monetary policy for the wealthy (see Chapter 9, here). And there can be no doubt that it has benefited large corporations and big banks disproportionately.

The euro crisis has got nothing to do with a crisis in capitalism. It is basically political. The single currency could, and would, work if German voters felt comfortable with spending their buoyant tax revenues on supporting the comparably trivial problems in Greece or Ireland. If Germany and Brussels can persuade Rome and Madrid to increase their economic competitiveness, it could even be something of a success. But this is a diplomatic game, not a fundamental problem with the economic system.

Even in China, nominally Communist, the largest migration of humans on the planet, that of migrant workers from rural China to its factories, is testament to the bargaining power of managed state capitalism over its people. Of course, there is a notable exception to this hegemony of capital over labour, and that is the industry where workers capture far more of the returns as wages and bonuses than the shareholders. Even as the UK economy slumped, even as some of their employers were bankrupt, three-quarters of workers in this industry expected higher or the same bonuses. Even when their bonuses were hosed down, fixed pay was simply adjusted up. As one British bank chief executive told me during the crisis: ‘Marx would have been proud of the triumph of labour in the banks.’ Everywhere else capital is most definitely in the ascendant. Right now it’s game, set and match to capitalism.

A different form of state action on living standards could be this: an all-encompassing strategy to make things cheaper: housing, education, transport, energy and food. Housing obviously has a rather bizarre status in the inflationary firmament. It is the only basic material need for which a price increase is supposed to be a cause.

Spending on housing benefit subsidises landlords, creates poverty traps and adds nothing to the housing stock. It’s not difficult to be bewildered that successive governments prefer to fund failure rather than invest in the future

Without a fundamental shift in planning, young British workers face a daft dependence on their parents for access to ever smaller properties, in places they don’t want to live. The forces opposed to changes to current UK planning law are extremely powerful. This does not mean that they are right.

In Britain, there were broadly two separate financial crises. A conventional consumer and corporate credit bubble, fuelled by lightly regulated demutualised building societies, such as Halifax, Northern Rock, Bradford & Bingley, tapping global flows of hot money in the shadow banking system.

But the City of London also had a massive role in creating and mediating these flows, through opaque derivative technology developed, sold and traded by investment banks. Britain consumed the credit madness, but was also the site of its main factory.

Recognising these truths about London banking is intellectually liberating: it helps explain why growth is sluggish, tax revenues are weak and business credit is slow. In future, governments should not rely on such unreliable sources of tax revenue. The Golden Goose is dead.

If governments and taxpayers are to implicitly backstop the banking system, why not skew the formulae in favour of growth and job creation and away from property?

State-run banks is one thing; a bank-run state is quite another.

Germany engineers finances towards productive industry and innovation. Britain has financialised our engineers towards useless financial innovation.

Now Britain needs a broader economic plan, one that stretches beyond deficit reduction and financialisation. To begin with, the generation of politicians that failed their nations need to reflect on, to account for and learn from their mistakes. This is a massive political opportunity.

What should be the rational response of a young person of talent to the way Britain is being run economically? Leave the country. And that is what many are doing.

I see a generational shafting of epic proportions, and the young whom we are relying on to create growth, jobs and tax revenues are starting to vote with their feet. They have choices, and so do we all.