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Haircuts for All . . . or Free Money?

IOU cartoonThis article is part 2 from Chapter 6 of Richard Heinberg's new book 'The End of Growth', published by New Society Publishers. This chapter looks at ideas for post growth economics. 

Get the book now - Amazon, New Society, Kindle, Nook Reader

Chapter 6, Part 1
Chapter 6, Part 3
Chapter 6, Part 4

 

This second excerpt from Chapter 6 follows a section in the book called 'The Default Scenario' in which Richard describes the inevitable outcome of business as usual policies and a failure to recognise that economic growth is over.

To get past the wall of potential financial-monetary collapse, governments would have to resort to extraordinary emergency measures. In the best instance, this would create time and space to begin coming up with long-term, infrastructural responses to declining energy supplies and climate change—responses involving the redesign of transport systems, power generation and transmission systems, food systems, and so on. Of course, there is no guarantee that time, once gained, will be well spent. Nevertheless, in principle the wall can be traversed.

The essence of the wall is this: We have accumulated too many financial-monetary claims on real assets—consisting of energy, food, labor, manufactured products, built infrastructure, and natural resources. Those claims, essentially IOUs, exist in the forms of debt and derivatives. Our debt cannot be fully repaid: every dollar saved in the past is owed ever-multiplying returns in the future, yet the planet’s stores of resources are finite and shrinking. Claims just keep growing while resources keep depleting—and real prices of energy and commodities have begun rising. At some point it will become clear that this vast ocean of outstanding claims will never be honored, and the result could be a tidal wave of defaults and bankruptcies that would sweep away most of the economy.
 
In theory, as Harvard economic historian Niall Ferguson points out, there are six ways of resolving a debt crisis: (1) increasing the rate of GDP growth; (2) reducing interest rates; (3) offering bailouts; (4) accepting fiscal pain—reductions in benefits and standard of living; (5) injecting more money into the economy; or (6) accepting defaults, “including every type of non-compliance with the original terms of the debt contract.”[1] If the premise of this book is correct and it has become nearly impossible to grow GDP, then we can eliminate option (1). Interest rates (2) cannot realistically be reduced lower than zero, which is essentially where they are now (for banks—though credit card interest rates are still in the range of 20 percent). As the debt problem worsens, bailouts (3) become more expensive and less effective. The austerity option (4) is distasteful to everyone and can only be pursued aggressively at the risk of a breakdown of social cohesion. Government printing of money (5) is frowned upon by trading partners and inflates away savings. Option (6), widespread defaults, could lead to a broad-scale failure of the monetary-financial system, so it will likely be avoided, except in limited circumstances.
 
Currently governments are dithering with all of these options, applying them in an ad hoc and piecemeal fashion. However, two of the six have at least a theoretical capability of being implemented in a fairly dramatic, strategic way if and when the crisis becomes otherwise unmanageable. These strategies would consist of a modified debt jubilee (a form of default, option 6), or a bout of inflation through the creation of non-debt-based currency (option 5). Both would come with major risks, but either could, in principle, buy time for the implementation of a more fundamental reform of the entire economic system.
 
Edward ScissorhandsA modified debt jubilee could take the form of a universal “haircut”—a term currently being used in financial circles to describe a situation where the market value of securities being held by financial firms as part of their net worth is significantly reduced. In the strategy being proposed, the “haircut” would apply to all financial claims. Government by edict would reduce all debt by a certain percentage—let’s say, somewhere between 75 and 90 percent. At the same time, all investments and savings accounts above a certain figure (allowance would have to be made for pensioners and low-income individuals) would get the same treatment. The process would be complicated and unpopular, especially among those with the most to lose, but it might help get us past the wall. It would reduce economic activity significantly—that’s going to happen anyway, even in the best instance—but it would also remove the overhang of debt that threatens to bring down the entire economy.
 
How might this work? Let’s say, as a starting point, that we wanted to protect all assets below a certain level. In the U.S., perhaps all assets below $25,000 could remain untouched. Then, one simple way to administer the “haircut” would be to slice a decimal place off everyone’s debts, savings, and other accounts. If you had a $250,000 mortgage, it would be knocked down to $25,000—but your $20,000 savings account would survive unscathed, as it fell below the $25,000 limit designed to protect pensioners and other low-income individuals. Your debt overhang would have shrunk from $230,000 to $5,000. A wealthy person who had gained $5 billion through investing in hedge funds would now have only $500 million. A business that owed $750,000 in loans would now owe $75,000. And so on.
 
The net result would be a “re-set” in the relationship between claims and real assets, bringing that relationship back into a somewhat more workable balance. Of course, this “re-set” would be hugely controversial, confounding . . . and painful.
 
Sound far-fetched? Certainly, an action like this would not be undertaken unless other tactics had failed. It would yield winners and losers: although everyone would feel the effects, the impact would be uneven. At first glance, it seems those with the fewest assets and highest debts would suffer least. A more likely outcome would be widely distributed dislocations, unemployment, and so on, so there would be plenty of suffering to go around. But, this “re-set” would give us the opportunity—if we took advantage of it—to restructure our economic and financial systems to be more sustainable and resilient.
 
The second strategy would consist of governments or central banks creating debt-free money. This is how economist Richard Douthwaite, founder of the organization FEASTA and editor of the book Fleeing Vesuvius, describes it:

The solution is to have central banks create money out of nothing and to give it to their governments either to spend into use, or to pay off their debts, or give to their people to spend. In the eurozone, this would mean that the European Central Bank would give governments debt-free euros according to the size of their populations. The governments would decide what to do with these funds. If they were borrowing to make up a budget deficit—and all 16 of them were in deficit in mid-2010, the smallest deficit being Luxembourg’s at 4.2 percent—they would use part of the ECB money to stop having to borrow. They would give the balance to their people on an equal-per-capita basis so that they could reduce their debts, or not incur new ones, because private indebtedness needs to be reduced too. If someone was not in debt, they would get their money anyway as compensation for the loss they were likely to suffer in the real value of their money-denominated savings. Without this, the scheme would be very unpopular. The ECB could issue new money in this way each quarter until the overall, public and private, debt in the eurozone had been brought sufficiently down for employment to be restored to a satisfactory level.[2]

An alternative would be to pass laws against usury (for example, any interest rate greater than 20 percent would become illegal), then print enough money to accelerate inflation beyond 20 percent. People’s debts would decline over time, as would the value of money being held. The government could spend money into existence for social welfare programs, thus ensuring that retirees and other vulnerable groups don’t get hit too hard.
 
In the U.S., a version of the “free money” strategy is being advocated by Ellen Brown, author of Web of Debt. Brown argues that the United States Congress has the constitutional authority to coin money, but historically has needlessly delegated the power of money creation to the banking system—and, since 1913, to the Federal Reserve. The Federal government has on occasion created money directly, without borrowing—notably to finance the Civil War. The Federal Reserve’s second bout of quantitative easing, in 2010, was essentially a version of this strategy: the Fed bought government debt with money created on the spot, and interest from the debt will be rebated to the Treasury. However, Brown argues that the best way to pursue this option would be for the government itself to directly issue debt-free money, rather than for the Fed to do it through a more circular means.
 
Weimar money in gutterThe objection usually raised against government “printing” of large amounts of new money is that this would be highly inflationary: the U.S. economy could suffer the same fate as Weimar Germany, with its currency becoming virtually worthless and all savings being wiped out in the process. Brown disagrees:

“Adding money (“demand”) to an economy with high unemployment and unused productive capacity serves to increase productivity, increasing goods and services or “supply.” When supply and demand increase together, prices remain stable. And adding money to the money supply is obviously not hazardous when the money supply is shrinking, as it is now. . . . Financial commentator Charles Hugh Smith estimates that the economy now faces $15 trillion in writedowns in collateral and credit. If those estimates are correct, the Fed could, in theory, print $15 trillion and buy up the entire federal debt without creating price inflation. That isn’t likely to happen, but it does make for an interesting hypothetical.”[3]

Over the short run, emergency measures could include the Fed buying up short-term municipal bonds in order to ease state and county fiscal crises, and the European Central Bank doing something similar with bonds of member nations, creating money to fill the gap left by the contraction in the money supply which resulted from the financial crisis of 2008 and that has led to soaring budget deficits.[4]
 
Another related, longer-term measure that could help, according to Brown, is the establishment of state or provincial banks. Currently, North Dakota has the only state-owned bank in the U.S., established by the state legislature in 1919. The bank’s original purpose was to free farmers and small businesses from indebtedness to out-of-state bankers and railroad companies. By law, the state deposits all its funds in the bank, and deposits are guaranteed by the state. The Bank of North Dakota is a bankers’ bank, partnering with private banks to loan money to farmers, real estate developers, schools and small businesses. It also purchases municipal bonds.
 
What would be the advantage to the state of having of such a bank? With fractional reserve lending, banks extend credit (create money as loans) in amounts equal to many times their deposit base. If a state owns its bank, it need not worry about shareholders or profits, so it could lend to itself or to its municipal governments at zero percent interest. If these loans were rolled over indefinitely, this would be essentially the same as creating debt-free money.[5]
 
Clearly, none of these strategies can solve the long-term problems of declining energy and minerals, rising population, and worsening environmental crises. They are merely ways to avert the looming wall of monetary-financial collapse. Once we have bought some time, we must begin to redesign certain basic structures of the economy that currently function properly only in a context of constant growth.
 
One of these structures consists of the money we use.
 
References
2. Richard Douthwaite and Gillian Fallon, eds., Fleeing Vesuvius: overcoming the Risks of Economic and Environmental Collapse –New Society Publishers, April 2011
3. Ellen Brown, “QE2: It’s the Federal Debt Stupid!Truthout, posted November 12, 2010
4. Ellen Brown, “Austerity Fails in Euroland: Time for Some ‘Deficit Easing’”, Truthout, December 24, 2010
5. Ellen Brown, “Cash-Starved States Need to Play the Banking Game: North Dakota Shows How,The Web of Debt, posted March 2, 2009
 
Image credits: Edward Scissorhands-James Morgan; IOU-zolierdos/flickr
 
Get The End of Growth http://www.postcarbon.org/eog | Watch the animation Who Killed Economic Growth? http://bit.ly/whokilledgrowth
 

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