Last week, Britain's new government said it would abandon the previous government's stimulus program and introduce the austerity measures required to pay down its estimated $1 trillion in debts. That means cutting public spending, laying off workers, reducing consumption, and increasing unemployment and bankruptcies. It also means shrinking the money supply, since virtually all "money" today originates as loans or debt. Reducing the outstanding debt will reduce the amount of money available to pay workers and buy goods, precipitating depression and further economic pain.
The financial sector has sometimes been accused of shrinking the money supply intentionally, in order to increase the demand for its own products. Bankers are in the debt business, and if governments are allowed to create enough money to keep themselves and their constituents out of debt, lenders will be out of business. The central banks charged with maintaining the banking business therefore insist on a "stable currency" at all costs, even if it means slashing services, laying off workers, and soaring debt and interest burdens. For the financial business to continue to boom, governments must not be allowed to create money themselves, either by printing it outright or by borrowing it into existence from their own government-owned banks.
Today this financial goal has largely been achieved. In most countries, 95% or more of the money supply is created by banks as loans (or "credit"). The small portion issued by the government is usually created just to replace lost or worn out bills or coins, not to fund new government programs. Early in the twentieth century, about 30% of the British currency was issued by the government as pounds sterling or coins, versus only about 3% today. In the U.S., only coins are now issued by the government. Dollar bills (Federal Reserve Notes) are issued by the Federal Reserve, which is privately owned by a consortium of banks.
Banks advance the principal but not the interest necessary to pay off their loans; and since bank loans are now virtually the only source of new money in the economy, the interest can only come from additional debt. For the banks, that means business continues to boom; while for the rest of the economy, it means cutbacks, belt-tightening and austerity. Since more must always be paid back than was advanced as credit, however, the system is inherently unstable. When the debt bubble becomes too large to be sustained, a recession or depression is precipitated, wiping out a major portion of the debt and allowing the whole process to begin again. This is called the "business cycle," and it causes markets to vacillate wildly, allowing the monied interests that triggered the cycle to pick up real estate and other assets very cheaply on the down-swing.
The financial sector, which controls the money supply and can easily capture the media, cajoles the populace into compliance by selling its agenda as a "balanced budget," "fiscal responsibility," and saving future generations from a massive debt burden by suffering austerity measures now. Bill Mitchell, Professor of Economics at the University of New Castle in Australia, calls this "deficit terrorism." Bank-created debt becomes more important than schools, medical care or infrastructure. Rather than "providing for the general welfare," the purpose of government becomes to maintain the value of the investments of the government's creditors.Britain Dons the Hair Shirt
Britain's new coalition government has just bought into this agenda, imposing on itself the sort of fiscal austerity that the International Monetary Fund (IMF) has long imposed on Third World countries, and has more recently imposed on European countries, including Latvia, Iceland, Ireland and Greece. Where those countries were forced into compliance by their creditors, however, Britain has tightened the screws voluntarily, having succumbed to the argument that it must pay down its debts to maintain the market for its bonds.
Deficit hawks point ominously to Greece, which has been virtually squeezed out of the private bond market because nobody wants its bonds. Greece has been forced to borrow from the IMF and the European Monetary Union (EMU), which have imposed draconian austerity measures as conditions for the loans. Like a Third World country owing money in a foreign currency, Greece cannot print Euros or borrow them from its own central bank, since those alternatives are forbidden under EMU rules. In a desperate attempt to save the Euro, the European Central Bank recently bent the rules by buying Greek bonds on the secondary market rather than lending to the Greek government directly, but the ECB has said it would "sterilize" these purchases by withdrawing an equivalent amount of liquidity from the market, making the deal a wash. (More on that below.)
Greece is stuck in the debt trap, but the UK is not a member of the EMU. Although it belongs to the European Union, it still trades in its own national currency, which it has the power to issue directly. But the "deficit terrorists" will have none of this obvious solution, ostensibly because of the fear of "hyperinflation." A June 9 guest post by "Cameroni" on Rick Ackerman's financial website takes this position. Titled "Britain Becomes the First to Choose Deflation," it begins:
"David Cameron's new Government in England announced Tuesday that it will introduce austerity measures to begin paying down the estimated one trillion (U.S. value) in debts held by the British Government. . . . [T]hat being said, we have just received the signal to an end to global stimulus measures -- one that puts a nail in the coffin of the debate on whether or not Britain would "print' her way out of the debt crisis. . . . This is actually a celebratory moment although it will not feel like it for most. . . . Debts will have to be paid. . . . [S]tandards of living will decline . . . [but] it is a better future than what a hyperinflation would bring us all."Hyperinflation or Deflation?
The dreaded threat of hyperinflation is invariably trotted out to defeat proposals to solve the budget crises of governments by simply issuing the necessary funds, whether as debt (bonds) or as currency. What the deficit terrorists generally fail to mention is that before an economy can be threatened with hyperinflation, it has to pass through simple inflation; and governments everywhere have failed to get to that stage today, although trying mightily. Cameroni observes:
"[G]overnments all over the globe have already tried stimulating their way out of the recent credit crisis and recession to little avail. They have attempted fruitlessly to generate even mild inflation despite huge stimulus efforts and pointless spending."
In fact, the money supply has been shrinking at an alarming rate. In a May 26 article in The Financial Times titled "US Money Supply Plunges at 1930s Pace as Obama Eyes Fresh Stimulus," Ambrose Evans-Pritchard writes:
"The stock of money fell from $14.2 trillion to $13.9 trillion in the three months to April, amounting to an annual rate of contraction of 9.6pc. The assets of institutional money market funds fell at a 37pc rate, the sharpest drop ever.
"'It's frightening,' said Professor Tim Congdon from International Monetary Research. "The plunge in M3 has no precedent since the Great Depression. The dominant reason for this is that regulators across the world are pressing banks to raise capital asset ratios and to shrink their risk assets. This is why the US is not recovering properly,' he said."
Too much money can hardly have been pumped into an economy in which the money supply is shrinking. But Cameroni concludes that since the stimulus efforts have failed to put needed money back into the money supply, the stimulus program should be abandoned in favor of its diametrical opposite -- belt-tightening austerity. He admits that the result will be devastating:
"[I]t will mean a long, slow and deliberate winding down until solvency is within reach. It will mean cities, states and counties will go bankrupt and not be rescued. And it will be painful. Public spending will be cut. Consumption could decline precipitously. Unemployment numbers may skyrocket and bankruptcies will stun readers of daily blogs like this one. It will put the brakes on growth around the world. . . . The Dow will crash and there will be ripple effects across the European union and eventually the globe. . . . Aid programs to the Third world will be gutted, and I cannot yet imagine the consequences that will bring to the poorest people on earth."