Debt, where is thy sting? The long march to angrynomics

Thirty years ago, these financial truths would have been seen as self-evident. First, profligate governments pay a price in terms of higher borrowing costs. Second, the magic combination of economic policy would be to keep both inflation and unemployment low; that would keep the voters happy.

But here we are in 2020 and the British government has just borrowed £62bn in the last month, more than it did in the previous financial year. It is on target for a budget deficit of 15% of GDP in the current financial year. On May 19th, that same government was able to borrow for three years at a negative yield; in other words, investors were willing to pay for the privilege of lending to it.

The combined total of inflation and unemployment used to be known as the “misery index”: Jimmy Carter cited it when he was campaigning in 1976 against Gerald Ford for the presidency. But the index was even higher in 1980, dooming Carter’s re-election bid. Barack Obama reduced the misery index during his two terms of office; indeed of all the Presidents since 1945, only Harry Truman left office with a lower misery index. But that didn’t seem to make voters happy; although Hillary Clinton (Obama’s party successor) won the popular vote, Donald Trump took enough key states to be elected. Similarly in 2016, British inflation was low and unemployment had been falling for years, yet voter anger resulted in Britain voting to leave the EU.

Clearly, then, something fundamental has changed about the global economy. Two conclusions are often drawn. First, “debt doesn’t matter”; governments seemingly can borrow without limit, as many on the left would now argue. Second, we have moved away from the idea that elections are settled by economics alone: cultural divides are more important.

A fascinating new book, Angrynomics, by Eric Lonergan and Mark Blyth, analyses what has been happening, and gives a highly plausible explanation. They set up three versions of capitalism, beginning around 1870. Capitalism 1.0 was the liberal laissez-faire version that had its heyday before 1914. Under this system, governments did not manage the economy; they assumed that the markets would do it for them. But the first world war destroyed the international cooperation that made the system work and required heavy government intervention to produce the armaments that armies needed. And then the Great Depression showed that markets do not automatically correct. And it produced its own “angrynomics” in the form of fascism.

Capitalism 2.0 emerged after the second world war. Economic policy was designed to avoid the excesses of the 1930s by keeping unemployment as low as possible, with the help of fiscal policy. To keep this system stable, banks were highly regulated and capital flows were tightly controlled. This model was highly successful until the early 1970s; growth was high, living standards of the poorest rose sharply and inequality fell. The period was known as the wirtschaftwunder in West Germany. But it broke down, the authors say, because low unemployment empowered trade unions and led to a wage-price spiral. The system also enraged the owners of capital who suffered high taxes and low returns, and were unable to move their money. They started to finance conservative politicians and thinktanks who argued for a change in approach.

This led to Capitalism 3.0, what some call the neoliberal model. This was marked by the reduction of high tax rates, “flexible” labour markets and the decline of trade unions, along with the rise of privatisation, globalisation and free capital movements. For a while, this system was heralded as the “great moderation” because it produced a long boom with low inflation. But Capitalism 3.0 was also marked by an uncontrolled banking sector, which eventually brought ruin in 2007 and 2008.

This, the authors rightly assert, set the stage for “angrynomics”, usually known as the populist movement. Voters had gone along with Capitalism 3.0 while it seemed to deliver growth but for them, “flexible labour markets” meant less job security, while globalisation meant a squeeze on their real wages. When the banking sector caused a crash, the bankers were bailed out but poorer voters suffered from austerity in the form of lower social benefits and squeezed public services.

This explains why the misery index was no longer a good indicator. Inflation may have fallen but real wages were not rising. And unemployment may have been low but many jobs were poorly-paid and had fewer rights. At the heart of all this, in the authors’ view, is that capitalism has tended to treat labour as a “commodity”, along with land and capital. But “labour is the only commodity capable of generating a social reaction to its movement in price”. When workers banded together in trade unions, and worked closely together in factories, they could use their negotiating power. Nowadays, with workers more dispersed, their frustration is expressed in the political sphere.

But anger can be a dangerous thing. As Messrs Lonergan and Blyth argue, anger can find vent in “tribal rage”, like the hostility of rival football fans; it is often expressed as hostility towards some outside group such as foreigners, or religious or ethnic minorities. The alternative is “moral outrage” which protests against legitimate wrongs, such as the exploitation of the system by rent-seeking plutocrats. To quote the book: “The challenge for politics today is to listen carefully to, and redress, the legitimate anger of moral outrage while exposing and not inciting the violent anger of tribes”.

As someone who has written a couple of books of economic history (Paper Promises and More), I would like to add another layer to the argument. The Capitalism 3.0 model was driven by monetary policy, which focused on low inflation, a target pursued by independent central banks. But globalisation by itself was driving inflation lower (as the former communist bloc joined the market-based economy) and technology cut the costs of manufactured goods. This created a feedback system whereby central banks cut interest rates in response to lower inflation, delivering capital gains to those who owned financial assets and those who had borrowed money to buy real assets like property. Higher debts made the system unstable, and when that stability resulted in a financial crisis, central banks propped up the system with lower rates and more liquidity.

The lesson learned by many traders and bankers was that taking risks paid off in the long run. Each crisis led to lower rates and more debt until 2009, when the only way that the system could be made to work was for central banks to buy bonds outright, cut interest rates below zero, and all the rest. This system is very fragile. The US has just enjoyed its longest boom in history. But the Federal Reserve was only able to raise interest rates in baby steps, and had to bring them back down to near zero at the first sign of trouble.

Far from debt “not mattering”, it matters a lot. But the mistake is to focus just on government debt when it is the total of consumer debt, corporate debt, financial system debt that matters. This debt is very high and needs to be refinanced on a regular basis; the only way it can be sustained is with very low rates. This explains the puzzle in the first paragraph; why governments can borrow at low rates despite needing to issue so much debt.

In political terms, this matters because the system has undermined the interest of the middle classes as well as the working classes. In the 1920s, German hyperinflation wiped out the savings of the middle classes creating a well of support for Hitler. The corollary this time is the effect of low rates on pension pots; middle class people could once retire on a generous final salary pension. But such pensions have gone and their replacements (defined contribution pensions) are dependent on bond yields to generate income. These have plunged meaning that many middle-class people have pension pots that won’t pay a decent income; they must work longer or live in reduced circumstances.

Anyway, enough of defining the problem: how to deal with it? The authors’ solutions are intriguing, but (in my view) skate over some of the practical issues. One proposal is to take advantage of negative real interest rates. The government could issue bonds and use the proceeds to buy global assets, such as equities, setting up a National Wealth Fund. The expected return on those assets will be much higher than the yield on the bonds, and the profits from the National Wealth Fund could be distributed to citizens every 15–20 years.

The obvious danger is that global equities have a prolonged slump, akin to that suffered by Japan where the stock market is still below its end-1989 level. The authors argue such an extended slump is unlikely at the global level. That may turn out to be right, but a more fundamental problem is that 15–20 years is a very long time to wait; it will not help people now. Angry voters, and the politicians they elect, can do a lot of damage in the interim. Another issue is that the authors propose distributing the proceeds to the “80% of households with the fewest assets”. Sounds fine, but we don’t have a register of assets by households, and the practical difficulties might be immense: the make-up of households (flat-sharing twenty-somethings, for example) can change quickly. Does a household with eight people get the same as a single person?

The other ideas include a tax (in the form of a royalty or licence) on tech companies to reflect the use they make of our data, with the proceeds paid out to all those who allow access to the data. Since most of these companies are American, it is not clear how Washington would react to this proposal (tech tax plans from France raised the ire of President Trump). Let us say it raised £20bn a year; with more than 50m adults in the UK, that would be £400 each. You would need to raise an implausible sum for this to generate a large income each.

The third idea is to borrow money (again at low rates) to invest in green projects such as wind power. Again, this seems entirely sensible; this is a good moment to invest in infrastructure. Whether it will assuage voter anger is another matter.

To be fair, this is a short book and the authors write that “our aim has been to introduce these ideas, not to seek to prove them or make the case that nothing else matters”. More focus could, I think, have been placed on land and inheritance taxes: the latter were very effective at destroying the fortunes of the aristocrats who lorded it over British society before 1914.

But as I hope this essay has demonstrated, this is an excellent, thought-provoking book that should be read by anyone with an interest in economics or politics. Angrynomics is a new term to me but one that should be at the heart of political debate.