In today’s Times, George Osborne promises to be straight with us, unlike that ‘phoney’ Blair.  At last, a politican that is going to be honest – someone should have thought of that earlier.  Bet Labour are kicking themselves (and Vince Cable is hoping to sue).

Osborne’s most important statement follows.  “We will turn an economy built on debt into one that saves and invests”.   And this winds me up, because in its very vagueness this promise at the least is far from straight.  For what does he mean by Saves, Invests, and Debt?

To see why my Goat has been Got, let us start with Japan.  Is Japan in debt?  According to Niall Ferguson (see the radio programme link), then yes: Japan’s government debt is somewhere in the record territory.  But Japan is also in massive surplus with the rest of the world.  It is the second largest holder of US government bonds, and has spent decades in Trade Surplus; that means, selling more stuff and services to the rest of the world than it buys.  It’s government is in debt, but its household sector traditionally in surplus.  The savings of the latter – via this wicked thing call debt – go towards the Japanese government.   No-one can ‘do an Iceland’ on Japan.

So what about Britain?  We all know about the government deficit, and everyone’s solemn promise to get it down.  Let us park that debate for now, because Osborne’s promise surely goes further. It is about how the  Economy works, and how that Economy becomes one that saves.  Now we can consider several interpretations:

1. Britain shall start running a trade surplus.  This may be a fine thing – higher net exports are a fairly unambiguously good thing if you want to get down leverage and still grow. But Japan is in this position, so it can’t mean everything.  And nobody in their right mind thinks that the UK is in trouble because of its trade deficits.  These numbers are not what sank us.  We could have run a trade surplus and still had a financial crash.

2a. The private sector shall be in surplus.  Since the private sector is the economy, really, then that is surely what he means.  But does that mean no debt?  Does it mean no longer being ‘built on debt’?  No, of course not.   What are 25 year olds meant to do to buy a house?  Wait until they have saved the entire cost?  No; they are meant to use this marvellous thing called ‘debt’, which enables other people who have ‘savings’ to lend them the money to buy what they need.  The savers get a return, so they can stop working at some point.

2b. Furthermore, as anyone who has read Martin Wolf this past two years will know, the recession IS ‘the private sector (suddenly) going into surplus’, broadly speaking.  Look at the figures here: we have a booming savings ratio. The public deficit is its demand-counterpart.  This is why what John Redwood has just written here is so misguided (I am trying to be polite):

It is especially galling for all concerned that at the same time as the private sector is learning to live within its means, the government is busily placing us all at risk by taking on more debt than we can afford. Why did they learn nothing from the private sector debt crisis?

aaaarrrrggggghhhhh!  If BOTH sectors save at once, where is the demand?

2c. Further furthermore: the debt ratio that got Prof Ferguson’s knickers so twisted is the GROSS private sector debt ratio.  Some sub-segment of the private sector owes 4XGDP – or whatever (see McKinsey research) to some other sub-segment, via the banking sector, largely.  Households owe 173 pc of their incomes. But the people who own the debts have an ASSET.    We could keep 2b going well, and still have this large potential imbalance between the debt-owners and owers in our society.  It depends on many things – in my view, above all the HOUSING MARKET.  As Spencer Dale* and David Willetts have made clear, the latter has been a wonderful vehicle for enriching the old and property-rich at the expense of their opposites.

If G Osborne is hoping to do something about that, I’d be interested to know how; and how he will explain it to some Tory NIMBYS that are behind a lot of this problem.

3a. Perhaps he means the banking sector.  After all, that is what got us in trouble.  And the Conservatives are famous for being very intolerant of financial market excesses, aren’t they? Furthermore, there is a meaningful interpretation here: that the banks should no longer be reliant on debt (boo hiss!) from the flighty wholesale markets, rather than the stable, worthy source of deposits (hooray!).   But if he is saying “banks shall not use wholesale funding” he is condemning the economy to a serious speed limit.  Credit shall not happen until enough patient savers have put out enough deposits to finance it.  Deposits grow slowly. Since a lack of credit is the current problem, we had better hope he means ‘in the very long term’.

3b. (UPDATE).  Or is he saying: more investment from corporates, more saving by households to finance this?  Possibly.  And maybe instead of debt intermediating, he wants equity to intermediate.  Who knows?  And does this suit the pension funds? (by the way; errant post deleted may have lost comment, apologies)

I am not saying Osborne has put out an incoherent policy; merely one that doesn’t mean anything without some hugely important details.  Some of the things that ‘move us from savings to debt’ are an unambiguous good, but impossible to promise: such as ‘develop a world beating export sector in something lovely’.  Some promise to send us back to the financial Stone Age, like ‘ban or render impossibly expensive the use of debt. Save first in future’.  If he wants to be called ‘straight’, he had better tell us which.

PS I am sure he means “More investment” – a bit like Wolf yesterday.   But at least Wolf acknowledges the complications of getting there.  Sometimes it involves debt

PPS George Osborne is not the only politician to be guilty of this.  Anyone can raise a cheer by shouting “Down with Debt! We like saving and investing!” I’m sure I could google up a few Clegg- or Cable-isms on just the same lines.  But Savings VIA DEBT leads to investments – unless you want us all to save for our own factories and windfarms.  Let’s hope for a future stuffed full of debts, of the right sort.

*Dale says:

First, any analysis of the increase in household debt over the past decade has to pay equal attention to the record accumulation of financial assets. They are two sides of the same coin. Second,  changes in house prices do not result in significant changes in aggregate household wealth: for every winner gaining from higher house prices is a loser facing less affordable housing. But that does not mean that changes in house prices can not have significant implications for the macroeconomy.


10 thoughts on “Down with Debt! proclaims straight-talking George

  1. I don’t think Mr Osborne understands debits and credits.

    The enormous indebtedness of 90% of the UK and US (among the most egregious examples) populations is in fact owed via the banking system as intermediary, mainly to the other 10%, and a few % to foreigners. The reason why the proportion of retail to wholesale deposits has been in secular decline for the last 20 years has been this very concentration of wealth, and the fact that the fruits of productivity increases have overwhelming flowed to Capital rather than Labour.

    And that’s just the liabilities. The net equity (such as it is) owned by our populations has also become unsustainably concentrated – as it has for thousands of years – by the toxic combination of compounding debt and private property in land.

    The result is that there’s no shortage of credit – just a shortage of the creditworthy.

    The Biblical solution was a Jubilee, and there are many good-hearted people who advocate just that.

    Taleb, and Buiter – among others – suggest that the requirement is for some sort of debt/equity swap: which would change not the quantity of financial obligations, but the quality. ie as Richard Werner put it the other day in a comment here – we need Qualitative Easing. A debt/equity swap is a sort of 21st century Jubilee, if you think about it, because it removes the debt obligation to repay on a specified date.

    I concur, and I’ve been working – with a little support from the Norwegian government – on a new and networked “Capital Partnership” approach to equity investment. This applies a 21st century approach to partnership law frameworks (which are actually thousands of years old), rather than conventional use of Victorian vintage Company law, or the archaic Trust law so beloved of lawyers.

    I propose that the ‘Unitisation’ of property rental value

    be applied to refinancing and thereby cancelling distressed property debt.

    This lecture in Ireland sets out firstly, my analysis of how the credit crunch came about

    and secondly sets out a solution – through unitisation of ‘rental pools’ – and this is also on YouTube here

    It’s not Rocket Science: and it’s not debt either.

  2. Urgh, stinky debt!

    It never ceases to amaze me that a party that hypes itself up as the party of the free market, can be so stupid over debt. Sure, an unfettered build up of debt can be bad (e.g. the subprime mortgage crisis), but regulated in the right way, debt has been one of the greatest liberators in history.

    And yes, with the problem essentially being desired savings are greater than actual investment, you could set about trying to increase private sector investment, but (and you may know better than me) I don’t know of any precedents for setting out to deliberately do that. Normally it’s “increase the government budget deficit, and that should kick start private demand in some fashion”. This seems to be “cut the deficit, and somehow magically micromanage corporate investment from Whitehall”.

    That sounds a bit like meddling New Labour 2.0, but I’m willing to bet that all it will amount to is their corporation tax cut (paid for by Kool Aid).

  3. And uh, I think we’re being to kind on George Osborne, because actually I don’t think you can get 3b from his speech. The problem is too much saving in the private sector meaning not enough demand. So he says take away the government deficit. But he also wants to increase (household) savings. So we now have a situation where there is even more too much saving, and he’s expecting corporate investment (somehow) to cover both the decrease in government spending, increase in household spending, AND any difference still left over between S and I since interests rates are at 0.5%!

    And all because the Conservative base is partly elderly, who see saving as positively virtuous.

  4. The John Redwood quote is very funny and a real howler. However, the utterly depressing aspect is millions would nod in agreement and see no contradiction. The media love to come up with big debt numbers as a means to scare the public. Just watch how they will run with national debt interest payments. They will always quote the figure in cash terms rather than as a percentage of the primary budget. There just seems to be an inability to understand that all debts cancel out. For everyone who owes a debt someone else is owed the debt. Moreover, when the Treasury pays out all that interest to the pension funds they will do nasty things with it like pay pensions. I think we are going to see more of this moralising from the Tories. Virtuous savers and evil debtors seems to be the message though they are symbiotic.

    With debt for equity swaps the government could do something for those trapped in housing negative equity. They could eliminate the negative equity part of the mortgage by issuing a gilt equivalent direct to the bank who hold the mortgage. The bank are happy and the person is released from negative equity. This would help the property market and the labour market as there must be many people who can’t move for employment because they are trapped in negative equity. To pay back the debt to the government the recipient could have a marginal change made in their tax rate depending on their age and the size of the debt. This would allow the debtor to repay the debt over the course of their working life and need not lead to an onerous debt burden. Therefore, they are swapping the debt for equity in themselves. Obviously some people might drop out permanently from the labour market and others move abroad. However, an interest rate could be set to account for the expected losses.

    1. @Richard

      I advocate a debt/equity swap for equity in property, rather than paying off debt with more government debt. There is no need for the government as middleman if investors can be found to invest directly in solid index-linked revenue streams based on property,

      This is quite straightforwardly possible with a new approach to investment in real property by ‘pooling’ rentals within a partnership framework (rather than a company or a trust), unitising them and then selling them to long term investors. These units are not bonds: there is no right to repayment of principal.

      The innovation I am applying is the creation of Units which are redeemable against property rentals.

      See this article on the Index Universe site

  5. @ Chris
    I have come across some of your articles before and thought you had some interesting ideas. I agree that getting long-term institutional investors involved in the UK residential property market is badly needed. We have allowed a ridiculous buy-to-let cottage industry industry to develop in this country. It almost guarantees instability and the appearance of property bubbles. Unitising residential property should have political support as it accords with what they are saying in other aspects of their ideology.

    1. @Richard

      Indeed. I lurk on the Gang8 group, and occasionally chip in the odd comment.

      I have long thought that the Gang has had a pretty shrewd idea as to the reality of a deficit-based economy, and was pleased to see you join, since I had become aware of your work in Japan.

      I think that a transition towards Peer to Peer Finance

      is the logical consequence of the dis-intermediating effect of the direct instantaneous ‘Peer to Peer’ connections of the internet .

      Where the music industry has gone, the financial services industry IS going, and it is – interestingly – in banks’ interests that they migrate from intermediation to service provision because this drastically cuts their capital requirement.

      By way of example of a transitional step, I am working with a South American Central Bank which is about to trial a system whereby VAT-registered firms may – in a process managed by service providers – discount VAT invoices directly with the Central Bank and thereby access working capital/liquidity.

      In this model there are no private banks as intermediaries (although bankers may well be service providers) and businesses settle obligations with obligations not FOR pesos or dollars, but BY REFERENCE TO the dollar as a unit of measure. The Swiss WIR credit clearing union has been operating in a not dissimilar way for 75 years.

      There’s no reason why the UK couldn’t do this either except that the banks would probably attempt to own it and extract a monopoly rent from it.

  6. One of the first things I learned in Macroeconomics 101 was that (on the Keynesian picture) savings = investment precisely because of the fact of debt, due to the fact S=I is an accounting identity.

    I’ve forgotten everything else, pretty much.

    But I remember that.

    George Osborne, go back to the beginning and see JMK after class.

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