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The Infinite-Planet Approach Won’t Solve the European Debt Crisis

by Eric Zencey

Last week European leaders met in Brussels and, like sophomores cramming before a final, pulled an all-nighter. Their exam was a real-world project: restore investor confidence in the Eurozone. A lot of pressure was put on David Cameron to bring the UK into the new agreement; he was adamant in his refusal. Even without the UK, the measures that the Eurozone nations have announced may restore investor confidence, but one thing is certain: they shouldn’t, because they’ll fail miserably at staving off future financial crisis.

That’s because “restoring investor confidence” and “fixing the broken system” are two very different goals.

If more investors were like Jeremy Grantham, who’s got a clear view of the origin of the financial crisis, the two would line up a lot better. But most investors, like all of the policy makers who met in Brussels, are working out of an old-fashioned and mistaken economic model. Restoring confidence in a system built on that model isn’t going to fix what’s wrong.

What, exactly, is wrong? The New York Times articulated the conventional thinking when it opined, a few days before the all-nighter in Brussels, that the root of the debt crisis is “lack of growth.” The first step toward success in solving any problem is to define it accurately, and the conventional diagnosis gets it wrong because it looks at just half the problem. A more complete diagnosis: Some of the European economies haven’t been able to grow fast enough to pay back the burden of debt that has been wagered on them.

This formulation lets us see the path to a sturdy solution: if we want to avoid crises of debt repudiation, we need to limit the total creation of debt, public and private, to the amount that we can reasonably expect to be paid back through economic growth.

But instead of solving the problem of recurrent (and increasingly painful) crises of debt repudiation by looking at the system as a whole, the policy makers who met in Brussels went after just the most recent and obvious symptom: government deficits and threatened government defaults by the weaker economies of the Eurozone. When deficits are created by sovereign governments — governments that have the power to print money to cover them — they’re inflationary, and inflation is one way that a system’s need for debt repudiation can be met. But within the Eurozone, the European Central Bank holds inflation in check, so the necessary and expected debt repudiation has to take a different form. It has come this time as Greece’s move to renegotiate bond liability under threat of default — holders of Greek government bonds will get fifty cents on the dollar, not the full amount they expect. The conventional view sees that and thinks, “if Greece didn’t run deficits it wouldn’t have to default.”

That’s true, but too limited to get at the root of the problem. What the conventional frame of analysis doesn’t foresee: If you let the burden of total debt grow unchecked, and if you control both inflation and governmental default by mandating balanced budgets, you’ll simply displace the pressure for debt repudiation to somewhere else in the system. It will come out as bankruptcies and foreclosures or other private defaults, as stock market crashes, as cuts in pension promises or wage contracts, as loss of paper assets or expected future income of any kind. We can’t forestall the next crisis of debt repudiation unless we rein in the total creation of debt.

The new EU plan would take a major step toward making the Eurozone monetary union into a fiscal union, with stronger centralized control of inflationary deficits. Under the new rules, Eurozone member nations will have to balance their budgets over the economic cycle (if they go into deficit in times of recession, they’ll have to run a surplus in times of growth) and submit their budgets to the European Commission for review and approval. Currently member nations face penalties if they run persistent deficits — penalties that Greece consciously chose to ignore rather than see its economy sink into unemployment and recession under the onslaught of cheap imports from countries running a surplus. The new plan would have Eurozone member nations suffer larger, automatic penalties if they don’t obey the budget-balancing rules.

That will control inflation and bond default as methods of debt repudiation by imposing austerity budgets on struggling Eurozone members. (There are no penalties for the countries, like Germany, that create the other half of the problem by running trade surpluses.) Governments will have to cut social services and regulatory enforcement — cuts that will be touted as the best way to restore growth, and which will work to the benefit of the 1%. The rich get richer and government gets smaller — just what neocons and moneyed interests like to see.

As plenty of commentators have noticed, fiscal integration under the new budget rules and procedures means a loss of national sovereignty within the Eurozone. As only some of those commentators have cautioned, this makes government in Europe less democratic and less responsive to citizen concerns. “No problem,” say bankers and financiers. Democratically empowered citizens are likely to demand the level of governmental services and environmental protection that well-to-do nations are expected to provide — and those are luxuries their country can’t afford, not if it’s to grow rapidly enough to pay back the burden of debt it labors under.

The movement toward fiscal union and budget austerity thus represents the victory of growth-for-the-sake-of-growth over democracy-for-the-sake-of-democracy.

On an infinite planet, the two need not be at odds, and in fact can be seen to support each other. They certainly seemed to track together through much of the nineteenth and twentieth centuries, as market economies expanded into an underdeveloped world. But in a world built out to the limits of what ecosystems can handle, it becomes increasingly obvious that there’s a tradeoff.

As should be obvious to policy makers, the expansionary phase of human economic history is over. It is no longer possible to have both democracy and robust, footprint-expanding growth. The freewheeling creation of debt, whether public or private, drives the latter. To preserve it as a very profitable feature of the economy, bankers and financiers are perfectly willing to sacrifice the former. That’s the deep and troubling lesson of the European Debt Crisis: today, the largest threat to democratic forms of government is the fact that the planet hosts a human debt-creation system suited for perpetual growth on an infinite planet.

Because an economy deals in physical reality — that is, it runs on matter and energy drawn from a finite planet — it is impossible for economic production to grow infinitely. Debt, being entirely imaginary, can grow however rapidly we choose to let it. A crisis of debt repudiation is the unavoidable result of a mismatch between the two. The conventional frame does not admit this, and it leads us straight toward regressive and destructive policies, including the elimination of environmental and social safeguards. Those safeguards set limits to what we let ourselves do in pursuit of economic growth, and thereby give us a higher standard of living by protecting us from environmental harms and economic insecurity.

Since a higher standard of living, and not growth for its own sake, is the ultimate purpose of the economy, it makes sense to allow for the possibility that the solution to our system’s regular crises of debt repudiation lies in controlling the creation of debt. The alternative — demanding more and more economic growth, ever larger throughput of matter and energy — is impossible to sustain on a finite planet.

Even in the short run, the infinite growth model is counterproductive. It leads to a declining standard of living and a loss of democratic freedom for the majority of the world’s population — Americans no less than Greeks, Italians and other Europeans. It does so because whether we’re prepared to admit it or not, we’ve reached the limits to growth. More often than not, further growth in GDP is uneconomic growth, because it costs us more in lost ecosystem services and other “disamenities” than we get in benefits.

Pro-growth people don’t see it that way, of course, no doubt because many of them are the ones who receive those benefits by imposing losses on the rest of us. Many of those losses emanate from, and aren’t fully contained within, the rapidly developing nations of China and India — countries whose leaders have mistakenly accepted a demonstrably flawed element of neoclassical thinking, the Environmental Kuznets Curve. This is the idea, much beloved of pro-growth advocates and members of the 1% everywhere, that environmental quality is a luxury that nations will be able to afford only after they develop more — which they can do by cashing out their natural capital for sale on world markets, and by hosting “sink” services, poisoning their land and mortgaging their future by absorbing the global economy’s waste stream.

The ecological footprint of the global economy is currently larger than the globe it inhabits. But you don’t have to believe that we’ve reached the limits to growth in order to see that the basic problem behind the European Debt Crisis is the mismatch between our rate of debt creation and the rate at which we can grow real wealth in order to pay that debt off.

How much can real wealth grow under reasonable environmental safeguards and with reasonable protection of worker (and citizen) health and safety? The answer is, in part, empirical. The non-empirical part has to do with those environmental and health and safety standards: what counts as “reasonable”? Opinions will differ, but only an out-and-out infinite planet theorist can argue that environmental constraints need to be lessened, and only an unreconstructed robber baron could argue that workers ought to be free — “free” — to starve or take on employment that could kill them.

Here’s how to begin to fix the broken system: Agree to minimum standards for environmental and health and safety regulation, such as those promulgated by the UN; find the sustainable rate of economic activity that’s possible within those limits; and limit the growth in debt — all debt, public and private — to what’s needed to support that activity. With such a fix, the human standard of living would be raised not though footprint- expanding growth, but through technological innovation that allows us to achieve more benefit from a constant, sustainably sized throughput.

If more investors understood that the excessive creation of debt in all its forms — not just government deficits — is the driver of our crises of debt repudiation, this reining in of the creation of debt would be the only way to restore their confidence.

Educating investors and policymakers about the economic and financial realities of a finite planet is a huge task, but eventually they’ll come around. They’ll have to. The planet is, after all, finite, and it’s going to keep offering the lesson until everybody gets it.

How to Turn the Power of the Wall Street Protests into Real Reforms

by Brent Blackwelder

As the Wall Street protests have spread from New York City to the rest of the country, some media pundits have criticized the protesters for being unfocused — as if there were only one thing wrong with the financial sector of the U.S. economy. The protests have provided a welcome response to Wall Street’s massive takeover of governance, and continued opposition to the status quo could produce opportunities to enact real reforms.

Don’t expect Wall Street to undertake such reforms voluntarily — some of the shady practices are too profitable. It’s going to take new laws, and key legislation is pending in Congress that could provide important remedies. But new legislation won’t pass without the strongest pressure. That’s where the protesters could make a difference, especially with some forceful activity in the districts where the obstructionists, like House Majority Leader Eric Cantor from Virginia, reside. Cantor said to the conservative Values Voter conference: “I, for one, am increasingly concerned about the growing mobs occupying Wall Street” but he backtracked a week later when cautioned by his political finger-in-the-wind testers about the growing popularity of the protests.

Among all the morally bankrupt practices on Wall Street, there’s one in particular that would be easy to abolish. Easy, that is, if we can translate some the energy of the protests into pressure on lawmakers. Pending in Congress are powerful bills such as Senator Levin’s S. 1346 (Stop Tax Haven Abuse Act of 2011) that would strike hard at tax dodgers. But a bill like that has no prayer of passage unless representatives like Cantor feel the pressure.

Instead of reform, Congress is in fact poised to give another “one-time only” tax holiday to companies that stashed profits in tax havens. Huge and wealthy U.S. corporations are actively seeking what is known as a “repatriation holiday” because they say it would create jobs. Such a holiday would allow them to bring home offshore profits at a reduced rate — a nice holiday for the well-to-do CEOs and shareholders, while the rest of us taxpayers suffer the consequences of losing $80 billion of revenue.

The Tax Justice Network and a number of small business associations are trying to right this wrong. They have sent a letter to Congress to dispute this repatriation holiday, noting: “Too many corporations have turned their tax departments into profit centers, using aggressive accounting manipulation to disguise U.S. profits as foreign profits.”

Bloomberg Business Week has pointed out prime examples: Google reduced its income taxes by about $3.1 billion over three years — first by shifting income to Ireland, then to the Netherlands, and finally to Bermuda. Another example is Forest Laboratories, a company that sells over 99% of its drugs in the U.S. but attributes the bulk of its profits to a law office in Bermuda.

Corporate abuses are all the more frustrating in light of how the Congressional “Supercommittee” is discussing the deficit. The Supercommittee is poised to recommend draconian cuts in important programs, but its Republican members are unwilling to address tax havens and tax dodgers that cost the U.S. Treasury an estimated $100 billion per year. The two biggest banks benefiting from taxpayer bailouts are Citigroup with 427 subsidiaries in tax havens and Bank of America with 115.

A recent report  by the Institute for Policy Studies (IPS) adds more grist to the protesters’ mill. The report notes that the salary of chief executives (CEOs) of the S&P 500 soared 27.8% in 2010 to $10.8 million, making the ratio between average CEO pay and average U.S. worker pay now 325 to 1. Back in the good old days of 2009, the ratio was much more equitable at “only” 263 to 1. The IPS study found that 25 of the top 100 CEOs received more pay than their companies paid in federal income tax. Furthermore, 20 of these 25 companies spent more on lobbying than they paid in federal income tax.

One more recent analysis,  published in the journal of the Association for Psychological Science, provides new support for those advocating major reforms in the tax code. The analysis found that those countries with the most progressive tax codes (those that are the exact opposite of a flat tax where everyone regardless of income pays the same rate) had the highest happiness ratings.

Americans want a sustainable and fair economy. But we won’t get one without fundamental financial reforms and a clamp-down on tax dodgers.  And we won’t get that without applying pressure to lawmakers and corporations.  Now that’s a good focus for a protest.