Ann Pettifor: speech notes for presentation to the Just Banking Conference, Edinburgh, 20th April, 2012

Last weekend, I attended the Just Banking conference in Edinburgh, organized by Friends of the Earth.  I gave a talk titled, “Five Tools and Six Steps towards global economic recovery: Making finance servant, not master of the economy” and have posted my speech notes below:

Last year, on the 13th December, 2011 Newsnight asked a group of economists to identify the most important chart of the year.

I chose this one, which had appeared in the first paragraph of the British government’s Budget Report of 23 March 2011. It shows, as you can see, the extraordinary high levels of UK private debt – but makes no reference to public debt.

 Treasury Budget Report, 23 March 2011,


The data for this graph is taken from an important report by the McKinsey Global Institute, published in January, 2010, titled “Debt and De-leveraging: the global credit bubble and its economic consequences.” It can be found here:

At the time of publication, McKinsey Global Institute (MGI) estimated UK total debt at 466% of GDP, with public debt only 59% of GDP.

You will note that the McKinsey Report included public debt in its chart – the smallest part of the UK’s total debt burden.

The Budget Report, by contrast, chose not to include public debt in its chart. But the Treasury writers of the 2011 Budget Report were quite upfront about the real crisis facing the UK. In para 1.1 entitled “rebalancing the UK economy” they wrote:

1.1 Over the pre-crisis decade, developments in the UK economy were driven by unsustainable levels of private sector debt and rising public sector debt. Indeed, it has been estimated that the UK became the most indebted country in the world.

1.2 Chart 1.1 highlights the rise in private sector debt in the UK. Households took on rising levels of mortgage debt to buy increasingly expensive housing, while by 2008 the debt of nonfinancial companies reached 110 per cent of GDP. Within the financial sector, the accumulation of debt was even greater. By 2007, the UK financial system had become the most highly leveraged of any major economy. The level of public sector net debt as a share of GDP steadily rose from 2001-02, as the government ran a persistent structural deficit, despite continued economic growth. (My emphases).

As you no doubt can surmise, I made much in my Newsnight interview of this chart, and of the Treasury’s emphasis on the levels of private debt which eclipses UK public debt. I also pointed out that the Treasury had carefully omitted to include McKinsey Global Institute’s full chart – which includes the much smaller share of public debt.

The Budget Report of 21 March, 2012 made a startling u-turn. Para 1.1. titled “A stable economy” opened with:

1.1  The financial crisis of 2008 and 2009 exposed an unstable and unbalanced model of economic growth in the UK based on ever-increasing levels of public and private sector debt. As a result of that crisis, and unsustainable levels of public spending, the Government inherited the largest deficit since the Second World War and the UK economy experienced the biggest recession of any major economy apart from Japan.

The chart on private debt was dropped.

McKinsey have updated their research (Debt and deleveraging: Uneven progress on the path to growth, Jan 2012). Total UK public- and private-sector debt has risen slightly, reaching 507percent of GDP in mid-2011, compared with 487 percent at the end of 2008 and 310 percent in 2000, before the bubble. The composition of UK debt—how much is owed by different sectors of the economy—diverges from that of other countries. While the largest component of US debt is household borrowing and the largest share of Japanese debt is government debt, the financial sector accounts for the largest share of debt in the United Kingdom:

“Although UK banks have significantly improved their capital ratios, nonbank financial companies have increased debt issuance since the crisis. British financial institutions also have significant exposure to troubled eurozone borrowers, mainly in the private sector. Nonfinancial companies in the United Kingdom have reduced their debt since 2008.

UK household debt, in absolute terms, has increased slightly since 2008. Unlike in the United States, where defaults and foreclosures account for the majority of household debt reduction, UK banks have been active in granting forbearance to troubled borrowers, and this may have prevented or deferred many foreclosures.

This may obscure the extent of the mortgage debt problem. The Bank of England estimates that up to 12 percent of home loans are in a forbearance process. Another 2 percent are delinquent. Overall, this may mean that the UK has a similar level of mortgages in some degree of difficulty as in the United States.

Moreover, around two-thirds of UK mortgages have floating interest rates, which may create distress if interest rates rise—particularly since UK household debt service payments are already one-third higher than in the United States.”

The government’s tune has changed, but, sadly the facts, according to McKinsey, have not.


It is time for some plain speaking.

The primary cause of the continuing financial crisis is the unprecedented explosion in private credit – and now the slow, chaotic and unmanaged – de-leveraging of that debt. That de-leveraging process is crippling the banking system, and leading to insolvency.

Until this cause and its effects are addressed, there will be no solution to the crisis.

The greatest economic disaster since the Great Depression is now unfolding around the world.

Despite massive injections of liquidity into the private banking system by taxpayer-backed central banks, the disaster gets worse by the day.

Policy makers – fixated on public debt, a consequence of de-leveraging and not a cause of the crisis – will not face a critical fact: the banking system’s financial transmission system is broken.

800 Eurozone banks are in such dire straits that they rushed to make use of the ECB’s generous re-financing operation – the LTRO – in December, 2011.

Barclays, Lloyds, HSBC and RBS are in such trouble that they had to borrow more than €37bn of the €1trillion offered at low rates by the ECB.

And still Eurozone banks founder while across the EZ bank shares are pounded by stock markets and rating agencies consider further downgrades.

In its latest Financial Stability Report (April, 2012), the IMF argues that European banks are set to shrink their balance sheets by $2.6tn (€2tn) over the next 18 months, with a quarter of the deleveraging likely to come from cuts in lending.

Deutsche Bank has told the WSJ that a one-notch downgrade of its credit rating could expose the bank to a €45bn “funding gap”. (WSJ 16 April, 2012.)

In other words even the mighty Deutsche Bank is exposed to insolvency.

And yet politicians and policy-makers refuse to acknowledge this, the real crisis – and instead continue to focus almost exclusively on one consequence of the deleveraging of private debt: the rising public debts of EZ states.

And that is why the Eurozone crisis rolls on.

Yesterday it was Italy, Portugal and Greece and Italy; today it is Holland and Spain.

European officials went to the IMF meetings in Washington in April, 2012, waving a begging bowl under the noses of countries like China and Brazil, with large numbers of very poor people. It seems that $1 trillion is just not enough to dampen the private bank debt fires igniting across Europe.

But more injections of public debt into private banks will not fix the insolvency of private banks; nor will monetary policy alone address economic failure across Europe.

As Richard Koo of Nomura Institute has shown, injections of liquidity by the world’s nationalised banks have not increased the money supply, or the availability of credit for the real economy: on the contrary. They have only helped to ‘kick the (bank insolvency) can down the road’ and shrink the availability of credit for the real economy.


Presentation by Richard Koo, Chief Economist, Nomura Research Institute, Tokyo, to the INET Conference, Berlin, 14th April, 2012.


Instead of lending into the real economy, banks today are borrowing from the real economy – a historically unprecedented, and bizarre development. As the Bank of England noted in its latest ‘Trends in Lending’

“The annual rate of growth in the stock of lending to UK businesses was negative in the three months to November.”

(Bank of England: Trends in Lending, January, 2012.

UK businesses are depositing more in Britain’s banks than they are borrowing from the banks. By doing so, they are lending to a banking system whose central transmission system is broken.

So the first step towards addressing the crisis is recognising its cause: the excessive private debts of the banking sector, the corporate sector and the private household sector – and the impact of unpayable debts on an increasingly insolvent banking sector.

Once we acknowledge the cause, it will be possible to address the solutions.


Consequences of mis-diagnosis by neoliberal economists.

While the world’s private banking system fights insolvency, governments around the world are imposing austerity.

This is like administering a ‘caveman’s diet’ to a patient with a broken spine.

And sure enough the consequences of austerity are plain to see.

Only thanks to a larger fiscal stimulus than in the UK or Europe, are there signs of hope in the US: but its recovery is profoundly threatened by the crisis of austerity in Europe.

China’s rate of growth is on a downward trend, while social and political instability there is on the rise.

Japan continues to languish. And Europe is threatened with catastrophic economic failure.


The political consequences – and threats

This profound global economic failure, is prolonged unnecessarily by adherence to the dogma of orthodox neoclassical economics, and has, naturally, a social and political impact.

From the Joppik Party in Hungary, to the Progress Party in Norway far-right parties have quadrupled their average share of the vote over the last few years.[i] In Holland Geert Wilders’ far right party is the third largest. In countries like Hungary the Far Right now command the same levels of support (around 16-17%) as the National Socialists did in Germany in 1930 (18.3%). In France, Marie Le Pen’s holocaust-denying party commanded the support of one in five French voters in the first round of the 2012 Presidential elections.

The crisis continues to claim victims. Bankruptcies are leading to suicides, marital breakdowns and the humiliation and loss of foreclosures on homes.

“In Italy’s wealthy northern Veneto region, a new helpline is advising struggling entrepreneurs to kill their businesses before they kill themselves.

This deeply Catholic part of Italy, where work is an article of faith, is home to nearly half a million small companies and workshops, one for every 10 inhabitants and one of the highest business densities in Europe.

The euro zone debt crisis came as a bitter shock after the boom of the 1980s. More than 300 people took their lives in this region between Lake Garda, the Alps and the Venetian Lagoon in 2010, the latest state data show.”

(Apr 16, 2012. Swiss info news:

“This past Thursday, at Modesto, California, man whose house was in foreclosure shot and killed the Sheriff’s deputy and the locksmith who came to evict him from his condominium unit. Modesto authorities responded by sending 100 police and SWAT snipers to counter-attack, and it ended Waco-style, with the fourplex structure burning to the ground with the shooter inside.

It’s not surprising that this should happen in Modesto: Last year the Central California city’s foreclosure rate was the third worst in the country, with one in every 19 properties filing for foreclosure.  The entire region is ravaged by unemployment, budget cuts, and blight — the only handouts that Modesto is seeing are the surplus military equipment stocks being dumped into the Modesto police department’s growing arsenal.”

(“Death by foreclosure” Mark Ames: Naked Capitalism. 18 April, 2012.

And unemployment rises relentlessly across the world (40 million) and Europe (24 million).  Youth unemployment is especially cruel and socially dislocating. Our young people are deeply alienated, and despair of a future.


Policymakers’ complacency: “the crisis is over. There is no alternative”

Despite this deeply distressing reality – obvious to all who can read and see – policymakers, economists and politicians are determined to act as if the crisis were over.

They argue that nothing more can, or must be done. That monetary policy is the only tool left in their toolbox. Jens Weidman, head of Germany’s Bundesbank, in an interview with Bloomberg after the first round of the French Presidential election (23 April, 2012) argued that Europe

“…can only win back confidence if we bring down excessive deficits and boost competitiveness. And it is precisely because these things are unpopular that makes it so tempting for politicians to rely instead on monetary accommodation.”

To fail to predict the 2007-9  crisis was crime enough, but economists and policymakers are now compounding their crimes by simply washing their hands of a crisis largely of their making.

They have adopted a stance of irresponsible and careless “policy defeatism” to quote my fellow panellist at this conference, Adam Posen External Member of the Monetary Policy Committee of the BoE in a widely quoted speech “How to do more” on 13 September, 2011.

This approach contrasts with that of the President of the Bundesbank, Jens Weidemann who in a speech at Chatham House just a few weeks before one in five French people voted for a fascist political party in the first round of Presidential elections, said:

“In my view, the risks of (fiscal) consolidation are …being exaggerated. In any case, there is little alternative.”

While policymakers would have us believe in austerity, others lay great emphasis on a wave of the ‘confidence fairy’s’ wand.

Having convinced politicians that neo-liberal policies would lead to first, ‘a great moderation’ and then nirvana – mainstream economists are now in a funk. Their elaborate models – which as Steve Keen has so decisively shown, exclude banks, credit and debt –  failed to account for the massive inflation of credit during the boom years, and the resulting deflation of the burden of private, household, corporate and finance sector debt.

Furthermore, they failed to see that once financial markets were liberalised – and bankers given the power to both create and then speculate with huge volumes of credit while fixing the price of that credit – that soon interest rates would rise, and debts become unpayable.

Indeed to this day, economists will not admit, or recognise that it was the high cost of borrowing that punctured the vast credit and asset-price bubble. However, as Richard Koo shows in the chart below, it was rising, high rates of interest that acted as a ‘dagger’ aimed at the overblown credit bubble – and led it to burst in the ‘credit crunch’ of 9th August, 2007.

(Presentation by Richard Koo, Chief Economist, Nomura Research Institute, Tokyo, to the INET Conference, Berlin, 14th April, 2012.)

Instead mainstream economists assume the bubble burst because of a form of “spontaneous economic combustion.”


Blaming the Victim

And, it is implied, those responsible for this spontaneous combustion are the victims.

‘Sub-prime borrowers’ are frequently named and blamed. Michigan hairdressers on $7 an hour with a mortgage sold fraudulently by the agents of banks at a very high rate of interest – are the innocents deemed culpable of bursting the vast global credit bubble.

Blame has been passed from criminal to victim: from the private banking system to government and to the public sector.

Worse than this, the victims – the poorest and the weakest – have been forced to foot the bill of bailing out the private banking sector. As Professor Joseph Vogl argued in Berlin in April, 2012:

“Each and every initiative taken has not been aimed at restoring the economy, but instead at protecting the interests of small and extremely wealthy elites in the finance sector, and consolidating or ‘solidifying’ the existing economic order.

“The turbulence of the financial markets has become a crisis of the entire capitalist system, including its political institutions and legal foundations. This political sclerosis is even more remarkable considering that the final decision, the restoration of the system, is foreseeable: the financial markets were or are being refinanced through bailout packages, cheap money and deficit-brakes. Despite all appearances, the recent collapse of the finance economy does not represent the end of an era: the crisis has proved itself as a way to solidify the existing economic order.”

(From Prof Josef Vogel’s presentation – ‘Sovereignty Effects’ to INET, Berlin, 12-15 April, 2012.)


So who is to blame for the crisis?  

It is my contention that ultimately politicians are to blame for the crisis. It was they who bowed before the power of Haute Finance, and de-regulated the financial system in their favour. By those actions they hurt other sectors of the economy – Industry and Labour – who rely for their prosperity on a stable financial system, and on low rates of interest with which to fund investment and job creation.

The result of de-regulation was for the bankers a form of ‘nirvana’. They now wield ‘despotic power’ over the world’s states and institutions (to quote Geoffrey Ingham in his book ‘The nature of money’). And as Andy Haldane, Executive Director for Financial Stability at the Bank of England showed with this chart in 2009, they did pretty well too – before the crash.

(Chart taken from a speech, on the 8 May, 2009 by Andy Haldane, Executive Director, Financial Stability, Bank of England.

Elected politicians were lured into transferring massive powers to Haute Finance by orthodox, neoliberal economists who argued that financial de-regulation would ‘discipline the market’ and maintain economic ‘equilibrium’.

These economists based their theories on deeply flawed analyses, as Steve Keen has so clearly demonstrated. At the heart of their mis-economics is the flawed notion that bankers are simply intermediaries between borrowers and lenders. That “for every borrower there is a saver”.

This, as we have known since the Bank of England was founded in 1694, is a misunderstanding of how the private banking system works.

It was the establishment of the BoE, and the adoption of the ideas of the Scottish genius John Law, that did away for ever with something that still lives on in the public memory as: “fractional reserve banking”.

The fact is, and it has been so since 1694, when a borrower approaches a bank for a loan, the funds for the loan are not in the bank. They are created when, after assessing risk, a bank clerk enters the loan amount into a ledger, demands collateral; sets the rate of interest on the loan and after agreement has been reached, transfers the funds – as ‘bank money’ – from the bank’s account to the borrower’s account. This loan creates a deposit in the borrower’s account. Loans create deposits. Credit creates money.

It gets better: credit creates economic activity. This is why I consider the creation of a sound banking and credit system to be a great civilizational advance. In countries without sound banking and credit systems, it is very hard to kick-start and sustain economic activity, through investment and job creation.

It’s because we have a sophisticated monetary system and a well-developed (if badly regulated) banking system – that we can afford to tackle climate change.

There is no shortage of money. There may be a shortage of skills; of regulation; of commodities; of land; of water and atmosphere – but there need never be a shortage of money.

For as Keynes recognised, with a monetary system: “we can afford what we can create.” Nothing more and nothing less.

Orthodox economists believe (and it is a belief) the opposite: that deposits create loans. That only after the farmer has planted his seeds, harvested his crop, sold it at market, collected a surplus – and deposited it in a bank – do we have the savings with which to invest.

Orthodox economists argue that without sufficient deposits, banks cannot undertake lending. That in order to invest we need savings. That in order to tackle climate change we need to save financial resources from elsewhere.

Not so. Credit – conjured out of thin air –  creates deposits. Credit creates money.

(Of course there are credit unions and savings banks that do no more than act as intermediaries between savers and borrowers. But the private commercial banking system does not operate on those lines.)

A second great flaw in orthodox economics arises from the wrong belief that credit or money is, or is like, a commodity. Because it is like a commodity, argue the neoclassicals, its ‘price’ – the rate of interest – is subject to the laws of ‘the market’; more specifically the law of supply and demand.

Credit or money is not a commodity. Unlike commodities there is no limit on the amount of credit that can be created (except the constraint of inflation of course, but more on that later.) Because credit is simply a book entry for commercial bankers, it is essentially ‘free’ or costless. For that reason, as Keynes argued, its ‘price’ should be very low.

Credit is a public good – like clean air – and as such should be managed in the interests of wider society, including industry – not just financial elites.

As things stand, the price of credit is a social construct. The ‘base’ or ‘policy rate’ – is decided upon by a Committee of men (sic) at the Bank of England, the Federal Reserve, the ECB and other major central banks. The wider spectrum of rates are decided by private bankers issuing credit. These rates include ‘real’ rates (the rate less inflation); rates for safe or risky loans; for short or long-term loans. All of these are artificially fixed by private commercial bankers.

The recent scandal around the setting of LIBOR – the British Bankers Association’s ‘London inter-bank offer rate’ – has been illuminating. It has exposed the role that private bankers play in simply fixing, and then colluding to agree (through the BBA) the daily rate upon which a wider spectrum of rates, including millions of US mortgages, is determined. The secretive process by which the BBA’s small elite members fix the daily rate has now been exposed to public scrutiny, and is subject to considerable legal challenge.

BBA bankers, it is alleged, having artificially set rates, then lured municipalities and pension funds into betting against them on whether the rate would rise or fall. Because they believe this market to have been effectively rigged, these municipalities and pension funds are suing the bankers associated with the British Bankers Association for losses in a market that is reputed to be worth at least $90 trillion.

Watch this space.


A blind spot for credit

Orthodoxy’s monumental blind spot for the nature of credit, and disregard for the impact of high borrowing costs, meant of course that economists were blind-sided by the crisis in 2007. The wealthy LSE e.g. could not do what we at the new economics foundation achieved in 2003 with very little funding and in a harsh and dismissive intellectual climate: the publication of a book that clearly spelled out the inevitability of the global asset bubble bursting.

Without the help of a single Dynamic Stochastic General Equilibirum (DSGE) model, and ignoring the Rational Expectations Hypothesis, I edited a nef book: “The real world economic outlook” (Palgrave Macmillan, 2003) which predicted “a seismic crisis” – the bursting of the credit bubble “in America, not Argentina”.  (Cover of the New Statesman 1st September, 2003.)

What confounded us for the next four years was how long it took for the ‘dagger’ of rising interest rates to puncture the credit bubble.

Three years later, in 2006, desperately worried about the borrowing habits of my fellow citizens, I authored a book with the cheerful title: The coming first world debt crisis’ (Palgrave 2006) which spelled out the causes, nature and extent of the threat facing the global financial system.

It was not rocket science!

Nor was much of it new.

We owed much of our analysis and insight to the genius of JMK, who himself failed to predict the 1929 crisis, and lost a great deal of money on the stock exchange as a result.

Central bankers and politicians would have us believe that there is only one tool – QE –  for reviving the economy. At a press conference on 11 October 2010, David Cameron confidently asserted that he had always been:

“.. a fiscal conservative and a monetary activist.”

There is only one tool these policymakers argue, with which to tackle the impending catastrophic crisis facing Europe: monetary activism by the Bank of England or the European Central Bank. That is shorthand for pumping money into private banks and leaving them to tidy up the mess.

But as Keynes taught us, we cannot, in a slump, separate monetary policy and fiscal policy. Pumping ‘liquidity’ into the stratosphere that is the globalised and largely unregulated banking system – without terms and conditions – means that the credit so created is invariably used by bankers for speculative purposes. It is particularly so now, because bank balance sheets are shot full of holes, and bankers and financiers urgently need to mobilise additional cash to clean up those balance sheets. And, after all is said and done, the returns on speculation tend to be higher than returns on sound investment in the real economy.

In a slump following the catastrophic bursting of a credit bubble which has left the private sector heavily indebted and risk-averse, the wiser action for the central bank would be to direct credit creation towards the last investor left standing: government.

But ideological antipathy to public sector investment prevents orthodox economists from recommending the only course of action that would revive employment and economic activity in the debt-laden Eurozone and the Anglo-American economies.

As Prof Chick and I spelled out in “The economic consequences of Mr. Osborne”, (July, 2010) the argument runs thus:

“ ‘we cannot afford to spend’.  The financial and economic crisis of 2008-9 proved that the preceding good years were unsustainable; countries were ‘living beyond their means’. By association, the public sector had become accustomed to revenues on a scale that could not be sustained indefinitely. We must therefore cut our cloth accordingly.

But this is to misunderstand the nature of affordability. Just as work makes things affordable to an individual, so too for society. A nation’s prosperity follows from the income generated by its employment, not the other way around. We make no apology for repeating for the umpteenth time Keynes’s profound wisdom: “Look after the unemployment, and the budget will look after itself” (CW XXI, p. 150).

Or, as Keynes argued in “The means to prosperity”:

“… it is a complete mistake to believe that there is a dilemma between schemes for increasing employment and schemes for balancing the budget. …

Quite the contrary.

There is no possibility of balancing the budget except by increasing the national income, which is much the same thing as increasing employment.”  (CW IX, p. 347)

(For more on this theme, please refer to a December, 2009 publication by the Green New Deal group: “The cuts won’t work”.)

The tunnel vision of policy makers, their refusal to constrain finance; to link monetary and fiscal policy, so that monetary policy supports public investment; their “policy defeatism” – all this would be bad enough in itself. However it is made much worse by their delusions.

Who seriously believes that austerity or ‘fiscal conservatism’ can rescue Greece or Spain? Or indeed Britain?

Who seriously believes that bankers can be richly rewarded, and harsh austerity imposed on innocent people across Europe – without a backlash from extremist anti-semitic political parties like France’s Front National, or Holland’s Islamaphobic “Party for Freedom”?

As we at PRIME have long argued, the crisis in Greece and Spain has been intensified by austerity.  It is both shocking and amoral to deliberately inflict unemployment on whole nations – and it is all likely to end very badly.

Today’s defeatist ‘hands-free’ economists and policy-makers are the guilty men of our era.

However austerity is a useful policy if the purpose is to shore up the nation’s savings to consolidate the existing, profoundly unjust economic order. Many policy-makers and economists believe that ‘austerity’ is the best way to mobilise the financial resources needed for the next banking bail-out.

Jean Claude Trichet, head of the European Central bank, in an article titled: “Stimulate no more – it is now time for all to tighten” (FT 22 July, 2010) wrote:

“Had our public finances not been credible when that 27% of GDP [NB a serious under-estimate] of taxpayer risk was mobilised, we would not have avoided a financial meltdown and a second Great Depression. We are doing all that is possible to avoid a future economic castastrophe…but even with the best G20 financial reform there may be…financial dislocation. Sound public finances are a decisive component of economic stability….”

Which translated means: European taxpayers must make sacrifices, face unemployment and hopelessness; undertake ‘fiscal consolidation’ and above all, be prepared to once again bail out the private financial system.


We know how to stabilise the system.

The economic instability, the financial crises of the past 40-50 years have followed from liberalisation.

With every financial crisis, the ‘solution’ was to intensify liberalisation.

So we began by de-regulating credit creation in 1971 – in the UK with the Competition and Credit Control Act (‘all competition and no control’).

This de-regulation of credit creation led to inflation: too much money, chasing too few goods and services. (Careful regulation of credit creation aims to prevent inflation.)

First, prices of goods and services were inflated by ‘easy money’. This inflation encouraged unions to press for higher wages for their affected members, which intensified the upward spiral. Next ordinary workers were blamed for inflation.

Blaming the victim is not a new game. The unions were only reacting to the inflation created by the credit bubble. Of course their actions exacerbated it…but they were not causal.

Easy, de-regulated money was causal. 

Then – through the 80s and 90s –  policy makers clamped down on wages and prices. Globalisation and unemployment helped wages and incomes to fall. However policy makers refrained from clamping down on spiralling asset prices. Assets – like stocks and shares, companies, property, works of art, race horses, brands – are owned, on the whole, by the wealthy. Their prices inflated massively during the boom years – and policy makers turned a blind eye – until the asset bubbles started bursting in the 80s and 90s.

The tragedy is that we have been here before.  But we are denied the opportunity to learn the lessons of the past.

They are taboo.

But instead of learning the lessons – the authorities globalised further; and intensified the liberalisation of easy money. This led to higher not lower interest rates.

After President Nixon unilaterally dismantled the Bretton Woods framework in 1971, higher borrowing costs around the world began to lead to the bursting of asset bubbles and thus, financial crises.

These crises began at the periphery, in Latin America and Africa, then moved closer to the core when Japan’s massive asset bubble burst in 1989; and in 1997-8 during the South East Asian financial crisis. In 2001 the bubble burst, and as a reaction interest rates were drastically lowered, but then slowly but systematically ratcheted upwards – making debts, including inter-bank debts, unpayable.

Finally on 9 August, 2007 global credit ‘crunched’ when banks, aware of looming insolvency, stopped lending to each other and central banks were forced to come to the rescue, by injecting liquidity into the system.


So what is the way out of crisis?

This is not the first time that a global credit bubble has burst, and caused havoc across the global economy. And the Euro is not the first attempt by policy makers to use mechanisms such as the articles of the Lisbon Treaty and more recently the European Fiscal Compact to entrench the interests of Haute Finance.

Both the ‘barbaric relic’ that was the Gold Standard of the 1920s and 30s and the harsh Eurozone Treaties entrench and institutionalise neoliberal economic policies whose purpose are to protect the assets of creditors – Haute Finance – above all else. The Gold Standard failed – at grave financial, human and environmental cost – and the Lisbon Treaty and Fiscal Compact will fail too.

John Maynard Keynes railed against the Gold Standard and its attendant economic policies, and was eventually proved right. He then devised tools and policies for recovery. These were used first by President Roosevelt to stimulate and revive employment and recovery in the US, and later accepted by a Conservative British government in the late 1930s.

His policies were spurned by German chancellors.

JMK devised these policies as a result of his direct experience of post First World War ‘austerity’ most notably in the Weimar Republic, where ‘fiscal consolidation’ was combined with unrestrained capital mobility. Austerity laid the ground for rocketing unemployment, social and political unrest and then the rise of fascism.

Keynes bequeathed to us – and to economics – five tools with which to transform an unstable financialised economy into a stable, managed financial system, which serves the interests of society as a whole.

In discussing these tools, briefly, I want to emphasise one point. It has to do with the way in which Keynes’s legacy has been distorted by his neoclassical enemies – both those who are anti-Keynesian, and many who claim to be Keynesians.

Keynes was a capitalist, not a socialist. He was overwhelmingly concerned with monetary, not fiscal policy. He believed that if only the authorities managed the financial system, the private sector would function well, without much help from government. However, in a crisis as deep as that of the 20s and 30s, when unmanaged finance   had buried the private sector in vast, unpayable debts – only then did Keynes believe it necessary for fiscal policy to be used to substitute for the private sector’s failure to invest and create employment.

“The important thing for government is not to do things which individuals are doing already, and to do them a little better or a little worse, but to do those things which at present are not done at all.”

(J.M. Keynes: “End of Laissez-Faire” p. 291 in “Essays in Persuasion” Volume IX of Collected Works, MacMillan, 1972.)

Keynes’s portrayal as a ‘tax and spend’ economist by neoliberal economists and commentators is not accidental. It conveniently eclipses the great body of his work – his monetary policies and theories for managing and regulating Haute Finance; and in particular, his policies for achieving permanently low rates of interest.

I leave you to speculate on why his legacy has been eclipsed in this way.


Keynes’s five key tools for recovery:

First, independent monetary policy:  to achieve stability Keynes drew on his understanding of how a monetary system works. He understood that in a monetary economy, there is never any shortage of finance. Therefore, in a slump there is no need to mobilise private savings for investment. Instead he drew on the credit creation tools (known to us today as ‘Quantitative Easing’ but understood before as ‘Money Market Operations’) of the Bank of England, but also the private banks. He argued that liquidity created by both public and private financial institutions should be directed towards sound public and private investment in productive, job creation activity.

Any attempt to divert liquidity/credit into speculation had to be curtailed.

Second, fiscal policy: Keynes understood that it was not enough simply to create liquidity. That money had to be spent, and spent wisely. Today economists and politicians like David Cameron (“.. a fiscal conservative and a monetary activist”) rely simply on monetary policy to inject liquidity into zombie banks.

This helps the banks, but does precious little to direct lending to firms and to stimulate recovery.

Today liquidity is pumped into private banks without any ‘terms’ or ‘guidance’ as to how taxpayer-backed liquidity should be spent. Instead policymakers rely on ‘faith’: that these generous injections of money into the banking system will somehow trickle into the real economy in the form of cheaper loans to sovereigns (in the case of the ECB) or in loans to SMEs etc. That has not been the outcome. Instead the credit/money is used by bankers for speculation in e.g. commodities, futures, currency trading etc., or to clean up bank balance sheets.

Keynes set great store by the spending of the credit created by the finance sector. And given the moribund state of over-indebted banks and firms, his advice was that credit (‘cheap money’) would have to be directed to the government, so that government could take up the cudgels and invest in sound infrastructure projects that would create employment (in both the public and private sectors) and generate income – in the form of wages, salaries, profits and taxes – with which to e.g. repay debts.

Managing debt de-leveraging

Keynes understood that the vast bubble of debt had to be de-leveraged in a managed way. Some debts inevitably have to be written off, with debtors granted a jubilee – as Steve Keen argues – simply because a high proportion of private debts are ultimately unpayable.

However, some debts can be repaid – but only through income.

So for banks to be stabilised, it is vital for government to help stimulate public and private economic activity which creates jobs and generates income.

This is the missing link in austerity policies: the generation of income (through employment) for a) decent livelihoods b) the payment of taxes (to e.g. reduce the public deficit); c) profits for firms and d) the repayment of debts to the broken, insolvent banking system.

It’s the contraction of income (through deliberate lowering of wages; through cuts in public spending which feed through to cuts in private investment; through unemployment etc.) that is causing the British and Eurozone economies to slide ever deeper into a prolonged Depression – one lasting longer than the Great Depression of the 1930s. See the NIESR chart below which compares recovery rates after financial crises, starting with the 1930s.


NIESR: The profile of recession and recovery.


Third: regulation of credit creation. To ensure that credit created by the private banking system was aimed at the real economy, and not speculation, Keynes advocated wise regulation of the credit creation powers of private banks (‘tight money’). In other words loans had to be carefully assessed for their ability to generate income to finance repayment; and for their ability to generate sound employment and economic activity.

Regulation of credit is also important for the management of inflation – and deflation. If too much credit is created – as happened after the de-regulation of the late 60s and early 70s – inflation is the result.

However, if as now, too little credit is created – the result is deflation. And a deflationary spiral is a terrible thing, as falling prices destroy profits, and then jobs and of course income. That is why careful regulation by the authorities of credit creation is so vital to financial stability.

Fourth: permanently low interest rates. This was one of the central pillars of the Keynesian revolution. It was also the one that invited the greatest hostility from private bankers – whose profits and capital gains depend on exacting high rents from the effortless activity of creating new loans, and from speculative activities.

Things are very different for those engaged in productive activity.  Permanently low interest rates are of the greatest importance to industrialists, entrepreneurs  and innovators; but also to labour, in the broadest sense of the word. For a firm to be profitable and stable, and to be able to afford to hire and offer decent pay to employees, requires that profits should exceed the cost of borrowing for investment in new ventures and in employment. When borrowing costs exceed profits, firms are either forced to ‘downsize’; look for cheap labour abroad; or face bankruptcy.

Keynes advocated permanently low interest rates across the whole spectrum of loans: short and long-term; safe and risky loans. He also wanted to ensure that the ‘real’ rate of interest – i.e. interest rates less inflation – was always low.

Low interest rates are also of immense ecological importance. For a firm to repay loans at high rates of interest, requires even higher rates of profit; and even higher rates of exploitation of both labour and the earth’s assets (commodities, natural resources etc.).

Finally, given that credit is effectively created out of thin air, it is morally reprehensible for interest rates to climb higher than 1% – 3%. For Muslims, interest itself (‘making money from money’) is morally reprehensible and is forbidden by the Koran (‘Riba’).


Fifth: capital control.

Capital control is important for a number of reasons. (NB: Capital controls are different from exchange controls. The former are controlled by taxing cross-border flows of capital as in e.g. the ‘Robin Hood Tax’. The latter are intended to control the volume of currency movements across borders. It is possible to have capital controls without exchange controls.)

One of the most important reasons for control over the mobility of capital is that management of financial flows gives democracies the freedom and autonomy to conduct their economic policies in the interests of society and the economy as a whole. In the absence of capital control, democracies are subject to the whims and interests of unaccountable global financial elites.

Capital control assists countries achieve a number of important goals. First: permanently low interest rates. Second: management of the appreciation or depreciation of its currency.

Such control need not inhibit trade; indeed some argue that international trade benefits from restraints over capital flows. The most notable proponent of this argument is the great free trader Jagdish Bhagwati who in a famous article in Foreign Affairs  in 1998: (‘The capital myth: The difference between trade in widgets and dollars’) condemned “the Wall St.-Treasury Complex” for “the self-serving assumption that the ideal world is one of free capital flows.”

Capital control is highly controversial with Haute Finance, which revels in, and profits from, the de-stabilising impact of volatile capital flows, the rise and fall of currencies and the ability to practice ‘regulatory arbitrage’ by setting one group of regulators against another. ‘Divide and rule’ is the name of their game.

Capital control is a fundamental pillar of Keynesian theory for managed finance, as opposed to globalised, de-regulated Haute Finance. The chart below demonstrates clearly the wisdom of Keynes’s policies for checks on capital mobility. It shows that the period of greatest financial stability was the Bretton Woods period, the ‘Golden Age’ of economics.


Capital Mobility and the Incidence of Banking Crises: All Countries, 1800-2007:

The six steps to economic recovery.

Step one: Introduction of capital control.

Step two: large scale reform and re-structuring of the banking system, including regulation of credit creation.

Step three: large scale reform of public debt management policy.

Step four: public investment in sound infrastructure projects, to generate income for both the private and public sectors

Step five: the creation of fossil-fuel substituting employment – in both public and private sectors – undertaken by a ‘carbon army’ of ‘green collar workers’. Such employment to generate:

  • Wages & salaries
  • Profits for SMEs and other firms
  • Tax revenues for government

Step 6: Recovery begins….


[i]   Gallagher, Laver and Mair, Representative Government in Modern Europe, 2011.

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6 comments to Ann Pettifor: speech notes for presentation to the Just Banking Conference, Edinburgh, 20th April, 2012

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