everybody’s crisis. Finally, it emphasizes that the risks arising from huge indebtedness (and implied trade imbalances) are still with us, irrespective of resource constraints. The latter signifies the necessary irony that never before have we been so indebted, which is essentially an expression of our faith in future economic growth, just as that growth becomes impossible due to resource constraints.
Earlier I explained that the monetary and financial system was a hub infrastructure of the global economy, with no operational alternative. It is based upon credit, interest and fiat currencies. Credit underpins our monetary system, investment financing, government deficit financing, trade deficits, letters of credit, the bond market and corporate and personal debt. Credit, and the promise of future economic growth, supports our stock market, production, employment and much else besides. It is a primary institutional infrastructure of the global economy.
Over the whole of an economy, in order for debt to be repaid with interest, the money supply must increase year on year to replace the money lost to the economy when interest payments are made.* Money is injected into the economy when additional loans are taken out. Accordingly, the payment of interest requires an increasing level of debt, and eventually, the level of debt will become unsupportable unless incomes grow as well, either because the economy has grown or because there has been an inflation. If loan repayments including interest exceed the value of the new loans being taken out, the money supply contracts. If it does so, less business can be done, so firms fail and there is less purchasing power in the economy and increasing difficulties with servicing debts. This causes people to spend less, and investment borrowing to fall. In other words, a deflationary spiral develops. On the other hand, if debt, and thus the money supply, increases without a corresponding increase in GDP, money’s purchasing power is reduced by inflation.
Increasing GDP requires increasing energy and material flows. With an energy contraction, the economy must contract. In a growing economy, debts can be paid off as they fall due, because borrowers are prepared to take out enough additional loans to cover the payment of the principal plus interest on old loans as they mature. In a permanently contracting economy, the shrinking income makes the payment of even the interest increasingly difficult as, with inadequate borrowing, the money supply declines. Another way of putting this is that reducing energy flows cannot maintain the economic production required to service debt. The value of the debt needs to be written down to a level appropriate to the new level of production. This write-down can be achieved by either mass defaults or by inflation. Consequently, if the economy is expected to shrink year after year, the number of people prepared to borrow or lend money in the conventional way will dry up, as no one will be confident that the borrowers will have enough income to make the interest payments.
A bank’s main assets are the loans on its books. If even a tenth of those loans cannot be repaid, that bank is wiped out because making good the losses would take more than its shareholders’ capital and retained profits. Its depositors could not be repaid in full and its government or central bank would have to step in to make good the loss and allow the bank to continue to trade. If the bank’s losses continued as incomes and asset values fell further, the government is likely to reach the end of its borrowing capacity. It would be open to the central bank to create money out of nothing to fill the hole in the bank’s books, but it is likely to be reluctant to do so for fear that the new money would cause inflation.
Unlike previous monetary crises, one caused by declining incomes and asset values would be systemic and global. There would be no “outside” lender to provide rescue, or external hard currency to provide reserves for important imports. Nor could the system be “re-set” in the expectation of future growth, because those expectations would have little foundation.
As the deflationary pressures would continue as the crisis developed, the prices of oil, food, and debt servicing would rise in relation to people’s falling incomes. There would be an increasing frequency of sovereign defaults, banking collapses and runs, declining production, panic buying and shattered public finances. In such a context, printing money (not necessarily by conventional quantitative easing) and currency reissues are likely to become necessary. Unless the money issue was tightly controlled, this could open the door to hyper-inflation. However, forecasting and control of money supply may be very difficult due to the intrinsic uncertainty of the monetary and economic environment. An additional inflation risk is that, if people began to have doubts over their bank deposits and future monetary stability, they may start spending on necessities and resilient assets, driving up the velocity of money and further increasing inflation.
Trust is the central principle underpinning the global monetary system and thus the trade networks upon which we rely. Governments can in theory print endless money, at almost no cost, to their hearts’ content. That we trade it for our limited assets, or our finite labors, is a measure of the remarkable trust bequeathed to us through our experience of globalizing growth. The economist Paul Seabright argues that trust between unrelated humans outside our own tribal networks cannot be taken for granted.26 Because trade is, in general, to all our benefit, we have developed institutions of trust and deterrence (‘good standing’, legal systems, the IMF, banking regulations, insurance against fraud, and the World Trade Organization, etc.) to reinforce cooperation and deter freeloaders. Trust builds compliance, which confers benefits, which in turn builds trust. But the reverse is also true. A breakdown in trust can cause defections from compliance, further reducing trust.
Because our governance and monetary policy is national (the Euro is likely to fail), but our basic needs are supplied globally, countries will be tempted to engage in predatory devaluations followed by inflations. This could occur even if governments were directly issuing debt-free money to citizens. Governments act firstly for their own citizens. In an evolving crisis, they are also likely to favor clear immediate benefits over uncertain future ones. Facing pressing immediate and projected national needs, the prospect of a continuing decline in the global productive base, and the risks of collapse in the operational fabric, governments are likely to face the following choice: maintain the value of your currency by limited issuance in the hope that it will in future be more acceptable to foreign traders, or “stealth” print money to make a grab for international assets and inputs before there is a major system failure. Furthermore, if currency crises are seen as inevitable, and hard asset barter or currency backing are likely to supersede it, then the breakup of countries’ dedication to monetary stability becomes a matter of when, not if. In such a manner, the globalizing trust dynamics that evolved in the confidence in future growth begin to break down.
Remember, we only exchange something of intrinsic value for currency if we can assume that the money we get can be exchanged later on for something else of intrinsic value. In other words, we need to be able to assume that exchange rates will be stable and that inflation will be low in the period before we spend the money again. The instability of debt money, fiat currencies and competitive devaluations all remove the basis for this assumption. Money becomes very difficult to value in space (for foreign exchange and trade) and in time (for savings and investment). We can say that it becomes opaque.
Bank intermediation, credit and confidence in money holding its value are the foundations of the complex trade networks upon which we rely. The mismatch between our dependencies upon integrated global supply-chains, local and regional monetary systems, and nationalised economic policy, which has not been a problem up to now, will become so as the monetary crisis develops. A complete collapse in world trade is an extreme but not unlikely consequence.
Even if debts are written off or inflated away, a much higher proportion of everyone’s reduced incomes will be absorbed by food and energy purchases. However, a country will only be able to import energy, food and inputs for its production processes by exporting something of equal value, because it will not be granted credit to run a trade deficit. The uncertainty about the value of money, and fears of future degradation of the operational fabric, is likely to mean that commodities such as gold, oil, grain and wood may be used as currency to settle accounts. However, this form of payment is ill suited to the complexity of global inputs.
Exports
