After the 1979 restriction, however, the story was different. This time, the central banks resolved to maintain the purchasing power of their monies in relation to energy and they did all they could to fight the inflation. In Britain, an ultra-tight fiscal and monetary policy was adopted. Interest rates were set at 17% and government spending cuts of £3.5bn were announced for the following year. The result was the “Winter of Discontent” with 29m working days lost through strikes, the largest annual total since the General Strike in 1926. In the US, the prime rate reached 20% in January 1981. Unemployment, which had dropped steadily from 1975 to 1979, began to rise sharply as the deflationary measures were put into effect.
The OPEC countries themselves moved from a small balance of payments deficit of $700 million in 1978 to a surplus of $100 billion in 1980. They put most of this money on deposit in US and British banks. But what were the banks to do with it, since none of their rich-country customers wished to borrow at the prevailing interest rates, especially as their domestic economies had been thrown into recession by the central banks’ policies? The answer was to lend it to the developing countries, since the loans made to these countries after 1973 had worked out well.
The result was the Third World Debt Crisis. In 1970, before it began, the 15 countries which it would affect most severely — Algeria, Argentina, Bolivia, Brazil, Bulgaria, Congo, Cote d’Ivoire, Ecuador, Mexico, Morocco, Nicaragua, Peru, Poland, Syria and Venezuela — had a manageable collective external public debt. It amounted to 9.8% of their collective GNP and took 12.4% of their export income to service.3 By 1987, these same nations’ external public debt was 47.5% of their GNP and servicing it took 24.9% of their export earnings. This doubling had come about because they had borrowed abroad to avoid inflicting drastic spending cuts on their people like those made in the US and the UK. They could, of course, have avoided borrowing and tried to manage on their reduced overseas earnings but this would have forced them to devalue, which would have itself increased their foreign debt-to-GDP ratio. They really had very few options.
Just how deep the commodity-producing countries devaluations would have had to have been is indicated by the decline in net farm incomes in the US. In 1973, these reached a record high of $92.1 billion but by 1980 they had dropped back to $22.8 billion, largely because of a decline in overseas demand, and by 1983 they were only $8.2 billion. Not surprisingly in view of the high interest rates, many US farmers went bankrupt. In 1985, 62 agricultural banks failed, accounting for over half of the nation’s bank failures that year. The high interest rates were also a factor a few years later when 747 US mortgage lenders, the savings and loans or “thrifts” had to be bailed out. The cost was around $160 billion, of which about $125 billion was paid by the US government.
Money’s exchange rate with energy fell in both 1973 and 1979 because there was too much of it in circulation in relation to the amount of oil available. In 1973, the inflation removed the surplus money by requiring more of it to be used for every purchase. The results were generally satisfactory. In 1979, by contrast, an attempt was made to pull back the price of oil by jacking up interest rates to reduce the amount of money going into circulation and thus, over a period of years, bring down the “excessive” money stock. The higher rates caused immense hardship because they ignored the other side of the money=debt equation, the debt that was already there. So, by setting their faces against allowing money to be devalued in relation to energy, the central banks’ policies meant that a lot of the debt had to be written off. Their policy hurt them as well as everyone else. Yet the same policy is being used again today.
So which policy should be adopted instead to remove the current surplus stratospheric money? Incomes in the real economy need to be increased so that they can support current asset values in the stratosphere and, since there is insufficient energy to allow growth to increase them, inflation has to be used instead. Attempts to use 1979-type methods such as those being promoted by the Germans for use in the eurozone will only depress incomes, thus making the debt load heavier. A lot of the debt would then have to be written off, causing the banking system to implode. Even if this could be avoided, such a policy can never work because the money is being taken from the real economy rather than the stratospheric one.
The choice is therefore between allowing inflation to reduce the debt burden gradually, or trying to stop it and having the banking system collapse, overwhelmed by bad debts and slashed asset values. In such a situation, account holders’ money would not lose its value gradually. It could all disappear overnight.
The inflation we need cannot be generated with debt-based money as it was in 1973 because in today’s circumstances that would increase debts more rapidly than it raised incomes. As Graph 4 shows, each $100 borrowed in 2006–7 in the US only increased incomes by around $30 whereas in 1973, the return was higher and the level of debt the country was carrying in relation to its income was about half what it is today. The same applies to most other OECD countries; their public and private sectors are already struggling with too much debt and do not wish to take on more.
The solution is to have central banks create money out of nothing and to give it to their governments either to spend into use, or to pay off their debts, or give to their people to spend. In the eurozone, this would mean that the European Central Bank would give governments debt-free euros according to the size of their populations. The governments would decide what to do with these funds. If they were borrowing to make up a budget deficit — and all 16 of them were in mid-2010, the smallest deficit being Luxembourg’s at 4.2% — they would use part of the ECB money to stop having to borrow.
They would give the balance to their people on an equal-per-capita basis so that they could reduce their debts, or not incur new ones, because private indebtedness needs to be reduced too. If someone was not in debt, they would get their money anyway as compensation for the loss they were likely to suffer in the real value of their money-denominated savings. Without this, the scheme would be very unpopular. The ECB could issue new money in this way each quarter until the overall, public and private, debt in the euro zone had been brought sufficiently down for employment to be restored to a satisfactory level.
The former Irish Green Party senator, Deirdre de Burca, has improved on this idea. She points out that (1) we don’t want to restore the economy that has just crashed and (2) that politicians don’t like giving away money for nothing. Her suggestion is that the money being given to ordinary citizens should not just be lodged in their bank accounts but should be sent to them as special credits which could only be used either to pay off debt or, if all their debts were cleared, to be invested in projects linked to the achievement of an ultra-low-carbon Europe. These could range from improving the energy-efficiency of one’s house to investing in an offshore wind farm or a community district heating system.
Creating money to induce an inflation may seem rather odd to those who advocate buying gold because they fear that all the debt-based money that has been created recently by quantitative easing will prove inflationary by itself. What they have failed to recognize is that most of the money they are worried about is in the stratosphere and has very few ways of leaking down. It is in the accounts of financial institutions and provides the liquidity for their trading. The only way it can reach people who will actually spend it rather than investing it again is if it is given out as loans but, as we saw, that is not happening. Even paying it out to an institution’s staff as wages and bonuses won’t work too well as most are already spending as much as they can and would use any extra to buy more assets, thus keeping it stratospheric.
A common argument against using inflation to reduce debts is bound to be trotted out in response to this idea. It is that, if an inflation is expected, lenders simply increase their interest rates by the amount they expect their money to fall in value during the period of the loan, thus preventing the inflation reducing the debt burden. However, the argument assumes that new loans would still be needed to the same extent once the debt-free money creation process had started. I think that is incorrect. Less lending would be needed, the investors’ bargaining position would be very weak and interest rates should stay down. Incomes, on the other
