Austerity or Stimulus: Either Way, A Dead End

Imagine you own a pizza shop, your debts are piling up, and because of the economic situation, people just aren’t buying as much pizza as they used to. It is becoming obvious to all your creditors that you aren’t going to be able to make your payments next month. So one day their representative, an impeccably dressed man named Vito, pays you a visit. “You can call me Uncle Vito,” he says, “I’m here to rescue you.” Loitering around behind him is a large man of menacing demeanor leaning on a baseball bat.

     “You’ve been spending too much money,” says Vito, “and that is why you can’t make your payments. But because I’m such a nice guy, I’ll give you one more chance. I’m going to arrange you a new loan, courtesy of the Legitimate Businessmen’s Club down the street, so that you’ll be able to keep making your other loan payments. You’ll be able to stay in business and sell enough pizza to pay everyone back.”

Vito continues, “Before I do this, you’re going to have to agree to some conditions. First, you’re going to have to spend less money on yourself, and give more to us. You’re going to have to stop buying your kids Christmas presents, and no more pedicures for your dog.”

     You respond, “But I don’t do any of those things. We already cut our expenses to the bone. All our money goes toward food, shelter, tuition, medical care, and grandpa’s living expenses.”

     “Too bad,” says Vito. “You’re going to have to eat less then and do without medical care. You can move to a trailer, take your kid out of college, and as for grandpa, well, it’s his fault he didn’t save enough for retirement.”

     “Oh, and another thing,” says Vito. “You’re also going to have to cut some employees – you can pay their salaries to Boris here instead when he comes to collect.”

     “But if I cut employees,” you say, “I won’t sell as many pizzas and it will be more impossible than before to make my payments.”

     “You’ll just have to be more productive,” says Vito. “Besides, when they get desperate enough, maybe they’ll work for less. That will help, because according to my calculations, even these cutbacks won’t be enough to ensure you can make your payments. So you’re going to have to sell off your personal and business assets too. Your pizza ovens, your delivery trucks, your catering contracts… if you liquidate these assets, you’ll be able to keep making your payments well into next year. I’ll send over one of my associates to make you an offer.”

     You protest, “But if I sell these things off, after that money is gone I will be out of business. My income will be much lower than it is now. In fact, I’ll be destitute.”

     “What? I can’t hear you,” says Vito. “That’s my offer, take it or leave it.” Vito’s associate pats his baseball bat ominously. “Did you say something about going out of business? Don’t worry, once you learn to make do with less, maybe Boris here will give you a job in the pizza shop.”

A World of Austerity

     The situation of Greece, Ireland, Portugal, Spain, and many other countries, U.S. states, and innumerable businesses and individuals is much the same as the person in this story. Let’s map the situation it describes onto the real world.

     Tens of thousands of people in Greece have been protesting “austerity measures” that its government is implementing to fulfill the demands of the International Monetary Fund (IMF), the European Central Bank, and the European Union – the “Troika” analogous to the Legitimate Businessman’s Club in our little story. The Greeks are protesting with good reason, because these austerity measures involve all the things Uncle Vito is demanding, and more. Eating less translates to pays cuts to public employees, layoffs, and a freeze on the minimum wage. Doing without medical care translates to reductions in healthcare spending. Taking the kid out of college translates to cuts in funding for education. Cutting off grandpa translates to slashing pensions. Other austerity measures include higher sales taxes (but lower corporate taxes) and business-friendly changes to the legal system. They add up to, “You are going to have to spend more of your national income on servicing debt.”

     As for selling off the delivery trucks, pizza ovens, and eventually the whole pizza shop, the austerity program also demands that Greece sell off national assets to pay its creditors. These include airports, utilities, banks, the telecommunications monopoly, the national airline, and even tourist sites or whole islands. These are to be “privatized”, ultimately to end up in the hands of foreign investors who will extract continuing tribute from the Greek people in what some term a “tollbooth economy.” For example, maybe you’ll have to pay to visit the Acropolis, but that money won’t go to the Greek people – it will go to the corporation that has purchased the newly privatized concession rights.

      Even more extreme than that, the Troika demands that this privatization, and the collection of taxes, be carried out by its own agency and not the Greek government. That would be the equivalent of Uncle Vito’s associate taking over the cash register at the pizza store. It means the end of meaningful autonomy for Greece, and the cession of its sovereignty to a non-elected agency accountable only to the global financial elite.

     In the end, however, it is clear that Uncle Vito’s attempt to keep the pizza joint paying its debts is doomed, just as is the Troika’s attempt to do the same to Greece. If you can’t pay the amount you owe now, then even if Vito lends you money at a low 5% interest rate, unless your sales grow by more than 5% a year, you’ll be even less able to pay when that loan comes due. He is kicking the can down the road. Similarly, even though the rescue packages imposed on Greece, Ireland, Portugal, Latvia, Hungary, and others over the past two years carried interest rates much lower than the bond markets would have offered, they were still around 5%. Unless their economies grow at that rate, their ability to pay when the loans come due will be even less than it is now.

     Almost no one believes that 5% growth is possible. Indeed, according to various mainstream forecasts I’ve found online (the actual situation might be much worse), the Irish economy is expected to shrink this year by 2.3%, the Portuguese economy by 1.4%, and the Greek economy by 3.5%. The austerity measures make growth nearly impossible: just as the pizza store can’t make more pizzas if it fires its employees and sells off its ovens, neither can a nation increase production or consumption in the face of massive loss of income from salary and pension cuts and layoffs, while privatization and tax hikes increase the cost of doing business.

     On the individual level, many people are feeling something very akin to austerity too, as they struggle to service per-capita household debt that is more than double the level of 1999 and nearly ten times that of 1950 (in real terms) by cutting expenses and selling off assets (for example, by taking a second mortgage. While the proportion of disposable income devoted to direct debt service has supposedly remained fairly steady, financing costs indirectly contribute – more and more – to everything we buy. If you pay rent, most of your rental payment goes to the bank that holds the landlord’s mortgage. If you buy a car with cash, a lot of that money goes to pay interest on the capital investment in factories. Whatever we do, whatever we buy, we pay an ongoing tribute to the owners of money (those who lend or “invest” it).

     In the end, Vito essentially says, “I’ll take over the pizza shop and you can work there.” The terminus on the national level is a rentier economy in which the cost of labor is extremely low, and all the profits from that labor go to the financial industry, which owns everything. Ultimately, Greek and Irish debt will be restructured to keep payments at the very maximum the people can bear. They will be indentured servants, in aggregate destined to work their whole lives in service of an unpayable debt.

Shifting the Debt

     But even that state of affairs is not sustainable for the financial industry, which feeds off growth and starves without it. When there is any large scale default on debt, it ignites a chain reaction through the financial system, as each debt represents a security that backs other debt. If you don’t pay Vito, soon he will default on his own creditors at the Legitimate Businessmen’s Club, and they’ll default on their creditors…. The entire economy is so heavily leveraged that a default of any one institution can be catastrophic, and so must be bailed out by more debt somewhere else.

     Recently, the debt has shifted from the private sector to the public sector as governments have bailed out banks and other financial institutions. In the United States at least, private debt has shrunk over the last two years, but public debt has more than compensated for it. If a major country defaults, it is likely that instead of bondholders losing their shirts, they will be “rescued”. But it is much easier to rescue them indirectly, by lending the troubled country even more money squeezed from its own citizens and those of everyone else. Either way, the volume of debt continues to rise, financial capital continues to garner essentially risk-free returns exceeding real GDP growth, and wealth concentrates in fewer and fewer hands.

     Under normal circumstances, defaults reduce the inequality of wealth distribution. If you owe $80,000 to the credit card issuer and declare bankruptcy, then your net assets have increased by $80,000, and the assets of the issuer have decreased by $80,000. The possibility of default is what is supposed to discipline lenders and deter them from making poor loans. It enforces the wise allocation of capital. This principle no longer operates when the borrower is so big and the financial system so interconnected that it becomes “too big to fail.” Then lenders can invest without regard for the ability of the borrower to repay, knowing that if it cannot, someone else will.

     Eventually, there is a limit to how much debt can be added in one place to cover unpayable debt somewhere else. As debts shift from one balance sheet to another, always growing, we are seeing austerity being imposed on a global scale. The trend is toward a tiny minority having vast wealth, and everyone else keeping barely enough of their income to survive. There can be no other outcome, when debt grows faster than the economy.

     Only with fast economic growth can this scenario be avoided. Even in the absence of too-big-to-fail institutions, wealth will polarize as defaults concentrate productive capital in the hands of the creditors. That is one reason why policymakers on both sides of the political spectrum see growth as the solution. Vito, quite unrealistically in the scenario I described, hopes that your business will pick up enough that you’ll be able to pay him back when the loan comes due.

Well Then, What About Stimulus?

     If Vito were smart, he’d do everything he could to encourage that to happen – allow you to keep your pizza ovens and perhaps even expand. Maybe he would lend liberally to you and everyone else on the street, so that everyone had money to buy each others’ products. This solution is known as “monetary stimulus” – the opposite of austerity – and it temporarily increases debt levels even more (albeit at lower interest rates) in order to stimulate growth.

     But that only makes sense if there is additional demand for more pizza, and more and more resources to make more pizza. If there is no appetite for a 5% a year increase in the amount of pizza consumption, then monetary stimulus is, as Keynes put it, like loosening ones belt in the hope it will make one fat.

     If the production and consumption of goods and services cannot keep pace with the exponential growth of debt, then, though more lending might temporarily increase demand, eventually the debts come due and no one will be any more able than before to pay them back. Eventually, more and more people in town will be in the same position as you and your pizza store. Everyone will be cutting back on expenditures, and no one will be buying much pizza or anything else because their income goes to servicing debt. Your pizza business will fail first, but eventually, because there is always less money than there is debt, healthier businesses will succumb too until Uncle Vito owns everything. The reason there is always a shortage of money is that it enters circulation as an interest-bearing loan. Whether it is a bank lending to a consumer or business, or the Federal Reserve buying Treasury securities, the entry of each million dollars into circulation accompanies a debt of more than a million dollars.

     The only way to keep the game going is to constantly create new money (lent into existence as new debt). But that cannot happen in a zero-growth environment, because lending at interest demands that the recipient of the loan be able to earn even more money than he received. Monetary stimulus only works if there are plenty of money making investment opportunities – as there were in the middle of the 20th century, and to some extent still are in the “developing world.” But no longer. In the United States, no one imagines that we will return to the six percent growth rates that were common in the 1950s and 60s, or even the four percent growth rates of the 90s.

     This leaves yet one more solution, called “fiscal stimulus.” Vito and the Legitimate Businessmen’s Club (now symbolizing the government rather than the financial industry, though the two are increasingly synonymous) could inject more money into the economy by hiring people themselves at high wages, or even by giving money away for free. That might get people buying more pizza again. They could hire people to do things that benefit the public good, but that no one usually does because it doesn’t bring an economic return to the person who does it – the benefits are socialized. Or, as Keynes quipped, they could even hire people to dig holes in the ground and fill them up again.

     But again, this solution runs into the same problem as before: it only works if growth is around the corner. In a world where fossil fuels, mineral resources, soil, groundwater, fisheries, forests, and the global ecosystem cannot sustain much more growth, it is likely that, as many environmentalists assert, we are nearing the end of growth. The argument that we are at the end of growth is actually quite complicated, because it must deal with the contention that endless innovation can create an infinity of new goods and services, as well as the (implicit) assumption that human needs are infinite. I present a preliminary argument for the end of growth in The Ascent of Humanity, Chapter 4, and in other essays (here and here), and more thoroughly in Sacred Economics.

     In the absence of underlying growth potential, fiscal stimulus runs into its own set of problems. Consider first that Vito isn’t likely to do what I have described, because this policy essentially takes money from him and gives it to everyone else, putting him at a disadvantage relative to the rest of the Legitimate Businessmen’s Club. The whole club would have to get together and force all its members to go along with it. That is what governments do: through taxation, they coerce the wealthy into redistributing their wealth in order to maintain the status quo. From their perspective, the ideal amount of money to redistribute is just enough to keep the debts serviced, keep the economy going, and prevent mass social unrest. Enough money must be recirculated to the debtor classes for them to be able to continue making payments.

     This policy goes against the short-term interests of the wealthy, but it is in their long-term interest because it perpetuates the system in which they sit on top. Moreover, if exacted upon a subset of the wealthy, then those exempt from it rise in proportion to the rest. This makes for a lot of interesting politics, as various factions of the creditor class vie for power, but it doesn’t change the fundamental dynamic. When the conservative factions gain ascendency, polarization of wealth accelerates and the public gets desperate, generating political pressure that the liberal factions then harness to take power back for themselves, distribute a little more of the national income, rescue the economy… but keep the basic relationship between creditor and debtor intact. The New Deal exemplified this latter scenario. The patrician Roosevelt was considered by many to be a traitor to his class, but actually he rescued it. His main rival prior to the 1936 election was Huey Long, who advocated truly dramatic financial reforms such as a confiscatory wealth tax. He was assassinated before he could run for President.

     Fiscal stimulus today is usually funded by deficits, not taxation. But this cannot be a permanent solution, because the deficits come with interest that goes to enrich the very same people who have all the money to begin with. Ultimately, deficits only redistribute wealth if they can spark an economic growth rate in excess of the interest rate on that debt. This was possible during the 1950s and 60s, when Keynesianism “worked”, because the natural growth rate of the economy was quite high. Today there is, in the developed world at least, little potential for growth. Public deficits only shift the debt from one balance sheet to another, but it still grows faster than the economy’s ability to pay. If we are indeed nearing the end of growth, then we will need some other way to put money into the hands of those who will spend it, some other way to prevent the accumulation of wealth in fewer and fewer hands.

     Austerity does the opposite – it intensifies that accumulation. In the long run, not even the wealthy benefit. Everyone in the world owes them money, they own all assets and receive the surplus of all the world’s labor, but for the system to work they must continue to own even more. Eventually there is no more to own, no more wealth to transfer. Sooner or later, wealth must be redistributed – either in small amounts, enough to give the system a new lease on life, or as Marxists propose, through a fundamental (and typically violent) redistribution of property and reform in its system of ownership.

A Third Way

     In Sacred Economics I draw out a third way: to remove the natural advantage held today by the possessors of capital that allows the rich to get richer and richer by the mere fact of owning. One way to understand this third way is to examine the existing method of wealth redistribution, implemented in many countries in the 1930s: tax the rich and redistribute the wealth through social programs.

     There is an inherent problem (besides the resistance of the wealthy) in taxing the wealthy to redistribute wealth or finance fiscal stimulus: usually this taxation takes the form of income tax, which doesn’t necessarily tax the already-wealthy. If these taxes are high enough, they create a disincentive for brilliant, dynamic people to generate economic activity. Income taxes as currently implemented don’t distinguish between passive investment income and income earned through hard work that benefits society. In fact, in the United States much investment income is actually subject to a lower rate than ordinary income because it is classified as capital gains. It would be more just if the income tax were zero, and all taxation were shifted onto interest, rental, estate, capital gains, and other unearned income.

     Sacred Economics draws from several traditions of thought that advocated various versions of this idea. The late-19th-century economist Henry George, for example, advocated shifting taxation onto capital gains in land, so that people wouldn’t be able to profit by merely owning land, but only by making improvements upon it or administering it well. Otherwise, land would have a carry cost equal to the rent that could be obtained from it. Sacred Economics applies this idea more broadly, and in particular to money itself. Accordingly, taxation should apply not to income, but to stores of wealth. One way to do this would be to subject money to a built-in negative interest rate, which functions as a wealth tax rather than an income tax.

      This idea, developed by Silvio Gesell in the early 20th century and carried forth by Irving Fisher, involves currency with a built in depreciation in its nominal value and, more importantly in a modern context, a negative interest rate on bank reserves held at the Federal Reserve (or other central bank). During the 2008 financial crisis the idea enjoyed something of a revival – my research uncovered papers on it by several prominent economists, including one at the Fed – because it allows central banks to breach the “zero lower bound” limit on monetary stimulus. In the context of Vito and the pizza shop, what it means is that Vito now has an incentive to lend you money at zero interest, and possibly even at negative interest, because if he keeps his money it declines in value. No longer do you need to implement more and more austerity to service more and more debt.

     We are today engaged in a game of chicken with the global financial elite. With each crisis, we face a choice of transferring yet more wealth to them, or seeing the whole system come tumbling down. It is probably true that the sudden collapse of the financial system would involve misery for billions of people. In America, it would probably mean an overnight disappearance of food from supermarket shelves, riots, martial law, rationing, and so forth. Moreover, a collapse of the financial system would not only wipe out hedge fund managers and bankers, but also the pensions and savings of ordinary people. Not every member of the “creditor class” is a plutocrat. Much as a clean sweep, a purge, a destruction of the old appeals to certain of our emotions, I believe the time for that kind of revolution is over. I favor an evolutionary approach that transforms money all the way down to its root, yet which allows time for people and institutions to adapt.

     Fortunately, negative-interest economics offers a way to do just that in the face of the debt crisis. Up until now, the bailouts of financial institutions have exchanged their bad loans for cold, hard cash. This is what happened when the Fed bought mortgage-backed securities, which had become nearly worthless on the open market; the same thing happens when it buys government securities in the quantitative easing program. And, outrageously, the recipients of this largesse now have an interest-bearing asset – money – that they can continue to invest, without risk, at interest, knowing that if these new loans become unpayable they will be bailed out again. More debt covers existing debt, and the need for austerity or growth is intensified. Well, what would happen if these bailouts were accomplished with the negative-interest money I described above? It would say, “OK, we will bail you out, but if you don’t put this money to productive use it will gradually lose its value.”

      In the bailouts and quantitative easing programs, huge amounts of money were injected into failing banks in hopes that they would lend it out into the economy, but with economic growth stagnant or negative, there would have been few lending opportunities even if borrowers weren’t maxed out. As it was, they just kept the money, earning 0.25% as Federal Reserve deposits. But if that money were subject to a negative 5% liquidity tax (also known as a demurrage charge), banks would be anxious not to hold excess reserves. Even in the absence of economic growth (and in fact, as long as economic shrinkage were under 5%), the bailouts would no longer have the effect they do today of making the rich richer. We could rescue the financial system and avoid calamitous disruption, while setting in motion a gradual and permanent redress of the inequality of wealth and the nature of the economy.

     An economic system based on interest-bearing debt compels competition, the monetization of relationships, and endless growth. When growth ends, competition intensifies, resulting in a sharpening divide between the winners and an ever-growing number of losers. This process is nearing its end. Sacred Economics envisions a different kind of money system, an ecological system consistent with a steady-state economy. Negative interest is one of its pillars. It will transform not only economics, but psychology, our experience of work and our relationship to money. Without it, dependent as we are on money in a society of mass scale and division of labor, we will always be enslaved to the owners of money.


About Charles Eisenstein

I am the author of The Ascent of Humanity and Sacred Economics. I am also a public speaker and member of the faculty of Goddard College.
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10 Responses to Austerity or Stimulus: Either Way, A Dead End

  1. Gab says:

    Hey! The content of the article is repeated. At the middle you start again with „Imagine you own a pizza shop”.

  2. Gab says:

    Just a quick thought on demurrage. If somebody would want to accumulate wealth it could still be done with gold. Sure, it doesn’t grow by time, but at least it doesn’t decay either. I’m sure you’ve heard this before, and as you said, a change of the money system is not enough, other changes will also happen simultaneously as well.

    • This is a valid concern, and you are in good company in raising it. J.M. Keynes discussed it a bit too. However, even though gold doesn’t rust, as a physical commodity it definitely does have carry costs, for instance the cost of storing it, insuring it against theft (or the risk premium of possible theft). Another thing about gold is that mining it is extremely destructive to the environment. Another aspect of the economic vision I am drawing out is a mechanism (several actually) to internalize such costs. This could take the form of a tax on holding gold reflecting the reparations costs of the social and environmental damage it has caused. So, I think this concern can be dealt with, as long as the demurrage rate isn’t too high. A bigger problem than gold is actually land, which must also be subject to a cost offsetting its appreciation in value. That is why the ideas of Henry George also play a significant role in Sacred Economics.

  3. Harlan Wallner says:

    I just wanted to let you know that when you say “We could rescue the financial system and avoid calamitous disruption, while setting in motion a gradual and permanent redress of the inequality of wealth and the nature of the economy” is completely apparent to me that this is what will happen. It’s like you just spoke it into existence, something I hadn’t known was possible, an outcome far better than the collapse that I saw no way around and am admittedly still quite nervous about. Breathing room. We have breathing room. It seems you are giving us breathing room, with the ideas in this book. Thank you.

  4. I just started reading “Winner Take All Politics” and (as you might expect) was hearing a lot about taxing the richest 1% to redistribute wealth. I think the idea that we should focus more on taxing “passive” income is interesting, and probably more palatable than increasing income/salary taxes. Other parts of this article were a bit over my head. In particular, I’m having trouble understanding the “standard” definition of money lent with intrinsic interest versus your proposal of lending money with “negative” interest. Is the negative interesting something that’s enforced by the creditor? Meaning, if I loaned you $100 with 2% interest, I would simply inject $100 into your account, which would depreciate by $2 every month unless you used it?

    Anyhow, thanks for the fresh ideas on the subject!

    • The way it works is that bank reserves would be subject to a negatiive rate, for example charged by the Federal Reserve. It would be like a tax on bank reserves. Say 5%. So if you are a bank and you don’t lend money to people who will spend it, then that money will depreciate by 5% a year. (Cash would also have to bear a built-in decay rate on its nominal value.) So the bank would rather lend it at zero interest, if the borrower is credit-worthy, than keep the money.
      How would banks make money, you ask? Well, suppose you are rich, say you have $1 million in cash. If you do nothing with it, you lose 5% a year. Maybe you could lend it to someone at zero interest, if you can find someone, but probably you’ll have a bank do it for you. You’ll deposit it at the bank at, say, -3% interest. The bank will lend it at zero. This is a big oversimplification — the book goes into much more detail. Consumer-level lending and ordinary business lending would probably still be at around zero interest — that’s the goal — but there could still be lending at higher or lower levels of interest, for very risky loans, for example, or extremely safe ones. So in the example you raise, it could indeed be that way, though not 2% a month — that’s way to high — but maybe 2% year. There would be a payment schedule, however, or a term of the loan. If you didn’t make payments, then your collateral could be seized or a judgement entered against you in court. So, negative interest doesn’t mean you don’t have to pay it back.
      Maybe I should go through various scenarios. It isn’t actually very complicated, and is in fact quite similar to the way lending works today. I’ll do the examples when the relevant chapters come out in the serialization.

  5. jerry raitzyk says:

    What is the role of alternative currency?

  6. Meg says:

    I like many of your ideas, but have a question regarding retired people. I am an elderly woman, whose working years started at $15 dollrs a week, and whose retirement income (including small pension and Social Security based on jobs left in 1953) is about $500 a month. When I retired, I could buy gasoline for twenty five cents a gallon, fruit for about nineteen cents to thirty nine cents a pound., etc. I have moved in with my daughter, whose place of employment closed, and she remains unemployed.. I share costs of food, gas, electric, water, insurance, etc. but had relied on interest on my savings to help. Today, of course, this is practically nil, and savings are being depleted to make up for past interest income. In your scenario, how do elderly retired people pay for rent, food, medicines, etc. especially if their savings are being constantly depleted by negative interest?

    • Retired people shouldn’t have to rely entirely on savings. A society should take care of its elderly. Part of the vision of Sacred Economics is a social dividend similar to the “royalty” paid to Alaska residents, but I think there should also be social security or something like it.
      It is not that there would be no savings; just that you wouldn’t be able to live off the interest income on savings. Moreover, depending on the details of how it works out in practice, if you put money in long-term time deposits you could get close to zero interest. The book has more details.

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