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Fact and fiction: politics behind the deficit debate

Are the cuts about ideology or necessity? Many on the left have argued they have more to do with Tory politics than raw economic necessity, a case put forcefully by journalist and blogger Johann Hari. Richard Brenner puts forward an alternative perspective

The state debt crisis went global this month. Stock markets dived and capitalists dumped their dollars after rating agency Standard and Poor’s (S&P) warned that the USA’s credit rating might need to be downgraded.

On 18 April S&P, one of the main organisations for assessing the credit-worthiness of states, said “Because the US has, relative to its [top rated] peers, what we consider to be very large budget deficits and rising government indebtedness, and the path to addressing these is not clear to us, we have revised our outlook on the long-term rating to negative from stable”.

Roughly translated, S&P is saying the banks and rich investors who lend money to the US government can no longer be 100 per cent sure they will get it back… unless Obama makes massive cuts.

This followed a similar message on the 1 April from Bill Gross, Managing Director of Pimco, one of the biggest investment firms in the world. To fund public spending, governments around the world issue bonds paying fixed rates of interest to investors -as one of the biggest buyers and sellers of US bonds, Pimco is a key lender to the USA.

So US policymakers were shaken when Gross announced that if he were in front of a Congressional hearing he would say:

“I sit before you as a representative of a $1.2 trillion money manager, historically bond oriented, that has been selling [US bonds] because they have little value within the context of a $75 trillion total debt burden. Unless entitlements [benefits] are substantially reformed, I am confident that this country will default on its debt…”

Of course as a mega-rich capitalist Gross’s solution is as predictable as it is barbaric: “Without attacking entitlements – Medicare, Medicaid and Social Security – we are smelling $1 trillion deficits as far as the nose can sniff.”

Sound familiar? So it should. In the UK the bankers, investors and money-men have spent the last two years pointing to the deficit and calling for vicious cuts in health, education, benefits, jobs and services to solve it.

They used just the same type of scaremongering too.

Just before the election the Tories claimed Britain could be downgraded if their plan to eliminate the deficit in four years didn’t get through. And last month Lib Dem Vince Cable told the bosses’ Financial Times that “The budget deficit … means that, in a world of financial markets nervous about sovereign debt problems, the government runs the gauntlet of a confidence crisis unless we plough ahead with our deficit-reduction commitment.”

The deficit – with fears of a state defaulting on its debt – is now the number one worry for capitalists and the number one justification for cuts.

The very people who caused this crisis are now demanding that working class people pay. The deficit sits at the heart of the economic crisis and of the bosses’ austerity offensive on working class people and our living standards.

And of course the USA and Britain are far from being the worst affected. It is in Europe and in particular the Eurozone that the crisis of state debt has been sharpest.

And it is Europe that poses the biggest risk of the crisis deepening and spreading. The British capitalists are all too keen to point to Europe, supposedly as a warning of what would happen unless they get away with the cuts.

Only a few weeks back Portugal joined Ireland and Greece as the third Eurozone state to need a massive bailout to avoid bankruptcy. As a condition of the bailout, eye-watering austerity packages have been imposed.

Now everyone is asking if Spain will be next to need a bailout. And rumours are spreading on the financial markets that Greece can’t meet its obligations under its existing bailout and will have to have its load lightened (by ‘restructuring’ its debt). The bankers and bondholders are worried that they will be asked to ‘take a haircut’, which is their revealingly blasé term for being told that they will not get all their money back at the expected rate of interest.

A leaked email from huge US bank Citigroup on 20 April said:
“The last few days the talks over [Greek] restructuring/rescheduling have intensified, despite the ongoing denials by [Greek] foreign officials. If a credit event [banker talk for default – RB] takes place it is crucial to see what the terms would be as a haircut would have a much different outcome vs an extension of maturities” In other words the bankers might actually lose some money, not just have to wait longer for it to be paid.

To avoid this Greece, Ireland, Portugal and Spain, countries which are already suffering terrible cuts and massive unemployment – more than one in every five Spanish people is out of work – are being asked to take yet another round of austerity and cuts.

So why is the deficit so high in some countries? Will countries default and if so what would it mean? And how can we answer the Tories and Lib Dems’ big lie that the deficit makes cuts inevitable?

The biggest lie?

In a brilliant short essay on his blog, Independent journalist and UK Uncut campaigner Johann Hari denounced the Tories’ deficit claims as the biggest lie in British politics:

“Here’s the lie. We are in a debt crisis. Our national debt is dangerously and historically high. We are being threatened by the international bond markets. The way out is to eradicate our deficit rapidly. Only that will restore “confidence”, and therefore economic growth. Every step of this program is false, and endangers you.”

Puncturing the Tory refrain that the deficit was caused by Labour somehow spending too much on hospitals and schools, Hari points out that Britain’s debt was relatively low when the crisis began. He correctly argues that cuts will dampen spending and reduce the speed of economic recovery, and calls for investment to be grown not sliced back.

In a classic example of Keynesian economics, he says: “debt isn’t the problem. Debt is part of the cure. The facts suggest need to spend more, not less, to get the economy back to life – and pay back the debt in the good times, when we will be able to afford it.”

He concludes that the deficit isn’t a real driver of cuts, that it is just an excuse: “The real reason why David Cameron is imposing these massive cuts has nothing to do with the national debt or the deficit. It is because he regards himself as, in his words, ‘the child of Thatcher’, and he wants to pursue her agenda harder and faster than she ever dreamed.”

Of course a lot of this is spot on and every socialist would agree with it. But at the root of Hari’s argument is a serious mistake – one that suggests the crisis is only being caused by wrong government policies, and that the debt crisis isn’t a real problem, let alone one that has arisen because of the whole way the capitalist system works.

While socialists agree the Tories are using the deficit to make the sharpest cuts they can for ideological reasons – they hate the welfare state – we also believe that this ideology is driven by the real demands of the capitalist profit system. We think the debt and deficit crisis is real.

If we’re right, then an Ed Miliband government would immediately give in to huge pressure from the bond markets and start carrying out the same cuts as the Tories. And if a radical government tried to abandon the cuts programme and spend as Hari suggests, we think the bosses would launch an investment strike, cut off funds and attack the British currency.

Unlike Hari, who quotes leading economist Paul Krugman to claim that the so-called “bond market vigilantes” are “invisible” and “don’t exist”, we think they are real, part of this rotten system, have huge power and massively influence economic policy.

That’s why socialists think to have a chance of sustained redistribution of wealth and planned extension of services we’d need to confiscate the funds of these huge financial institutions and investors, impose state control of foreign exchanges, renounce (“default”) on the debt altogether, and spread that as fast as possible from one country to another.

“My deficit’s bigger than yours”

One of Johann Hari’s strongest arguments is that the scale of Britain’s deficit is nothing like as big as the Eurozone states that are facing bailout and the threat of default.

He says “Our debt is not high by historical standards, and it is not high by international standards.” The implication is that this means there is no risk that bond markets would downgrade British sovereign debt in the way they have Eurozone economies or have threatened to do to the USA.

But looking at the facts we can see how weak this argument is. Today the Office of National Statistics reports that at the end of December 2010 UK government debt was £1.1 trillion, equivalent to 76.1 per cent of GDP. The OECD forecasts the UK’s debt to GDP ratio will reach 95 per cent by 2012. HSBC predicts that it will hit 94.1 per cent this year.

Certainly Greece is way beyond that level, with its debt at 155.8 per cent of GDP this year and predicted to rise to 165.1 per cent in 2012. So is Ireland: 110.4 per cent this year and 125 per cent the next. (Both estimates from the Economist Intelligence Unit)

So is Hari right in making a positive comparison with the Eurozone? Sadly not. Bailed out Portugal’s deficit last year was 81.3 per cent of GDP. And Spain, next in the firing line for the bond market attack and next on the list for a potential bailout, has a debt to GDP ratio of 69.6 per cent this year, well below the UK.

So it is no good pretending the problem doesn’t exist or that a different type of government could make British capitalism work without cuts. It is true that British debt is longer dated than Ireland’s and Greece’s, but the bond markets are not only concerned about immediate repayment. If the bond markets can target the USA, they can certainly target Britain.

Similarly Britain’s deficit of 10.2 per cent of GDP in 2010 contrasts with 9.7 per cent in Greece, 34.2 per cent in Ireland, 7.3 per cent in Portugal and 9.2 per cent in Spain.

Therefore our programme of action against the cuts needs to include not only calls to clampdown on tax evaders, not just calls for more spending on jobs and services, but a call to renounce the debt and bust the bondholders.

If Cameron says he wants to eliminate the debt and the deficit in four years, and Miliband says he’ll halve it in two years, our answer is to abolish it overnight: by telling the bondholders and the Bill Gross’s of this world that we won’t pay them back a single penny.

There might be a few people in Greece, Portugal and Ireland that would follow suit if we did.

The risk the bosses are worried about is that the ‘contagion’ of sovereign debt crises spreads further across the Eurozone and starts to hit countries not in the periphery of the EU but at its highly developed core. Investors breathed a momentary sigh of relief in mid-April when the Spanish government succeeded in selling €3.4 billion in long term bonds. But this episode revealed just how nervous the financiers are about Spain. A few days before the sale Spanish economy minister Elena Salgado, had had to make an appeal for calm when an earlier bond sale got into trouble. A continuing fall in house prices and rising declarations of bad loans by Spanish banks spooked bond markets.

Can the Eurozone survive?

The Economist Intelligence Unit, in its report State of the Union: Can the Euro Zone Survive its Debt Crisis, raises concerns that “Spain faces, above all, a liquidity risk [cash flow problems] in the next five years as it tries to reduce its deficit against a background of extremely high unemployment, a medium sized property crash and a risky banking system.”

None of this is to predict that Spain necessarily will need a bailout, let alone default. But the possibility is real enough to be being debated in financial and government circles. All this stiffens the resolve of the European capitalists to clamp down hard on spending and on the working class.

Could the EU – and in particular its strongest powers Germany, France and Britain – afford to bailout Spain? The answer is probably yes: but only just. The bigger question is whether the EU could handle the potential knock-on effects.

The EU’s current emergency credit mechanism for bailouts goes by the ungainly name of the European Financial Stability Facility. It is a special fund that borrows money in commercial credit markets, backed by loan guarantees from the strongest EU powers, and then lends – not gives – the money to EU member states that get into trouble.

At the moment its capacity to lend is limited to €250 billion, but the Eurozone states have agreed to extend that to €440 billion, in case Spain needs a bailout.

So could it cope? The Economist Intelligence Unit’s “main risk scenario”, which it claims has a probability of 25 per cent, says that if Spain asks for a bailout for its funding needs for 2011-13 (estimated at €470 billion), the EFSF could cover it, so long as it could draw on existing available IMF funding taking its capacity up to €525.

So, at a stretch it could be done.

But that assumes a Spanish bailout would have no impact on the banks in Germany, France and Italy. Suffice it to say, it would.

German banks’ exposure to Spanish government debt is vast: €29.4 billion, more than their exposure to Greek debt and more than twice their exposure to Portuguese and Irish debt put together. Italian banks are also exposed. And French banks would really make a loss. They have €19.8 billion in Greek debt, 6.6 billion in Irish debt and 16.1 billion of Portuguese debt already…but a massive €46 billion is held in Spanish debt.

As the EIU points out this could have a severe impact, with banks across the Euro area “exposed to securities that in the worst case face a value destroying restructuring.”

If these banks needed bailing out, that would increase pressure on state funding still further, causing bond market lenders to look very closely at the finances of other, apparently more stable states.
And it is very clear that, as the EIU report puts it, the current EFSF plus IMF funding would “not be enough for Spain plus any other potentially vulnerable country, such as Belgium (which has funding needs of around €140 billion during 2011-13) and certainly not Italy (€820 billion).”

Would a Spanish bailout turn the attention of the “invisible” bond market vigilantes onto Belgium and Italy? It can’t be ruled out, especially when we remember that Belgium’s state debt is more than 100 per cent of GDP, and Italy’s is around 120 per cent.

This would bust out the EFSF and leave the EU staring death in the face. Germany and France could risk cranking up support for bailouts even higher, but they are already deeply unpopular at home. And with the nationalist True Finns party doing so well in the recent Finnish election on a “we shouldn’t pay for Greece and Portugal” ticket, it is doubtful governments could maintain the fragile constellations of class forces needed to drive another mega bailout through.

Historic crisis of the system

Avoiding this scenario assumes several things. The Spanish government will have to impose another round of austerity and make it stick. The European banks will have to hold firm. The economic recovery will have to switch up a gear and after extremely painful cuts allow Greece and Portugal to start growing their way out of debt.

And above all, Germany – the economic motor of the EU – will have to continue its strong recovery, which is based on massive expansion of its exports to China, whose soaraway growth cannot last forever and whose economy is at danger of overheating, raising the prospects of a crisis of its own over the years to come.

The outcome depends on the class struggle. Re-establishing a stable equilibrium of capitalist expansion can only be done over the ruins of the jobs, services and benefits of the working class of Europe. We can resist and can break the cuts and bring down the austerity governments if we follow the path of the French and Greek workers and exceed their efforts by launching indefinite general strikes not limited in time in advance, that stay out until the regimes fall like in Egypt.

Every victory in the battle against the cuts will without doubt meet a frenzied response from the international financiers who will threaten to bankrupt whole nations if they do not make the workers pay for the crisis. That is why the logic of the mass anti-cuts movement leads directly towards generalised working class action and a struggle for political power. It’s why militant opposition to cuts takes on anticapitalist logic – one that we need to raise into mass consciousness by linking our struggles to the fight for an alternative system.

The Tories claim the deficit was caused by the working class – too much spending on our health, our welfare, our education. Left-wing reformists and the more militant union leaders increasingly claim, less eloquently than Johann Hari but with the same basic arguments, that the deficit is just an excuse and has no real bearing on the cuts.

Both these ideas are false. The deficit was caused by the great financial crisis and the downturn that followed it. As rates of profit fell in 2007-08, the banks stopped lending and destroyed huge swathes of capital. They had to be bailed out to the tune of trillions from state money. Then the downturn bit as companies scaled back, sacking millions around the world. State revenues from tax plummeted just as the cost of unemployment and other benefits skyrocketed. The capitalist crisis caused the deficit and it is real and the bosses want you and me to pay for it.


So let’s take the argument back into the heart of the resistance everywhere – the crisis of state debt arose because the bosses used the state to socialise the losses of the employers and the bankers. The debt is unsustainable and shows that the capitalist system doesn’t work.

Even if the bosses struggle through the next two years without a country going bankrupt and defaulting, the next financial crisis will leave governments unable to raise the funds for another round of bailouts. An even deeper breakdown of the system could result; creating enormous competitive pressures on the major global powers and threatening the integrity of the world currency and trading systems.

Denying the existence of the deficit and the power of bond markets will dull the ability of the resistance to target the system itself. We need to point out the reality and the insanity of this system so we can prepare an international movement to overthrow it.

Read Johann Hari’s blog post ‘The Biggest Lie in British Politics’ here

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