Crunch time

2 October 2022
Ben Hillier

Central banks around the world have made it clear that they are prepared to drive economies into recession by pushing up interest rates to protect the enormous wealth of international finance. The US Federal Reserve has led the charge with a 3 percentage point increase so far this year. And there’s more to come.

“No-one knows whether this process will lead to a recession or, if so, how significant that recession would be”, Fed Chair Jerome Powell said in late September. “We have got to get inflation behind us. I wish there were a painless way to do that. There isn’t.”

From the point of view of central banks, inflation—the devaluing of money—is worse than recession because it disproportionately hurts creditors. High inflation markedly reduces the real value of outstanding loans, which were made in “yesterday’s money” but will mostly be paid down in tomorrow’s money. That money will look the same and feel the same, but it will be worth less and less as every year passes with higher inflation.

To offset the declining value of the debts owed to them, banks raise the rate of interest to get more money directly out of the debtors and to reduce economic demand, which should reduce the speed at which money is being devalued. This is the “pain” the bankers tell us we must endure: governments and mortgage holders paying more to service existing debt, and millions of people being thrown out of work as entire economies are sacrificed to protect the value of the financial system’s assets.

It is important to understand that this has nothing to do with protecting working-class living standards from the scourge of rising prices. Anyone concerned about that would simply make sure that wages were lifted in line with consumer prices. Instead, economists are forecasting that Powell will put up to 2 million Americans out of work next year in his crusade. “There are too many Americans getting too big a pay rise”, Matthew Cranston writes in the Financial Review, in an article titled “The jobs that must go to curb inflation”.

By rapidly driving up rates—and with them the exchange value of the US dollar—the Federal Reserve is exporting additional inflationary and recessionary pressures to the rest of the world as well. Inflationary because the dollar’s strength is leading to local-currency price increases for a range of US-dollar-traded imports such as agricultural and energy commodities. Recessionary because other central banks are following the Federal Reserve in part to limit their own currencies’ declining values against the dollar, damping domestic economic activity in the process.

The Bank of England says that the UK is already in recession, but it is still pushing interest rates higher to defend the pound’s value and to shield creditors from a 10 percent inflation rate. Europe, facing an energy crisis as well, is following Britain into recession. Economic downgrades have flowed from country to country. There is still talk of “soft landings”—slowdowns or shallow recessions, as opposed to sharp contractions. As far as headline economic growth is concerned, that might be the case in a range of countries, both advanced and underdeveloped.

Either way, the world has shifted away from the period of cheap credit and “quantitative easing” (central bank bond-buying to encourage a greater supply of money than near-zero interest rates could manage) to a sort of race to the top in monetary policy. The previous period was supposed to reduce the amount of debt in the system through a combination of higher economic growth and reduced government spending. But it resulted in liabilities recently reaching more than US$300 trillion, about 350 percent of global economic output, according to the Institute of International Finance. That’s up from around 280 percent prior to the 2008 global financial crisis.

Now, it’s crunch time. As inflation in the core economies erodes the real value of these gargantuan liabilities, creditors everywhere—central banks, commercial banks and other large financial corporations—are rushing for compensation.

Earlier this year, the International Monetary Fund estimated that about 60 percent of low-income countries were already at risk of, or already in, financial distress (having difficulty making debt repayments). The value of loans from the so-called lender of last resort has now reached a record high, according to the Financial Times.

Where loans are denominated in US dollars, the increased burden from the declining value of local currencies and from higher interest has far outweighed the small gains debtor countries have made from inflation eroding the real value of their debts. Where the loans aren’t in US dollars, there’s still capital flight to US bonds—so while total debt dropped by around half a trillion US dollars this year in so-called emerging markets (a euphemism for poor, impoverished and underdeveloped economies), debt as a proportion of GDP is rising as growth stalls.

In the advanced economies, governments and business are pushing down the real value of wages, pensions and other social security payments, while justifying budget cuts with reference to onerous government debt repayments. Meanwhile, the banks are crushing mortgage holders and central banks are trying to push up unemployment.

The Institute for Fiscal Studies, a think tank, forecasts that the UK government will spend more than £100 billion in 2023-24 in interest payments on its debt. That’s double the amount that was projected just six months ago, when interest rates were lower, and more than the country spends on its entire education budget. Yet, while the National Health Service is mired in crisis, the government is increasing its debt to fund tax cuts for the wealthy, the news of which almost broke the country’s pension system and forced the Bank of England back into quantitative easing.

Sections of the corporate world are also finding it difficult to service debts after a decade of easy money allowed them to compensate for low returns on investment. The number of “zombies” is on the rise in every jurisdiction, which the Institute of International Finance warns may lead to “a significant increase in bankruptcies” as rates increase. A zombie is an established company (at least ten years old) that, for three years in a row, has not generated enough income to pay the interest on its debts.

While the rise of zombies has been most notable in the US, Australia has an even higher proportion—13 percent of ASX listed companies compared to 10 percent—according to Australian Financial Review contributing editor Christopher Joye. When Joye adjusted his estimate to include all companies, rather than simply those that have been around for ten years or more, he found that more than one-third are currently in the zombie category, compared to 19 percent of their US counterparts.

Like everywhere else, the messaging from the Reserve Bank of Australia is about pain and the perils of inflation for working people. But, like other central banks, it wants to do everything it can to hold down wage growth and to protect the interests of creditors and those with large savings.

According to a relatively recent estimate by economists, published by the Bankwest Curtin Economics Centre, the richest one-fifth of Australians have 75 percent of household savings, while the bottom 60 percent hold less than 10 percent. For workers, wages are far more important than accumulated savings, which are, in the scheme of things, negligible. Even affluent workers generally have only enough savings to cover living expenses for several months or so before they would have to find paid work again after losing a job. Most people run out of money as soon as they are unemployed, if they aren’t out of money and juggling credit card debt already—almost 30 percent of people with credit cards say that they couldn’t manage their finances without one.

The main way for workers to defend themselves in the crunch, then, is to fight for higher wages and increased government spending on welfare and social services. We are told that the worst of all possible worlds would be the one in which there is a “wage-price spiral” that keeps inflation elevated for longer. The message is that “wage restraint” and reduced government spending are in the best interests of everyone.

But anyone with credit card debt or a mortgage would gain immensely if only wages would rise with consumer price inflation: wage inflation is great for working-class debtors, and Australian households have the fifth-highest debt-to-income ratio in the OECD. Somewhat ironically, that’s because the RBA has few qualms about stoking another type of inflation that has been rampant for much of this century: asset-price inflation, which includes residential property and greatly benefits investors.

The central bank would of course retaliate with higher interest rates to keep workers in the debt prison and to tank the economy. But central banks are doing that anyway for their own reasons. That is all the more reason to put big finance under public control: so that bankers can be forced to lift living standards, rather than push them down to protect their own balance sheets.

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