by Adam Tooze
Chapter 15
A TIME OF DEBT
“Well, my message, Glenn, is that PI[I]GS are us. . . . [W]e very quickly could find ourselves in a similar situation to Greece.”1 These were the words of historian Niall Ferguson, then at Harvard, on Glenn Beck’s Fox News TV show on February 11, 2010. The “we” Ferguson invoked were the citizens and taxpayers of the United States. The PIIGS were the eurozone problem cases—Portugal, Ireland, Italy, Greece and Spain. Beck and his guests regaled their audience with scenes of disorder, strikes, riots in the streets, cars burning. As Greece demonstrated, once markets lost confidence there was no easy way out. As Ferguson put it in drastic terms: “You either have to default on a large part of the debt or you have to inflate it away. There really aren’t many other options open to our country that has debts this size. And none of these processes is really much fun.” If interest rates spiked it could happen in the United States within the year. As Ferguson explained: “[T]he lesson of what’s going on in Europe today and what happened to Russia 20 years ago is that collapse can sneak up on you and strike very sudden [sic] indeed.” Given this prospect, Ferguson hailed the populist backlash that was going on in America against big government. That was a healthy sign. But it needed something else: “[U]ntil there’s a political leader that has the courage to spell out to Americans, ‘We need to do this, we need to reform our system, root and branch,’ then I’m afraid we’re going to slide downhill in the direction not just of European economics but of Latin American economics.”
Ferguson was the Ivy League academic. Beck was one of the most excitable drummer boys of American conservatism. But fear of debt and its potentially disastrous implications was everywhere in 2010. It had been there before the crisis, in the Rubinite calls for consolidation and in the campaign for a debt brake in Germany. It was now massively amplified by the shock of 2008–2009. This dealt the most serious blow to government finances that any of the major developed countries had suffered since World War II. The fate of Greece in 2010 seemed to spell out what lay in store for any state that slid over the edge into insolvency. Warnings ranged from outrageous rants and scaremongering from the likes of Beck to ultrarespectable academic research, most notably by two former IMF economists, Carmen Reinhart and Kenneth Rogoff.
Following their surprise bestseller This Time Is Different: Eight Centuries of Financial Folly, in January 2010 Reinhart and Rogoff launched a research paper with the title “Growth in a Time of Debt.”2 This purported to show that as public debts passed the threshold of 90 percent of GDP, economic growth slowed down sharply. It was a slippery slope that ended in a cliff. Excessive debt weighed on growth, which made the debt even less sustainable, further slowing growth. To avoid this fate, it was crucial to take action sooner rather than later. On closer inspection, Reinhart and Rogoff’s analysis turned out to be riddled with errors. Once their Excel spreadsheet was properly edited, there was no sharp discontinuity at the 90 percent mark and the case for emergency action was far weaker than they made out.3 But in early 2010 their arguments ruled the roost. In the Financial Times they opined: “[T]he sooner politicians reconcile themselves to accepting adjustment, the lower the risks of truly paralysing debt problems. . . . Although most governments still enjoy strong access to financial markets at very low interest rates, market discipline can come without warning.” Once bond markets realized the full measure of the “fiscal tsunami” unleashed by the banking crisis, their judgment would be merciless. “Countries that have not laid the groundwork for adjustment will regret it.”4 No one was safe. As Rogoff told Germany’s right-wing Welt am Sonntag, a newspaper that hardly needed encouragement: “Germany’s public finances are not on a sustainable path. . . . There will come a time when Germany will have its own Greece problem. . . . [I]t won’t be as bad as in Greece, but it will be painful.”5
As commentators as knowledgeable as Ferguson, Reinhart and Rogoff must have been aware, the market discipline on display in the eurozone had not “come without warning.” The ECB and the German government were deliberately courting the bond vigilantes who swarmed over Greece. If they wanted to ease the pressure, all the ECB needed to do was what the Fed, the Bank of England or the Bank of Japan did as a matter of course—buy Greek bonds. But the ECB had no intention of doing that, not, at least, until the very last minute. The ECB meant to send a message: Austerity or else! They must have been delighted by the global reaction. The year 2010 would become a turning point in the recovery. Using Greece as its exemplum, an alliance of convenience among right-wing fearmongers, conservative political entrepreneurs and centrist fiscal hawks shifted the political balance. Though unemployment remained high, though output was limping back, stimulus was abandoned. Earlier and more sharply than in any other recession in recent history, the fiscal screw was turned. On both sides of the Atlantic the result was to stunt the recovery.
I
The most remarkable instance of austerity contagion was the UK. The hotly contested election that would bring an end to the long reign of New Labour concluded on May 6, 2010, the same day that banks burned in Athens and the flash crash sent US financial markets plunging. Fiscal politics were key to both the election and the coalition negotiations that followed. Britain had been among those hardest hit by 2007–2008. Though the Bank of England, unlike the ECB, never let there be any question of official support for UK Treasury debt, and though the UK maintained its credit rating, sterling plummeted against the dollar and the euro. As long as the Bank of England stabilized the bond market, it was not an immediate cause for concern. But it made Governor Mervyn King into a pivotal figure and, as he had demonstrated in the spring of 2009 ahead of the G20 meeting in London, he was not afraid to bring his influence to bear.6
On December 21, 2009, “shadow” Chancellor George Osborne opened the electoral campaign for the opposition Tory party by claiming that unless Britain put together a credible program of fiscal consolidation, it would soon go the way of Greece. “By testing the patience of international investors,” Osborne declared, “Labour are playing with economic fire.” Countries that wished to retain a AAA rating did “not have the luxury of waiting for the recovery to be secured before announcing credible fiscal consolidation plans.”7 Osborne bolstered his case with quotes from analysts at Paribas, Deutsche and Barclays. Bill Gross, the star fund manager at bond market giant PIMCO, chimed in to tell the Financial Times that he had now placed UK bonds in the category of “must avoid.” In his characteristically flamboyant style, Gross declared that UK public debt was “resting on a bed of nitroglycerine” and should be placed in a “ring of fire” that included not just the UK, Greece and Ireland, but Spain, France, Italy, Japan and the United States.8 On February 14, 2010, twenty senior economists, including Ken Rogoff, wrote to the Sunday Times repeating Osborne’s charge that the Labour government was not doing enough to bring the budget under control.9 They were answered by a letter to the Financial Times from a much longer and no less distinguished list who opposed the call for fiscal retrenchment as premature and pointed out the irony that “[i]n urging a faster pace of deficit reduction to reassure the financial markets, the signatories of the Sunday Times letter implicitly accept as binding the views of the same financial markets whose mistakes precipitated the crisis in the first place!”10
The result of the May 6 election was a defeat for Labour, but the conservatives failed to win a majority and were left needing the support of the Liberal Democrats. The coalition negotiations became a high-stakes struggle over the future of fiscal policy.11 “The deficit,” wrote David Laws, a Liberal negotiator, “was the spectre which loomed over our talks.”12 The conservatives made spending cuts the central issue of the negotiations. And the Tory debt hawks knew that they could count on both the Treasury and the Bank of England. On May 12, 2010, Mervyn King instructed the new government that “[t]he most important thing now is . . . to deal with the challenge of the fiscal deficit. . . . I think we’ve seen in the last two weeks, p
articularly, but in the case of Greece, over the last three months, that it doesn’t make sense to run the risk of an adverse market reaction.”13
In what was dubbed an “emergency budget” in June 2010, Chancellor Osborne slashed spending and raised VAT. The aim was to calm markets by committing to close the deficit by 2015.14 The argument in 2010 was “necessity.” But, as Neil Irwin later commented: “Britain . . . was embarking on something that has rarely been attempted . . . cutting spending and raising taxes in a preemptive strike against the risk of a future debt crisis.”15 As Paul Krugman remarked from New York: “It’s one thing to be intimidated by bond market vigilantes. It’s another to be intimidated by the fear that bond market vigilantes might show up one of these days.”16 As the squeeze continued, other motives revealed themselves. Shrinking the state, it turned out, was an aim in itself. The ultimate goal, as David Cameron would put it in his speech to the Lord Mayor’s Banquet three years later, was “something more profound”: to make the state “leaner . . . not just now, but permanently.”17
By 2015 Chancellor Osborne would claim to have slashed £98 billion in annual spending from the UK budget. From a maximum of 6.44 million public sector employees in September 2009, the UK public sector workforce would be reduced to 5.43 million in July 2016.18 One million jobs were cut, privatized or outsourced. It was a reduction larger than that imposed by the Thatcher or Major governments of the 1980s and 1990s. Translated to the US public sector payroll, it would be the equivalent of the elimination of 3.3 million positions. Because pension and health spending were ring-fenced, the pain was concentrated above all in local government. As the minister in charge roundly declared: “[L]ocal government is a massive part of public expenditure. It has lived for years on unsustainable growth, unsustainable public finance. . . . People blame the bankers, but I think big government is just as much to blame as the big banks.”19 Between 2010 and 2016 spending by local councils on everything from elderly day-care centers to bus services, public parks and library facilities fell by more than a third. Britain became a darker, dirtier, more dangerous and less civilized place. Hundreds of thousands of people who were barely coping on disability and unemployment benefits were tipped into true desperation.20 According to the OECD, only Greece, Ireland and Spain were put through worse contractions than those inflicted on the UK.21
Federal Deby Held by the Public
Sources: Congressional Budget Office, “Understanding the Long-Term Budget Outlook” (July 2015), and Congressional Budget Office, “Historical Data on Federal Debt Held by the Public” (July 2010), www.cbo.gov/publication/21728.
The reason why American liberals followed the politics of the UK so closely was not just their partisanship for the defeated Gordon Brown. They feared that events in Britain in 2010 might foreshadow a similar turn at home. Nor did the pressure come only from alarmist experts and the alternate reality of Fox News. It came from inside the Obama administration. As early as February 2009 the president had hosted a Fiscal Responsibility Summit at the White House. A year later, the administration was under pressure from Democratic Party centrists anxious about their fiscal credentials. The administration needed their support in raising the ceiling that limits debt issuance by the federal government.22 To the horror of Keynesian commentators, on January 27, 2010, in Obama’s second State of the Union address, it was deficit reduction, not jobs, that took priority.23 Obama promised that as of 2011, all nonmilitary discretionary spending would be frozen at its current levels. “[F]amilies across the country are tightening their belts and making tough decisions,” Obama declared. “The federal government should do the same.”24 It was the simplistic householder analogy that drove economists to despair.25 And it was fully in tune with the talk of “fiscal responsibility” that now dominated Washington. As one conservative commentator remarked, “[I]f the arguments in the coming years are between spending freezes and spending cuts, then we’ve already won.”26 On February 18, 2010, by executive order, the president appointed the National Commission on Fiscal Responsibility and Reform, also known as the Simpson-Bowles Commission. It was to make recommendations designed to achieve primary budget balance by 2015. Simpson-Bowles would not report until December, after the congressional midterms. In the meantime, damaging divisions opened within the Obama administration over the fiscal issue.27 Hawks like Orszag were pushing for tax hikes even for those earning below $250,000. This would violate a basic Obama campaign pledge, and it was bitterly resisted on political grounds by Emanuel as chief of staff, but also on economic grounds by Larry Summers. Meanwhile, the alternative to debt alarmism was spelled out most cogently by Ben Bernanke, who had recently been reappointed as Fed chair. Bernanke did not deny the scale of the deficits or the serious implications in the long run of a much larger debt burden. But he cautioned against drastic austerity efforts. America’s nascent economic recovery might not withstand a sharp fiscal shock. The crucial thing was to separate the short and medium term. Continued short-term stimulus should be accompanied by a realistic plan as to how to end deficits in the medium term.28 The combination would provide both an immediate prop to the economy and a comforting lift to investor confidence.
It was not enough for budget hawks like Orszag, who left the administration in the summer of 2010.29 The judgment of the electorate on Obama’s first two years would be even more devastating. With unemployment stuck just shy of 10 percent, four out of five Americans rated the economic situation as bad or fairly bad. The Tea Party was rallying conservative nationalist opinion against the Washington elite.30 Even among Democrats, a plurality attributed the bailouts of 2008 to their own side.31 They were wrong about the president, but given who had supported the measure in Congress, the association was not entirely far-fetched. On November 2 the angry electorate handed a historic victory to the Republicans. The GOP gained sixty-three seats in the House of Representatives, the largest swing since 1948. It was a shift that would redefine American politics.
Desperate not to allow the recovery to grind to a halt, the Obama administration worked feverishly to pass a second round of stimulus in the lame duck session of the old Congress. The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of December 2010 provided, by some estimates, a demand boost of as much as $858 billion.32 But it was a measure of their political predicament that the stimulus now consisted entirely of tax cuts, including the prolongation of the grossly inequitable giveaways for top income earners inherited from the Bush era. Two years into eight years in office, it would be the last major economic policy bill that the Obama administration would pass. In the New Year, with the new Republican Congress, they would be on the defensive. Because they included modest increases on the revenue side, the centrist recommendations of the Simpson-Bowles committee were dead on arrival, even though they were heavily slanted toward cuts in entitlements. Led by Eric Cantor, the forceful House majority leader, the so-called “Young Gun” Republicans would countenance no tax increases.33 Their target was immediate spending cuts of $100 billion, which, when concentrated in discretionary spending, would cause havoc across a range of federal programs, including food safety, disaster relief and air traffic control. By “starving the beast,” they would lift the curse of big government and revive the American dream.
II
Both the United States and the UK had suffered severe fiscal damage from the financial crisis. It was not, therefore, surprising that they faced calls for retrenchment. Were there other economies that might take up the slack? Apart from Japan and the emerging market economies, the obvious candidate to serve as a global counterweight was Germany. As Angela Merkel admitted in the summer of 2010, “[O]ther EU members, and the US administration, have urged Germany to spend more to maintain the current economic recovery, and reduce its export surplus.”34 But that was not how Germany saw its role. The crisis, so the prevalent German interpretation went, was a result of excessive debt. What the world needed to guide its recover
y was for Germany not to act as an expansionary counterweight but to lead the way in offering a model of austerity.
Given the prevailing mood, it was easy enough to make the case. Germany’s deficit was running at 50 billion euros per annum. Its debt had surged beyond 80 percent of GDP. The Reinhart and Rogoff meme had reached Europe. Finance Minister Schäuble invoked the menacing 90 percent threshold to argue for the need for immediate countermeasures.35 Announcing the largest budget cuts in the history of the Federal Republic, on Monday, June 7, Chancellor Merkel declared that restoring Germany’s budget balance would constitute a “unique show of strength. . . . Germany as the largest economy has a duty to set a good example.”36,37 In 2011, 11.2 billion euros ($13.4 billion) were to be cut, and a total of 80 billion euros by 2014. In Germany too this required choices to be made about the future shape of the state. Tellingly, the heaviest cuts proposed by the Merkel government fell on the defense ministry, which was asked to cut by 25 percent by 2014. The strength of the Bundeswehr was to be sliced and conscription to be phased out. For Berlin it was more important to achieve the 3 percent deficit rule specified by the eurozone’s Stability and Growth Pact than it was to honor its commitment to NATO to spend at least 2 percent of GDP on defense.38