Paul Krugman in his New York Times blog tells us he believes the austerity push in America and Europe is bound for failure. Krugman points out that the Republicans claim that defaulting on US debt is no big deal. They (the Republicans) claim that raising interest rates and slashing Government spending in the face of massive unemployment will somehow make things better, rather than worse. In regards to Europe, Krugman points out that there is a "particular belief in the confidence fairy, that is belief that slashing spending will actually create jobs, because fiscal austerity will improve private-sector confidence."
The debt game has been going on for quite some time. Bank debt growth of 10% to 20% has been going on for so long most people would think it is the norm. The last time we had debt growth that dipped below 5% was back in the 1991 recession. I remember Westpac dropping to $2.50 in July 1992 from $4.00 two months earlier. I think Kerry Packer took a private placement at $2.25 and a board seat to shore up the bank's finances. At least Kerry picked the bottom. From there debt growth picked up and, from 1995 the housing boom kicked in. That enabled us all to finance the things we needed from debt rather than old fashioned savings.
The current political structure of the world is that the Lenders must be protected at all costs. The American banks were paid out at 100 cents in the dollar on the basis that if they weren't, the financial meltdown would have even been worse. As Krugman says, "European leaders offered emergency loans to Nations in crisis, but only in exchange for promises to impose savage austerity programs, mainly consisting of huge spending cuts. Objections that these programs would be self-defeating not only would they impose large direct pain, but they also would, by worsening the economic slump, reduce revenues were waved away. Austerity would actually be expansionary, it was claimed, because it would improve confidence."
Lenders managed to lend Iceland $100 billion or 850% of their Gross Domestic Product, with all three of their major commercial banks failing. The stock market fell 90%, interest rates were 18%, and their currency was devalued. Thats the problem when a country borrows in a currency other than its own. It means other countries get a say in how your economy is run. The UK Government used anti-terrorism legislation to try and get compensation for 300,000 UK savers and suspended Icelandic assets.
The stage was set back in the 1970's when Richard Nixon took the US off the gold standard after the world worked out that the US was spending more than they had in Gold. Had that been the end of it the US would have taken a different path. The greatest coup for the US was in 1974 when they convinced OPEC to settle oil only in US dollars. If you wanted to buy oil for your expanding economy then you would have to buy dollars first. There was natural demand for the US currency. This led us to the 1980's with Ronald Reagan and Margaret Thatcher convincing their countries to close all those inefficient mining and manufacturing industries, take on the unions and shed jobs, and get Japan and China to do it all cheaper. Companies became a lot more profitable, but getting rid of all those jobs caused a problem - not enough demand. Here is the good bit. Japan and China were prepared to swap all their hard work and goods for pieces of paper. So to create demand you just needed to get the consumer to borrow it, all funded by Japan and China.
It was a virtuous circle, a few hiccups admitably, but debt growth soared, with our housing and investment assets going up in value. We hit a low point in 2005, but that was solved with a bit of sub-prime lending.
The Australian Government's budget is premised on debt growth. You won't get a 20% growth in GDP without borrowings increasing by a similar magnitude. The paradigm will eventually change, but probably not over the next few years.