LONDON (Reuters) - Here’s a cheerful thought to take to the beach: the only way to avoid a global depression that could doom society as we know it is for the U.S. government to borrow to the hilt and invest in cutting-edge technologies.
That’s the provocative crux of a book, “The New Depression”, by economist Richard Duncan, who captured attention with a 2002 volume arguing that the disintegration of the Bretton Woods gold-linked system of semi-fixed exchange rates had inflated a credit bubble that would end in tears.
Duncan was wrong in that earlier book to forecast a collapse in the dollar. But he has not abandoned his belief that today’s economy can be understood only through the prism of untrammeled credit creation.
He says the world long ago swapped capitalism for “creditism”. In 1964 credit in the United States totaled $1 trillion. By 2007 the figure had reached $50 trillion.
Immense wealth was created along the way until the private sector exhausted its ability to take on any more debt.
The danger now is that if credit shrinks significantly, the world could be in for a re-run of the 1930s, a decade that began with the Great Depression and ended in political catastrophe.
As laid out in 1933 by American economist Irving Fisher, debt liquidation would drive down prices, increasing the real burden of servicing the remaining loans and so ushering in a vicious cycle of more forced selling, Duncan said.
“After a four-decade-long, $50 trillion expansion of credit, if credit now begins to contract, the debt-deflation death spiral of the kind described by Irving Fisher would destroy our civilization. Austerity is death,” Duncan said in an interview in London.
Global output could halve and oil could fall to $3 a barrel in such a disaster scenario. China’s Communist Party would collapse and hunger would trigger territorial expansion into Southeast Asia. The re-emergence of political extremism could once again test Europe’s democracy to destruction.
Bangkok-based Duncan’s apocalyptic vision might be extreme, but he is not alone in warning that financial markets and politicians are still underestimating the potential consequences of the explosion in debt in recent decades.
“This crisis has not even started. It will take an extremely long time to reach its peak velocity, and by a long time I mean at least 15-20 years,” Jamil Baz, chief investment strategist at GLG Partners, said in May.
Leigh Skene of Lombard Street Research, a London consultancy, said he fears deflation is looming that will lead to half of all debt being written off; global assets will be reduced by one third and most governments will have to shrink by half to maximize unemployment, Skene said in a report.
Hugh Hendry, the founder of hedge fund Eclectica Asset Management, added: “We have reached a profound point in economic history where the truth is unpalatable to the political class - and that truth is that the scale and magnitude of the problem is larger than their ability to respond.”
Hendry was speaking at the Milken Institute global conference in May. The Financial Times ran a story about his views on Wednesday.
Where Duncan differs from the consensus is in his conviction that piling debt on debt is necessary for the time being to keep the show on the road.
But as the private sector is already drowning in red ink, and indeed has begun to deleverage, it is the government that has to keep playing the role of borrower of last resort.
“Private sector debt has already started to contract a little bit, and if it were not for these trillion-dollar budget deficits by the U.S. and most other governments, topped up by a whole lot of paper money creation, we would have already spiraled into a new Great Depression,” Duncan said.
Duncan shares the view of the Austrian school of economics that credit creates an artificial boom and that much of the debt now outstanding has gone into “malinvestments” and cannot be repaid. Think of new houses sitting empty in Spain or Florida.
But passively accepting that a credit crunch is needed to restore equilibrium between savings and investment, so that resources can once again be allocated more efficiently, would do untold damage to the global economy.
“Many people who agree with the Austrians believe we should just now take our medicine and allow the system to adjust. But I don’t think they realize how harsh the medicine would be,” Duncan argues.
What about other options?
Slashing government spending, as advocated by U.S. libertarians such as Ron Paul or by the Tea Party, would immediately lead to a new depression, Duncan said.
Continuing along the current path of deficit spending to prop up consumption is a better policy but is not the answer either. It might buy another five to 10 years but ultimately governments would end up as insolvent as Greece is now, he said.
Instead, he advocates vast government spending in frontier fields such as solar power, genetic engineering and nanotechnology that he says would pay for itself many times over, eventually allowing Washington to balance its books and reduce the national debt.
“They can continue borrowing, but just invest the money in transformative 21st century technologies that actually create massive investment returns,” he said.
Duncan anticipates the objection that his proposal is a political non-starter.
“People tell me ‘you must be insane’,” he acknowledged. He retorts by citing the success of the Manhattan Project in World War Two when the U.S. government gathered the best scientists and gave them unlimited funds to develop the atomic bomb.
Carpeting the Nevada desert with solar panels to create unlimited cheap energy would be to display the same pioneering spirit, Duncan said.
“We can take advantage of this opportunity and borrow and invest at 1.5 percent interest or we can collapse into a depression. Those are our options. Be imaginative and brave or fail because of our past mistakes,” he said.
editing by Ron Askew