ceedee's posterous

The Government's austerity package remains "the right thing to do", the head of the International Monetary Fund said today in a boost for Chancellor George Osborne.

Christine Lagarde gave her firm backing to maintaining the deficit-cutting measures, despite the threat of recession and economic forecasts being revise downwards.

Figures released on Wednesday showed the economy shrank by 0.2% in the final quarter of last year - slightly more than anticipated and fuelling Labour calls for a change of course.

The IMF has dropped its forecasts for UK growth to just 0.6% for this year, down from 1.6%, and 2% in 2013, down from 2.4%.

Remarks by its chief economist Olivier Blanchard that the UK might have to consider slowing the speed of cuts if growth proved to be "dismal" were seized on by shadow chancellor Ed Balls as backing for Labour's demands for a change of direction, including a tax cut stimulus.

But asked if she thought that was something the IMF would be happy to see, Ms Lagarde told BBC Radio 4's The World at One: "Our sense is that under the present circumstances the policy that is in place is the right one, and we have said that very explicitly.

"Under the current circumstances, the policy in place that consists of letting the automatic stabilisers move without readjusting and tightening the principles is the right thing to do."

The IMF was "very consistent" about that backing, she said, backing Mr Blanchard's analysis.

"If you ask a top-class academic 'what if?' then of course he has to envisage. But as it stands, under the circumstances and with the automatic stabilisers playing out as they do, this is fine."

Pointing to the 2013 forecast, she added: "Under current circumstances and with the policies that have been designed as they have been, we see a progression of growth.

"That's what's intended and that's what's good."

Spanish unemployment broke through the 5-million barrier on Friday as the new government of Mariano Rajoy began to quietly beg the European Union to ease up on deficit targets that are sending the country hurtling back into recession.

Spain, which already boasted Europe's worst unemployment rate, recorded 350,000 people losing their jobs in the last quarter of 2011.

That rate now stands at 22.8% of the population and is set to worsen as Rajoy's conservative People's party government pursues a €40bn (£33bn) budget adjustment, most of it in spending cuts, to meet the EU's deficit target of 4.4% this year.

With a record 5.3 million unemployed, Spain faces a spiral of decline. The IMF has already predicted that the economy will shrink by 1.7% this year, with a further decline in 2013.

While Rajoy, who met German chancellor Angel Merkel in Berlin on Thursday, publicly maintains his target of reducing the deficit to 4.4% from more than 8% last year, his ministers are letting it be known that they want the EU to ease up on deficit targets which require severe adjustments.

Rajoy himself has pointed out that the EU's target for 2011 supposed not only that last year's deficit would be 6%, but also that growth this year would reach 2.3%.

"We need growth predictions from Brussels and that is when we will start negotiating with them on Spain's stability programme," the finance minister, Luis de Guindos said.

Almost 1.5m Spanish households now have no wage earner, with 3.5 million people joining the dole queue over the past four-and-a-half years. Southern Andalucia has a 31% unemployment rate, while 35% of immigrants and 39% of under-25s are jobless.

"Harsh adjustment policies not only fail to solve the problem, they can make it worse," warned Cándido Méndez of the General Workers' Union.

Further evidence that public austerity programmes were damaging the wider economy came from figures on company closures.

Around 35,000 companies folded in the second half of the year – a third of all those to have shut since Spain's economy ran into trouble at the end of 2008.

Much of the spending cuts have to come from regional governments, who provide basic services such as health, education and social services.

Spain's pharmaceutical companies said regional governments were now taking 525 days to pay bills for medicines provided to hospitals, with €6.3bn outstanding.

Meanwhile, the chairman of the Caixa savings bank, Isidre Fainé, predicted further gloom in the housing market, in which up to 700,000 new-build homes remain unsold after a housing bubble burst several years ago.

He predicted that house prices, which have dropped around 30% since their peak, could fall to 50% or 60% of their top value before recovering.

The threat posed to the British economy from the eurozone crisis was underlined on Wednesday when Portugal saw its borrowing costs soar to a record high amid market fears that the bailed-out country will not be able to break free of its financial crisis in the near future.

The yield, or interest rate, on three-year bonds reached 19.4%, while the rate on 10-year bonds was 14.6%, figures that compare with British rates of less than 2%.

Portugal needed a €78bn (£65bn) rescue package last year as its high debt load and feeble growth pushed it towards bankruptcy.

A three-year programme of austerity measures and economic reforms is aimed at restoring investor confidence in the country, but a deepening recession, with a 3.1% contraction forecast for this year, is undermining the faith of the markets in Portugal.

The worsening crisis in the eurozone has hit the British economy, and analysts fear that the contagion from Greece may spread throughout the eurozone and drag Britain and the rest of the world into a prolonged recession.

Antonio Barroso, an analyst with Eurasia group, said in a note that the recent downgrade and Greece's troubles "are increasing the perception that Portugal might not be able to avoid a default".

However, given Portugal's commitment to restoring fiscal health, he said: "It is likely that the government might have an easier time negotiating a new rescue package than Greece."

Portugal's government has repeatedly rejected speculation it that might try to renegotiate its bailout deal.

Thinktank says rich will prosper but 'squeezed middle' will not regain pre-recession earning power for eight years

Millions of ordinary families are unlikely to see their earnings return to pre-recession levels until at least 2020, a report from a leading thinktank has warned. But it predicts that the income of the wealthy will continue to rise over the same period.

The study, which focuses on the state of the "squeezed middle" and is produced by the independent Resolution Foundation, looks at the situation of 10 million adults, who crucially do not rely heavily on means-tested support from the state, and their 5.2 million children.

A report by the foundation last year led to Ed Miliband's championing of the squeezed middle, a part of Britain that the foundation says remains a key political battleground. It says that households without children earn between £12,000 and £29,000 a year to be part of the squeezed middle; homes with children, between £16,000 and £41,000.

On Monday Labour's welfare spokesman, Liam Byrne, will debate the report's implications with Liberal Democrat MP David Laws at the foundation's London offices.

The two have not met since the former Treasury secretary Byrne's infamous note in 2010 to his successor, Laws, which read: "There's no money left." Since then, the UK's economic woes have deepened and the foundation paints a "gloomy picture on incomes for the next decade".

Byrne told the Guardian that Britain risks replicating the US's "lost decade" where the middle class has fallen so far behind the rich that "Time magazine recently wrote its obituary". Byrne said the report underlined the fact that "the government's economic strategy is doing nothing for jobs, which is why wages are stagnating and welfare reforms are doing nothing for working people. The result is inequality between the middle and the top. Working people do not have a government working on their side."

Taking the Office for Budget Responsibility's latest forecasts, the researchers show that if growth remained sluggish for the next eight years the average annual disposable income of people in this crucial electoral battleground, representing a third of the population, would be £20,200 in 2020 – around £1,700 less than in 2007.

It would take growth rates not seen for almost a decade to let incomes in the squeezed middle return to pre-recession levels by 2020.

While such strong, persistent growth might ensure ordinary families recover lost ground, the real winners would be the top half of the country's earners, whose real disposable income would rise by almost 10% by 2020. Even under the slow growth scenario envisaged by the foundation, the top half of society would see incomes rise by 4%.

The report's author, Matthew Whittaker, said there was a "growing inequality of earnings" at the heart of the long-term squeeze. "Members of the squeezed middle did not share in the spoils of economic growth in the pre-recession years, with wages at the median and below stagnating. Gains instead flowed primarily to higher income households and, more particularly, to those at the very top of the distribution.

"If this trend continues once growth returns it may not be just those on low and middle incomes finding themselves left behind in the next decade, but rather the majority of society."

Part of the reason for the disparity in future spending power according to the report is that the incomes of the lower middle class rise more slowly than the rich, with their spending power eroded by fast-rising fuel and food costs. If low- to middle-income households faced the same price rises as higher earners since 2003 in the types of goods they typically buy they would be better off by £427 in 2011.

The report says the squeezed middle also has to cope with a prolonged wage squeeze – with real wages falling 4.2% over the last year – and warns that the most significant cuts to tax credits have yet to kick in. It says that the major recipients of tax credits are facing a further loss of income of nearly half a billion pounds from this April.

According to the report's calculation, this will see 2 million households worse off by £305 in 2012.

Whittaker pointed out that as the coalition's cuts have hit women harder than men, lower to middle-income families are likely to be "hurt twice". There are also dire figures for young people in rented accommodation and for young property owners who had already borrowed too much to get on the housing ladder, leaving themselves dangerously exposed if interest rates rise.

The proportion renting and aged under 35 has soared from 28% to 47% in the last six years alone.

In the same period the number of homes owned by under-35 members of the squeezed middle fell from almost a third from 770,000 to 562,000.

Those with mortgages may be benefiting from record low interest rates, but with one in five signing up to a 100% mortgage before the recession, a quarter of families still spend between 25% and 50% of their income on their mortgage.

Gordon Brown's administration realised too late to do anything about the widening gap. A treasury paper in 2009, obtained by the Guardian, identifies a "squeezed middle" facing stagnant or falling wages since 2004 – believed to be the first official reference to the phenomenon.

To solve this, Brown's Treasury argued in 2009 for removing "low level regulatory burdens" on the industries such as retail and hotels where "squeezed Britain" works. It also suggests finding ways to get 10 hours more per week per household by 2020 by finding ways of making work more family friendly. It controversially called for "the tax and benefit system to transfer £2bn more each year".

Whittaker said the foundation's analysis "shows rising pressure from pretty much all sides".

He added: "continued low interest rates and the start of a fall in inflation offer only limited respite. This will be far outweighed by further deep cuts to tax credits due this April which will come as a shock on top of the continued wage squeeze."

A spokesman for the Treasury said: "The government has taken decisive action to tackle the deficit, which has helped to keep interest rates low for businesses and families. We recognise that people are feeling squeezed and the government is doing what it can to help, reducing fuel duty so taxes on fuel are 6p lower than they would have been, freezing council tax and implementing an increase in the personal allowance in April, taking over 800,000 of the lowest paid out of tax."

The Simpson-Bowles Commission, just established by the president, will no doubt deliver an attack on Social Security and Medicare dressed up in the sanctimonious rhetoric of deficit reduction. (Back in his salad days, former Senator Alan Simpson was a regular schemer to cut Social Security.) The Obama spending freeze is another symbolic sacrifice to the deficit gods. Most observers believe neither will amount to much, and one can hope that they are right. But what would be the economic consequences if they did? The answer is that a big deficit-reduction program would destroy the economy, or what remains of it, two years into the Great Crisis.

For this reason, the deficit phobia of Wall Street, the press, some economists and practically all politicians is one of the deepest dangers that we face. It's not just the old and the sick who are threatened; we all are. To cut current deficits without first rebuilding the economic engine of the private credit system is a sure path to stagnation, to a double-dip recession--even to a second Great Depression. To focus obsessively on cutting future deficits is also a path that will obstruct, not assist, what we need to do to re-establish strong growth and high employment.

To put things crudely, there are two ways to get the increase in total spending that we call "economic growth." One way is for government to spend. The other is for banks to lend. Leaving aside short-term adjustments like increased net exports or financial innovation, that's basically all there is. Governments and banks are the two entities with the power to create something from nothing. If total spending power is to grow, one or the other of these two great financial motors--public deficits or private loans--has to be in action.

For ordinary people, public budget deficits, despite their bad reputation, are much better than private loans. Deficits put money in private pockets. Private households get more cash. They own that cash free and clear, and they can spend it as they like. If they wish, they can also convert it into interest-earning government bonds or they can repay their debts. This is called an increase in "net financial wealth." Ordinary people benefit, but there is nothing in it for banks.

And this, in the simplest terms, explains the deficit phobia of Wall Street, the corporate media and the right-wing economists. Bankers don't like budget deficits because they compete with bank loans as a source of growth. When a bank makes a loan, cash balances in private hands also go up. But now the cash is not owned free and clear. There is a contractual obligation to pay interest and to repay principal. If the enterprise defaults, there may be an asset left over--a house or factory or company--that will then become the property of the bank. It's easy to see why bankers love private credit but hate public deficits.

All of this should be painfully obvious, but it is deeply obscure. It is obscure because legions of Wall Streeters--led notably in our time by Peter Peterson and his front man, former comptroller general David Walker, and including the Robert Rubin wing of the Democratic Party and numerous "bipartisan" enterprises like the Concord Coalition and the Committee for a Responsible Federal Budget--have labored mightily to confuse the issues. These spirits never uttered a single word of warning about the financial crisis, which originated on Wall Street under the noses of their bag men. But they constantly warn, quite falsely, that the government is a "super subprime" "Ponzi scheme," which it is not.

We also hear, from the same people, about the impending "bankruptcy" of Social Security, Medicare--even the United States itself. Or of the burden that public debts will "impose on our grandchildren." Or about "unfunded liabilities" supposedly facing us all. All of this forms part of one of the great misinformation campaigns of all time.

The misinformation is rooted in what many consider to be plain common sense. It may seem like homely wisdom, especially, to say that "just like the family, the government can't live beyond its means." But it's not. In these matters the public and private sectors differ on a very basic point. Your family needs income in order to pay its debts. Your government does not.

Private borrowers can and do default. They go bankrupt (a protection civilized societies afford them instead of debtors' prisons). Or if they have a mortgage, in most states they can simply walk away from their house if they can no longer continue to make payments on it.

With government, the risk of nonpayment does not exist. Government spends money (and pays interest) simply by typing numbers into a computer. Unlike private debtors, government does not need to have cash on hand. As the inspired amateur economist Warren Mosler likes to say, the person who writes Social Security checks at the Treasury does not have the phone number of the tax collector at the IRS. If you choose to pay taxes in cash, the government will give you a receipt--and shred the bills. Since it is the source of money, government can't run out.

It's true that government can spend imprudently. Too much spending, net of taxes, may lead to inflation, often via currency depreciation--though with the world in recession, that's not an immediate risk. Wasteful spending--on unnecessary military adventures, say--burns real resources. But no government can ever be forced to default on debts in a currency it controls. Public defaults happen only when governments don't control the currency in which they owe debts--as Argentina owed dollars or as Greece now (it hasn't defaulted yet) owes euros. But for true sovereigns, bankruptcy is an irrelevant concept. When Obama says, even offhand, that the United States is "out of money," he's talking nonsense--dangerous nonsense. One wonders if he believes it.

Nor is public debt a burden on future generations. It does not have to be repaid, and in practice it will never be repaid. Personal debts are generally settled during the lifetime of the debtor or at death, because one person cannot easily encumber another. But public debt does not ever have to be repaid. Governments do not die--except in war or revolution, and when that happens, their debts are generally moot anyway.

So the public debt simply increases from one year to the next. In the entire history of the United States it has done so, with budget deficits and increased public debt on all but about six very short occasions--with each surplus followed by a recession. Far from being a burden, these debts are the foundation of economic growth. Bonds owed by the government yield net income to the private sector, unlike all purely private debts, which merely transfer income from one part of the private sector to another.

Nor is that interest a solvency threat. A recent projection from the Center on Budget and Policy Priorities, based on Congressional Budget Office assumptions, has public-debt interest payments rising to 15 percent of GDP by 2050, with total debt to GDP at 300 percent. But that can't happen. If the interest were paid to people who then spent it on goods and services and job creation, it would be just like other public spending. Interest payments so enormous would affect the economy much like the mobilization for World War II. Long before you even got close to those scary ratios, you'd get full employment and rising inflation--pushing up GDP and, in turn, stabilizing the debt-to-GDP ratio. Or the Federal Reserve would stabilize the interest payouts, simply by keeping short-term interest rates (which it controls) very low.

What about indebtedness to foreigners? True, foreigners do us a favor by buying our bonds. To acquire them, China must export goods to us, not offset by equivalent imports. That is a cost to China. It's a cost Beijing is prepared to pay, for its own reasons: export industries promote learning, technology transfer and product quality improvement, and they provide jobs to migrants from the countryside. But that's China's business.

For China, the bonds themselves are a sterile hoard. There is almost nothing that Beijing can do with them. China already imports all the commodities and machinery and aircraft it can use--if it wanted more, it would buy them now. So unless China changes its export policy, its stock of T bonds will just go on growing. And we will pay interest on it, not with real effort but by typing numbers into computers. There is no burden associated with this, not now and not later. (If the Chinese hoard the interest, they also don't help much with job creation here. So the fact that we're buying a lot of goods from China simply means we have to be more imaginative, and bolder, if we want to create all the jobs we need.) Finally, could China dump its dollars? In principle it could, substituting Greek bonds for American and overpriced euros for cheap dollars. On brief reflection, no Beijing bureaucrat is likely to think this a smart move.

What is true of government as a whole is also true of particular programs. Social Security and Medicare are government programs; they cannot go bankrupt, and they cannot fail to meet their obligations unless Congress decides--say on the recommendation of the Simpson-Bowles Commission--to cut the benefits they provide. The exercise of linking future benefits and projected payroll tax revenues is an accounting farce, done for political reasons. That farce was started by FDR as a way of protecting Social Security from cuts. But it has become a way of creating needless anxiety about these programs and of precluding sensible reforms, like expanding Medicare to those 55 and older, or even to the whole population.

Social Security and Medicare are transfer programs. What they do, mainly, is move resources around within our society at a given time. The principal transfer is not from the young to the old, since even without Social Security the old would still be around and someone would have to support them. Rather, Social Security pools resources, so that the work of the young collectively supports the senior population. The effective transfer is from parents who have children who would otherwise support them (a fairly rare thing), to seniors who don't. And it is from workers who do not have parents to support, to workers who would otherwise have to support their parents. In both cases this burden sharing is fair, progressive and sustainable. There is a healthcare cost problem, as everyone knows, but that's not a Medicare problem. It should not be solved by cutting back on healthcare for the old. Social Security and Medicare also replace private insurance with cheap and efficient public administration. This is another reason these programs are the hated targets, decade after decade, of the worst predators on Wall Street.

Public deficits and private lending are reciprocal. Increased private lending generates new tax revenue and smaller deficits; that's what happened in the 1990s. A credit collapse kills the tax base and generates more spending; that's what's happening now, and our big deficits are the accounting counterpart of the massive decline, last year, in private bank loans. The only choice is what kind of deficit to run--useful deficits that rebuild the country, as in the New Deal, or useless ones, with millions kept unnecessarily on unemployment insurance when they could instead be given jobs.

If we could revive private lending, should we do it? Well, yes, up to a point there is good reason to have a robust private lending sector. Government is by nature centralized and policy driven. It works by law and regulation. Decentralized and competitive private banks have much more flexibility. A good banking system, run by capable people with good business judgment who know their clients, is good for the economy. The fact that you have to pay interest on a loan is also an important motivator of investment over consumption.

But right now, we don't have functional big banks. We have a cartel run by an incompetent plutocracy, with its long fingers deep in the pockets of the state. For functional credit to return, we'll have to reduce the unpayable private debts now outstanding, to restore private incomes (meaning: create jobs) and collateral (meaning: home values), and we'll have to restructure the big banks. We need to break them up, shrink the financial sector overall, expose and prosecute frauds, and create incentives for profitable lending in energy conservation, infrastructure and other sectors. Or we could create a new parallel banking system, as was done in the New Deal with the Reconstruction Finance Corporation and its spinoffs, including the Home Owners' Loan Corporation and later Fannie Mae and Freddie Mac.

Either way, until we have effective financial reform, public budget deficits are the only way toward economic growth. You don't have to like budget deficits to realize that we must have them, on whatever scale necessary to restore growth and jobs. And we will need them not just now but for a long while, until we've shaped a strategic program for investment, energy and the environment, financed in part by a reformed, restored and disciplined financial sector.

It's possible, of course, that all the deficit hysteria is intended to divert attention from the dysfunctions of private banking, and so to help thwart calls for financial reform. Is that giving them too much credit? Maybe. Maybe not.