Debt Crisis Spells Doom
for "Free Market" Consensus

The credit squeeze is set to trigger the end of the boom that has shaped our times. Politics will have to change with it.

By Seumas Milne
The Gairdian (UK)

Seumas Milne is a columnist and associate editor with The Guardian (UK).

New Labour has led a charmed economic life for the past decade. Britain's ejection from the European exchange rate mechanism in the early 1990s and a unique set of international conditions helped deliver a record that earlier generations of British politicians could only have fantasized about.

Whatever other disasters and scandals they could be held responsible for, the economy was always Tony Blair and Gordon Brown's secret weapon: the "longest period of sustained economic growth since records began," low inflation, rapid job creation and a strong boost to public spending, all at the same time.

The fact that it has also been a story of rising inequality, stubborn unemployment and ballooning levels of debt — and has depended on the international financial system's toleration of a huge trade deficit to sustain it — has until now barely shifted the perception of economic success. That has been the crucial backdrop to the me-too politics of recent years and the free market consensus that underpins it. It is also, of course, the record that finally propelled Brown into 10 Downing Street.

But there can now be no doubt that such halcyon days are coming to an end. What kicked off in the US earlier this year, in the shape of the sub-prime mortgage lending crisis, has now spread like gangrene across a deregulated global financial system, imposing a vice-like squeeze on the very credit cushion that has hitherto kept the US and British economies afloat.

In Britain, it has already led to the collapse of Northern Rock and the first run on a British bank since the Victorian era. But the impact will certainly go much further, particularly in an economy so lop-sidedly dominated by the financial sector. Already, the house price collapse and prospect of mass repossessions is tipping the US economy towards full-blown recession. In Britain, which now has the highest level of personal debt of any industrial country — at £1.4 trillion, larger than national income — the expectation must be that the economy is heading in the same direction. As the full impact of the credit crunch makes itself felt, the house price bubble is bound to deflate further. That in turn will cut demand, bringing with it a painful economic slowdown at the very least.

Searching for a soft landing

The central banks have, of course, been busy cutting interest rates and pumping cash into the system to try to achieve the kind of soft landing that saw them through earlier international financial crises, in 1998 and 2001. The recent coordinated announcement of billions in new loans to banks shows both how ineffective those earlier interventions have been and how serious the situation has become.

But there are good reasons to believe that even this latest move is likely to prove too little, too late, to turn back the incoming tide. And for the first time since the 1970s, there is a growing risk of stagflation — the combination of recession and rising inflation — which makes sharp interest rate cuts particularly risky from the point of view of neoliberal orthodoxy.

International oil, commodity and food prices are all currently on the rise, just at the point when the credit squeeze and emerging first-world debt crisis show all the signs of bringing the boom of the past 15 years to a juddering halt.

That long boom was made possible by the collapse of the Soviet Union and the opening of China (and to a lesser extent India) in the 1990s. The effect was to bring hundreds of millions of educated and low-waged workers into the framework of the international capitalist market — who, as the former US Federal Reserve chairman Alan Greenspan put it, have "restrained the rise of unit labor costs in much of the world." Along with the wider weakening of organized labor, the deregulated expansion of international finance and a flood of cheap imports into the rest of the world, the result has been a corporate profits bonanza and power grab which has shaped the economic and political temper of our times.

The signs are, however, that some of these conditions are reaching their limits. Global growth is starting to press on natural resources, forcing up prices, most obviously in the case of oil. The evidence is growing that China's downward pressure on global prices may be coming to an end, as its economy overheats and inflation builds. Add to that the dizzying overreach of the credit-fueled casino that is the global financial system and the "corrections of imbalances" — as sharp falls in living standards and unemployment spikes are classified in the financial institutions and ministries — are likely to be very damaging indeed.

What is certain is that the end of the long boom will have a profound ideological impact. So long as market fundamentalists appeared to be delivering the goods — however unequally and insecurely — their political dominance was assured. That is now clearly no longer the case.

As Martin Wolf, conservative doyen of British economic commentators, wrote in yesterday's Financial Times: "What is happening in credit markets today is a huge blow to the credibility of the Anglo-Saxon model of transactions-orientated financial capitalism." If the credit squeeze does indeed trigger a wider economic meltdown, that will certainly mean the end of the neoliberal consensus that has dominated politics for almost a generation.

But politicians have yet to wake up to the sea-change that is already under way. It's a measure of how tight the ideological straitjacket on British politics remains that it has been left to the acting leader of the Liberal Democrats, Vince Cable, to press the commonsense case for the nationalization of Northern Rock, while Labour ministers take any amount of punishment over the scandal to avoid so much as a hint that they might believe a private solution to be anything other than preferable in all circumstances, even in such a classic case of market failure. If, as now seems increasingly likely, the government is in fact forced to nationalize the bank to secure its own loans, that will at least help break the ludicrous ideological spell against public ownership.

For Brown, the man who promised the end of boom and bust, the growing economic dangers pose an unavoidable challenge. For someone so closely associated with the neoliberal agenda, it may be too late to change direction. But unless he and his already damaged government are prepared to adopt a more interventionist and radical approach to deal with the crisis head-on, the political backwash is likely to sink them all.