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The current economic choices pit austerity against growth strategies. Are there alternatives? David Kauders FRSA thinks so. He argues the financial system that evolved from the early Italian bankers has hit a roadblock and fundamental change is needed.

Austerity means we pay down the debts of the past. Every austerity programme cuts spending, thereby cutting the immediate level of economic activity, shrinking economies and bringing economic decline. With less work, citizens find it harder to service and repay existing debts.

The idea is that growth is bought by borrowing from the future, creating more credit so as to stimulate economies, but this is not happening. Instead, stimulus leads to false financial speculation, and for a short while at least, markets recover their poise. The threat of inflation returns. Later, as bad debts rise, the markets tumble again and a new crisis emerges. Yet if the policy were to be successful, extra debt would lead to even more defaults. A rise in defaults would then threaten the solvency of lending institutions.

These contradictions show us that the current financial system has reached a limit. Bailout (or stimulus) takes a little longer to turn into economic decline, but extra debt always brings a cost, visible several years later. Governments are so frightened of the financial equivalent of detoxification - deflation - that they return every time to the rescue, never considering the longer-term consequence. And as the debt burden grows, so the crises come around more frequently, bringing greater destructive power with each successive cycle. Whichever way they turn, the authorities are damned. My recent book argues that the financial system has reached a natural limit. Lack of new borrowing, plus excessive weight of debt obligations from past borrowing, combine to slow economies down. This is a barrier whichever way policy makers turn. It is like the lid on a boiling kettle. Enough steam can lift it for a while but it always snaps back into place. The financial system limit is a roadblock preventing growth.

Japan’s stagnation in the 1990s ought to have taught the world a lesson. In Japan, every policy option recommended by experts failed after a couple of years. After the bubble burst in 1990, the authorities tried to fix the Japanese financial system using looser monetary policy. But this achieved little; interest rates tumbled yet a minor economic recovery soon petered out. Fiscal policy and political reform also failed and there is still too much debt in Japan.

Similar challenges now face the global economy and, again, the policy options currently available will not work as none tackle the real underlying problem of too much debt.

Originally, the financial system evolved. There was no regulation to tell the early bankers how to do their business. Today politicians posture about their requirements then set armies of bureaucrats to work on implementation. The result is a straitjacket that inhibits evolution.  Public services, taxation, borrowing and regulation are in a four-way contradiction: and it is impossible to satisfy all four.

Regulatory conformity means that our society is slowly losing the capability to adapt and learn. In his book The Collapse of Complex Societies, Joseph Tainter showed how the sudden end of the Mayan and other civilisations could be explained by the declining marginal return on investment in complexity. Sophisticated societies continually add to their complexity because early growth phases bring greatly increased benefits from more complexity. But complexity becomes a machine with a life of its own and once the marginal return falls below its cost, then the society is steadily undermined. Tainter's theory shows us why more regulation is self-destructive.

We now face a deep challenge. The debt-based system cannot exceed the system limit. The challenge is to allow this system to wither slowly, without precipitating a solvency crisis in our banks and thereby destroying Western society as we know it. Evolution is needed: original ideas that nobody has thought of, to bring forward alternatives to debit and credit.  After all, the invention of debit and credit was original at the time: there were no rules to prevent such new ideas emerging from the early Italian bankers.

The nations that will make progress and initiate new ideas will be those that encourage business, make individuals responsible for their own actions, encourage market mechanisms and generally avoid extensive regulation and restriction in the majority of areas, not just in finance. With only the exception of banks and banking, detailed prescriptive rules should be replaced by principles in those societies (like Britain, America and most of Europe) that have travelled too far along the prescriptive road. The winners will be nations with diversity of thought rather than the groupthink, which makes so many conform to the way things are.


David Kauders is an investment manager and author of The Greatest Crash: How contradictory policies are sinking the global economy, published by Sparkling Books.

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