In July 2015 George Osborne made some heroic assumptions on debt and all of them were wrong

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David Graeber has an article in the New Statesman this week on the build up of personal debt in the economy. In it he notes:

For almost a decade now, since 2007, we have been living a lie. And that lie is preparing to wreak havoc on our economy. If we do not create some kind of impartial forum to discuss what is actually happening, the results might well prove disastrous.

The lie I am referring to is the idea that the financial crisis of 2008, and subsequent “Great Recession,” were caused by profligate government spending and subsequent public debt. The exact opposite is in fact the case. The crash happened because of dangerously high levels of private debt (a mortgage crisis specifically). And - this is the part we are not supposed to talk about—there is an inverse relation between public and private debt levels.

He illustrates this with this data:

These graphs show the relationship between public and private debt. They are both forecasts from the Office for Budget Responsibility, produced in 2015 and 2017.

This is what the OBR was projecting what would happen around now back in 2015:

This year the OBR completely changed its forecast. This is how it now projects things are likely to turn out:

First, notice how both diagrams are symmetrical. What happens on top (that part of the economy that is in surplus) precisely mirrors what happens in the bottom (that part of the economy that is in deficit). This is called an “accounting identity.”

And he asks:

The OBR observed, austerity and the reduction of government deficits meant private debt levels would have to go up. However, the OBR economists insisted this wouldn't be a problem because the burden would fall not on households but on corporations. Business-friendly Tory policies would, they insisted, inspire a boom in corporate expansion, which would mean frenzied corporate borrowing (that huge red bulge below the line in the first diagram, which was supposed to eventually replace government deficits entirely). Ordinary households would have little or nothing to worry about.

This was total fantasy. No such frenzied boom took place.

David Graeber rightly asks why the OBR got this so wrong.

So could I, but I can say I asked the question in July 2015, saying:

As I have long explained, if the government is to run a surplus within the economy somebody else has to borrow. That’s basic double entry book-keeping at play at a national level. It’s a fact that cannot be ignored or denied. What that also means is that if the government is to clear a big deficit somebody else has to borrow a lot more. This fact is reflected in the following chart from yesterday’s Office for Budget Responsibility forecasts:

Screen Shot 2015-07-09 at 07.15.49

The bottom, red line, is government borrowing. The grey area is the forecast. And the requirements for a government deficit are:

1) Households stick with much higher lending then they did from 2009 to 2013

2) The overseas sector borrows much more in the UK (which effectively requires a significant improvement in the balance of trade)

3) Business borrows heavily, which goes against a trend that has been persistent from at least 2001.

Unless those happen as a matter of fact George Osborne will not clear his deficit, which he is assuming he will do.

It’s important to note that he has missed all his previous forecasts on deficit reduction and I have to say I think he will do so again. To illustrate the point, the apparently innocuous flat line on personal borrowing requires substantial increases in household debt, as this OBR forecast shows:

Screen Shot 2015-07-09 at 07.26.06

First, that implies a massive change of behaviour for which there is no evidence right now. Second, the resulting ratios imply dangerous levels of borrowing in the household economy that exceed pre-crash levels. The implications are obvious.

The assumed change in business behaviour is equally dramatic:

Screen Shot 2015-07-09 at 07.29.59To get to required borrowing levels business investment will have to reach real levels substantially higher than anything seen in the Uk for the last 35 years.

Someone is living in cloud cuckoo land if they think that this is going to happen.

And it’s only in cloud cuckoo land that Osborne’s budget will balance as a result because these assumptions are not just heroic, they are utterly implausible.

I hate to say I was right, but without a shadow of a doubt that was the case.