the prices of the things the users of that currency purchase. Energy bills, interest payments and labor costs are key components of those prices. If a currency shows signs of losing its purchasing power, the central bank responsible for managing it will reduce the amount in circulation by restricting the lending the commercial banks are able to do. This means that, if energy prices are going up because energy is getting scarcer, the amount of money in circulation needs to become scarcer too if it is to maintain its energy-purchasing power.
A scarcer money supply is a serious matter because the money we use was created by someone somewhere going into debt, and if there is less money about, interest payments make those debts harder to repay. Money and debt are co-created in the following way. If a bank approves a loan to buy a car, the moment the purchaser’s check is deposited in the car dealer’s account, more money — the price of the car — comes into existence, an amount balanced by the extra debt in the purchaser’s bank account. Consequently, in the current monetary system, the amount of money and the amount of debt are almost equal and opposite. I say “almost” as borrowers have more debt imposed on them every year because of the interest they have to pay. If any of that interest is not spent back into the economy by the banks but is retained by them to boost their capital reserves, there will be more debt than money.
Until recently, if the banks approved more loans and the amount of money in circulation increased, more energy could be produced from fossil-fuel sources to give value to that money. Between 1949 and 1969 — the heyday of the gold exchange standard under which the dollar was linked to gold and other currencies had exchange rates with the dollar — the price of oil was remarkably stable in dollar terms. But when the energy supply was suddenly restricted by OPEC in 1973, two years after the US broke the gold-dollar link, and again in 1979, the price of energy went up. There was just too much money in circulation for it to retain its value in relation to the reduced supply of oil.
The current “credit crunch” came about because of a huge increase in the price of energy. World oil output was almost flat between September 2004 and July 2008 for the simple reason that the output from major oil fields was declining as fast as the production from new, smaller fields was growing. Consequently, as more money was lent into circulation, oil’s price went up and up, taking the prices of gas, coal, food and other commodities with it. The rich world’s central bankers were blasé about these price increases because the overall cost of living was stable. In part, this was because lots of cheap manufactured imports were pouring into rich-country economies from China and elsewhere, but the main reason was that a lot of the money being created by the commercial banks’ lending was being spent on assets such as property and shares that did not feature in the consumer price indices they were watching. As a result, they allowed the bank lending to go on and the money supply — and debt — to increase and increase. The only inflation to result was in the price of assets and most people felt good about that as it seemed they were getting richer, on paper at least. The commercial banks liked it too because their lending was being backed by increasingly valuable collateral. What the central banks did not realize, however, was that their failure to rein in their lending meant that they had broken the crucial link between the supply of energy and that of money.
This break damaged the economic system severely. The rapid increase in energy and commodity prices that resulted from the unrestricted money supply meant that more and more money had to leave the consumer-countries to pay for them. The problem with this was that a lot of the money being spent was not returned to the countries that spent it in the form in which it left. It went out as income and came back as capital. I’ll explain. If I buy petrol for my car and part of the price goes to Saudi Arabia, I can only buy petrol again year after year if that money is returned year after year to the economy from which my income comes. This can happen in two ways, one of which is sustainable, the other not. The sustainable way is that the Saudis spend it back by buying goods and services from Ireland, or from countries from which Ireland does not import more than it exports. If they do, the money returns to Ireland as income. The unsustainable way is that the Saudis lend it back, returning it as capital. This enables Ireland to continue buying oil but only by getting deeper and deeper into debt.
As commodity prices rose, the flow of money to the energy and mineral producers increased so rapidly that there was no way that the countries concerned could spend it all back. Nor did they wish to do so. They knew that their exports were being taken from declining resources and that they should invest as much of their income as possible in order to provide an income for future generations when the resources were gone. So they set up sovereign wealth funds to invest their money, very often in their customers’ countries. Or they simply put their funds on deposit in rich-country banks.
The net result was that a lot of the massive increase in the flow of income from the customers’ economies became capital and was lent or invested in the commodity consumers’ economies rather than being spent back in them. This was exactly what had happened after the oil price increases in 1973 and 1979. The loans meant that, before the money became available again for people to spend on petrol or other commodities, at least one person had to borrow it and spend it in a way that converted it back to income.
This applied even if a sovereign wealth fund invested its money in buying assets in a consumer economy. Suppose, for example, the fund bought a company’s outstanding shares rather than a new issue. The sellers of the shares would certainly not spend the entire amount they received as income. They would place most of their money on deposit in a bank, at least for a little while before they bought other assets, and people other than the vendors would have to borrow that money if it was going to be spent as income. As a result, it often took quite a lot of borrowing transactions before the total sum arrived back in people’s pockets.
For example, loans to buy existing houses are not particularly good at creating incomes whereas loans to build new houses are. This is because most of the loan for an existing house will go to the person selling it, although a little will go as income to the estate agent and to the lawyers. The vendor may put the money on deposit in a bank and it will have to be lent out again for more of it to become income. Or it may be invested in another existing property, so someone else gets the capital sum and gives it to a bank to lend. A loan for a new house, by contrast, finances all the wages paid during its construction so a lot of it turns into income. The building boom in Ireland was therefore a very effective way of getting the money the country was over-spending overseas and then borrowing back converted into incomes in people’s pockets. Direct foreign borrowing by governments to spend on public sector salaries is an even more effective way of converting a capital inflow into income.
We can conclude from this that a country that runs a deficit on its trade in goods and services for several years, as Ireland did, will find that its firms and people get heavily in debt because a dense web of debt has to be created within that country to get the purchasing power, lost as a result of the deficit, back into everyone’s hands. This is exactly why the UK and United States are experiencing debt crises too. The US has only had a trade surplus for one year — and that was a tiny one — since 1982 and the UK has not had one at all since 1983.
Table 1. The Worst External Debtors per $1,000 of GDP in 2006
| 1 | Ireland | $6,251.97 |
| 2 | United Kingdom | $3,530.89 |
| 3 | Netherlands | $2,887.82 |
| 4 | Switzerland | $2,836.01 |
| 5 | Belgium | $2,686.21 |
| 6 | Austria | $1,843.11 |
| 7 | Sweden | $1,554.06 |
| 8 | France | $1,551.52 |
| 9 | Denmark | $1,471.46 |
| 10 | Portugal | $1,413.50 |
DEFINITION: Total public and private debt owed to non-residents repayable in foreign currency, goods, or services. Per $ GDP figures expressed per 1,000 $ gross domestic product. Source: CIA World Factbooks 18 December 2003 to 18 December 2008
Table 2. Ireland’s Gross External Debt Triples Over Five Years
CSO data for the final quarter of each year (
| 2002 | 521,792 |
| 2003 | 636,925 |
| 2004 | 814,446 |
| 2005 | 1,132,650 |
| 2006 | 1,338,747 |
| 2007 | 1,540,240 |
| 2008 | 1,692,634 |
| 2009 | 1,611,396 |