US/UK responses to the credit crunch

This year I have read many times commentators and market experts tell me the USA is “already in recession”. They should take a look at the first quarter figures, which shows the US economy still grew at 0.6%, thanks to improvement in exports following the devaluation of the dollar, some increase in government spending and stockbuilding. So far it’s on course for the sharp slowdown without two negative quarters. The Fed once again confirmed its determination to prevent a recession by cutting interest rates to just 2%. This quarter should see some modest stimulus from the tax cuts, whilst the second half of the year will see more impact from the shift to cheap credit. At some point even the very distressed housing sector will stop falling, as it has crashed so far.

Meanwhile on this side of the Atlantic we get a pep talk from the Bank of England, telling the banks they should lend more! Is this the same Bank of England that was telling bankers last autumn they were lending too much to the wrong people? Do they still belong to the tripartite regulatory system, which is telling banks they need to have more capital and more cash just to sustain the business they have already written, let alone to offer any more loans? Does the right hand know what the left hand is doing in this three way split of a regulator?

No-one pretends it is easy to move from credit being too readily available to a situation where levels of credit are appropriate. It is wrong to claim it is all the banks fault – it was the authorities who encouraged the excess lending by setting low interest rates and drawing up regulatory rules which encouraged off balance sheet wizardry. The UK has decided to go for boom and bust banking, lurching from too much credit to the absurd spectacle of a government owned mortgage bank halving its very extensive mortgage book over a three year period, whilst the government and its agencies urges the banking sector to lend more! It will take time for the effects of the wind down of Northern Rock to work through the system, thanks to bad decision to nationalise it. We will pay a price for the authorities not making the £50 billion of swaps available last August to prevent the run on the Rock, and pay a further price for now owning a business which they want to halve in size, with all the lost jobs and downward pressure on the housing market that entails.

The US is handling this credit crunch better than the UK. The UK authorities should study the US response more, and should stop making the problem worse through regulatory confusion and inconsistency. The government should reinstate the Bank of England as principal banking regulator, going back to the pre 1997 system. That worked better during periods of error and crisis.

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12 Comments

  1. Robert
    Posted May 1, 2008 at 9:39 am | Permalink

    I see that now, it was not the banks making billions on the back of high risk it was Labour, rubbish money grabbing little men in suits chasing massive bonus payments who would lend money to an asylum seeker even if he was on the plane home. get real

  2. Tony Makara
    Posted May 1, 2008 at 10:54 am | Permalink

    The fact that we are no longer a nation that produces and exports, or even a nation that produces and supplies our domestic market ought to make us think twice about following the example of the Fed in cutting rates. Any benefits that might be gained by what little is left of our manufacturing industry will be offset by the inflation that will come into our country on the back of imported goods, particularly EU foodstuffs. At this time the MPC must set the focus on maintaining price stability, and that, unfortunately means the MPC shadowing the ECB, if they don't cut nor should the MPC. Otherwise the differential between Sterling and the Euro will widen making the already spiraling cost of EU food even more expensive.

    Gordon Brown and the MPC have to take the blame for allowing Sterling to remain overvalued for too long. This was deliberate strategy to prevent inflation showing up when credit-fuelled spending was lavished on imported goods. Now we are all forced to pay for Gordon Brown's artifically created consumer feelgood-factor. Now the emphasis must be put on maintaining price stability, particularly in relation to imported food. An increase in high street prices will create a demand for higher wages and meeting such demands would be very difficult at this time, particularly for the bloated state sector. It is far better for the economy to flatline or even contract and maintain price stability than to make a dash for growth and by so doing open the door to inflation.

  3. Jon
    Posted May 1, 2008 at 11:12 am | Permalink

    I do hope George Osborne is a regular reader of your column!

  4. Brian Tomkinson
    Posted May 1, 2008 at 12:21 pm | Permalink

    I fear your analysis of the strength of the US economy is premature and that the real effects of this mess have barely been seen yet in the UK. In this country these problems have been caused by the greed of bankers and others in the financial markets encouraged by politicians who in order to satisfy their own greed and lust for power have encouraged the process. This Brown government has spent taxpayers' money profligately, taken massive future liabilities off balance sheet (something which he now cynically criticises banks for doing) and set in train massive problems for years to come. In general, the country and its citizens have been living wildly beyond their means. The delusion that this could go on forever had to end and the necessary corrections will take time to work through. Regrettably, those thrifty people who didn't join in this binge will also lose out and the main culprits in the banks and government will still be financially rewarded for their abysmal failure.

  5. mikestallard
    Posted May 1, 2008 at 6:49 pm | Permalink

    There are a number of long term problems which have to be faced sooner or later:
    1. The EU dominates our finance system through the FSA. The EU is not England friendly at all and the Commissioners are lobbied all the time by the French government and technocrats and, no doubt, the German bankers. The CAP, which is cast in stone, rules out any form of agricultural reform or even cooperation. How much help, for instance, was France in the BSE crisis or foot and mouth? The USA does not have this.
    2. The government collects tax and then hands it back. This is shown most clearly in the 10p fiasco. It is not going to change. Taxation levels, therefore, will remain prohibitive – including petrol and diesel prices. The USA does not have this.
    3. After Hungary, we have the largest debt in Europe. (Telegraph today).

  6. Matthew Reynolds
    Posted May 1, 2008 at 7:53 pm | Permalink

    The Bank of England should get back its powers and be left to preside over a clear cut , streamlined regulatory system . Excess red tape could undermine the £50 billion plan announced recently while the tripartite system is too unwieldy . Stamp duty needs cutting on shares & property to help the Square Mile & housing market at a time of economic uncertainty . If those economic sectors show a marked improvement in the short to medium term then the UK can bounce back from the credit crunch on the back of sound tax reform . It is shocking that public borrowing will be £32 billion more over the next 4-5 years – this is even more than Gordon Brown predicted & that was bad enough . Spending what you have not got is never wise – the never never always becomes the now now . If you have not got the cloth – then trying to make the coat is stupid . Rising public debt is really bad – future generations will face higher taxes or diminished public services as a result of higher debt interest payments . We need a harsh period of austerity with public expenditure barely rising in real terms as money is moved from QUANGO’s to priority areas like Defence , pensions , higher child benefit , more police etc . That tough period on government expenditure ought to last as long as is needed to wipe out the PSBR . The right response to the credit crunch must mean a more effective regulatory framework for the banks and a tight fiscal policy meaning a far smaller state sector leading to year on year cuts in the budget deficit . On the monetary policy side the MPC should have greater independence & be told to slash RPI-x to 2% within four years . RPI-x is a far more credible inflation measure – HCIP excludes too many factors & was a fudge to get us in sync with the Euro Zone . Time we had a British monetary policy to wring out that old British economic nemisis : Inflation ! We cannot have a sound economy without low inflation , a balanced budget and a stable system of financial regulation . On that basis we need a Conservative government to implement a conservative economic policy – socialists do not understand economics ! Just look at Northern Rock et al…..

  7. Matthew Reynolds
    Posted May 1, 2008 at 7:53 pm | Permalink

    The Bank of England should get back its powers and be left to preside over a clear cut , streamlined regulatory system . Excess red tape could undermine the £50 billion plan announced recently while the tripartite system is too unwieldy . Stamp duty needs cutting on shares & property to help the Square Mile & housing market at a time of economic uncertainty . If those economic sectors show a marked improvement in the short to medium term then the UK can bounce back from the credit crunch on the back of sound tax reform . It is shocking that public borrowing will be £32 billion more over the next 4-5 years – this is even more than Gordon Brown predicted & that was bad enough . Spending what you have not got is never wise – the never never always becomes the now now . If you have not got the cloth – then trying to make the coat is stupid . Rising public debt is really bad – future generations will face higher taxes or diminished public services as a result of higher debt interest payments . We need a harsh period of austerity with public expenditure barely rising in real terms as money is moved from QUANGO’s to priority areas like Defence , pensions , higher child benefit , more police etc . That tough period on government expenditure ought to last as long as is needed to wipe out the PSBR . The right response to the credit crunch must mean a more effective regulatory framework for the banks and a tight fiscal policy meaning a far smaller state sector leading to year on year cuts in the budget deficit . On the monetary policy side the MPC should have greater independence & be told to slash RPI-x to 2% within four years . RPI-x is a far more credible inflation measure – HCIP excludes too many factors & was a fudge to get us in sync with the Euro Zone . Time we had a British monetary policy to wring out that old British economic nemisis : Inflation ! We cannot have a sound economy without low inflation , a balanced budget and a stable system of financial regulation . On that basis we need a Conservative government to implement a conservative economic policy – socialists do not understand economics ! Just look at Northern Rock et al…..

  8. Matthew Reynolds
    Posted May 1, 2008 at 7:59 pm | Permalink

    A pro-growth agenda of cuts in taxes & public spending is required so that we can try to match the Eire economic success story ! That would be shock treatment to an economy suffering a neo- Carter Malaise under Gordon Brown !

  9. Matthew Reynolds
    Posted May 1, 2008 at 8:59 pm | Permalink

    A pro-growth agenda of cuts in taxes & public spending is required so that we can try to match the Eire economic success story ! That would be shock treatment to an economy suffering a neo- Carter Malaise under Gordon Brown !

  10. Tim
    Posted May 1, 2008 at 11:54 pm | Permalink

    The real shame is that after 10 years when economic growth has been above our Eurpoean competitors. We have a higher budget deficit which means the scope for the Government to cope with these challanges. Currently our Government is running a budget deficit of 3.3% higher than Italy's.

    This means as the credit crunch hits the real economy we only have to look at todays results by world of leather with a 30% fall in sales to see that Consumer expenditure ( Which makes up to 70% of consumption) is slowing . That the Government has little room for manouvre.

  11. Michael Peevey
    Posted May 2, 2008 at 9:18 am | Permalink

    John, I love your website. So much well written, considered common sense. I would vote for you for PM. I hope you get a cabinet position when the Tories get back in.

  12. APL
    Posted May 2, 2008 at 10:54 am | Permalink

    JR: "This year I have read many times commentators and market experts tell me the USA is “already in recession”."

    "WASHINGTON (AP) — The number of newly laid off workers filing claims for unemployment benefits soared last week.
    The Labor Department reported Thursday that claims for unemployment benefits rose by 35,000 to 380,000. Private economists had expected claims would rise by a smaller 18,000.
    The report on jobless claims came a day ahead of a report on unemployment for April. Economists expect that report will show that the unemployment rate edged up to 5.2 percent in April, from 5.1 percent in March. The economy is expected to lose 70,000 jobs, the fourth straight month of job losses."

    Now exclude the government trickery with the employment statistics, not to mention the election campaign currently going on and these figures are probably understated.

    JR: "thanks to improvement in exports following the devaluation of the dollar, .."

    Surely the problem here is that when your primary export actually is the US$ the last thing your customers want is something that is declining in value.

    Imagine, about eight years ago, Gordon Brown had sold british gold and used 40% of the proceeds to buy US$, that holding of US$ would now be worth about 20% less. Over the intervening period the US government bonds would pay what 5%?

    Brown wouldn't have done that though would he?

  • About John Redwood


    John Redwood won a free place at Kent College, Canterbury, and graduated from Magdalen College Oxford. He is a Distinguished fellow of All Souls, Oxford. A businessman by background, he has set up an investment management business, was both executive and non executive chairman of a quoted industrial PLC, and chaired a manufacturing company with factories in Birmingham, Chicago, India and China. He is the MP for Wokingham, first elected in 1987.

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