The Treasury and Bank declare war on the UK economy

The Treasury and the Bank lurch from policies which promote boom, to bust, and from boom to bust again. In the period 2001-6 they followed a low interest rate strategy, supplemented by a regulatory approach which encouraged the most extraordinary boom in off balance sheet financings and a credit bubble. The government was especially keen on this, ballooning its own true balance sheet with PFI and PPP packages which it did not include in its stated borrowing figures.

In the summer of 2007 the Chancellor and the Governor concerted their rhetoric to blame the banks for this inflationary bubble, telling them that there would be no bail outs and they would have to correct it on their own. Readers of this site will remember I urged them (as others did from the banking sector itself) to make the markets more liquid in August and early September to avoid a banking crunch. The pleas fell on deaf ears, so we witnessed the run on Northern Rock. If the authorities had made less than £50 billion available in September to the markets the Rock crisis could have been avoided.

Once the Rock run began, many of us urged a quick deal to buttress the bank’s mortgage book. Instead, the Bank claimed it could not do this owing to EU rules – although on the continent under the same rules banks were rescued quickly. We had to watch the agony of the Rock leading to the eventual nationalisation of the bank.
I argued strongly against nationalisation. The government, the BBC and others allowed Vince Cable to front the ridiculous case for nationalisation and give it plenty of airtime so it would go through without it being an Old Labour idea. The Lib Dems showed themselves to be old time spend and tax socialists wanting to stick anything really expensive onto the taxpayers account: now the taxpayer has to pay the losses as the business is run down. As a result Northern Rock has effectively withdrawn from the mortgage market (for good competition reasons as a nationalised and subsidised bank) making the housing market worse. It will have to sack more than half its staff as it retrenches and fights to pay back the huge sums of money taxpayers were forced into lending it. The collapse of Northern Rock is a huge hammer blow to the housing market in the UK, as it was a large participant who can no longer play any serious part and is effectively in run off.

After the Rock had been nationalised at huge cost to taxpayers – with a maximum potential liability of over £100 billion – the Bank then made available up to a £100 billion to ease credit shortages in the markets! Why on earth didn’t they do that before the run on the Rock? Then they would have saved themselves the large sums they spent on the Rock as well. At last it seemed the authorities understood that they had to be in the downturn fighting business, and had to ease the credit squeeze.

More recently, following further increases in international oil and food prices, the Bank has decided its policy is too loose, and has warned that it might have to put interest rates up again! It effectively declared war on the property sector, and helped trigger large share price falls in the shares of the housebuilders. It threatened higher rates at a time when banks were seeking to recapitalise themselves by asking shareholders for more funds, helping to drive their share prices lower and jeopardise those fund raising activities.

The idiotic inconsistency of the authorities has reached new heights. The early 2000s saw low rates and boom boom. 2007 brought higher rates and bust. Early 2008 saw edging to lower rates and more liquidity. Middle 2008 has delivered the threat of higher rates and bust. This is made worse by their gross insensitivity to markets struggling to recapitalise the banks, and to the financial plight of the housebuilders, retailers and others. They should want a better equity market to raise the large sums of new capital it will take, following the wealth destruction brought about by their lurch from credit boom to credit bust.

It seems clear that we no longer have an “independent” Bank of England, if we ever did. The Chancellor and the Governor concerted their tough talk and their decision to say “No” to more liquidity in the crucial summer months of last year. They concerted their bungled response to the run on the Rock, and agreed the eventual nationalisation. They clearly agreed the extra liquidity earlier this year, and are now both trying to talk price increases down. I just don’t think the international oil and food markets are listening, and it makes the Governor and the Chancellor both look silly.

As a result the government’s housebuilding strategy is in tatters. When the government published its work telling us the problem in the UK was one of a shortage of new homes being built, I pointed out that you need to understand the impact of mortgage finance on the market. Take the excess credit creation away, as they have now done, and you have no shortage of homes for sale, as you cut off the possible buyers. The government went out with a demand that the UK industry move towards building 300,000 homes a year at the very top of the cycle when ti was obvious there would be a sharp fall, not an increase. How stupid can you get? They should revise their position, for this year will see a big downturn in the numbers of new houses being built.

The government should recognise there is a credit crunch, for after all they created it. In a credit crunch businesses can’t afford to build new homes, and people can’t afford to buy them. The government needs to be in downturn fighting mode.

I know my critics think I am too careless about the inflationary threat. I tell them that was something to worry about a couple of years ago when the authorities were encouraging a bubble with too much credit. You cannot stop global demand for oil and the action of global oil speculators by hiking UK interest rates. Tightening money here is not going to stop Chinese and Indian housewives buying more meat and grain. The UK economy is no longer inflationary. Each time oil and food prices go up we do not demand more wages – we take a further cut in our real pay, and rein back on other items in our budgets. That’s not evidence of an inflationary problem. It’s evidence that the government has declared war on individuals and families, and is going to make them pay for its economic mistakes by a very nasty squeeze on the living standards of us all.

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7 Comments

  1. Neil Craig
    Posted June 12, 2008 at 11:43 am | Permalink

    I think building 300,000 homes a year would be a good thing because a house price fall is in the best long term interests of the economy. Goods being cheaper is generally better than them being more expensive. The price of housing is overwhelmingly dictated by their scarcity which, in turn, is dictated by government restrictions. A house should be for living, investments should be something different. I grant that now is a particularly painful time (for owners only) to be allowing new building to undercut the stuff already standing.

    Britain's housing stock is 21.1 milliion homes so 300,000 is only 1.5% which, with an assumed lifetime of the average house of 100 years thus needing 1% to stay even, is not that great an increase in supply.

  2. Tony Makara
    Posted June 12, 2008 at 12:07 pm | Permalink

    I suspect that the MPC would like to cut rates, but they know they cannot cut rates without importing inflation. This again shows the dangers of becoming to dependent on imports. I have been monitoring the price of imported foodstuffs at my local store and a 2 litre carton of full fat EU milk has gone from 1.05 to 1.55 since the start of the year. Why on earth are we importing milk? It is true that imported goods can sometimes be cheaper, but they can also be more expensive too, depending on currency differentials. The more we can produce here at home the less we will be hostage to these swinging prices and the economic uncertainty they cause.

    Any moves now to increase liquidity are going to weaken Sterling and push the cost of imported goods up. For this reason Mervyn King is right to put price stability ahead of all other considerations. Once the ECB starts to cut rates we can do the same but perhaps it might be wise to hold on rates if the ECB were to cut and bring the cost of EU food imports down. Of course the MPC will have to play this as they find it, but one thing is for sure, a push for greater liquidity at the current time is going to de-stabilize Sterling and push the cost of imports up and up.

  3. Mark Wadsworth
    Posted June 12, 2008 at 12:20 pm | Permalink

    Yes, there was a credit bubble, and the BoE/FSA would have done well to read its own training manual of 1997 (read the last couple of pages of this!) on how to spot potential Northern Rocks.

    But the credit bubble is only one half of the equation. The other half is the asset price bubble (you can't really have one without the other – that was why the dotcom boom/bust caused relatively little damage – there was no credit bubble – duped investors were losing their own money; there was no 'debt hangover').

    And which asset price bubble are we talking about? The property price bubble! Yet another reason for shifting to more local taxation in the form of land or property value tax – it acts like a higher interest rate and keeps property prices low and stable. I tried to explain this on ConHome a couple of months ago, but I am afraid it didn't go down very well.

  4. Richard Calhoun
    Posted June 12, 2008 at 1:30 pm | Permalink

    Surely the only realistic response to the current financial crisis is to cut government spending radically.

    If this was done there would be no need to push up interest rates, there would be international confidence that we were tackling the problem seriously and sterling would benefit.

    It must surely be time for the Conservative party to spell this out to the electorate and bring forward their strategy for us all to understand.

    When you are overspending and no money in the bank you cut spending, the British public understand this.

  5. William B.
    Posted June 12, 2008 at 4:19 pm | Permalink

    It seems a lifetime ago that inflation was the dominant economic issue in a general election. We saw throughout the 1960s and 1970s the appalling effects of government control and militant union power on inflation. It took a long time to drive out those deleterious forces and to show that allowing businesses to operate more freely, with less interference from government and unions, results in more stable prices because the interests of the customer become paramount.

    Over the last 11 years the government, partly as a result of EU directives, has imposed greater and greater regulation on business causing a raft of fixed administrative and "compliance" costs. Combined with substantially higher taxes, these increased costs have been a hidden inflationary force. I say "hidden" because the credit bubble kept them out of view – so many people have been adopting a personal strategy of "spend, spend, spend" that the weight of these wasteful fixed costs has been spread over a wide customer base.

    As individuals have less spare cash (through a combination of ever increasing taxes and the absence of cheap credit), so the dead-weight costs of regulation and tax will become a greater and greater percentage of overheads with an inevitable inflationary result.

    I agree that, at the moment, inflationary pay demands are not surfacing but I have no doubt that they will appear soon. People can only tighten their belts so far, eventually there are no more notches left. We cannot be far from that position now, in my view, particularly for those on lower incomes.

    You can only cut back on discretionary spending and put the money into essentials for so long as you have discretionary spending. Once everything you earn goes on essentials, any increase in the price of essentials simply cannot be met without an increase in income. Further, having to cut-back on discretionary spending is itself likely to cause demands for increased earnings because those who work and are accustomed to a couple of pints and a trip to the cinema as a treat at the end of the week will only tolerate the loss of their treat for a limited period of time.

    Without a sustained and substantial assault on tax and regulation these wage-inflationary pressures will continue.

  6. Robert
    Posted June 12, 2008 at 5:43 pm | Permalink

    The cacophony of market and media noise is obscuring reality. The current fashion is the ‘blame game’. Politicians, central bankers, regulators, commercial banks, investors and voters are all throwing brickbats at each other. Pointless. In every downturn since the first fish walked out of the primordial soup, controls always fail. The regulators, whose rules are designed to prevent the previous downturn, are always unprepared for new twists. Central
    banks have little real power; their prime purpose is to 'ooze' stability, so will always be slow to react to sudden changes. Commercial bankers are paid to be greedy; it’s what their
    shareholders want so are doing their job. Politicians exert control at the margin only, usually making things worse. Supply and demand, also known as markets, will always rule and must
    always be cyclical. The problem with wasting time on name-calling is that conditions are about to get much worse. For the investment facts suggest accelerating stagflation. UK 10-year bond yields have risen 11% to 5.15% in three weeks and US bonds a bit more; sterling inter-bank has crept from its March quarter low of 5.35% to 5.97%. Panic buttons will be pressed when it rises over 6%,
    again. Markets are rightly forecasting inflation and weak growth.
    Debt markets closed last year to banks for new capital, now equity markets are about to follow.The myth of overseas immunity from the US housing downturn is as frail as pixie dust. UK,
    Irish, Spanish and Greek developers are dropping like flies (none ever held). Another myth is that homeowners, seeing an annual fall in the value of their homes greater than their salaries, will continue to buy BMWs. Retailers are in for a brutal collapse, from food to 'fripperies'. A third myth is that emerging markets are immune from a US downturn; it too is being exposed.China’s index has more than halved in seven months; it may well halve again.The UK Office of National Statistics announced input costs rose 27.9% in May, the highest headline rate since 1975, whilst factory gate (exit) prices rose 8.9%. Let’s keep it simple. It crudely implies manufacturing profits have been slashed by 19%, before falling sales. Consensus investment analysts, displaying a staggering ignorance of cycles, forecast corporate profits’ growth of 15%.
    The end of ever-rising oil prices is in sight: developing countries are funding their local energy subsidies that are unaffordable. A broad range of countries – China, India, Lithuania, Vietnam and
    Indonesia – have announced reductions. Grim news for their inflation stats of course. Since 1945 there have been only four years in which global oil consumption declined; 2009 will be
    the fifth! So there will be eventually some relief – so Tin hats on boys it is going to hell of a ride!

  7. mikestallard
    Posted June 12, 2008 at 9:42 pm | Permalink

    Some fragmentary remarks:
    1. The Regional Authorities have decided to build a lot of eco towns. There is one just south of here. My brother who lives in the green belt is furious. Meanwhile, nobody round here can sell their homes – and a lot are up for sale too. It is strange how out of touch the government of the Regions is.
    2. In 2003, I lived in a house which was owned by a milk farmer. He was going under. He was a good farmer too. But the price he was given for milk was derisory. He is now bust – and so is his loyal farmworker too, along with his family.
    3. This is the finest land in the country. It is growing, as far as the eye can see, bio fuels. Almost no animals, no orchards, no strawberries, nothing but biofuel.
    4. We have to go and collect my mother from Hertfordshire next week. We live in North Cambridgeshire. Total cost? £50 for petrol.

    Meanwhile, we watch as £1 billion here, £200 million there are just – well – wasted.

  • 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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