Month: November 2008

The MPC should be changed, before it does any more damage.

In my New Year message at the end of 2007 I called again for lower interest rates. It was obvious that rates were too high, and they would bring many job losses and factory closures. Inflation would rise during 2008 owing to previous MPC mistakes, but would fall again in 2009.

As the MPC are intelligent economists, we must assume they could see that too. So why, now the magnitude of job losses and factory closures is becoming clearer, do they suddenly panic, and do what they should have done a year ago? Have they been pressurised by the government acting through the Bank of England?

I would normally welcome a major U turn by a group of powerful people who have got it wrong. However, on this occasion, they have missed another important change in the last few months. The government’s borrowing requirement has shot up from the £43 billion forecast in the Spring, to more than £120 billion.

The MPC should have written a letter to the Chancellor, saying that for inflation reasons they wanted to cut rates substantially, but they needed guidance on the likely size of the government deficit,given the impact this will have on the ability of the government to borrow enough money. They could have added, the more the government controls its deficit, the more they could cut interest rates.

We now have monetary policy at variance with fiscal policy. The Chancellor should take urgent action, to avoid the imbalance doing damage to his plans.

Just to show you how abnormal the economic world now is, a few hours after the large interest rate cut sterling is stronger and Uk share prices are down!

It’s time for all men and women of good will to defend the market.

It’s currently fashionable to say that the state has to do more, and the market less. It’s is conventional wisdom that “markets have failed” so we need to try more regulation, nationalisation and state direction. The left are on the march, telling us that markets are cruel and immoral, forcing people into low pay or no pay, delivering boom and bust.

I am a democrat. I believe in democracy. It is the least bad way of organising government. At its best it allows political choice, defends the rights of all, protects minorities from abuse and offers a peaceful way of settling differences and changing course.

The market is democracy in action in the worlds of business and consumption. The market is more democratic than political democracy. In the latter you get a chance every four or five years to express your view and change the government. In the market you have a minute by minute opportunity to express your view and exercise your choice. In democratic government there is the danger of a single decision by a small group of people messing everything up. In a market for everyone deciding to do something there is someone else deciding to do the opposite. They will not all be wrong.

Markets are n either cruel nor immoral. They are amoral – they are a stage for your drama, a platform for your train, an opportunity for your future. They are more likely to be the source of new employment than the cause of the loss of your job. They allow you to buy the daily bread to stay alive, and to visit the weekly circuses to enjoy yourself. We should be grateful for their myriad successes, as well as rightly worrying over their troubles and failures.

My youth was disfigured by the cruel experiment in the Soviet bloc. They thought that comprehensive nationalisation, direction of labour, state planning and the denial of the market would cut out the waste of competitive capitalism and the injustices of the markets. Their experiment ended in ignominious failure. Their people were much poorer as well as much less free than we in the west. Their technology was years behind, they were starved of fridges, cars and washing machines, they diverted too much production to weapons and privilege for the political bosses. There was not much moral or just about the Zil lanes and the special education for the favoured few.

No sensible defender of the market believes in an absence of law or a lawless state of anarchy. We seek a legal freedom, with sensible rules laid down by democratic assemblies. You cannot have a successful market without a law of contract and a law of property. You need a strongly enforced competition law to prevent monopoly abuse. You need to enact a minimum income ( wider than a minimum wage) and generous treatment for those who cannot compete in the market for a job. You need a strong Central Bank which upholds the value of a monopoly currency, and polices the solvency and liquidity of the commercial banks well.

It would be wrong to go from a position where the state has failed to carry out its side of the bargain to one where the state nationalises banks and other companies, seeks to regulate individual transactions and activities, and seeks to influence what we make and what we buy and sell. That way is the way back towards the failures of state socialism, which will be worse than failures of the market.

This recession is a failure of a regulated market. The regulators must carry much of the blame, for stoking the fires of credit too high, and then tipping too much water over the fire in one go. There is one thing worse than too much credit, and that is too little. Many people will pay with their jobs and businesses for these mistakes. Yes, the bankers got it wrong. The bosses should pay for their mistakes. But so too did the regulators, whose main task should be to prevent such excess. Today the Regulators main task should be to get the banking system going again. They are still too tempted to put out the fires when the economies are now shivering to death.

Wall Street slumped by more than 5% on the back of Mr Obama’s victory. The morning after the great result, reality set in.

We need change in policy. We need the right sort of change.

Changing to a more protectionist stance would be damaging. Markets are now hoping there is one breath of life and hope left in the outgoing Bush Administration. They are looking to the incumbent to chair a successful G20 on November 15th, and to bring together a trade deal. Mr Obama’s rhetoric in this area has scared them.

Changing from the state borrowing too much to the state borrowing even more would also be unhelpful. Mr Obama seeks a targeted stimulus, but it will all have to be borrowed, on top of the huge borrowings the Bush regime has inaugurated to cover the expenditure on the banks, mortgage companies and AIG.

So what change do we need?

We need a government which understands you cannot solve a private sector debt crisis by turning it into a public sector debt crisis.
We need a government which ditches the Bush/Paulson plan. It is too expensive for the taxpayer, and not big enough to solve the banking problem.
We need an Administration which seeks to return nationalised financial companies to the private sector, whilst supplying enough liquidity and offering sufficient transitional guarantees to maintain confidence in the system.

Freed of the burden of carrying the financial sector with state equity and subsidy, then the President could cut taxes on the lower paid, to provide a needed stimulus to consumption. We are going to need more jobs worldwide. They have to come from individuals wanting to buy more goods and services. At the moment US families cannot afford them, as they are too much in debt, and new debt is too scarce to come by. If the US state could cut its own appetite for debt, it could leave US taxpayers with more of their own money, which would start to arrest the decline.

My worry about Mr Obama is not that he represents change, but that he will not implement major changes quickly enough. It is tough on him because he inherits a mess. It is now his mess, and the sooner he turns up at economic meetings and starts to assert himself the better. There is no time for partying and choosing the curtains. The very financial foundations of the house are being questioned, so it’s time for change, time to get rebuilding.

He should also quietly dump his idea of escalating the war in Afghanistan. The US needs to conserve her military strength, and concentrate on rebuilding her economic strength.

Congratulations to Mr Obama. It is a great achievement. He has reached a new level in organising a grass roots campaign, in raising money from the many and articulating the message for change. Change is much needed on both sides of the Atlantic.

John Mc Cain was right to hail his opponents achievement. I am glad he did not make race an ugly issue in the election, and trust that now Mr Obama has been elected the USA can put the long and divisive issue of race behind it. Mc Cain showed a grace and fluency in defeat which was becoming. When you lose an election you need to show it is still your country and that you understand that the wishes of the majority prevail.

Mr Obama was right to reach out well beyond his jubilant supporters, It was good to hear him say that Republicans, in seeking freedom and responsibility for more people, were seeking something worthwhile and patriotic. He was right to say he would need their support for many of the things he has to do, and wise to say he woudl listen to them when they disagree with him. If he lives up to those fine words in office he could become a successful President.

The natural instincts of partisans after a scrap is to continue the battle after the hustings has been dismounted. Party activitists on the winning side want to revel in their triumph over the opponent. Activists on the losing side want to be told they were right all along and will get their revenge. Such instincts have to be discouraged by their leaders. Both last night rose magnficently to that challenge.

There is a tendency of the left in Brtain not to accept that those of us who usually speak for more freedom and less government do so for the best of motives. We believe that will improve the lot of the people. If Mr Obama continues to remember that such a position is honourable, and deserves at least to be considered on any issue where government is thinking of intervening, he will make better decisions and have more chance of uniting his country.

The Republicans now need to become a loyal opposition. They should not oppose for its own sake, or try to make it more difficult to mend the mess. They should be strong and clear in their remedies, and in their criticisms when they think their new President elect is taking a wrong turning for their great nation.

Democracy is the stronger for yesterday’s events. For those of us who believe in it, our faith is renewed. For those who are uncertain or cycnical, they may be more persuaded to vote and participate in future.

Readers will know I have wanted cuts in interest rates to stave off recession for many months. I have gone hoarse telling the MPC they have got it wrong again, lurching from too easy to too tight.

This week, instead of having their normal MPC meeting wasting time reaching the obvious conclusion that rates have been too high for too long and the economy is nosediving into recession and deflation, they should instead ask themselves what will the impact of the rate cuts we need be on the massive public debt the government needs to raise?

The Governor and his committee should spend a day penning letter to the Chancellor. It should say:

“Dear Chancellor,
We accept that we need much lower interest rates than currently, to lessen the depth and length of the recession and to relieve some of the mounting pressure on borrowers. We accept this is disappointing for savers, but we wish to avoid a situation where banks and the authorities are offering interest rates higher than the market can sustain. Iceland should be a warning to us all, where high savers rates helped push the institutions into difficulties.

However, we are concerned that as the government is now planning to borrow at least £120 billion this year compared with the Budget forecast borrowing of £43 billion, it will prove difficult to fund all this at low interest rates. We recommend immediate action to cut the borrowing volume by the government, to give us more scope to cut interest rates.

We think the Bank of England needs to be given control once again over raising government debt so we can co-ordinate our interest rate decisions with the issue of government bonds, to improve our chances of successful sales. We wish to avoid too much downward pressure on sterling allied to a reluctance by foreign investors to help fund the government deficit.

We appreciate that the elected government is responsible for the overall conduct of economic policy and must remain so. We do feel it necessary, however, to point out that if we proceed with big interest rate cuts in the absence of better fiscal discipline by the government, other problems could emerge which may be painful for both the government and the economy.

We await your guidance, as we do not wish to see monetary and fiscal policy undermining each other, which is the current danger.

Yours etc

When I first called for lower interest rates the government was not planning to increase borrowing by £55 billion to buy bank shares. This makes a huge difference to the wisdom of the policy.

TAXPAYERS BANKS

GROSS LIABILITIES (Balance sheet size)
100% owned

Northern Rock £99 billion
Bradford and Bingley £52 billion

Likely Majority owned

RBS £2000 billion

Possible Substantial minority shareholding

HBOS £680 billion
Lloyds £368 billion

TOTAL £ 3200 BILLION
TOTAL OF SUBSIDIARIES £ 2150 BILLION

LOSSES TO DATE

Northern Rock 1st half 2008 loss of £585 million. £3 billion of new equity capital

RBS 1st half 2008 loss of £692 million

HBOS announced writes offs of £5.2 billion

The government has decided to set up a holding company, UK Financial Investments Ltd, to own and manage all the shares in banks and building societies the government is accumulating at enormous expense to the taxpayer.

This conglomerate is designed to give Ministers a buffer between their decisions, and the actions of all the banks in the portfolio. They hope that as the avalanche of letters and emails comes in complaining about repossessions, foreclosures, cancelled loans, higher fees and charges, interest rates well above market rates and reduced company and individual overdrafts, Ministers will be able to claim it is someone else’s fault. The Chairman of UKFI Ltd will need to spend some of his salary on a flak jacket.

Why doesn’t the government just say they will hold the shares direct but leave the management of each bank to get on with it without Ministerial involvement? I guess they have ruled that option out for two reasons. Firstly, they do want to intervene, but need an intermediary or conduit to do it quietly. What better than a well paid quango company acting as the buffer and the prod to the banks? Secondly, they probably reckon the left in their party would not put up with a policy of complete non intervention. What is the point of a nationalised bank, the left would correctly ask, if it does the same things, imposes the same charges, withdraws the same facilities and pays the same bonuses as a private sector bank? UKFI allows some flexibility when answering the left’s criticisms behind closed doors. The plan is to have studied ambiguity, so the left can travel in hope, whilst markets are reassured.

The government has already had to modify three of its proposed interventions. It stated at the time of the original deals with RBS, HBOS and Lloyds that there would be no dividends, no big bonuses and maintained lending at 2007 levels. Now we learn there can be dividends once the Preference chares are repaid – a lower threshold to jump. There can be bonuses to senior people not on the Board – a good reason for some to resign directorships or to refuse them. There seems to be some retreat from the idea of artificially boosting lending to the levels of the boom, when there could be a shortage of takers for new loans on offer.

All this augurs badly for the experiment in nationalised banking. Still there is no proper audit of the risks and liabilities the taxpayer is being asked to take on. Parliament has been presented with no balance sheet, no accountants report, no revaluation of assets, before it makes its £37 billion commitment to the famous three, nor its £18 billion commitment to Bradford and Bingley. The most basic things that any private sector buyer would require do not appear to have entered the heads of our Ministers. They behaved recently as if they were in the rush of the first day of the January sales with the chance of mega bargains. They plunged into bank buying with a careless ferocity that will come to haunt them.

We have seen how we as taxpayers have already lost £580 million in half a year on small Northern Rock (c.£100 billion of assets) and had to put an additional £3 billion of equity in. How much could we lose in a full year on the £3 trillion of assets at RBS, Lloyds and HBOS combined and the £120 billion at Northern/Bradford? How big should the write downs be to establish safe values on the taxpayers balance sheet? What assessment has been made of recent and prospective loan loss rates? Can Ministers give us an assurance that all their new banks will be profitable from here, and hold assets that do not have to be written down any more? Maybe the government thinks with a portfolio the profitable ones will offset the loss makers. It would still be wise to undertake some audits and do some sums first.

To those who say there was no alternative, I say fiddlesticks. Of course the government and Bank of England needed to lend money and to make cash available. That is their role in the banking system. The government did not need to put up more capital. That is something the banks could have done for themselves, one way or another. The fact that three did not bother to, shows the terms for the taxpayer were not tough enough on the banks.

The government has created a political problem, as well as an economic one. It will have to find a way of answering its many critics, as the banks in public ownership upset customers and make judgements that individuals and companies dispute.

Months ago I urged the authorities to override the Bank of England’s MPC and slash interest rates to head off recession. At last the cries are coming from all parts of the spectrum to do just that, months too late.

I have also urged a sharp reduction in UK spending on bank shares and bank nationalisation. You cannot do the one without the other safely. If they press on with both interest rate cuts and with massive spending on bank shares, expect more strain to be taken on the exchange rate and in due course on the government debt markets.

It means still dearer imports. less spending power and more risk. Why can’t these people in authority understand the large numbers they are playing with, and see they are putting too big a burden onto taxpayers?