Month: December 2008

In Opposition Gordon Brown came up with a sensible economic policy which was attractive to moderate conservatives and moderate socialists. He said:

1. Cut the costs of welfare by getting more people back to work. He called welfare expenditure the “costs of economic failure”
2. Cut the costs of interest charges by reducing government debt.
3. Spend more of the money on schools and hospitals
4. Freeze tax rates at Conservative levels.

I agreed with all of this. I would have added cut bureaucracy and undesirable government programmes (like embryo unelected regional government and related quangos) more so tax rates could also be reduced. I was always sceptical about whether Labour would do it as well as say it.

The Blair/Brown programme was attractive in 1997 and they got a good vote and large majority to carry it out. In the first Parliament they did repay some debt, in line with 2. They failed to reform welfare in line with 1. They did keep tax rates down, but started to introduce some Stealth taxes against the spirit of 4. They began to accelerate spending the Health and Education departments. In 2001 they were re-elected, but with many fewer votes. The public put them on probation, with many floating voters still wanting the original prospectus.

From 2001 onwards they ditched virtually the whole programme. They not only failed to reform welfare, but the bills shot up, with many more people being offered a range of new benefits instead of working. Over 5 million people of working age are now on benefits. They started to borrow again, and now are out to break the all countries borrowing record at huge future cost to taxpayers. They greatly increased spending on Health and Education, but too much of this was spent on central and regional management and interference, too little in the schools and hospitals themselves. They did spend on some new buildings and higher pay, but we have ended up very short of beds, short of certain specialities in hospitals, and short of places at high performing state schools. They accelerated the Stealth taxes, and finally propose a hike in the Income Tax rate on higher earners.

Labour’s vote plunged in the 2005 election to disastrous levels, polling less even than the Conservatives in England when the Conservatives had another very bad year. The public no longer believed the government would do what it promised in 1997.

Today we learn that Mr Brown now wants another go at Item 1. I welcome that. The Opposition is likely to support the changes. I will want reassurance that severely disabled people are not going to be put under pressure or treated meanly, and reassurance that the rest of the reform is serious and not just more spin and window dressing. It is not the best of times to launch such a project when many people in work are having to battle to keep their jobs and when new vacancies are plunging, but there is no need to delay. We do need to tackle it and need to take the state of the job market into account when evaluating early results.

If Mr Brown is a “serious” politician rather than just another spinner from the spin era, he would also take up his other three policies which made sense and were popular in 1997 and could make sense again today. Of course there will be some increase in borrowing owing to the recession, but there should be nothing like the irresponsible surge he is currently undertaking. He does need to have some discipline in the debt programme. He needs to redirect more of the large budgets into the schools and hospitals themselves and buy us more places at good schools and more beds and consultants in hospitals. He needs to reverse his proposed Income Tax rate hike, and end the VAT reduction. Any tax reductions this year should be Income Tax reductions helping the lower paid.

Meanwhile the Conservatives have put in place many of the ingredients for a good economic strategy. The Leader’s attack on excess borrowing, his wish to curb wasteful spending, his opposition to the VAT reduction, his wish to revisit the banking support package and his wish to concentrate more of the present public spending in the schools, hospitals and other local facilities all makes sense. Mr Brown needs to be careful. He could find at the next election the Conservatives adopting a lot of his late 1990s strategy, backed by the wish and the ability to see it through. The pity with the PM is either he did not mean it when he set it out more than a decade ago, or he was incapable of implementing it.

One of the disappointments yesterday was the voting behaviour of the one UKIP representative in the Commons.
He voted with the government against allowing more time for the debate. He then went on to back the government in the crucial close vote which the government won by just 4 votes.

Once again our part time Parliament had to rush the task in hand. Only three hours was allowed yesterday for the debate about the public’s right to know what its government is doing. There was no chance of being called for many MPs wanting to speak, and even interventions were strongly rationed by Miss Harman and others.

It was yet another irony, that on a day when some of us wanted to talk about the need for the government to be freer with more informaiton, they decided yet again to prevent us having time to discuss it. A few loyal Labour backbenchers even had the temerity to argue no-one was interested in which documents we are allowed to see about the government’s approach to immigration.

I agree with them on one thing. The economy is currently very important and Parliament does need to discuss the job losses, factory closures, banking weakness and the large government borrowing. The Queen’s Speech debate going on for a week allows us to do just that for once. It is a luxury we can enjoy, as I did last Wednesday. Who knows when next we will be allowed to debate the state of the economy in between all the breaks and holidays?

In the UK the government are revealing how they think they can borrow £157 billion this year, followed by another high borrowing year next year. They will tap into three sources of demand for government paper.

The banks will need to be substantial buyers, as the authorities are currently consulting on proposals to “significantly” tighten liquidity standards for banks. That means they will have to lend more to the government through the gilt market.

The pension funds will need to be buyers. Market declines in the value of many assets will create more large black holes in their funds. As company contributions are increased to make up for the losses the regulators and actuaries will direct the money to a considerable extent into gilts. Some pension funds will unfortunately end up in trouble where the sponsoring company has gone bankrupt. These are likely to be put into government bonds to a greater extent, directly or indirectly.

There will also be some volunteer buyers, concerned about the risks of other investments and taking note of the large buying demand from the first two sources. Many investment managers who held large positions in equities during the 2008 collapse are now increasing their government bond holdings.

The trouble with this approach by the regulatory authorities is that it makes increasing bank lending and getting things moving again in the real economy that much more difficult. Compare these two regulatory statements:

“We continue to expect Basle II to result in a reduction in our regulatory capital requirement compared with Basle I” (Northern Rock Accounts published in 2007)

“Firms will be obliged to hold sizeable buffers, and we would expect a marked increase compared with holdings under the predecessor regimes” (FSA December 2008)

In the heady days of 2007 before the August tightening of the money markets, many banks like Northern were lending large sums, and were concluding that they could either lend even more or return some capital to shareholders under the future regime. The Rock Directors in Spring 2007 were happily discussing how to handle their regulatory windfall of being told they needed less capital for their volume of business. Today banks are told that they need to hold a lot more in liquid government bonds, lending to the government at low rates of interest, to have a buffer against bad news.

The FSA itself says that its new policy will entail a substantial revenue loss for the banks. Capital that could have been employed lending to companies and individuals at higher interest rates will be lent to the government at low rates. The FSA says of bank turnover

“diminution in revenues – this diminution could be in the order of £1-5 billion (or even higher if the spread between the yields on government bonds and other debt widens).

This change to banking capital is a fundamental one and will mean less lending and therefore a slower economy. The Regulators no longer like much reliance on wholesale market funding, where banks borrowed through the money markets. Instead Regulators wish banks to rely more heavily on deposit taking from the High Street and the web. Paradoxically it was the High Street deposits which pulled Northern Rock down, for it was only when that run became apparent that action had to be taken. Aware of this the Regulator says a bank needs more cash and government bonds as a buffer. That means lower bank profits, which in turn means the banks have less capacity to lend to others. Gaining deposits will also require the banks to offer a lot more than 2% to draw in the funds.

The round trip of money between banks and government which I have described before should be seen in this context. If we take the example of the money lent to 3 of the banks as Preference capital by the government at 12%, we can see what this does to banks profits and therefore to their future balance sheets. The money effectively has to be lent back to the government at around 4%, leaving the banks with a loss of around 8% each year, or £1100 million of losses between them. Far from strengthening the banks, this adds to their problems.

If the government is serious about wanting an early recovery it needs to revisit the banking problem. Its current strategy of bolting the banking stable long after the horses have gone is not going to get us back to sensible economic trotting let alone to the races. It has now designed a regulatory system for both pensions and banks which will provide a substantial supply of lending to the government, but which will make it more difficult to kick start the productive economy again with the right amount of new lending to business and equity investment. The sad truth is we need more profitable banks if we are to get the economy moving at a sensible pace. Given the way some are fanning the dislike of banks and bankers, few are going to like this uncomfortable truth even though as shareholders we are all now part owners with a stake in their profits and losses.

There is some good news about the massive £157 billion the UK government has decided to borrow this year. They seem determined to use the banking system to lend them some of the money, to make it a bit easier to lay their hands on it and to try to keep long term interest rates down.
They will also doubtless keep up the regulatory and actuarial pressure on pension funds, which has been a feature of recent years, to get them to lend more to the government as well. Indeed, the policy of undermining the pension funds, forcing many of them to close for new members or even for continuing member contributions, was a stroke of genius for funding the government’s excess spending. The more pension funds that are “mature” or closed, the more they have under current actuarial and regulatory practise to buy government bonds. The government created a virtuous circle for itself, creating more natural buyers of government debt at ever lower interest rates.
The bad news is that all this borrowing is not achieving the desired effect of stimulating the economy and sorting out the banks. All the time the banks are sending much of the money back to the government at a loss, the private sector will be starved of funds and the banks will remain weak owing to poor profits.
So what should the government do, I hear you ask me again? Let me briefly repeat:

1. Cancel the VAT reduction early.
2. Revisit the regulatory framework for the banks, to give them some more transitional capacity to lend by amending the Tier One Ratio and related rules
3. Revisit the £450 billion package of bank support, so the banks wish to use it more
4. Reaffirm government support for all the major UK banks
5. In private negotiate the repayment of the Preference capital to taxpayers through asset sales, item 2 above and banks generating more profit.
6. Accelerate Gershon style public spending reductions.
7. Cancel undesirable public programmes like the ID card and related computer databases.

Let me say a few words in praise of Germany.
I am glad Mrs Merkel has better things to do with her time than attend the grandstanding “Save the world” session with the UK and France today.
I am glad she has avoided mock reflation based on massive borrowing. The UK plan to borrow more to pay for a VAT cut has backfired badly. Maybe Mrs Merkel understands that if the money is borrowed from nationals, there is very little reflation. The extra savings made by individuals and companies to lend to the government cannot also be spent by the savers, so it offsets much of the benefit of the extra spending by the government. Clearly she understands that this year’s reflation on public borrowing is a future year’s tax increase when you have to start repaying the debts.
Germany has fought its way back from over borrowing to finance the reunification. It has maintained some very good engineering based industries, and built a large balance of payments surplus. Mr Brown’s strategy of treble deficits, where everything rests of borrowing, is not going to prove as robust a model as the German one. Germany’s reluctance to join the others today should be taken as an opportuntiy to rethink the UK strategy, which is taking far too much risk with the public accounts.

The banks are “persuaded” to borrow money from the government at 12% per annum through Preference shares.
The banks are then advised to lend it back to the governemnt, by buying gilts, yielding around 4%. The regulator sets capital ratios that “encourage” the banks to own more gilts.
So the banks lose 8% per annum on large slugs of money,and for once the taxpayer gains.
Unfortunately, the banks then make less profit or have bigger losses. The taxpayer owns lots of shares in several of them, so the taxpayer then loses money on the shares.
Meanwhile the banks have no more money to lend to families and businesses, because they have to lend to the government!
So the only winners in this round tripping are the advisers to the government and advisers to the banks who helped dream up this bizarre money go round.
It’s wonderful to have such talented people in charge of sorting out the banks.

Labour use the language of fairness all the time. They use the idea of fairness to justify all sorts of limitations on liberty and tax attacks on the many. One of the biggest disappointments and surprises is just how unfair they have turned out to be.

I feel a speech coming on like Neil Kinnock’s best one, adapted to modern conditions:

I warn you, do not be a saver under this government. They will slash your interest rate, undermine the value of your currency, and tax you on the meagre proceeds of your prudence.

I warn you, do not be a motorist under this government. They will try to regulate and tax you off the road, blaming you for all the environmental crimes of the planet.

I warn you, do not be a resident of the Home counties. They will tax you more to pay for the rest, and will build all over your remaining greenfields.

I warn you, do not be a small business owner creating jobs. They will hurl the regulatory book at you, undermine your market by bad economic policy and tax any success you may still have.

I warn you, do not seek to avoid dependence on the state to keep your independence. The Inspectors and Regulators will still come after you to capture your every personal detail and movement for their databases.

I warn you, do not think you live in a democracy with freedom of information. If you criticise the goverment and publish some government information, you may be hounded and harried.

I warn you, do not seek to have thoughts that are different from the government’s. The thought police will monitor your blogs, listen to your conversations, and charge you with thought crimes if you offend the politically correct nostra.

I warn you, do not own a TV under this government. If you do you will be expected to pay a Poll Tax and dutifully accept Labour propoganda put out by the BBC in so many of their editorial choices of questions, guests and story lines.

I warn you, do not be well educated under this government. To be have done well at school and university shows you are privileged, and part of the problem as the governent sees it.

I am all for more fairness for the disabled, the elderly, and those who cannot compete in this fast moving competitive world. That does not require a government which treats many of the prudent, responsible, independent people as the enemy. It just requires a government which runs the economy and public spending well enough for the active and successful so there is enough money at sensible tax rates to be generous to those in need.

This morning I wrote that I have been getting some of my better information on the state of our finances from official published Bank of England sources.

I am grateful to those who blogged in to point out that the government wants to use the Banking Bill to stop us finding out how much inflation or deflation the authorities are putting into the system on a week by week basis . Apparently they are trying to stop the weekly publication of the figures. Well, there’s a surprise!

What possible good reason could they have for that?