For recovery mend the banks, change the Bank and stop the talk of cuts

Listening to parts of the public sector, it’s as if they want things to go wrong.

Yesterday we had to be treated to a leaked letter from the Department of Justice, enabling the media to have another round of discussions of “deep and damaging cuts”. Few point out that current public spending in cash terms will rise by 15% over the period 2010-15 overall, which should give plenty of scope to protect everything worth protecting.

I often had to “cut” budgets in companies I helped lead. We never cut the quality or reduced customer service, and never treated the customers or the wider public to a running commentary on how we were going to cut budgets to make ourselves more efficient. Cutting waste, inefficiency and overall unit costs is just part of good management. It’s what you have to do if you want to compete with China.

Today the Bank of England will confirm the barrage of gloomy briefing about how it needs to cut its forecast of growth and increase its forecast of inflation. It will be implied that the “cuts” and the VAT increase are to blame. It could just be that once again the Bank has made lousy forecasts and needs to get its act together.

After all, it was the Bank which recommended the ERM which did so much economic damage in the early 1990s. It was the same Bank which fuelled the credit boom in 2005-7 with too much easy money, and the same Bank which helped bring the bloated banks down by starving the markets of money and hiking interest rates in 2007-8.

The “cuts” – a slower rate of increase in cash spending – should have come as no surprise as Labour enacted prospective cuts before they left office, and Conservatives made clear they wanted to speed these up. That should not have been difficult to forecast. The current high inflation has nothing to do with Mr Osborne’s future VAT increase, and everything to do with the Bank’s erratic monetary policy.

Finally, why does the Bank expect its QE and low interest rate strategies to produce faster growth in credit and in output, when the banking regulator is insisting on the banks holding so much more cash and capital? The Bank prints more, then the banks have to sit on it to satisfy the authorities. It also forces the commercial banks to put up prices and write less business.

The Bank seems to be following a growth rather than an inflation target. If it wants to do that more successfully it needs to mend the banks, and change the regulations.

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39 Comments

  1. gyges
    Posted August 11, 2010 at 8:30 am | Permalink

    John tells us of people talking about, “deep and damaging cuts”, whilst Paulo Freire in the Pedagogy of the Oppressed says,

    "Any attempt to 'soften' the power of the oppressor in deferrence to the weakness of the oppressed almost always manifests itself in the form of false generosity; indeed, the attempt never goes beyond this. In order to have the continued opportunity to express their "generosity", the oppressors must perpetuate injustice as well. An unjust social order is the fount of this 'generosity', which is nourished by death, despair and poverty."

    If they didn't want to nourish an unjust social order, shouldn't cuts be welcomed?

    ps As to 'death' (as well as despair and poverty) nourishing an unjust social order, consider the following,

    "On average, children born in the poorest areas will die 13 years before those in the richest."

    From a post (on another site-ed)who extracted the information from a January 2010 report from the UK government's National Equality panel. The panel also, "pointed out that the gulf between rich and poor in the UK grew wider under the Labour Party than at any time since the Second World War."

  2. Mick Anderson
    Posted August 11, 2010 at 8:44 am | Permalink

    The BoE was given a very narrow target to hit with a very blunt instrument. The law of unintended consequences waiting to happen….

    The commercial banks are all claiming that they have too few customers to hit their lending targets. This suggests to me that interest rates are too low – there is too much money chasing too little business.

    As such, it should have relatively little impact on these companies to start raising interest rates. It should also have little impact on mortgages, as very few people are still paying interest at or about bank rates – many of the tracker rates that carried peoples payments down have expired.

    With a typical variable mortgage rate at 6%, the 0.5% bank rate appears to be doing harm to savers, and no good to the vast majority of borrowers.

    If the BofE is to continue regulating interest rates, it needs to be given a more realistic brief, and a better toolset.

    • Mark
      Posted August 12, 2010 at 11:03 am | Permalink

      I suspect that larger businesses worry about what would happen if their bankers folded. They would not rank well in the list of creditors, but their debts would be demanded by the receiver. That provides a powerful incentive to pay down loans and to try to find a safer haven for cash. The incentive is magnified by the interest rate differential between borrowing and deposits.

  3. APL
    Posted August 11, 2010 at 9:12 am | Permalink

    Off topic:

    The association of chief police officers really have gone too far. Why is a private for profit company allowed to use public money to spout such drivel?

    Those people who:
    Forget or don't bother to draw their curtains, prime suspects – students.
    Prefer to pay with cash rather than use credit cards that charge exorbitant rates of interest – anyone sensible.

    Is now potentially a terrorist suspect.

  4. Ian Jones
    Posted August 11, 2010 at 9:14 am | Permalink

    The BoE is supposed to only follow inflation but has failed miserably for 10 years. The UK imported deflation which had to be matched by massive domestic inflation to bring us to 2%. Now we have devalued the pound by 25%, we have imported inflation which means we need domestic deflation to offset it. The BoE is not allowing this by pushing for growth using QE and has thus abandoned inflation targeting totally. Where is the legal framework for it to do this? I do not remember seeing an act of parliament or a vote for them to do this.

    Another utter failure of a Gordon Brown policy and fully expect inflation to be 5% and more for the next few years to deflate away the debt.

  5. chris strange
    Posted August 11, 2010 at 9:47 am | Permalink

    Printing money, oops sorry, Quantative Easing was never anything to do with the economy, it was simply to stop the government going bankrupt. Note how close the figure of the amount spent on QE was to the amount overspent by the government. Also note, as you do, that just as the Bank of England was pumping newly printed money into the government coffers it was foring the banks to remove money from the wider economy through larger capital requirements.

  6. Simon
    Posted August 11, 2010 at 9:58 am | Permalink

    It is pretty much business as usual in my dept. Ok we get blood curdling promises of job losses which of course create a heads down self protecting attitude and of course blog type consultations about what can be done which degenerate into online rows about grades and the pay of senior staff but errr that's about it!

    we still work in the same old ways still fund dinosaur IT projects that have delivered nothing and never will we are told that Ministers are very pleased with our performance and that we are doing the rigtthings in the right way etc etc

    I conclude that we have collectively no idea of what is required or how to go about it we have to understand that we have not been doing a good job accept that we have spent money to no good effect and that change is both urgent and do-able and we need to get on with it if nothing changes then there will be no change and of course no increase in efficiency

    Politically this is awful the coalition cops the political flak and hands ammunition to it's opposition without any upside benefit in efficiency.

    Please get to grips with this, identify those that agree with the efficiency agenda and support them and clear out those who made their bones under NL and cannot comprehend what doing more for less actually means.

    Action This Day not Waffle This Day

    Hope Dwindles!

  7. JimF
    Posted August 11, 2010 at 10:03 am | Permalink

    "The Bank seems to be following a growth rather than an inflation target"
    'Twas always thus.
    Interest rates were kept too low from 2005 in order to promote growth. If you remember, there was the worry that businesses wouldn't borrow to invest if interest rates were too high then, and growth would stall. At the same time cheap money fuelled property speculation.
    The answer to this was then and is now to increase interest rates and decrease business taxes on employment to encourage growth, whilst increasing the tax take on purely speculative activity.

  8. Lola
    Posted August 11, 2010 at 10:50 am | Permalink

    The BofE 'forecasting' stuff is fatuous. There was an excellent report in the FT recently that showed how they have always failed to get it right. The fact is no-one can 'forecast' the future. It's risible to think that we can. We might as well use seaweed and soothsayers. It's positively medieval.

    What we can say is that investors and entrepreneurs have an expectation of return based on risk. This drives economic growth. In other words the 'authorities' and the Bank need to get right out of the way, stop pretending that they 'run the econmy' and let us get on with it.

    The one thing that we can do is to have sound money. And in this too the B of E has utterly failed, in complicity with corrupt politicians. It's about time the State returned to us the fredom to make our own money, or rather gave up its monopoly.

    What do we want? Sound Money! When do we want it? Now!!!!

  9. Acorn
    Posted August 11, 2010 at 10:55 am | Permalink

    So, why does the BoE pay interest on the excess reserves held at the BoE? My bank offers me interest to encourage me to keep my money with it. The BoE interest rate on reserves and its relationship to Bank Rate and Overnight money rates, is all part of the Keynesian plan. The regulator is well aware of the BoE strategy. It is also aware that shrinking bank balance sheets are continuing to create far less "cash and capital" than they would wish. The banks are still full of toxics. Deflation is the only cure for the current mess; not QE inflation. Even though the latter is the Savior of busted banks and governments.
    I recommend reading the BoE experience after its 2006 policy change. (page 11-14) http://www.federalreserve.gov/pubs/ifdp/2010/996/

  10. Geoff not Hoon
    Posted August 11, 2010 at 10:55 am | Permalink

    Mr. Redwood, a year or so ago someone wrote the longer interest rates are held down during a period of rising inflation (RPI now over 5%) the higher they will have to go when 'things' finally start to move. How true that seems today.

  11. Bill
    Posted August 11, 2010 at 10:59 am | Permalink

    The BOE should provide a rock of stability,a lighthouse.. instead they are all over the place and few people have confidence in them.

    The government needs, somehow, to get the message across that the cuts are a slowdown in acceleration, rather than a “brake” in the public sector

    In the private sector there’s an unhelpful dose of “breaking” taking place, this plays second fiddle in much of the media.

    It’s a move on from the “taking money out of the economy”….NI increases predicated… on the assumption that the government can spend money more efficiently than the taxpayer can.

  12. Richard1
    Posted August 11, 2010 at 11:21 am | Permalink

    What's your view on the Austrian economists' idea of abolishing the Bank of England, moving sterling onto a gold standard and ending fractional reserve banking?

    • Mark
      Posted August 12, 2010 at 11:13 am | Permalink

      The global economy is too large to permit money to be backed by gold. That's basically why the gold peg was finally abandoned at the Smithsonian Agreement in 1971. Even then, it had only been workable with fractional reserve banking.

      • FaustiesBlog
        Posted August 13, 2010 at 1:13 pm | Permalink

        The global economy is "too large" precisely because there is more 'money' sloshing around than there is true value. That is because, despite the call for increased capitalisation, the banking system is leveraged by at least 10 times the value that exists.

        It is a monetary system entirely based upon debt. The banks get their money from debt.

        Force the banks to deleverage each year – down to 9 times, 8 times, 7 times, etc., until the point where it is no longer leveraged. Then we can get back to sound money and sound governmental budgets, and the banks will no longer be able to hold countries to ransom.

        Does any government have the guts to do this?

  13. Steve
    Posted August 11, 2010 at 11:50 am | Permalink

    John, I agree with you that the BoE seems to be following a growth rather than an inflation target, but who has given it permission to do so? Surely, it is still owned by the government and must report to the Treasury and Chancellor? Have they secretly changed the official targets? If not, then isn't it time that Mr. Osborne gave Mervyn King and Charlie Bean a hefty kick up their backsides and instructed them to do as they are ordered, and not act as they happen to feel like?

    Which brings me back to a point I have been making for months – why, oh why, is Mervyn King still in his cushy feather-bedded job? He has been a disastrous failure as governor and has cost each and every one of us thousands of pounds. His Bank's forecasts have been dismally inaccurate for years. He utterly failed to foresee the impending financial crisis, even though he was personally responsible as you point out for stoking its fires with his foolhardy policies of low interest rates. What does this man have to do to get fired? Walk off with what's left of our gold reserves?

  14. FaustiesBlog
    Posted August 11, 2010 at 1:34 pm | Permalink

    Central banks are part of the problem, not part of the solution. We tend to forget that the BoE is a privately run corporation which makes astonishing profits.

    Might there not be a conflict of interest for the BoE to be steering the country's monetary ship, when it coins billions by dint of the country's profligate debt spree and spending? Is it a coincidence that Austrian Economics economists, like Peter Schiff, predicted the crisis in 2003, but the BoE seemed unaware until the crunch was on our doorstep?

    Hardly credible, is it?

    I say again – let's have a national bank for just domestic deposits and loans and let's ensure that never again will a bank be "too big to fail" – another outrage about the public, as usual, was not informed, even though it foots the bill.

  15. Brian Tomkinson
    Posted August 11, 2010 at 1:50 pm | Permalink

    We need a new Governor of the Bank of England. Mervyn King's record is quite appalling. His main responsibility has been to keep inflation as measured by the CPI at or below 2%. The Bank's inflation forecasts have been wrong 41 times out of the last 52 months. The record for growth predictions is little better. Why is this man still in charge with such an appalling record? He is about as good at forecasting as those incompetents at the Met office. Perhaps he could find a job there, he seems to have the necessary attributes. John Redwood would be my choice for his replacement but I suppose that is regarded as too much of a political appointment. However it is, to say the least, frustrating to see someone with ability not been utilised for the good of the country.

  16. EJT
    Posted August 11, 2010 at 2:19 pm | Permalink

    "Listening to parts of the public sector, it’s as if they want things to go wrong"

    Yes. Of course they do. The best way of protecting their budgets is to ensure any reductions are directly transmitted to cuts in the deliverables, with the maximum negative publicity.

  17. EJT
    Posted August 11, 2010 at 2:31 pm | Permalink

    PS – just to prove the point, we've had it explicitly stated by many commentators over the milk cuts that the ability to cut is set by the level of political damage to the government.

  18. Alan Jutson
    Posted August 11, 2010 at 3:22 pm | Permalink

    John

    I guess the leak was from an employee who has never been in private industry.

    Its an opening salvo of fear, to get media headlines and some sort of sympathy with threats of closing prisons, compulsary redundancies, the breakdown of law and order and the like.

    Why if government spending is going to increase over this Parliament (as you have said many times) does the Conservative Party or the coalition Government not say this out very loud, from the rooftops even, and shut up all those who say its all cuts, cuts, cuts.

    I can tell you for certain that the private prisons (of which there are a number) are run on a very different basis, and with a totally different culture, to those under the direct management of Government Departments.

    The Government is losing the media battle to those who should simply be disgraced, for their past spending feast.

    In short the Government needs to up its presentation game.

    • Mark
      Posted August 12, 2010 at 11:29 am | Permalink

      The present plans do show modest growth in expenditure, and are certainly much more realistic than the fictions that Darling was publishing. However, they do depend on tax revenue holding up and on economic growth returning. Both these could be thwarted by external events, never mind things not going to plan inside the country. Best not be too much hostage to fortune – much better to blame the Labour disaster (which is where the blame should lie in any case).

    • waramess
      Posted August 14, 2010 at 6:54 pm | Permalink

      Well said, and I hope someone is listening

    • waramess
      Posted August 14, 2010 at 7:02 pm | Permalink

      I read your comment too rapidly and now regret the response.

      Were you to have said the government should go ahead and cut, then I would agree. You are certainly right, the government are in danger of losing the media battle and this is probably because they are more interested in winning the debate than having a strong commitment for what they are doing.

  19. richard
    Posted August 11, 2010 at 6:10 pm | Permalink

    Great article, one that should be printed in every national newspaper, but it seems they are only printing scare stories about the effect of cuts.
    It is a real difficuly for the Government to counter this hysterical media coverage.

    I think central government should give local government a set of standards they have to meet in basic services once these have been achieved then and only then can they spend money on their pet projects.

    Councils near to me are sending out steady stream of propaganda saying how basic services will need to be cut whilst they carefully protect their own jobs in the town halls

  20. Demetrius
    Posted August 11, 2010 at 7:26 pm | Permalink

    Could it be that central banks are the problem rather than just being part of it? Should the government simply close the Bank of England down?

  21. grahams
    Posted August 11, 2010 at 7:41 pm | Permalink

    The Governor's statements yesterday seems to confirm that the inflation target is officially in abeyance and therefore, for practical purposes as dead as Gordon Brown's golden rule. The implcations for the next crash are frightening and that cannot be good for confidence or growth.

  22. Vernon Butcher
    Posted August 11, 2010 at 10:04 pm | Permalink

    Excellent article John.

    There will be a time for flogging the banks for their part in the economic crash – but that time has not arrived. We need strong and healthy banks to lead us out of the mess this country is presently in.

  23. Deborah
    Posted August 11, 2010 at 10:59 pm | Permalink

    Well said.

  24. Angry Saver
    Posted August 11, 2010 at 11:13 pm | Permalink

    Yesterday, comments were made on the Swiss economy that has general prosperity and almost no inflation (ie devaluation) of the Swiss franc. I.e. Your grandfather's franc is still woth its full value now.

    Successive governments of all persuasions have failed to give the British people since the war this sort of prosperity and currency stability. How much more/ how many more times must the pound be devalued to compensate for the economic incompetence of our successive governments leading to a so called export led recovery and then a bust followed by in effect another devaluation.
    Surely we should all withdraw our money from the banks and buy gold or something else that our government can't devalue.

  25. Sally C.
    Posted August 11, 2010 at 11:36 pm | Permalink

    '.. why does the Bank expect its QE and low interest rate strategies to produce faster growth in credit and in output, when the banking regulator is insisting on the banks holding so much more cash and capital? '

    Much to my surprise, Mervyn King announced today that the UK will pursue growth by rebalancing the economy away from private and state consumption and towards exports. I didn't know it was in his purview to make statements like that, however, it does explain why he is so keen to pursue QE and keep interest rates artificially low. Basically, he is in favour of anything that will devalue sterling.

  26. Mark
    Posted August 11, 2010 at 11:55 pm | Permalink

    News management shouldn't really be an issue – and it probably wouldn't be if there had been proper opposition from the Conservatives and Lib Dems during the Labour governments of the past 13 years, rather than agreeing to share the proceeds of growth which were in fact overseas borrowings on behalf of those racking up their mortgages to fund the balance of payment deficit and the government deficit while pretending that house prices can only ever go up.

    The BoE pursued extremely lax monetary policy after 9/11, as well as in 2005-7. Our housing bubble was inflating most of the time between 1997 and 2007, with a brief pause in 2004. Slackened regulatory standards added to the low interest rate environment. The computer risk model was always right. Inflation is now being fed with the lagged effects of QE, compounding the negative real interest rates offered to favoured borrowers and disfavoured savers. These effects still have 18 months to go to work their way through the system.

    We know where the problems in the banking system in the UK lie: they are overwhelmingly dominated by property lending that created an asset bubble. Banking markets have been rigged to allow banks to earn extra profit to shore up their balance sheets. The idea of the last government and the BoE appears to be that the £800bn funding gap they face can be financed if property prices can somehow be propped at unrealistic levels, and that the extra capital will persuade lenders to provide the funds.

    Realistically, there are few sources for these funds. If they are provided by the BoE they will become part of government debt. Only some very clever asset shuffling is going to permit an element of BoE lending that isn't going to be re-classified (and banks aren't lending enough to business to make that a possibility on anything other than a minor scale). Domestic sources can also be ruled out: in the straightened economic times there will be little saving to tap. That means that the funds will once again have to come mainly from overseas.

    Overseas lenders are all too aware that our property bubble remains almost fully inflated, and they can compare with halved prices in Ireland since the peak for example. With no plan to tackle the bubble, it is doubtful that overseas lenders will be willing to lend. Go to a banker with a proposition that says you have a problem and need finance, they will help if you can provide a plan as to how to turn the situation around. With no plan comes no funds.

    This is why it is essential that the excess capital built up by banks is applied to writing down their property portfolios: it is a plan, designed to reach a position from which recovery and normal banking can be resumed. Moreover, as property values shrink and loans required to buy property fall in size in tandem, people will be left with more money in their pockets, and will once again be competitive with foreigners who aren't having to pay such huge multiples of earnings for a house. They may even be able to save for a pension, providing funds for investment, instead of the risk of fund liquidation to meet liabilities creating selling pressure in markets. We need to rebalance our finances.

    Write down those mortgages and deflate the house price bubble.

    • Simon
      Posted August 12, 2010 at 12:02 pm | Permalink

      Yep , agree , the housing bubble has to be deflated and never puffed up again .

      Ultimately massive mortgages force us to pay far too much in tribute to the financial services industry . We are being farmed by them , it's just wealth concentration .

      I like the idea of compulsion to save for old age with an element of redistribution to properly fund a national pension which pays out at the subsistence level so enabling a whole swathe of means tested benefits to be scrapped .

      Removal of means tested benefits would stop people who decided to save beyond this from being penalised .

      I'd suggest also legislation to :-
      – restrict ownership of UK residential property below 30 times median earnings to British Citizens
      – limit rates of interest on loans to consumers to less than 15% above BOE base rate

      • Mark
        Posted August 12, 2010 at 2:54 pm | Permalink

        I have no objection to foreigners paying bubble prices for property with cash. They can then suffer the losses just as if they put money on the table at Aspinall's. Indeed, if we could persuade foreign investors to buy all our council houses it could help make a real dent in the national debt. It might be appropriate if they bought not through offshore vehicles that permit them to avoid stamp duty. Ownership is a separate issue from immigration though.

  27. @vincelammas
    Posted August 12, 2010 at 12:23 am | Permalink

    There is much in the Coalition programme which can be applauded and there is clearly waste and inefficiency in the public sector (as you say waste in private sector organisations is simply not discussed in the public domain).

    Everyone else seems clear the financial constraints require far more than simple efficiency and reduction of waste. Both the Coalition and Labour governments have had to contemplate reductions in expenditure to live within the country's means while paying for the cost of the recession.

    If the Coalition is talking up the crisis, the need to make difficult choices and has asked for inflated "illustrative projections" when there is no need, it is surely guilty of exacerbating the loss of confidence and slowing the recovery it wants to encourage.

    It would be nice if there is a magic wand that Mr Osborne will wave next year and make the whole problem go away …… but that seems unlikely. How do you explain the rhetoric if things are just peachy?

  28. DBC Reed
    Posted August 12, 2010 at 9:41 am | Permalink

    For years people have been advocating the differential taxation of property in order to stop cheap money being hedged into the property market – notably the big guns on the Financial Times Martin Wolf and Sam Brittan who have advocated Land Value Tax,as have ,from time to time ,Vince Cable and Chris Huhne .The problem is practical one: the likelihood is tax measures to restrain inflationary house price rises would lose elections for those advocating them.The alternative is to tighten up mortgage credit so that house prices drift down long term.This is what the Coalition seems to have embarked on without drawing attention to it..However this might not work because property developers and homeowners would deliberately restrict the supply of houses coming onto the market so keeping up prices on very low volumes.So a bit of a shove from LVT may still be necessary to rebalance the economy
    The Right's ideological preoccupation with the public sector is misplaced: it is still the private sector property market that is the problem.

    • Mark
      Posted August 12, 2010 at 11:55 am | Permalink

      The only shove that's needed is from LTV, not LVT. If you can't borrow excessive funds, you can't pay an excessive price. Sellers can imagine their property is "worth" the asking price – but that's all they can do – imagine. If they want cash, they'll have to drop the price to what a buyer can afford.

  29. StrongholdBarricades
    Posted August 12, 2010 at 11:34 am | Permalink

    If I might add one more criteria:

    Get Lord Digby Jones onside, or at least an energetic equivalent

  30. waramess
    Posted August 14, 2010 at 6:51 pm | Permalink

    It is almost as if the electorate do not matter and the politicians play to the newspapers and, sometimes the opposition. Government needs to be cut; even the Labour administration paid lip service to it.

    Raising VAT to twenty percent is not about cutting government, it is about growing government, and you know it.

    So, why not stop playing to the press and instead do what is necessary. You will gain popular support which you will not gain by increasing taxes.

    And… why should the Bank of England want to print some more money? I am amazed you ask the question. It's the easiest answer.

  • 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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