Month: November 2010

          After the failure of the Exchange Rate Mechanism we had an interlude of successful economic policy. From 1992 onwards the economy recovered well. Labour continued the fiscal  policy of the outgoing Conservative government for the first couple of years. By 2000 the UK economy was in good shape and the public finances were recovering strongly from the ERM disaster. There were still many in the Establishment who cast envious glances to Germany. If we could not import German discipline by hitching  our currency to theirs, they reasoned, why not adopt a German style independent Bank to enforce our own teutonic controls?

            Labour doubted it could command respect for an independent monetary and economic policy, so it was vulnerable to these siren  voices. It offered two reassurances. It would follow Conservative spending plans for a bit, and would not raise Income  Tax rates. Once in office it added the decision to “make the Bank of England independent”. As always in an age of spin  it was important to look at what they did rather than what they said. They stripped the Bank of its bank regulating powers, and took away its job of raising money for the government in the money markets. Far from making the Bank overall more independent they all but demolished it, making it less in tune with how money and debt markets were moving. They created a so called independent Monetary Policy Committee. Their task was to set interest rates with a view to keeping price inflation close to a stated low target for RPI increases.

                    Every person on the MPC was a direct appointment chosen by the Chancellor, or was chosen by someone chosen by the Chancellor in the case of Bank employees. Some found their tenures renewed, others served just one term. There was no transparency over how you got selected or re selected. Treasury Ministers sometimes seemed alert to  likely future interest rate changes.  During the second Labour Parliament the Chancellor changed the target from RPI to CPI in  a way likely to result in looser monetary policy, as he did not fully allow for the lower historic  rate of increase in CPI compared to RPI. In more recent times  Chancellors have become intimately involved again in monetary policy, as their  consent is required for quantitative easing.

               A body with a single aim should be judged by their results. For  most  of the last 60 months inflation has been higher than the permitted level. In their most recent report the Bank and the MPC have stated they do not have much idea of what will happen next in the economy. They stand ready to fight deflation and to fight inflation. They have had once again to revise  their forecast for the inflation rate upwards. This has all happened against the background of depressed western world demand and very low price inflation in the US, Euroland, Japan  and the other main advanced countries.

               The apologists for the Bank claim that it was not the Bank’s fauilt that the UK economy lurched from a credit soaked boom in 2007 to the deepest recession since the 1930s in 2008-9. They argue that international factors were to blame. Alternatively they say it was the fault of  the banking crisis where the FSA was the prime regulator. They still have to explain why it should be that against such a background the MPC was not even able to control price increases when practically everywhere else in the advanced world inflation had ceased to be a problem. They also need to explain why the Bank of England did not take its duty to avoid systemic collapses in the banking market more seriously at an earleir stage of the crisis.

                 The truth is the Bank of England lurched from money which was too easy and interest rates which were too low, to money which was too tight and rates which were too high in 2007-8. Their policy allowed or fuelled the bubble, and their policy helped burst it. They did an extreme version of what the ERM had done to the UK economy a couple of decades earlier. Many people and two Opposition parties warned that credit and mortgages were too easily available  prior to 2007. We called for tighter policy. A few of us urged the Bank and government to loosen in the summer of 2007 to avoid the run on the Rock, but our well intentioned advice fell on deaf ears. There were even fewer of us offering an alternative to bank nationalisation, once the monetary tightening threatened to overwhelm bigger banks in 2008.

                   The Bank now accept that current inflation in the UK is partly the result of a major devaluation of the pound which the Bank allowed and facilitated during  the crisis. If they wish to uphold the value of the currency they need to take actions designed to retain its external value as well as its internal value, as the two do have an intimate relationship. The combination of money printing and low interest rates  has undermined the external value of sterling. In an open economy like ours where we import so much it has directly slashed our living standards. This site has been warning against excessive devaluation and inflation for many months, but the Bank seemed unable to see it when it mattered. As a result we have ended up with a stunningly high 5% RPI inflation at worst , and a 25% devaluation.

               Meanwhile, what became of the bold German model for these two schemes?  Germany gave up on the Exchange Rate Mechanism and moved rapidly into the Euro so other countries could no longer  devalue against her. Her Central Bank remains, but no longer has a currency or an interest rate structure to operate. In the dying years of German monetary independence even Germany showed that her Central Bank was not and could not be truly independent in a democracy. On the two main questions of the day the politicians overruled the Bank. They ordered a badly chosen  swap of ostmarks for DM on the reunification of Germany against Bank advice. Their chosen rate of one ostmark to one DM was boudn to cause economic problems.  They ordered the abolition of the DM, the currency the German Central Bank had to maintain and defend as its main purpose in life.

               Tomorrow we will look at what would be a better system for curbing wanton politicians and for curing Central Banks with bad judgement. Meanwhile both major parties, Conservative and Labour, should reflect sorrowfully on how their experiments with auto pilot monetary policy  resulted in boom and bust, leading in both cases to bad election defeats. The  autopilot  model, whether exercised through exchange rate linkage or through an independent Central Bank, has both times done damage to the Uk economy and to the political parties in office at the time.

               The political classes in the UK have for most of my active life in politics been gripped by a destructive  wish to find an “independent” discipline to run the economy to take it out of the hands of politicians. Some will say this shows a great wisdom and a certain humility about their own skills in this area. I wish to make an alternative case.

               In a democracy the ultimate power rests with the people. They can pressurise and lobby their elected government, or they can remove it if it fails to deliver what enough people want.  Mortgage and savings rates, the number of jobs and the advance or retreat of prosperity are often the dominant preoccupations. Whether economic policy has been subcontracted or not the voters will hold the elected government responsible for the outturn. The buck rests with the PM and Chancellor, whatever the details may say about who controls banks, money and interest rates.

                  In the last 30 years there have been two experiments with delegating the crucial powers. The first was the Establishment decision to join the Exchange Rate Mechanism. A Conservative government did it and carried the can for it, but all major political parties and the principal lobby groups all wanted it.  The second was the Labour idea of a so called “independent” Bank of England. This was also widely welcomed by the other political parties and by the main interest groups.  Both these approaches resulted in wild swings from boom to bust. We need to ask why.

                 Both policy approaches have been heavily influenced by Germany. The UK establishment was impressed by the long period of post war low inflation and growth achieved in Germany in the period from 1950 to 1980. The decision to tie the UK’s fortunes to the DM by putting the pound into the Exchange Rate Mechanism was designed to import Germany’s excellence at controlling inflation. If the DM was a low inflation currency, surely they argued we could hitch a ride to low inflation by linking our fortunes to it?

               I remember how lonely it was opposing this view in the later 1980s. A handful of us did so. I even took the large company I was chairing out of CBI membership partly  in protest at their support for joining the ERM.  I published a pamphlet in April 1989, before we entered the ERM, explaining how it would be destabilising. I argued that  in the short term, because the markets wanted to push the pound up, it would be inflationary. The Bank of England would create more pounds to sell across the exchanges to try to keep the rate down. This would become high powered money in the banking system leading to a surge of credit.

               The Uk joined and this was exactly what happened. A credit boom was unleashed by the bizarre monetary policy forced on the Bank by the need to keep the pound down. This in turn drove up prices. In  due course the reverse happened. Foreigners wanted to sell sterling. The Bank had to buy up pounds to try to keep the rate up. The credit bubble was burst by the  monetary contraction and by the need for much higher interest rates to try to keep the hot money in the UK. The UK lurched from a bad inflationary bubble created by excess money and credit, to an even worse recession, caused by too little money and credit. Both were the direct result of the independent system which all its supporters had said would lead to greater price stability and underpin smooth growth.

                        Few now would defend the ERM or are even prepared to remember their misplaced enthusiasm for it. The British Establishment has moved on, and has told itself the Conservatives lost in 1997 for other reasons. In truth the Conservatives lost in 1997 because the public were sore at the ultra high interest rates and the plunging activity levels created by ERM membership. A domestic policy could have been smoother and better for the UK.

                      Tomorrow I will look at the experiment with a so called independent Bank of England.

            I spent some of yesterday with a group of Conservative members and activists. Their views on the government’s progress to date were interesting.

             They are all pleased to see the end of Gordon Brown’s regime. They wanted an end to reckless spending and borrowing, and to the rash of political correctness and non jobs that characterised the dying months of the Labour government. They wish this new government well.

              They refer to it as “them” not “us”. They have a number of messages for the leadership. The most common word they used to describe their reactions to events so far was “disappointed”.

               I asked them why. Were they not pleased that the government has promised to tackle the deficit and to curb  public spending? Yes, they welcomed that but they were critical that spending is going up on overseas aid and the European budget. They think  more could be done more quickly to rein in excess and waste.

                 Were they not pleased that the government has said it will reform welfare? Yes, they were strongly in favour of that. They especially welcomed the decision to provide some high cap or limit on the amount of Housing benefit that can be claimed. Their concern was why it was taking so long to bring it in. Some expressed worries that the government might amend the proposals  or back down.

                 Some were unhappy about the defence cuts. They would rather we pulled out of Afghanistan as soon as possible, to save the money on that venture, in order to preserve more of the procurement programmes. Many  wanted the Harriers to be kept on for the carriers, and at least  one wanted new early warning aircraft.

                Many were unhappy about the recent decisions on EU matters. They wanted a referendum on  the extra duties and spending of the EU, disliking the expanded diplomatic service. The one Lib Dem policy they liked, a referendum on the whole matter of the EU, is the one Lib Dem  policy they notice  that has not made it to the Coalition table.

                All want to know from the leadership what distinctive Conservative programme will be developed for by elections and the next General Election.  Fresh from their experiences earlier this year of making the case against Lib Dem candidates in local elections and the General Election, they need reassurance that there will be a distinctive set of policies to sell that show some difference from what a Coalition government can do.

                The US announced its quantitative easing just before the G20. This was a provocative act to many of the other G20 leaders, showing that the US was willing to lower the dollar come what may.

                The US action has ensured that the main issue thrust onto the table will be the extent to which countries intend to follow beggar their neighbour devaluation policies. The successful exporting countries like China, Germany and Japan will be saying that the deficit countries need to work harder and to make more products they wish to buy. The deficit countries will be hoping that the big exporters will agree to revalue their currencies and to stimulate their domestic markets, making it easier for the deficit countries to sell to them. The surplus countries will object strongly to deficit countries undermining their own currencies by creating too many electronic  banknotes, especially as the surplus countries now own substantial amounts of deficit country IOUs. The deficit countries will object to the way some surplus countries restrict trade in their currencies or otherwise manipulate their exchange rates, delaying the inevitable adjustments.

            The best we can hope for from the leaders is emollient language, followed in due course by a greater williingness on both sides to resist interference with  the markets seeking sensible values for the currencies. If the President takes back home the anger about US QE II he might just let it be known to the Fed that this will  be the last time he does it. If China grasps the strength of western feeling about the current level of its currency, it might just allow more upward drift after the meeting.

              The markets have also arranged their little  economic question for the G20 party. Is there any level of borrowing costs for Ireland, Greece and the other stressed members of the Eurozone that might get the European countries to firm up their offers of financial help to them? The Europeans would be best advised to avoid too much talking about their problems, as the more exposure they are given in the media the more people are likely to worry about the situation.

             The EU is rapdily trying to put in place the kind of economic government  and controls you need if you are to run a successful single currency. In Euroland the centre does need to control how much each region and country within the zone can borrow, and does need to ensure common economic policies to facilitate adjustment within the zone to offset the shock of the common external currency rate. The failure to do this at the beginning has left a very lop sided zone, with some countries uncompetitive and running up huge bills.

               In the UK where one area becomes very uncompetitive at our common exchange rate, with high unemployment, the rest of the UK automatically pays the bills. Germany is reluctant, as the main  paymaster of the Eurozone, to do this for the most uncompetitive areas. The very public arguments over how much grant, loan and other financial assistance might be available to Greece or  Ireland is bound to be destabilising. If Germany now wants  bondholders of Greek and Irish debt to accept a cut in what they are owed, rather than helping with guaranteeing those loans, then it has to ready itself for German banks also taking a subtantial hit. Germany is about to discover things are already more integrated than they might like. A single currency is not just for Christmas. A single currency is not just a guarantee of no devaluations by your trading partners to give you good access to their markets. It is also a solemn commitment to them, to  have and to hold, for richer, for poorer.

             As I have always said, having a joint bank account with the neighbours may not be such a good idea.

                  Today we have the debate on how to secure faster and more consistent economic growth in the UK.  I will be proposing a five point plan for the government.

                  HONEST MONEY   The Bank should be told no more quantitative easing  and reminded its sole aim is to get inflation back to target. Neither the public nor the private sectors can afford inflation of nearly 5% on the RPI.

                  LOWER TAXES  The government needs to raise an extra £176 billion a year in tax by 2014-15 to deliver its plan. If it cut Capital Gains Tax and Income tax rates it would be easier to deliver, as lower rates lead to higher revenues and more growth.

                  MORE AND BETTER BANKS  The policy to make the UK banking market more competitive needs to be brought forward. The Regulators should agree that the main UK banks now have  enough cash and capital  to be secure, allowing them to lend more to business and for major infrastructure projects.

                  LESS AND BETTER REGULATION  The government needs to revive its promised deregulation bill. Deregulation is the tax cut for business that does not cost the Treasury revenue. Sensible deregulation saves the government money as well.

                 MORE PRIVATELY FINANCED INFRASTRUCTURE   The government needs to make prompt decisions on the regulatory frameworks and planning position to allow the construction of a new generation  of power stations and  to permit more privately fiannced transport provision. It needs to crack on with its plans for faster and better broadband throughout the UK.

Dear EU shareholder and citizen,

              I am writing to reassure you that all is going well with our great European project. We have agreed plans to expand our spending for next year, and are busy working on a future budget strategy which will ensure continuous growth in our activities for the decade ahead. I am sure you all agree that after the huge success and popularity of the Common Agricultural and Fisheries policies the peoples of the EU are keen to do more together through our Brussels head office and central staff.

             We are especially pleased with the long term progress made with our own currency department, managing  the Euro. So popular is this that we have a queue of territories wishing to sign up to enjoy the advantages of it. Even our UK subsidiary, which has been reluctant in the past, has recently signed a document which their local Works Council says  confirms the long run intention of all territories to join.

            There have been some problems in the press with territories that have borrowed too much in local subsidiaries. I must stress to their CEOs that this is contrary to company policy and we will be taking further measures to control such behaviour in the future. We are currently drawing up a new Stability and Growth Pact to set out limits to each subsidiaries borrowing. We will also be adding better surveillance of all their business policies, and adding penalties for those who do not follow the company’s recommended approach. I am sure all local and regional managements will come to  appreciate the need for a common approach, as one subsidiary does not like having its cashflow diverted to pay the bills of another.

               We are concerned about our Greek subsidiary. We have issued a stern warning that they must spend less, until they build up their revenue more. It would not be good for the comnpany’s image if they failed to meet all their interest bills and repayments. We are very pleased with the way our Irish subsidiary is undertaking its third round of spending cuts to get its own excess borrowing under control. It is an example to all those subsidiaries with disappointing trading results in recent years.

              I am pleased to report that the new management in the Uk subsidiary is settling in very well, and seem to be keen on collaborative working.  They have willingly agreed to EU GMB taking more responsibility for their customer discipline policies and legal matters, have agreed to an expansion of the role of our external representation functions, and are enthusiaists for the new  borrowing and economic disciplinary framework. This has come as a wonderful  surprise. I think it shows the wisdom of our approach to the recruitment of new management. We have allowed   the anti company factions full rein to run their own candidates for management who never succeed in winning, to make sure no new management is appointed with full power to take an anti company line. We are hopeful that we can help them reform the whole system, to modernise it to one where it is unlikely ever again that an anti company management could be elected. The new Deputy CEO for the UK is a strong company supporter and is important to our future in this territory.

             We have been watching the antics of  US  Inc who have developed a passion for printing more money as a way out of their trading difficulties. I wish to confirm that this is not our company’s policy. We may of course need to give a wider range of powers and policies to our banking department so they can compete in an increasingly sophisticated world of money and finance, but this is entirely different to the wanton printing of dollars being undertaken by US Inc. Buying in bonds the way we do it will not be inflationary, I can assure you.

Yours sincerely

Chairman

               It’s been a bad few days for some European government bonds. New alarms in the market have arisen, as investors fear that some countries may have to reschedule or reduce payments to bondholders.

                 Germany can borrow ten year money for around 2.4%. Greece has to pay nearer 11.5%, and Ireland more than 8%, following recent market movements.  Portugal’s rate is around 6.9%.

                  The losses on these Irish and Greek  bonds in recent days may be a headache to some European banks, who own these bonds. It is certainly a headache for the countries concerned. As they come back to tap the markets for more money, so they will find the interest bill surges again, squeezing out more desirable forms of public spending. I notice that commentators who were sceptical of the UK’s government insistence that the deficit needed to be tackled have gone very quiet about the plight of the oevrborrowing Euroland members, now suffering from the cost of too much debt.

                The European Central Bank itself is not very happy about the situation. They have offered some support by buying up some of these government bonds, to try to stablise prices and limit the interest rate increases. So far it has not worked. There would need to be a much more concerted effort, doubtless paid for by  the  now usual process of the Central Bank creating the money to pay for the bonds. This in turn would weaken the Euro and make the weaker countries a bit more competitive, at least in the short term, intensifying the race to the bottom in currency markets. Alternatively the stronger  Euro member states would have to go to the rescue of the troubled states more whole heartedly, offering grants, cheap loans and other subsidies to tide them over whilst they try to adjust their spending and their economies.

             The problem for the peripheral Euroland economies is now most serious. Without economic growth they cannot get out of their debt trap easily, if at all. All the time they have to cut and cut again, and all the time they have to accept the exchnage rate that the stronger countries think appropriate, the recovery is further delayed.  There will be more stresses and strains ahead. There will be tension between the ECB and the stronger member states. I suspect the ECB will emerge with a wider range of powers, and will become the engine for trying to fine tune the running crises in the heavily borrowed countries.

           I have been reading the lengthy documents on EU Economic Governance which the Uk administration invites Parliament  to take note of . I do not think I can in any way  support them.

           The sheer audacity and ambition of them makes clear that many in the EU are now driving hard to complete an economic and moneatry union.  The sheaf of Parliamentary papers begins with the statement  “The main elements of the EU’s common economic policies are the Economic and Monetary Union, with the eventual aim that all member states will adopt the Euro, and the Stability and Growth Pact.”

             The documents refer to the excessive deficit procedure under Article  126 of the latest Treaty, and the power to use the right  to grant financial assiatnce to a member state  facing ” severe difficulties caused by natural disasters or exceptional circumstances beyond its control”.  To this is now added the Special Purpose Vehicle for mutual Eurozone support.

                The economic surveillance goes well beyond deficits to  include a “scoreboard of competitiveness indicators, including productivity, labour costs, employment, productivity, current accounts, foreign assets and real exchange rates”. Recommendations are the constructed for each member state based on how well or badly they are doing according to EU judgement.

                “The Government believes there is some merit in the idea of the “EU semester”, which would allow the EU to consider each Member state’s fiscal position at the same time as analysing its performance on structural reform issues… this would also allow all Member states to be given recommendations under the Stability and Growth Pact at the same time of year”

                    The UK is exempted from the sanctions and enforcement measures, but is still part of this big increase in economic surveillance and common policy making. If it is all as harmless and unimportant as the governemnt says, why don’t we just exempt ourselves from the whole thing, and demand powers back in return for any assent to a new Treaty?

             Melissa Kite in yesterday’s Sunday Telegraph revealed that the much vaunted Freedom Bill has been scaled down and transferred to the Home Office, as suggested on this site recently. She went to Liberal Democrat sources, who told her that Mr Clegg does not want to sift through the mountains of suggestions that came into the Cabinet Office website when they launched their consultation. I thought that was what we were paying his salary to do.

            I find it difficult to understand why Mr Clegg should be so reluctant.  When he set up the site he spoke well about the need to listen to the public and adopt their best ideas for remodelling government. The public exceeded expectations, inundating him with proposals. He should welcome that, and enjoy selecting the best for the first Freedom Bill.

              The Home Office has not ruled out incorporating ideas from other departments in their Bill, but it sounds as if the whole exercise has been scaled back to just make it a civil liberties Bill. Meanwhile, when it comes to excessive burdens on business, we are back in study mode. The governemnt is  consulting widely yet again over what if anything to deregulate. If the government is trying to sandbag deregulation then consulting  big business again  is the best way to do that, as big business nearly always confirms it can handle existing regulations, seeing them as a useful barrier to new and more competitive entrants to the market. Most small business is too busy minding the shop to spend time answering endless government consultations which might not lead anywhere. How many more do we have to go through before the government repeals anythigng that costs busienss a lot and delivers little? They are spoilt for choice. I trust Parliament will have plenty to say about this on Thursday.

               On Thursday I will be leading a one day debate in the Commons on the UK economy and economic growth. This is possible owing to the excellent reform that gives a Backbench Committee the right to allocate debates for one day a week. I asked for this wide ranging debate on what is needed to encourage decent growth and was granted it.

              In the run up to the debate I will highlight some of the issues I expect to arise and some which I will be tackling in my opening speech.

              The first requirement should be honest money. For twenty five years now I have found myself in dispute with the ill judged stance of the Bank of England, which has lurched from boom to bust and from boom to bust again. In the late 1980s I wrote and argued against joining the Exchange Rate Mechanism,  saying that joining would lead to boom or bust. We subsequently joined, and had both boom and bust as a result. It did huge damage to the UK economy, and plunged  the Conservative party into a 13 year political wilderness. People rightly objected to the high interest rates and the recession which ERM membership brought about.

               In the middle 200s I found myself arguing with the Conservative front bench about the wisdom of backing the so called independent Bank of England. I thought the MPC was likely to lurch from boom to bust. They did so in a way surpassing even my wildest fears, creating the conditions for the most extreme credit bubble I have ever seen followed by the worst financial crisis since 1929-32.

               Today I find myself arguing against more quantitative easing. The direct creation of money is an extreme measure for extreme conditions. If prices are falling or are in danger of falling, if there is a lot of unused capacity and if the money supply is falling there can be a case for money creation once interest rates have been depressed to near zero.

               The current situation is very different. RPI inflation is 4.6% and has been around 5% for some time. CPI inflation has been above target for most of the last five years and remains so. Much manaufacturing capacity is now back in use, following a violent shake out in 2008-9. There is evidence of inflationary increases in input costs,with many commodity prices and oil leaping up from the lows of 2008-9. Money growth has resumed.

               The public spending figures show how important control of costs, wages and prices are. In an era of low cash increases in total spending each year it is even more important to keep down inflationary increases to maximise what the money can buy. As we import around one third of what we buy keeping the pound up is crucial to avoid more imported inflation.

               The first task of the government must be to go forward to honest money. The MPC needs the Chancellor’s permission to print more. He should make it clear his permission will not be forthcoming in this climate. The UK needs to be weaned off inflationary shots of extra money.