Month: October 2011

         I have been asking a few Ministers to tell me how much current public spending  has gone up by so far under this government. So far no-one has been able to tell me it has gone up by £56 billion or 9.3%, 2011-12 compared to 2009-10.  They have seemed rather suprised by the size of the increase.

       Then they have said it must be a real cut. It is difficult to see how a  9.3% increase  is an overall real cut, even at the current rate of inflation. We need to take into account the pay freeze, where pay is such  a large element in public sector costs, and the better buying initiatives which are said to be keeping cost increases down. It is of course true that there are some cuts in some budgets within the growing totals. It is also true that some departments favour sacking some staff at considerable cost, and then  hiring new people at further cost.

                 If you allow for the full 4.5% of stated CPI inflation (Ministers chosen measure), and then allow for some forecast drop in CPI inflation early next year as higher VAT falls out, you do not get to 9.3% inflation for the two years. RPI inflation is higher, but there ought to be a big offset in public sector costs for the pay freeze.

         The issue before us is by how much will the deficit increase as lower growth is put into the forecasts? We know that the Office of Budget Responsbility is going to have to cut its growth forecasts again.  These were last seen at 1.8% for 2011-12, 2.7% for 2012-13, and 2.9% for each of the following two years. That gives us 10.7% over the four remaining years of the plan.

         Let us suppose  growth this year is 1.0%, and then growth averaged 2.0% for the last three years. This is a moderate forecast by the standards of current forecaster gloom.  That gives us 7.2% instead of 10.7%, or 3.5% less. That would imply that the government would have to borrow an additional £5 billion this year, an additional £9 billion for 2012-13, an aditional £14 billion in 2013-14 and an  additional  £20 billion in the final year to make up for lost revenue. That makes a total of £48 billion more borrowing, on top of the £485 billion planned for the five years of this Parliament.

          It is also quite likely more spending would be needed, as there would be more people on benefits and other spending pressures from slower growth.  We might need to add in another £20 billion of spending slippage. This means we could be in for a another £68 billion of borrowing, an increase of 14% for the period as a whole. This comes on top of the £34 billion increase in total period borrowing announced in the March budget.

          The Treasury will say this is all allowed as the cyclical effects will be higher. It all, however, needs financing. It just goes to show how crucial growth is to getting down the deficit, if you want to do it mainly by increasing tax revenues rather than by cutting spending.

           My advice was to have a small spending  increase in Year 1, a 2% increase in year 2, then larger increases than the Coalition plans in Years 3-5, averaging 3% per annum instead of  their 1.9%.  This alternative would have cut borrowing back  from the £485 billion planned for the five years  thanks to lower spending in the first two years, whilst giving better spending increases in  the second half of the Parliament.

                   Now the government has difficult choices ahead. How much of the slippage will it seek to erase by spending cuts or tax rises? I assume none. How much extra slippage in the short term will it permit, in an effort to buy some more growth?  How many more EU one-offs will there be, like extra money for the IMF?

            We hear that the EU is working away at a solution to the Euro crisis. It comprises three main elements – more capital for banks, bigger write-offs on Greek debts, and a huge support fund to bail out any other country or bank that needs subsidy.

             If the package lives up to the billing it might impress the markets for a bit, and buy them some more time. It does not solve the underlying problems. There still needs to  be a solution which enables the uncompetitive countries in the south to become more competitive to earn their living. If they cannot do that by the stealth of devaluation, they need to cut wages and other costs sharply, which is unpleasant and difficult to do.  There has to be  a way for  the countries too heavily in debt to get their deficits and in due course their levels of debt down. Lending them more money puts off the adjustment, it does not make the adjustment for them.

              The proposal to put more capital into  the banks is not unalloyed good news. The EU governments would prefer the private sector to do this, under orders. The easiest way to do get better banking ratios is for the banks to lend less. This will not help the recovery.

             The German end of the argument does not like the idea of  big state injections of capital. The German position has favoured private sector solutions, ranging from raising more capital on the markets through controlled administration for failing banks, with bondholders and shareholders taking the loss. I advocated controlled administration for failing UK banks in 2008.  It would have been a cheaper and more rapid solution than the nationalisation model adopted, and would have spared the taxpayers such anger making losses.

            The UK has moved to this position through the FSA work on “living wills”, advanced plans to wind up a bank in an orderly way if it runs out of cash and capital. The Vickers Report rightly endorses this approach. It now sounds as if the EU is back tracking, moving back  to the old idea that in the last resort the state gives a failing bank any amount of cash and capital it needs, effectively nationalising the losses and risks. Given the weak state of most country finances, and the dislike of banks amongst electors,  this is a kind of madness. Weak countries and weak banks cannot in the end prop each other up: they pull each other down.

            We are openly told the governments are working on a second Greek default proposal where lenders to the Greek state will lose more than the one fifth of their money in the old plan. It is now universally accepted that Greece “cannot” pay back its debts. If they fail to pay back half or more of what they owe, they will then be spared substantial  interest and capital payments which eases the pressure on their state budget. It is a short term palliative. Once again it does not solve the underlying problem, which is the Greek propensity to live beyond her means.

             A Greek default is not necessarily helpful for the other weak countries in the Euro scheme. If one country is allowed to default and does so, might another?  How do the Euro authorities draw a line under a Greek default, and convince markets that other countries will be made to honour their debts? It is hardly a good advert for Euro zone management that a member state is actively encouraged to say to the countries, companies and individuals who lent to it they will not get their money back. Markets are likely to price in default danger in other Euro sovereigns, charging the weaker countries more for a loan as some protection against similar treatment.

              The EU is proposing a mega fund, briefed at anything from Euro 2 trillion to Euro 3 trillion, to provide shock and awe to markets. Euro 3 trillion would probably  impress the markets. It would show there was a lot of fire power, enabling Euroland authorities to help secure  lending  to Italy and Spain  at low interest rates if the market is unwilling to do so, and enabling them to prop any bank in the system that was weak. This has to be done indirectly and clumsily, as the ECB cannot lend direct to Euro sovereigns.

               The issue here which the markets  may test is how much political will is there to spend this money if need arises? How real is the Euro 3 trillion? Where does it come from? How does it get repaid in the end? In  short, it has to be a genuinely available Euro 3 trillion that comes from a plausible source or sources. Is it any more than saying Euroland as a whole will borrow on its combined credit rating to lend to its weaker members at subsidised rates? Is Germany really up for this? Does it mean that the AAA ratings of France and Germany have to be downgraded, as they come to assume more responsibility for the debts of the weaker states?

                   Euro 3 trillion is a lot of money even for Euroland. It either is borrowed, or it has to be raised from taxpayers. Either route poses problems, as well as offering a temporary answer for markets. Higher taxes can have a depressing effect. There seems to be no agreement to a financial transactions tax as part of the package.

                       Of course, there is a third route. They could sanction the European Central Bank to go printing it. The Bank could buy up as many bonds as was needed, using electronically created money like the US and UK. That might work for a bit as well. If you do that to excess it causes too much inflation. I doubt the Germans would openly  sign up for that. We need to watch the small print behind the spin.

                     I was pleased to hear yesterday  that the UK and US were both objecting to a greater use of IMF money to buttress the single currency scheme. I have been trying to persuade the UK government that IMF money should not be used to bail out rich countries that have chosen to inflict a currency scheme on themselves which does  not work. Why should some of the world’s poor have to subsidise the rich in their folly? And why should UK taxpayers be dragged into subsidising Euroland through the IMF, when we did them a good turn by staying out?

                       Today’s news that despite the opposition voiced the UK might go along with another increase in IMF resources to allow more bail outs of the Euro zone is bad news. The UK needs to get its public spending under control. Starting with no new money for EU bail outs should the the easy bit. The public will not be pleased if we end up picking up yet more of the bill for this ill judged and expensive scheme.

                     The UK should say to the IMF it should stop encouraging the idea that other countries should send money to rich countries that decided to inflict so much damage on their own economies, and intend to persist with doing so despite all the evidence. The answer to the Euro scheme is to reduce its membership, not send it more cash.

            The liberal media tends to call anyone “right” as a term of abuse for people they disagree with.  The “right” within the Conservative party is a term used  to describe a wide range of people, often with very different views on issues.

            There are, for example, right wing  liberals, and right wing authoritarians. The right wing freedom lovers want more civil liberties, seek proper checks and balances to the abuse and use of state power, distrust ID cards, excessive stop and search, detention without trial and the rest.  The right wing authoritarians think the state’s prime duty is to defend its citizens. They think the state might have to restrict freedom, keep more records, spend more on police, prisons and surveillance.

              The first group of “right wingers” often find themselves in alliance with “left wing” civil liberty lobbies. The second group of authoritarians have more in common with Blunkett and the populist authoritarianism of New Labour.

                There are then the small state “right wing”  Conservatives, who want the state to do much less, spend, borrow and tax less. These are countered by the better state Conservatives, who want expanded Armed forces, police and security budgets and budgets for some other public services even at the cost of higher borrowing and taxes.

                  There are “right wing” moral Conservatives, following a Catholic style morality. They want tight control on abortion, religious education, tax breaks for the married family, support for traditional families. There are then the new liberal right wingers, who want much greater freedom for various lifestyles, and favour liberalising drugs, and avoiding moral comment on how people live.

              In foreign policy there are “new right” neo-cons, who support muscular intervention, often led by the USA. They gave Tony Blair strong support for Iraq and Afghanistan. They are opposed by small state Conservatives, who disliked the assertion of force in the Middle East by the UK.

                 The Commons often throws together some unlikely collaborators. Traditional socialists want less power to go to the EU, as they see the EU as a kind of capitalist plot. Many Conservatives want less power to the EU, as they see it as a kind of social democrat plot. The two groups agree about several things, They agree that decisions should be taken in the UK, not in Brussels. The main decisions should be taken by elected officials answerable to the UK electorate. The decisions should be capable of reverse if the Uk government changes.  They merely disagree passionately about what those decisions should be. Anti EU votes bring together so called left and right.

                Some Labour people were upset by the attack on civil liberties mounted in the name of counter terrorism by the last government. They do end up voting with Conservatives to curb the powers of the state.

                      The Catholic family agenda has adherents on the Labour benches as well as on the Conservative benches.

                      It is all a lot more complex and fluid than a simple left-right analysis would suggest. The prism of party loyalty and dog fights is no longer a perfect one through which to see three party politics with many pressure groups and splintered factions within main parties.

                     The Prime Minister was correct to seek the facts on Dr Fox before making a judgement. Dr Fox himself decided to resign as he reflected on the facts that were emerging about his case. The Prime Minister need not worry about the “backlash from the right” that the media have been trying to create  as the next phase of this story. The right accepts the Prime Minister behaved sensibly in a tricky situation.

                    I have never felt right-left is a particularly good way of analysing modern UK politics. It is, however, preferred by many in the media, so let’s try and shed some light on it. To me the one big division in modern UK politics is pro and anti EU, the division  between those who want the EU to do more and more, and those who want it to do less or want out of it altogether. This cuts across right-left and across party.  The unifying characteristic of those the media call the “right” is that they want a lot less EU or want out altogether. There are many more Eurosceptics in the Conservative party than in the other two main parties.  They are joined in this by figures on the “left” as well. The Bennites in Labour have the same view as the Better off outers in the Conservatives.

           The “right” of the Conservative party are perhaps best defined by who they vote for. They are the MPs who voted Graham Brady in as Chairman of the 1922 Committee. The establishment wanted a different candidate. The party choose a Eurosceptic, who also believes in selective education, lower taxes and other such causes. This election showed that the “right” has the majority in the Parliamentary party. That same majority in an earlier Parliament had voted for Iain Duncan Smith as Leader. Some of the “right” voted for David Cameron as Leader in 2005, believing him to be a Eurosceptic too.

            The “right” was not keen on a Coalition government. It did not want the issue of the EU blurred by Lib Dem enthusiasm for it.The “right” would have preferred a looser arrangement possibly followed by an earlier election. In the first Cameron Cabinet the “right” felt it only had three clear champions, Liam Fox, Iain Duncan Smith and Owen Paterson.   The Home Secretary has been giving Criminal Justice powers away to Brussels. The Foreign Secretary put through the expanded External Action Service and keeps saying now is not the time to sort out the EU issues and demand powers back. In areas like energy, environment and business we are effectively governed from Brussels for much of the time.

             The “right” saw that Liam Fox was determined not to let the EU take any more powers in defence matters, and to keep the UK as free as possible to make its own decisions. They saw that Iain Duncam Smith and Chris Grayling are trying to get more control over UK benefit and migration policy.

               There are other issues for the “right”. The right would like more cheaper energy, disliking the global warming ideology. They see the EU as a  major obstacle to commonsense on fuel. They are very strong supporters of the deficit reduction policy, and want this to be primarily achieved by spending reductions. They would like to have more cuts in selective areas, starting with the EU budget.

               The right felt the old Cabinet grossly under- represented their strength and views. The reshuffle does nothing  to correct that feeling.

               So how does the “right” feel about the new Cabinet? I will have a better view next week when Parliament is back. The “right” has no ill will to Justine Greening: nor does the “right” think she has been pushing for a more muscular approach to EU negotiation. Now she is in the Cabinet MPs will be watching to see if she will take up the cause.

               It will also be interesting to see if she wishes to redress the anti road transport and motoring bias in modern transport strategy, and to see how she tackles the highly contentious HS2 project. The BBC today were saying that Mr Hammond was a “safe pair of hands” at Transport. That’s not how the right saw him. They were very disappointed by his failure to end the war on motorists as promised, by his refusal to back more private sector investment in transport, and by his repeated defence of HS2, a very expensive project which many would like cancelled or deferred until the national budget is in good shape.

               Meanwhile, at Defence, there will be new concerns about how robust the government will be when dealing with the constant drift to more EU control.

           I have written before that for centuries one of the main aims of UK foreign policy has been to avoid one single power dominating the continent of Europe. The question today is why has the modern Foreign Office changed its mind on this fundamental issue? Why is it now UK government policy to welcome a single country with a single currency controlling most of the continent?

          In the sixteenth and seventeenth centuries the UK fought against Spanish domination of the continent. In the seventeenth and eighteenth centuries the UK successfully opposed French domination. In the twentieth century the UK with the help of the USA successfully resisted German domination.  

          The UK used to fear that if a single country came to dominate, they could close the continent off to fair trade with the UK. There would be the ever present danger they would want to take us over as well.

          Today the UK goverment tells us encouraging the emergence of a single government for much of Europe would secure our trade and improve our relations with the continent. It is difficult to see why they believe this. All those people who for years have been telling us Europe is “going our way” and under Labour how “we have influence in EU matters” now have to explain how it is most countries in the EU are poised on the edge of substantial further economic and political integration, with the UK on the outside with no clear view of how its relationship with such a new country might work.

             There is evidence of protectionist tendencies in the bureaucracy of Brussels. It is ever ready to impose taxes and regulations on business, to create barriers to entry and to seek to control or reduce UK successes from the art market through to various financial services. The Franco-German architects of the current phase of ever closer union are no friends of the finance sector, the one which just happens to be the UK’s most successful.

             The truth is it will be more difficult for the UK to protect herself from EU rules and regulations if there is further integration and the creation of a strong inner Euro bloc within the EU. The Foreign Office should have thought more carefully about the economic dangers of more Euro integration, as outlined here yesterday. It needs to follow up that thinking with more thought about what the UK should demand and insist on to protect against the obvious dangers of a more powerful and more integrated Euro  zone emerging as the UK government claims to want.

         The Care Quality Commission Report yesterday was shocking.  I would be interested to hear comments on other experiences of the quality of care in hospitals, especially for the elderly. Why have there been such serious lapses in nursing standards?

The UK government – Coalition Ministers, senior officials, the Bank, the FSA and the rest – buy the argument that a collapse of the Euro would do untold damage to Euroland, and therefore to us, given the trade we do with Europe.

Their predecessors took a similar view of the Exchange Rate Mechanism. They spent and borrowed huge sums to try to peg exchange rates at levels markets thought wrong. All the time they tried to keep the impossible pegs in place they triggered inflation, recession and other extremes. The ERM first gave the UK inflation, then it gave us recession. It meant we always had the wrong amounts of money and the wrong interest rates.  They discovered that it cost large sums of money to try to buck the markets. In the end they were overwhelmed by the force of the markets against them, and abandoned their quest.

The Uk economy started recover as soon as we left the torture of the ERM. Our currency found a competitive level to help exports. The Bank and Treasury could return to following a sensible monetary policy. The country no longer had to throw good money after bad trying to keep the pound at an artificial rate and then losing large sums as a result. Interest rates came down rapidly.

Nicholas Ridley and I kept the flag flying against the ERM in government, but lost to the Treasury and Foreign Office combined. Eventually the Treasury realised the game was up and made the brave decision to tell the Prime Minister he had to abandon his policy and try something better. Our exit from the ERM ushered in a good period for the UK.

I find it difficult to grasp why so many people think the Euro is good for Greece or Portugal. They have lost their democracy over it, as they now have to be run by a committee of lenders to them. Their politics rests on the regular inspections of the bank managers. They cannot devalue to make themselves more competitive. The Euro scheme encourages some in those countries to think that the answer to their problems lies in bigger transfer payments from outside, rather than in coming up with local solutions to their problems and being responsible for their own destinies.

It is also difficult to see why Germany thinks it is such a good deal and a good idea. Of course some of her leading export companies enjoy selling goods into other parts of Euroland at advantageous exchange rates . More and more of Germany’s exports however need to go to places outside the EU given the slow growth or economic declines within the zone. Germany used to be a successful exporting country with a rising DM.

On the other side of the account Germany is about to pay a large price for her politicians’ enthusiaism for the Euro. German taxpayers will have to pay more tax to bail out other Euro countries. Germany’s own credit rating could be damaged by assuming debts on behalf of others.

The nonsense that a single market needs a single currency needs knocking on the head. The North American free trade zone does not require a currency union. Many non EU countries trade quite happily with the EU without sharing a currency. The UK still trades with the EU  whilst keeping the pound.

Others mutter in hushed tones that they have to save the Euro to save the EU banks. It is the Euro scheme and the excess sovereign debts it has allowed that has weakened the banks. Keeping the Euro does not solve these problems, but will probably make them worse. The banks need sorting. It is not easier to do if you keep the zone together, as you are not sorting out the underlying problems.

Extend and pretend cannot work. Deficits have to be curbed by spending less or raising more revenue. Weak banks have to be sorted out by raising more capital, selling assets, and making proper provision for losses.

The truth is that the Euro is an ERM that does more damage, that will lose its participants more money and be more painful to split up. It is not an ERM that works.