Category: Blog

 

           One of the biggest disappointments of the last fourteen years has been the growing divide between the North and the South of the UK.

          Labour in office promised their policies would reduce inequalities, and start to put right the big gap between living standards and economic success in London and the Southeast of England compared to the rest of the UK.

        They set up or expanded regional and devolved quangos and governments, gave them large  budgets, and attempted to balance the country through government led programmes. The more they did this, the larger the gap got, with London especially powering itself to ever higher levels of growth, wealth and income. The north-south divide existed when Labour came to power, but grew much worse whilst they were in power.

          Labour attempted to cover this over by extending benefits to more and more people to augment their incomes from the state, and by creating more public sector jobs in its heartland northern areas. Whilst some individuals and families benefitted from this state intervention, the inequalities got bigger. The private sector led southern economy just kept outperforming the state led economies of the northern cities in receipt of special programmes.

        The economy did create numerous private sector jobs up to the Credit Crunch  crash in 2008, but these did not go to unemployed people in northern towns and cities sufficiently to make a positive difference.

        Today the Coalition government, like the Labour government before it, says these inequalities are too big and something should be done about them. The government envisages a private sector and manufacturing led recovery, with many more new jobs being created in the great northern cities. Last week we were told that a new High Speed train to Birmingham and Leeds would be central to this vision.

        When you look at the small print you discover that the new train will not be running this decade. Work will not start on the line until after 2015, if all goes well with the project from here. We can’t afford to wait that long to make inroads into the northern unemployment problem.

         I was sent a document recently showing deprivation and unemployment by area, coloured onto a map of the UK. The highlighted areas of low incomes and high joblessness fit well with a political map showing  Labour’s seats. Our politics is not healthy where one party represents most of the low income areas, and the other two parties represent the more successful areas. It encourages a Labour mentality that spending more in the public sector is the only answer, despite the evidence of the last decade that it did not reverse the growing gap or create enough jobs to solve the problem.

          I have written often before of the policies that are needed to foster a faster and wider private sector recovery that spreads to the northern cities as well as to EC1. We do need to spend enough on good quality schools and Colleges, and take what action we can to enable children who cannot go to independent schools to compete successfully with those who can. We need to cut taxes and control the costs of regulation, so business has a better chance of taking root. We need a pro business approach to planning and transport. What is remarkable about central London is the energy and vitality, the round the clock provision of services by a host of competing small businesses jostling alongside global corporations and brands.

            When I went to Huddersfield on Thursday for Question Time the BBC proposed using the train. That was fine for the outward journey, but it turned out there were no trains after 10pm, about the time I needed one to get back home. It was also obvious there would be no connecting train from London to anywhere near where I live.

            I was booked on the 5pm to Wakefield. It would require a car to get from there to Huddersfield. I was sent an electronic summary of the ticket, seat reservation and confirmation of payment like an airline. It said I had to take it to a ticket office to get the physical ticket.

          On arrival at Kings Cross I queued at the temporary ticket office I found from the tube station entrance to the mainline station.  The ” savage spending cuts” meant that the station itself is undergoing a very comprehensive and expensive refurbishment and reconstruction.  When it was eventually my turn I was told the man at the ticket office window was unable to handle my request for my train ticket. He redirected me to another ticket office.

          I queued there. I was told by the BBC to transfer to the earlier train, the 4.31, and told in the electronic confirmation that the ticket they had bought was transferrable.   I asked the ticket office to issue a ticket for the earlier train. I was given a ticket, and another ticket which was a seat reservation. It was difficult to see why they needed to issue two tickets for the same journey.

          As I walked towards the train I realised I had been issued with a seat for the 5pm, not the 4.31. I went back to the ticket office, and queued again. I asked why I had not been issued with the train ticket I had requested. I was told that if you wished to change trains you had to arrive 3 hours before the train you wished to catch! I asked if there were spare seats on the 4.31. The ticket officer said he was unable to tell me! The ticket office seemed to have plenty of computers, but little ability to help customers.

          As it turned out there were plenty of spare seats. There seeemed to be plenty of scope to cut costs and raise the quality of customer service.

          

 

          Mr Andrew Cooper’s arrival at Downing Street has brought an admirable wish to speak truth to power to the centre of the government.Tthe results of some of the polling lies behind  the recent decisions to change policy. The polls did not just do for some of the more hotly contested changes to the NHS, but also have warned the government not to go soft on sentencing, and to take controlling immigration very seriously.

        A good pollster can warn a government off doing things which are currently unpopular. This may often be the best advice, as they may be unpopular for a good reason. Their unpopularity might grow if you persevere with the policy – as past governments discovered with the ERM, the Community Charge, the Iraq war and political correctness agenda of Labour. The politicians in receipt of the polling also need to avoid killing off projects that are unpoppular in prospect, but which may well be in the national interest. Sometimes political leaders have to stand and argue their case. If they are right, the public will come round to support them. Some of the important reforms put through in the 1980s that have stood the test of time and are now accepted would have polled very badly at the time.

            There are a number of policies that Conservatives would love to see submitted to the polling test. How much support is there for EU bail outs? How popular are the climate change policies and carbon taxes?   How much support would there be for a less intrusive relationship with the EU, and for asking the UK people what they think of that relationship?

             Bring on the polling. It could make politics more exciting, and make the government more popular, if used intelligently. What would you like to be submitted to the poll test?

 

              The UK government is about to ask Parliament’s permission to subscribe for £9.5 billion of new capital to the IMF. I expect we will be told we have to do this, there is no alternative, it’s part of the price of our memebrship of this international club.

              So let me begin by saying I am not recommending we withdraw from the IMF or refuse all new subscription. What I would like us to do is to argue against the IMF making more money available for a second Greek bail out when the first does not work.

              I also think we could offer a lower additional subscription than the one currently proposed. The interesting  thing about the proposed new subscriptions is how variable they are. China and India are offering large percentage increases in their subscriptions, to reflect in their IMF share their growing stature in the world economy. Meanwhile despite their good oil revenues, Kuwait is only offering a 40% increase and Saudi a 43% increase in their sub compared to the UK’s proposed 88%.

             It’s not merely the oil countries that are below us. Germany at 83%, Switzerland at 66%, Holland at 69% and Canada at 73% are also all below us. Belgium at 39% shows that just like an oil country a rich European country can offer a much lower amount.

          If the Uk matched Belgium and Saudi our new subscription would be £4.3 billion rather than £9.5 billion. In our financial position that would be a lot more comfortable. It would also be a smaller loss in Greeece and fringe Euroland if we did not win the agrument about what the IMF should be doing with our money.

         The IMF needs to heed the market warnings about the dangers of Greece and maybe others  not being able to repay all their debts on time.  Greece would have to pay 17% interest to borrow 10 year money in the market today. Holders of 10 year Greek debt  have lost 40% overthe last three years (capital and income combined). Portugal and Ireland woudl have to pay 11% today for 10 year money. Holders of 10 year bonds have lost 20% over the last three years (income and capital combined) in these two cases.

 

             Friday’s first report of the Financial Policy Committee of the Bank of England was an important event. This is the new body charged with regulating the banks and main financial institutions. To the tabloids, it is the Bank’s committee to prevent another Credit Crunch. It will absorb and take over many of the duties of the Financial Services Authority and the Bank’s remit to manage systemic risk.

              As you would expect the Committee produced a heavyweight document. It had plenty of analysis and factual information. It correctly identified sovereign debt risk as the biggest immediate threat to the whole system of global banks. It pulled no punches about the severity of the Euro crisis.

             The  worry I had reading it was a simple one. Did these clever and well informed people make a sensible judgement about what they should do – if anything – to manage the risks they rightly perceived? A systemic regulator has to go beyond coming to well informed academic conclusions about the state of the world to deciding if it can and should make an intervention which will reduce the risks being run in a helpful way.

             Their prime recommendation to tackle the sovereign debt dangers was to “advise the FSA to ensure improved disclosure of sovereign and banking sector exposures by major UK banks…” I support more disclosure of these positions. Better knowledge allows the market to make more sensible judgements about risks in banks. It also might make bank executives more worried about owning too many government bonds which could go wrong.

             However, it does not help solve the sovereign debt problem. Nor does it help the banks in  the short term. It will enable market participants to apply discounts to the holdings of government debt by banks to reflect risk of default in the worst cases, and risk of loss owing to rising interest rates in all cases. Meanwhile the regulators continue to score government debt in each country of issue as risk free. The Regulators need to ask themselves tougher questions about how in the medium term they will reflect in their calculations the interest rate risk and credit risk in sovereign bonds. A sharp move to too  much caution now would not be helpful, but the longer term position is not sustainable, as these bonds in some cases have been imprudently evaluated and counted. 

                 The second main recommendation of the FPC sees them wrestling with the central conundrum for the UK economy. Is the priority to build up more and more bank capital to prevent another 2008-9, or is it to secure more bank lending to allow faster economic growth?

                They say “The Committee advises UK banks that, during the transition to the new Basel III capital requirements, they should take the opportunity of periods of strong earnings to build capital so that credit availability is not constrained in periods of stress.”

               This goes to the heart of the current dilemma. The government and public want a more vigorous recovery. That requires more bank credit to pay for more private sector demand and more business expansion. The Regulators want to buttress cash and capital at banks to much higher levels, so they can relax about the impact of any future crisis on banks. You cannot easily do both at the same time.

              The crucial advice to banks is unclear. Is now a time of “strong earnings” so they should be putting away more profit for a rainy day? How can you make more money available at times of stress, if a time of stress is defined as a time when little money is available? Isn’ t the danger of all this that the regulators are in effect encouraging the banks to be super prudent at a time of little growth?

             The FPC needs to discuss the idea of counter cyclical regulation. Many now genuflect to this idea. It states simply that when economies  are running hot and banks are expanding rapidly, the regulators should lean to demanding banks hold more cash and capital to cool things down a bit. When economies are running slowly and banks are not expanding their balance sheets much, the Regulator should relax the advice on cash and capital sensibly, whislt keeping acceptable minimum standards. China, for the last year, has been calling for much higher special deposits, raising interest rates and taking other monetary action to slow her economy because of the inflation and fast growth. She did the opposite in 2008-9 to offset the deflationary effects of the western Credit Crunch.

                The FPC needs to have a view of the cycle, and to express this in its cash and capital advice. Of course there should always be acceptable minimum levels. All the main UK banks are well above those today, following a huge squeeze on the RBS balance sheet and appropriate action elsewhere.

                I would have liked the FPC to say this:

“The UK economy, in common with several other western economies, is operating below the peak levels of 2007-8, and has been growing slowly since the recession bottom. We judge the current need is to accelerate the growth rate somewhat. We regard an 8% Tier One Capital Ratio as the necessary minimum (compared to 5% hit by some in 2008). We advise banks to exapnd their balance sheets sensibly, offering more Uk lending. We will only be requesting higher levels of cash and capital in the event of sustained  resumption of growth above trend for more than a year”

 

               Yesterday we saw the first Financial Policy Committee Report from the Bank of England, as the new regulator of banks awaiting full hand over from the FSA.

              Their first instruction to the FSA is:

“The Committee advises the FSA  to ensure that  improved disclosure of sovereign and banking sector exposures by major UK banks becomes a permanent part of their reporting framework”

             The explanation for this requirement is

“Sovereign and banking strains are the most material and immediate threat. Market concerns remain over fiscal positions in a number of Euro area countries and the potential for contagion to banking systems. Any associated disruption to bank funding markets could spill over the UK banks”

              If you read on into the Report one of their charts tells us the horror story. It shows that markets think there is an 80% probability of  Greek government  debt default within the next five years, a 50% chance of a Portuguese government debt default, and a 45% probability of an Irish default. The Bank rightly points out that the amount of dangerous government debt owned by the main UK banks is under good control. Their implied conclusion is UK banks will be fine even if there is a default of one or two of the smaller Euro governments. The only danger is a third round effect, if  there is  a drying up of wholesale finance to continental  banks who lose more on dodgy sovereigns, which in turn could start to disrupt wholesale funding to banks in general.  

           However, they also say that “since 2008 major UK banks have increased their holdings of global government debt securities from 5.9% to 9.6% of total assets. ” They rightly warn that government  bond yields, currently very low in advanced country markets, “could..be susceptible to a reversion towards more typical levels”. This means that there is a risk of  capital losses on government bonds even where those bonds are in no danger of  default. It is true they can be held to repayment in which  case the bank gets all its money back.

          The bottom line is the UK is not badly exposed to the Euro crisis. The biggest risk would come if the UK government  lent lots of money to troubled countries which it subsequently lost.It  is reassuring that Mr Cameron has kept us out of the second as well as the first Greek rescue package, as the UK state cannot afford losses on Euro bail outs. Now the Uk government needs to tell the IMF to be careful with our money as well.

 

          Yesterday was a day when Parliament asserted itself against the executive. Nellie is saying Good bye to the circus, if Parliament has its way.

          Conservative MPs had been placed on a  three line whip to vote down Mark Pritchard’s motion. The government favoured better regulation of circus animals. Mr Pritchard favoured a ban.

           It appears that some of the new intake of MPs  went into the Chamber to say they too suported a ban, whilst others decided to leave Parliament in preference to voting against a motion they sympathised with. The whips sensibly decided to remove the three line whip against the motion, and it duly passed unopposed.

           Mr Pritchard’s speech in the chamber told us of the pressures he had been under to change his motion. It was an interesting moment in  the evolution of this Coalition government, when the government had to accept it was  better not to  test the mood of the Commons.

 

           When some of us opposed early and wide monetary union within the EU we said joining the Euro was joining an Exchange Rate Mechanism you could not get out of. Some went further, and said the danger of joining the Euro was locking yourself into a common European house  and throwing away the key when the house  might catch fire.

           It is not easy for any one country to leave the Euro. It is best done rapidly, taking markets by suprise and presenting them with a fait accompli. It is easy to redonominate all bank account money in any given country by a press of  a button. It takes longer, allowing people to trigger a run on banks, to print the new currency and circulate the new bank notes. Why would people hang around with money on deposit in a Greek bank, if they thought a 15-30% devaluation was just around the corner? They would want to pocket their Euro notes and expect them to be honoured.

             It would be fairest to devalue the currency of all Greek bank account holders, but not all holders of Y serial number Euro notes. Once the drachma replaces the Euro as the legal tender in Greece, Greek holders of Euro notes would be able to sell them into drachmas. The Greek state would be wise to impose a limit on how many Euro notes a Greek citizen could convert into drachmas, imposing a lower rate of exchange on excess. There could be some leakage by Greek citizens travelling abroad to exchange larger sums. The Greek state should print a starting level of drachma notes as quickly as possible to cut down the time people had to play games against the devaluation. Once the new currency had been announced it would be possible to limit cash withdrawals pending the full print run of drachma notes.

              All debts, contracts and agreements in Greece denominated in Euros would automatically  be changed into drachmas by law. International contracts including Euro debt owed by Greece to foreigners would require negotiation by both sides where the governing law was not Greek law.

                 The new drachma should be allowed to find its own level in the markets against the Euro. The Greek central bank would need to make a clear statement of its intent vis a vis the issue and control of the new currency and the Greek government would need to make a full economic policy statement with guidance on proposed inflation, growth and monetary targets.

              Greek people would be worse off when buying foreign goods by the amount  of the devaluation. Greek goods and services would be cheaper by the amount of the devaluation. The Greek economy could start to recover as it exported more and welcomed more inward investors, holidaymakers and other sources of income and jobs.

                Countries with free floating currencies do adjust more quickly to changed circumstances and to falling living standards than  coutnries with pegged or shared currencies. Faster adjustment means less pain in the longer run.

 

             You read it here first!. I support the CPS scheme for transfer of bank shares to the public in the UK, and am glad Mr Clegg has joined the supporters list. I raised it again in Treasury Questions this week.

 

                There are three possible ways of handling the Greek phase of the running Euro crisis.

1. Muddling through – or Pretend and Extend. This is the way favoured by the current Euro establishment. Greece is offered loans on special terms from Euroland members and the IMF in return for promising to make major cuts to spending, increases to taxation, and to sell assets.

2. Devalue and default. Greece could withdraw from the Euro, establish the drachma again, devalue, and come to an agreement with  creditors about how much of past debt will be repaid, and on what terms.

3. Press  on to political union for the Euro zone. The richer areas within the Union would then have to send more money by way of grant to the weaker areas, including Greece. Greece would have a budget controlled or influenced by the central Euro political auithority, and would be able to benefit from the common interest rate for borrowings that were part of the Euroland budget.

          Today I wish to explore Pretend and Extend, as this is the main option on offer. Its attractions to the political establishments of Europe are obvious. It delays having to take the losses on Greek sovereign debts. The authorities can still pretend that banks that have lent to Greece on favourable terms will get all their money back on time. It leaves open the chance that Greece will sort out its domestic economic problems sufficiently to be able to borrow again in the normal way from the markets and banks. It does not require richer Euroland members to have to send more grant to Greece, which their own electors might oppose.

             Many people in the markets are sceptical. They do not see how Greece can get back to a credit worthy position. They point out that the first loan package was meant to buy enough time for Greece to sort herself out, but it has not been successful. Every addition to the Greek debt mountain makes future budgets that much more difficult, as the interest rate bill is constantly rising.  The authorities can pretend that the banks have not lost money on their Greek loans, but if they were to mark them to market – value them at today’s prices – they have already lost a lot.

          The Greek people are not impressed. They think they are being asked to sacrifice too much as they see the tax rises and the spending cuts. The Greek government was unable to hit targets for reducing the deficit in the first half of this year. There are serious questions over how successful its latest austerity programme will be. There are doubts that it can raise as much money as planned from asset sales, as Greek assets are not popular at the moment. The protests of the Greek people against their EU and domestic governments make Greece a less attractive place to holidaymakers and investors.

           The Greek recovery plan needs a lively pace of economic growth. Greece is restricted in seeking this. It cannot devalue to price itself back into world markets as the US and UK are doing. It cannot create extra money to stimulate activity. Its banks are losing deposits, as savers withdraw their money in fear of adverse changes to their wealth.

           If Euroland is determined to save Greece from within, they need to sit down and hammer out a new plan. Pretend and Extend on its own delays but does not resolve the crisis. This may well require EU intervention to an even greater extent in Greek budgets and EU involvement in the implementation of a deficit reduction programme. It also needs changes to Greek banking and to policies for growth and enterprise to give the Greeks some chance of working their way out of the problem. It would help if the Euroland area accepted more of the responsibility for funding Greece, by sending more grants to her to offset the adverse consquences of the currency on that part of the zone.