Category: Blog

 

             The IMF under Mme Lagarde says it wishes to have more money at its disposal to be able to bail out the bigger states of Euroland if necessary. The lady tells us that their current facilities of $400 billion may seem like a lot of money, but they  could spend it all quite quickly if one of the larger EU countries needed a rescue.

             I thought the IMF was there to lend money to near bankrupt sovereign countries when all else had failed. They normally put in a programme of spending controls, asset sales and devaluation, to give the problem country a chance to work its way out of debt difficulties. They regard it as a sovereign risk, as the state in question can always print some more money to meet the nominal liabilities it faces.

              If Scotland or California got into financial difficulties and needed to borrow more than the markets wanted to lend, the IMF would not go anywhere near the problem. The IMF would  say that  Scotland is part of the sterling currency union and UK federation, so it would expect the rest of the UK to sort it out. It would regard California as part of the US federation and a member of the dollar currency union, so again there would be no loan for that state.

              So we have to ask why are there loans for states who have given away their monetary and currency sovereignty and are now members of the Euro currency union? They can’t print the money they might need, and they can’t devalue, so why should they be regarded as sovereign risks that the IMF might take on and tutor back to economic health? They are clearly riskier bets than sovereign states, because they do not control their own Central Bank and monetary policy.

                  In her new role Mme Lagarde should not be an apologist for a failing Euro model. She should  not seek to distort the IMF portfolio by placing  massive bets on failing Euro states. These loans merely put off making the proper adjustments to the single currency model. Greece and Italy have to become like Scotland and California are within their single currency areas,  within the Euro union. They are the Euro area’s problem, not the IMF’s or the world’s.

                As a leading member and contributor to the IMF I would like the UK to ask some sceptical questions about the wisdom of the IMF bailing more Euro countries. Without proper budget discipline, monetary reform and new political architecture the Euro cannot work properly, so it is a huge mistake to go on pretending and extending more credit as if it was fine.

               Trying to bail out Italy if Italy finds it too difficult to borrow money in the normal way on the market should be too expensive for the IMF to contemplate. If Italy cannot finance herself in the Euro in the markets, there must be something  very wrong with the design of the Euro.

              I do see we have lost E1 trillion overnight in the latest briefings. Sunday’s newspaper stories of E3 trillion have become E2 trillion today. The longer the Euro authorities leave coming up with a plan which has been thought through in detail and looks as if it could work, the more damage the markets will do the exposed positions of Euro sovereign debts.

I was thrilled to learn from briefings in today’s papers our problems are all to be solved by a E3.0 trillion rescue package for the  Euro. Banks will be recapitalised, sovereigns in need  lent more money, some bad sovereign debts written off. I have just two simple  questions. Where does the E3.0 trillion come from? Who pays the bills?

If there is a spare E 3.0 trillion hanging around, you would have thought they would have spent it already.

 

           Yesterday’s papers were briefed to tell us we can expect £100 billion of extra money printing in QEII. On top some of this new money will be lent directly by the government to small and medium sized enterprises.  We are promised adherence to the deficit reduction programme as the prudent offset to the monetary adventurism.

          I would suggest this package has been flown as a kite which might not make it to formal launch.  First, the deficit reduction. Does it mean they will find ways to reduce spending below current plans, given the likely shortfall in tax revenues as growth slows? Will sacred cows like overseas aid and HS2 at last come up for review and possible deferral? Will they stop replacing civil servants who retire or leave the service?  Will they remove some more quangos?   Or do they intend to use the “fiscal stabilisers”, which in effect means borrowing more and a less tight fiscal stance?  I suspect they mean the latter. They should recognise this means less scope for monetary experiment, as bond markets will be getting more nervous about the amount of debt the UK continues to build up.

             I am also worried about the idea of a new state owned bank. Who would run this? Why should we trust them to make good judgements about who to lend to and what security to take? How can a new state bank avoid lending too much to the wrong people, damaging commercial banks it competes with, or lending too little because it is understandably cautious with taxpayers’ money? The bank would need great wisdom to get the balance right, and to avoid more taxpayer financed banking losses of the kind we are used to from RBS.

             My preferred route to stimulate the private sector without adding to the burdens of the state sector remains to finance new banking activity in the private sector. The government should be prepared to stand up to the existing management of RBS and tell them to create three new banks out of their UK assets, and sell these on , raising more private capital for them at the same time. That way we get banking competition, properly financed  new banks, and some capacity to lend subject to a market test.

            A new state bank leaves the risks with the public sector, does not strengthen fair competition in a guaranteed way, and  makes a loss of market confidence in  the UK state less unlikely.  If we want to live in a free society we have to find solutions to our banking  problems which give the state a smaller role, not a bigger.If we wish to get state finances into order, an orderly disposal of banking risk is an important part of that task.

                         Gordon Brown’s effective nationalisation of RBS was a disaster. It is still there , on the state’s books, losing money, paying large sums to its senior people and not lending enough. The government should tackle that, rather than trying to by pass it with a new state bank spending newly printed money. We need some market discipline, and hard earned and taxed cash committed to new banks, not artificial money created by fiat at the Bank of England.

                          Sterling has been falling in anticiaption of more QE. Expect more inflation to result.

 

           Yesterday’s papers were briefed to tell us we can expect £100 billion of extra money printing in QEII. On top some of this new money will be lent directly by the government to small and medium sized enterprises.  We are promised adherence to the deficit reduction programme as the prudent offset to the monetary adventurism.

          I would suggest this package has been flown as a kite which might not make it to formal launch.  First, the deficit reduction. Does it mean they will find ways to reduce spending below current plans, given the likely shortfall in tax revenues as growth slows? Will sacred cows like overseas aid and HS2 at last come up for review and possible deferral? Will they stop replacing civil servants who retire or leave the service?  Will they remove some more quangos?   Or do they intend to use the “fiscal stabilisers”, which in effect means borrowing more and a less tight fiscal stance?  I suspect they mean the latter. They should recognise this means less scope for monetary experiment, as bond markets will be getting more nervous about the amount of debt the UK continues to build up.

             I am also worried about the idea of a new state owned bank. Who would run this? Why should we trust them to make good judgements about who to lend to and what security to take? How can a new state bank avoid lending too much to the wrong people, damaging commercial banks it competes with, or lending too little because it is understandably cautious with taxpayers’ money? The bank would need great wisdom to get the balance right, and to avoid more taxpayer financed banking losses of the kind we are used to from RBS.

             My preferred route to stimulate the private sector without adding to the burdens of the state sector remains to finance new banking activity in the private sector. The government should be prepared to stand up to the existing management of RBS and tell them to create three new banks out of their UK assets, and sell these on , raising more private capital for them at the same time. That way we get banking competition, properly financed  new banks, and some capacity to lend subject to a market test.

            A new state bank leaves the risks with the public sector, does not strengthen fair competition in a guaranteed way, and  makes a loss of market confidence in  the UK state less unlikely.  If we want to live in a free society we have to find solutions to our banking  problems which give the state a smaller role, not a bigger.If we wish to get state finances into order, an orderly disposal of banking risk is an important part of that task.

                         Gordon Brown’s effective nationalisation of RBS was a disaster. It is still there , on the state’s books, losing money, paying large sums to its senior people and not lending enough. The government should tackle that, rather than trying to by pass it with a new state bank spending newly printed money. We need some market discipline, and hard earned and taxed cash committed to new banks, not artificial money created by fiat at the Bank of England.

                          Sterling has been falling in anticiaption of more QE. Expect more inflation to result.

 

            The EU is close to agreeing new measures to give it control over Europe’s economies.  It will come as  a “six pack” – six directives and regulations to try to ensure that in future, unlike the past, the EU will control budget deficits, spending levels and tax levels to restore stability.

           The UK will agree to all this. The government will claim it is all about sorting out the Euro. They will argue that of course the Euro area needs the EU to meddle and control budgets. After all, it is Euro states borrowing too much which has landed them in a great mess. Surely it is time for the EU to put a stop to it. The UK will be safely opted out.

                It is true that four of the six measures apply just to the Euro zone members. So far so good.

               However, the other two apply to all member states of the EU including the UK. One demands that the UK tables a budgetary framework with the Commission.  The country is meant to comply with the “reference values on deficit and debt in the Treaty”, and to adopt a multi annual fiscal planning horizon and submit its homework to Brussels to be marked.

               The other is a proposal for a surveillance regulation. The EU wishes the UK to submit “for the purpose of multilateral surveillance at regular intervals under Article 121 of the Treaty in the form of a convergence programme, which provides an essential basis for price stability and for strong sustainable growth conducive to employment creation”. The EU  “shall monitor the economic policies in the light of convergence programme objectives with a view to ensure that their policies are geared to stability and thus to avoid real exchange rate misalignments”  etc

            The government will say it does not have to submit new documents – the EU can read the Budget Red Book for itself. As practically no-one else seems to read the book, that at least would be a use for it. They will say the EU can give us advice but cannot impose penalties. The government already has to submit figures, and the EU already passes judgement or gives an opinion.

              However, it still entails obligations on the UK to submit facts and figures and to hear the EU’s view of our policies. They do still regard our exchange rate as a matter of concern, just as they did when the UK political establishment wrongly put our exchange rate into the EU managed system with such disastrous results. I would be happier if we were clearly opted out of the entire six measures. Their passage offers a great opportunity to the UK to start to redefine its relationship.

                 As the government agrees we cannot and should not join in the Euro, there is no need for us to work with them in any way on budgets, taxes and exchange rates. Doing so merely encourages them.

              Some of their aims are a good idea. If only the UK had kept its deficit down to 3% and its stock of debt to 60% of GDP, we would all be better off. However, that misses the point. These new proposals wish to tighten the surveillance, and give the EU more say over the UK’s economic policy. This policy has to be settled in the UK Parliament, and to be one of the main items debated in elections, if we are to be a democracy.

                  It is scary that the draft regulation seems to regard the UK exchange rate as common property where the EU should have its say. When they last did that properly through the ERM it did untold damage to our economy.

                   The Uk needs to be opted out of all of this. What may make sense for the Euro area should be irrelevent to states with no intention of ever joining.

 

                  Yesterday was another very bad day in stock markets. It was the day when investors and investment managers let out a great cry for help. It was the day they decided the west’s  political leaders had no answers.

                    The immediate cause was the results of the two day Fed meeting to consider the crisis and what to do next. The Fed decided to do very little. It announced no new great money printing scheme. There are to be no fistfuls of extra dollars to push up asset values.

                   They did say they would sell some short term bonds, and buy some longer bonds. They did say they would use the proceeds from repayments of mortgages they own to buy some more  mortgages. They also said the economic outlook was poor.

                    Clearly it was not enough for the optimists still left in the market. They had been hoping that the Fed would have a new magic bullet. They hoped the Fed would have a way of puffing up the economy again.

                    Markets had come to realise the US President cannot deliver his package to boost the economy by spending more, taxing more and borrowing more. Nor do they think such a package would work anyway. They also know the Republican package of spending less and taxing less is stillborn. The balance of the US constitution has delivered a log jam at the top, when people want decisive leadership.

                     The biggest falls took place  in Euroland. There no-one speaks convincingly for the Central Bank. The Bank often has to pursue its policies by stealth, for fear of upsetting the prudent ones led by Germany. The leading politicians of Euroland are in disagreement with one another. They cannot decide whether to print more or borrow more to tackle the heavy debt problems of Greece and Portugal, Italy and Spain. They say they do wish to keep all the problem countries in the zone, but do not communicate a vision on how that is possible.

                               The Euro remains an orphan currency. It is in search of political parents to love it and take care of it. It needs a sovereign to tell it what to do. It needs a grown up Central Bank that has clear views on how much to print and how much support to offer the commercial banking system.

                                 At the heart of the crisis unfolding is too much debt.In the first phase of the crisis in 2007-8 the problem was too much private sector debt. Banks had borrowed too much. Banks had lent too much, especially against property in the US, UK, Ireland, and Spain. Governments eventually got over the worst of this by taking many of the debts of the banks onto their own balance sheets one way or another. They also decided on a reckless expansion of their own borrowing, to stave off the full adjustment.

                                      Now, the second phase of the crisis is on us. In this phase weakened banks lend money to heavily over borrowed governments, and spendthrift governments lend or spend money on propping up the weakened banks. We have often talked here of the dangers of this arrangement. The Regulators have made the banks lend more to governments, claiming this is risk free. The governments have often propped up the banks, without demanding action to sort them out.

                                   So what should be done? The governments and banks both have to get their houses into order. For the governments, that does mean spending less . You cannot get out of a debt crisis by borrowing more. For the banks, that should mean quicker action to sell assets, write off liabilities, break up weak  conglomerates, raise new capital until each main bank is trusted by the market.

                                     None of this is easy. The sooner the adjustments are made, the sooner we can resume decent growth. There is no safe way left to kick the can down the road. Print more cash and you will get more inflation. Borrow more, and you will undermine markets further. Pretend and extend more credit, and you continue the gnawing erosion of confidence.

                                     Yesterday the World Bank, the IMF and some of the leaders of the west made statements telling us things are bad, but saying that someone else needed to take action. The US Treasury Secretary has urged Euroland to sort itself out, but has to admit the US can’t settle on a single policy either. Euroland keeps delaying decisions, as individual countries make heavy weather of even implementing what the zone agreed last July. There is a lot riding on the G20. In the end it will come down to individual countries sorting out their own budgets and tackling the problems of their own distressed banks. Those who do so convincingly will get a better ride from the markets than those who hope the problem will go away if  they ignore or simply hire more spin doctors.

Last week John reviewed our new book Masters of Nothing, and he has invited us to reply to the comments left on the site.

 

We’ve found that you keep learning about a book you’ve written after you’ve written it, thanks to the comments of others, and the discussion it provokes, so we are grateful to everyone who put fingers to keyboard.

 

One of the reasons we wrote this book is because we wanted to provoke a discussion that was largely absent before 2008, a discussion about the way our financial markets behave, and the need for regulators to look to the big picture, instead of huge piles of box-ticking rules.

 

The discussion under John’s review is wide-ranging, informed and insightful. One of the key themes that emerged was the importance of competition within the financial system. Nearly all comments agreed that a more competitive banking industry would go a long way towards averting future systemic crises. There was also a broad consensus on the principal that market discipline must be restored – that banks should be allowed to fail without disrupting the wider economy.

 

We agree. More competition is crucial. But we would add an important qualification.

 

Groupthink, the herd mentality and our impulsive inclination to buy into ‘get-rich-quick’ stories, mean that large numbers of smaller financial institutions are just as capable of getting swept up in bubble manias as their global counterparts. People behave differently in groups than as individuals: that’s a fact of life.

 

The best defence against such complacency is not only downsizing or ring-fencing, but a culture of responsibility amongst the senior management of major financial institutions. This points to stronger boards, a regulator prepared to challenge irresponsible behaviour, and the ultimate sanction of prosecution for those executives who imperil our economy.

 

Several readers argued that in a free market the composition of a board, or the compensation package of a senior executive is the business of shareholders alone. Conversely shareholders and not taxpayers should absorb the consequences of banking failures.

 

Yet there’s a reason the state stepped in to save banks: when the whole financial system, and so whole economy  was put at risk. So the taxpayer is on the hook – whether we like it or not. 

 

All too often in recent history shareholders have not made it their business to assess the effectiveness of their executives, or the true nature of so-called ‘incentive’ packages. The structure of modern shareholding, which conveys a disproportionate influence on huge institutional funds, often means individual shareholders are ill-equipped to provide this kind of oversight. This is a market failure, which is why we call for the greater professionalisation of non-executive directors, who need both the time, the expertise and the incentives to hold the executive management to account.  

 

Several comments, which throw light on some of the most interesting issues, deserve a more specific response.

 

‘Major Loophole’ made an argument that we strongly identified with, suggesting that in the late 1990s the ‘old hands’ of local branches came to be dominated by ‘younger, less experienced ‘bean counter’ style managers,’ who ‘crucially, were given lending targets, the meeting of which, of course, led to qualifying for our old friend—the bonus.’

 

Such perverse incentives were a key aspect of the crash, but Major Loophole hints at a more fundamental problem with modern finance: a detachment from the society it serves. Too few decision-makers at the height of the boom questioned the wider consequences of what was effectively financial pollution.

 

Robert K wrote: ‘the idea that a rule-maker should control waves of waves of optimism and economic greed is silly.’

 

We agree. One of our central arguments is that you cannot legislate human nature out of existence.    The cycles of euphoria and panic – and the asset bubbles they generate are an inherent part of capitalism. What we suggest instead is that both policy and economic thought should be shaped in a way which takes account of human nature. We know, for example, that there can be no risk-aversion without fear, and we have to bear this in mind when we think about incentives. Similarly, we know that there is a relationship between testosterone and risk-taking, and this needs to be considered when we think about the role of women in finance.

 

Ralph Musgrave picked up on the role of the Bank of England’s new Financial Policy Committee:

 

‘The idea that the Bank of England should have the “the authority and the power to be able to tell a large bank that its strategy is too reckless…” is naïve. Various regulators had that power prior to the crunch, but they just got swept along with the irrational exuberance.’

 

This is a question we deal with at length in the book. It’s absolutely true that the regulators got caught up in what Alan Greenspan labelled ‘irrational exuberance’: the euphoria of the bubble. As we argue in our chapter on regulation, the FSA’s failure was a failure of institutional culture, in which box-ticking and the rulebook came to replace big-picture thinking and personal initiative. We need instead a regulatory institution capable of offering both a big-picture view of the UK financial system, and a culture of discretionary decision-making, so that the regulator is always one step ahead of those who game an abuse the rules. The Bank of England is well placed to provide these two things. But crucially, regulators themselves will inevitably fail, so the system needs to be structured so regulatory failure doesn’t bring the whole economy crashing down.

 

Finally ‘lifelogic’ asked ‘Who, on earth, has ever though that people behaved rationally?’

 

In a word: economists.

 

       PFI was coming in when I was a Cabinet Minister. I remember surprising officials by turning down seeking  a PFI proposal for a new hospital and saying we should do it from state borrowing as it would be cheaper.

        Andrew Lansley is right to highlight bad value contracts, and to try to do something to correct them. The private sector may have been better at keeping construction to budget and to timetable, which argued for suitable contracts to do just that. Adding in twenty or thirty years of responsibility for the building and including  borrowing the money meant higher prices overall in some cases. These are now proving dear for taxpayers, and inflexible at a time when we need to do more for less.

 

             In opposition Mr Cable told us “the road to Harare is not as long as we might hope”. Widely reported then  as a staunch opponent of printing money, owing to his colourful language about “Mugabe economics”, his argument was more hedged if you actually read what he said. He recognised that monetary easing was a judgement. You could have too much of it.

             Today in government Mr Cable has throw caution to the winds. He backs more money printing. He is urging the so called independent Monetary Policy Committee to print some more. Is he right to do so? What are the dangers?

              Remember the deal – this Coalition government was to offer us a tight fiscal policy in return for the Bank offering us looser monetary policy. The government  would control excess spending in the public sector, and allow the banks to fuel a private sector led recovery on the back of cheap money.

              I have no problem with the theory. I just have some doubts about whether that is what we are getting. Last month the UK government borrowed a record amount for an August – £15.9 billion  – up from £ 14 billion a year earlier. Tax revenues were up, so the increased deficit was the result of higher spending. That does not sound like a tight fiscal policy yet. If the media stopped saying there had been big and premature cuts in overall public spending it might be possible to have a  more informed debate about what is going wrong with the UK economy.

           Nor do I see the loose money policy for the private sector. Reports continue of small and medium sized companies finding access to new borrowing difficult. The very low interest rates only apply to the government. All the time we have some weak banks, and banks generally under strong regulatory requirements to increase their cash and capital, we will not have an adequate supply of new lending to fuel the private sector led recovery.

         I do not see how another round of creating money to buy up government debt would help much. The government interest rate is already low. It will not of itself unblock credit to SMEs or to the private sector generally. We need to fix the  state banks, and to improve the banking sector’s position  to do that.

         I do see some downside from more QE. The obvious danger is more inflation. I thought the Monetary Policy Committee were meant to keep inflation to 2% on the CPI. They seem to have abandoned all attempts to do that any time soon. Their loose talk about possibly having another bout of money printing has already triggered a slide in the pound against the dollar.

             Don’t they realise that it was the huge devaluation in part brought on by QE1 that produced the high inflation we are now suffering? Don’t they see the danger of yet more weakness in our currency bringing on yet more inflation? In an economy which imports as much as ours it is no good saying they have domestic inflation under control. Go into any shop and see how many things we now import from the emerging markets of the world, and see how vulnerable our living standards are to a weaker pound.

              Inflation is a kind of theft. High inflation is an unfair tax on the savers and strivers, and a windfall to the borrowers. I appreciate the main borrower is the government. That is all the more reason the MPC should for once stand up for the savers, and say “No” to anything which would undermine the pound and rob the prudent.  

             The government should also understand that high inflation this year is itself damaging recovery prospects. It is big price rises for enegry and other essential items that leaves people with too little money to buy the goods and services which would create faster growth. As inflation makes people poorer, so they can afford less tax, which leaves the government unable to afford all its spending. Money printing may not yet be a short road to Harare, but it is  far from helpful to a private sector led recovery.

               Recovery requires the government to fix the banks it owns, and make a bigger contribution to creating a strong and expanding banking sector serving the domestic UK market. Without that growth will continue to disappoint and QE will not get round that fundamental problem. Savers will worry about “Mugabe economics”, which is not good for confidence.

 

             In opposition Mr Cable told us “the road to Harare is not as long as we might hope”. Widely reported then  as a staunch opponent of printing money, owing to his colourful language about “Mugabe economics”, his argument was more hedged if you actually read what he said. He recognised that monetary easing was a judgement. You could have too much of it.

             Today in government Mr Cable has throw caution to the winds. He backs more money printing. He is urging the so called independent Monetary Policy Committee to print some more. Is he right to do so? What are the dangers?

              Remember the deal – this Coalition government was to offer us a tight fiscal policy in return for the Bank offering us looser monetary policy. The government  would control excess spending in the public sector, and allow the banks to fuel a private sector led recovery on the back of cheap money.

              I have no problem with the theory. I just have some doubts about whether that is what we are getting. Last month the UK government borrowed a record amount for an August – £15.9 billion  – up from £ 14 billion a year earlier. Tax revenues were up, so the increased deficit was the result of higher spending. That does not sound like a tight fiscal policy yet. If the media stopped saying there had been big and premature cuts in overall public spending it might be possible to have a  more informed debate about what is going wrong with the UK economy.

           Nor do I see the loose money policy for the private sector. Reports continue of small and medium sized companies finding access to new borrowing difficult. The very low interest rates only apply to the government. All the time we have some weak banks, and banks generally under strong regulatory requirements to increase their cash and capital, we will not have an adequate supply of new lending to fuel the private sector led recovery.

         I do not see how another round of creating money to buy up government debt would help much. The government interest rate is already low. It will not of itself unblock credit to SMEs or to the private sector generally. We need to fix the  state banks, and to improve the banking sector’s position  to do that.

         I do see some downside from more QE. The obvious danger is more inflation. I thought the Monetary Policy Committee were meant to keep inflation to 2% on the CPI. They seem to have abandoned all attempts to do that any time soon. Their loose talk about possibly having another bout of money printing has already triggered a slide in the pound against the dollar.

             Don’t they realise that it was the huge devaluation in part brought on by QE1 that produced the high inflation we are now suffering? Don’t they see the danger of yet more weakness in our currency bringing on yet more inflation? In an economy which imports as much as ours it is no good saying they have domestic inflation under control. Go into any shop and see how many things we now import from the emerging markets of the world, and see how vulnerable our living standards are to a weaker pound.

              Inflation is a kind of theft. High inflation is an unfair tax on the savers and strivers, and a windfall to the borrowers. I appreciate the main borrower is the government. That is all the more reason the MPC should for once stand up for the savers, and say “No” to anything which would undermine the pound and rob the prudent.  

             The government should also understand that high inflation this year is itself damaging recovery prospects. It is big price rises for enegry and other essential items that leaves people with too little money to buy the goods and services which would create faster growth. As inflation makes people poorer, so they can afford less tax, which leaves the government unable to afford all its spending. Money printing may not yet be a short road to Harare, but it is  far from helpful to a private sector led recovery.

               Recovery requires the government to fix the banks it owns, and make a bigger contribution to creating a strong and expanding banking sector serving the domestic UK market. Without that growth will continue to disappoint and QE will not get round that fundamental problem. Savers will worry about “Mugabe economics”, which is not good for confidence.