There is an insatiable demand everywhere I go for comment on what we should do now.
I have tried at each step to offer advice on how to start getting out of the very large hole we are in, but the authorities seem very keen on digging it ever deeper. Let me summarise briefly some of the steps that should be taken – and remind readers of some of the steps that have been taken that need to be retraced.
This began as a crisis of overborrowing – in both the UK and the US. Too much borrowing has led to too big a balance of payments deficit, as the country lived beyond its means and sucked in imports. It has led to governments with colossal debts, which will prove expensive to service and repay and may mean higher taxes in the future unless we get some growth and better management soon. It has left many companies overborrowed, stretching them badly as the downturn develops. It has left many individuals overborrowed, facing a big cut in their living standards to repay the debt or facing bankruptcy. Much of the excess borrowing went on sky high property and asset prices which are now plunging. Meanwhile the major banks also started running large casinos playing the tables with derivatives, options, futures, CDOs and many other exotic financial instruments. This all added to total risk, overcommitting the banks.
The way out of it is to work harder, earn more of our own living, gradually repay the debt and extricate the economy from the overinflated asset prices and financial instruments. We can do that in big and painful bang, and then pick up the pieces, or try to manage it over a longer period. The authorities opted for the former through their monetary policies in 2007, and now are desperately trying to opt for the latter with their latest monetary and spending intentions.
In the UK the government’s policy of making us all poorer to adjust the balance of payments and the private sector deficit is working all too well. The huge fall in sterling will soon produce sharp price rises in a whole range of imported goods from clothing through furniture to electrical items. The Japanese will not be able to hold their prices of TVs and music players with such a big rise in the yen against the pound. The Textile producers will have to increase their prices. The continental Europeans will certainly not cut their wages in order to hold down the sterling prices of their exports to us. So we will face some big import price increases soon, and that will choke off some of the import demand. Demand will also be cut by the big increase in unemployment, and the earnings reductions that will flow in the private sector as companies struggle to reduce their costs, remove bonus payments, reduce overtime or put people on short time working.
Asset prices have plunged substantially, although property prices and rents still seem high relative to individual and company incomes. The adjustment will doubtless continue until sensible values are reached. The sooner this adjustment happens the better.
The real changes we need are in the conduct of the banks. All the time a bank can finance itself in the market we can let it get on and do that, subject to more sensible regualtion than we have enjoyed so far. For the banks that are now fully or semi nationalised we need new policies.
RBS is too big for the British government to own and manage. They should immediately set about breaking it up and returning what they can to the private sector. The taxpayer should not stand behind a £500 billion derivatives business. If it is as low risk and sensible as the company says it will find a buyer in the private sector. If it isn’t, the sooner it is wound down the better. The taxpayer cannot afford to put at risk one year’s tax revenue in such activities. They should offer the foreign profitable businesses for sale even in these conditions. Getting them away for anything north of £1 would at least reduce taxpayer risk, and allow the government to concentrate on the UK banking business which is presumably why they got involved in the first place. They should demand cost reductions from the parts of the bank that have to remain in public hands, and reduce top remuneration to levels appropriate for a failed bank making huge losses and relying on taxpayer cash. The sorry truth is they have lost most of the £37 billion they put in already. They did not take friendly advice warning them against such a rash course of action. Now we all have to pay the bill for the worst £37 billion of public spending ever undertaken. There were so many cheaper and easier ways of “saving” the banks.
Taking such action would signal to markets that the government has realised it cannot carry on borrowing at the present rate, and it does need to cut its financial risk. If the government started to show any remorse for its fiscal laxity, and signs that it now wishes to set some limits for public borrowing and waste, it would start to take the pressure off the pound.
There should be no more interest rate cuts. To cure too much borrowing you need more saving. Savers need some reward.
The government does need also to ease the squeeze on the corporate sector, creating some more money growth as the current squeeze is far too tight. Lower interest rates are not the way to do that in current conditions. The Bank of England needs to learn again that too little money is damaging just as too much is. They have lurched from one mistake to the other. They now seem to understand that there are ways they can ease the squeeze, so they had better get on and do it, unless they want the first option of major meltdown to wipe out more of the debt through bankruptcy on a big scale.