Yesterday I was asked by one blogger if there is a beginner’s article, and by another to set out a Conservative alternative to the current “rescue” policy. So let’s ask today Why aren’t the UK and US initiatives working? In doing so I will answer these points.
There are four main reasons why it’s not working.
The first is the authorities did so much damage, both by stoking up credit and then by tightening too much too quickly, creating a very nasty crash. It was bound to take time to deal with the injuries from the crash. Some readers will remember how I shouted at the authorities to relax their grip earlier to avoid a bad downturn, but they were adamant they would not do so. The results were entirely predictable. It was a crash they created, so why are they so surprised?
The second is that some of the actions now taken to relax, especially lower interest rates, take at least a year in normal conditions to work through. These authorities have been driving by looking in the rear view mirror instead of looking ahead, so no wonder they keep crashing. They now need to be patient and to start looking ahead.
The third is the state of the banks, who have made such huge errors along with their Regulators for the last seven or eight years. The banks need to be mended before economies will work at more normal levels of activity and growth.
The fourth is that confidence is low, and is being driven lower by the foolish responses of the authorities pursuing weekly initiatives that are all going to cost mega bucks for taxpayers. The authorities wrongly think that transferring the bad and doubtful debts and the bad investments from the banks to taxpayers solves the problem. It doesn’t. It creates a new problem – weaker credit status of the governments themselves, and in some cases like Iceland national bankruptcy.
So what should they do?
They were right to cut interest rates, though they did it a year too late. This will have some beneficial impact in due course.They have now cut them more than is sensible.
They should concentrate on getting the banks to change their approach. Banks need to cut their costs substantially. They have staff numbers and pay levels geared to the heady days of the credit bubble. They need fewer people paid at realistic levels to handle personal and business banking. They need to cut back their investment banks massively, closing out positions, selling investments and trying to minimise the losses whilst owning up the them and reducing the risks of their books. The larger weaker banks need to raise money by selling off parts of their businesses to those with cash and more wisdom to run them better.
Governments need to stop shoving cash down bankers throats as a reward for bad conduct. Under the current model the banks that did the worst job get the most cash from taxpayers. No wonder nothing works. The bad banks have to slim down and sober up quickly. Taxpayer cash delays them doing that.
If the authorities continue to follow the present absurd model more countries will have their credit worthiness brought into question. The main country players are already trying the competitive devaluation game to steal a march on others, and trying to find ways round the international rules to limit trade and encourage business at home. It is not a good background to recovery. No wonder markets still find it difficult to be confident about the future.
Trying to print the right amount of extra money to turn the economy without creating inflationary fears is not an easy trick to pull off. It would be more plausible as a strategy if at the same time governments reined in their wilder – bank oriented- spending – and showed they recognised there have to be limits to how much risk taxpayers can run and how much borrowing they can repay. Present actions show that governments have learnt nothing from the Credit Crunch. What was it all about, if it wasn’t designed by the authorities to send a warning to people and companies not to borrow so much? Why is it then a good idea for people and companies to be forced to borrow even more in the name of the state?
March 3, 2009
Rather than looking at a re-run of FDR’s failed New Deal policies which saw persistently high unemployment in the 1930’s, Messrs Brown and Obama might do well to copy President Harding’s “hands off” approach. In 1921 in the US output fell by 9% and unemployment rose to 11.7% But, left alone from meddling, the economy bounced back in 1922 with unemployment at 6.7% and only 2.4% in 1923.
Does anyone even claim the so called ‘fiscal stimulus’ will achieve this level of reduction?
(Source: “Downsizing the federal government” from the Cato institute)
March 3, 2009
Agree that the Panic measures of Government do not appear to be working, and History shows they rarely do.
Agree that shoving money into failed Banks (any failed Business) in effect makes it harder for those who are in the same market/segment or industry and who were stable, more difficult, in some cases it makes sound businesses unstable, and thus compounds the problem.
Its almost similar to the Friday -Monday trick of Administration and then new set up.
At a stroke you can dump your liabilities and put yourself at an advantage over your competitors who continue as normal.
The big difference this time is that the Taxpayer is picking up the tab, not the suppliers but we have not dumped the liabilites.
There is no point in throwing huge sums of money into the pot if the rules and practices are not changed, and it is sensible to change the rules BEFORE you throw in the money.
We are told that there was only hours to spare, I have no idea if this is fact or fiction, but experience shows that when you work to someone elses time table, you are not in control.
If we are not careful the (proposed solution) actions taken, may well turn out worse than the original prognosis without help.
If the Banks had gone bust, then the Government would have had to have underwritten deposits, at the moment we are chucking in Billions and are taking on the complete liability of the Business as its a going concern, and we will still have to underwrite deposits.
Aware that the Government did not want a run on the Banks if the message had got out, but this present solution is a very high price to pay.
Lets hope all this investment will eventually pay off, but it is a huge gamble the like we have never seen before.
The problem, as has been highlighted here before, is that we are now in so deep that any incoming Government has little chance of changing things their hands will be tied to huge debt and tax rises for generations.
Surely decisions of this magnitude should need to have an approved vote in Parliament before they are allowed. Although again history shows that the opposition Parties would probably not get all of the information needed in any case (Gulf War) to make a balanced decision.
Hate to say so, but with Labour it all eventually turns sour, again as History has shown.
March 3, 2009
I agree with most of your points and we will be stuck with debt no doubt, but that needn’t mean tax rises, if the next government gets really radical with spending, say a 20% cut across the board save for immediate combat military.
You or I would be able to do so with ease, yet I wonder if there is either the willingness or the ability to tackle the Westminster spending machine. Indeed, I’m not sure most politicians can even bring themselves to consider such an option (with the honourable exception of the author of this blog, who (I believe) can think out of the box).
March 3, 2009
Stuart, Agree with your points about cutting spending entirely. But will it happen ???.
The next Government will have to be almost revolutionary in the way it looks at Taxes, Benefits, National Insurance, Number of Civil Service/Government employees and their Pay, and Pensions etc if it is to have any impact at all.
In short we need a complete re-think “To think the unthinkable” to coin a phrase.
I made this point on the blog last week, but will they have the balls ??????? I doubt it.
March 4, 2009
In one sense, the circumstances maybe such, that they can do the most radical things because they can say “there is no alternative” and that may well be right. Whether or not there is the will to do it? As you say, it remains to be seen.
Oddly, the ghastly economic circumstances they will no doubt inherit, may give them the opportunity, to once again turn Britain from Eurosclerosis, to Asian tiger. Imagine if the government only spent around 17-20% of GDP instead of the current 40+%
They could transform the economy and the country for decades to come. If there is real courage, vision and sense of purpose it could be done. And if it is, how could the next change of adminstration go back to 40% GDP spend? They couldn’t. It would shift the whole centre of political gravity and shatter labour for a generation.
March 3, 2009
The 20th century was an experiment in government control of prices. From the price of bread, rent control, and now money* it has been a costly failure. Isn’t it time we let the market choose the price of money?
*setting interest rates or printing money is just a very clumsy way of setting the price of money.
March 3, 2009
I could be wrong, but it seems to me we are not going to get appropriate leadership and quality decisions from the current Government.
So until the next election, the economy will have to do the best it can do in the circumstances and despite the actions of the Government.
Then, I pray, the Conservatives will get Labour out and although the jury is out on what the Conservatives will do, it’s pretty clear at this point it will be an improvement on Labour.
March 3, 2009
Blank Xavieron 03 Mar 2009 at 10:03 am ……………….
I agree with this premise. Brown’s only thought, as was Blair’s, is for his own power regardless. This attitude makes for a flawed individual, irrational and foolish, unable to take stock of self inflicted failure or take sensible advice. As for Obama, seems he’s beginning to see George was not so dum after all.
March 3, 2009
The current UK administration won’t do any of this because it implies that they will have to admit their own complete failure. And the implication of that is the admission that lefty tax ‘n spend ism doesn’t work and that would be the final nail in the coffin of socialism.
Obama won’t do it because he comes with the same lefty baggage.
March 3, 2009
But the underlying problem is that government size has now increased to be at least 50% of the economy & that it is so heavily regulating the rest to prevent productive economic activity (preventing the building of cheap nuclear electricity, keeping housebuilding costs 4 times what they should be, preventing development of GM & other new technology) that it is not surprising we have exported much of our productive industry. Even when the “boom” was on Britain’s growth was only half the world average of 5%.
If the underlying problem was solved there would be plenty of opportunities for real, rather than bubble, investment.
March 3, 2009
Agree absolutely. Anyone would believe that FDR fixed the Great Depression. In fact, America probably didn’t exit the depression until the 1950s. Worse, institutions created in the depression are deeply implicated in the current crisis – people tend to forget that it was the US government that backed most of the US mortgage market through Fannie Mae (set up in 1938) and Freddie Mac.
March 3, 2009
I would like to develop your fourth policy point. Confidence is low and will remain depressed so long as we have a government that is building up an enormous debt burden. The more the government spends the more I try to cut back on my own spending because I know in a year or two taxes will have to go up. Similarly, the money I save from lower interest rates on my mortgage needs to be reserved to pay for the inevitable hike in rates that will come once inflation gets a grip. I imagine that many people in this country will be thinking the same way.
Under these conditions, which business is going to invest for future growth if they have no reliable means to predict the cost of their capital? Which entrepreneur will look to set up a business if he cannot tell what tax or regulatory burden will be placed upon him? How much confidence can business people have when we have a government whose actions are causing so much consternation and uncertainty amongst consumers?
In terms of government policy, it was crazy to have bought equity in UK banks, as John has pointed out regularly in this blog. There is a perfectly well established mechanism for dealing with failed businesses in this country – it’s called Administration. Banks that are insolvent should be dealt with in the same way as any other failed business. Administration would allow them to be wound down in a controlled way. The successful banks would quickly mop up the better bits of their failed rivals. Capital would be reallocated swiftly and confidence would re-build. There would be no taxpayer money wasted on bailing out failure, no angst over bonuses and pensions, no Star Chambers in an attempt to get the banks to “confess” to their bad debts. Nor would we have the ludicrous situation of the government being the only lender willing to give 90% mortgages (which press reports suggest that Northern Rock is doing).
I sometimes feel like I am in a very small minority who believe that there should be no bailouts. The argument put in their favour is that the world economy would not be able to bear a collapse of the financial system. I look at it the other way: why on earth would we want to preserve a financial system that has caused such econoimc damage?
March 3, 2009
Administration is fine, but all of the proceeds seem to go to the Administrators and little left for anyone else.
(Name suplplied) is a prime example.
Fees about ÂŁ35 million, amount left for creditors about ÂŁ600,000, they got less than a penny in the pound.
This is nearly always the case there is just enough to pay the Administrators and no one else,
Such a co-incidence.
March 3, 2009
I’m not sure I agree that lower interest rates will work this time. That will only work if this recession is like previous ones, where the banks wanted to lend, but nobody wanted to borrow.
At the moment, we have companies and inidividuals who want to borrow, but the banks have no money to lend. Lower rates discourage people from putting money on deposit in banks, and reduce the bank’s profits from lending. So aren’t low rates likely to make the credit crunch worse? And if the recession is actually a credit crunch, and not a traditional recession at all, then low rates are part of the problem, not part of the solution.
If there’s a shortage of something, shouldn’t the price go UP in a properly functioning market?
Obviously a reduction in State borrowing would help too. (Why would anyone put their money in (lend to) a bank at 0.5% if they can lend to the government at a decent return?) But State borrowing is being deliberately increased.
March 3, 2009
The reason why Obama and Brown are not going to come up with anything, is that there is little or nothing they can agree on. Brown has blamed the USA, but Obama thinks, and indeed knows that Brown is as much to blame as Bush ever was. The USA needs effective decisions, and Brown cannot deliver them. The USA needs to sort things out with Europe, and Brown cannot do this. The USA is after the tax havens, and Brown is their peripatic spokesman in the world because so many of them are UK operations of one sort or another. The USA is after the tax avoiders, and Brown has been the friend and helpmeet of all the tax avoiders in the world. Moreover, suddenly the USA is recalling more about 1814 than about 1941.
March 3, 2009
The blogger asked for “the Conservative alternative to the current rescue policy”. As usual John gives us an excellent critique and clear recommendations. If only those on the Conservative front bench could deliver the arguments half as well! Unfortunately, we have come to rely on Vince Cable to take the Government to task and to argue for the common sense alternatives.
March 4, 2009
What an excellent, clear and full statement on what has happened, on why it has happened and on what ought to be done about it.
All the talk of banks closing their ATMs in October and national chaos with bank failures seems to me to smack of the lies told during the 45 minutes crisis which triggered the Iraq war. Rumours and lies flourish when there is no real discussion in parliament and where politicians openly tell porkies when they are under oath not to.
What a shame that I have not heard anything like this from Labour List which, natch, is against the fat cat bankers (what a scam that argument is from fat cat politicians!)
I have not heard anything like it on Conservative Home.
I have been in Australia for a few weeks, but have not heard anything like it on the BBC. They seemed usually to talk about quite ridiculous parallels which I couldn’t understand or to present the ubiquitous Vince Cable as Opposition/Conservative Party Spokesperson.
This message needs to be spread – fast. Before the country goes bankrupt (again).