We still call our Heads of State “sovereign”. Their “sovereign” powers have long been stripped away by Parliaments keen to take over the power of commanding  taxation, armies, public services and lawmaking.  Governments still make laws, sign Treaties and undertake deeds in the name of  Her Majesty.  The Queen would not dream of interfering in how they use these powers.

              Sometimes people write to me to say the Queen should intervene and demand back many of these “sovereign” powers that are now exercised by the EU. They sometimes  say they are writing to the Queen to insist on her upholding her Coronation Oath. They think she has some magical power to enforce Magna Carta, as if this ancient law has primacy or more relevance than the modern Statute law including the European Communities Act which commands us. Sometimes they demand the Queen requires  the repatriation of powers from the EU  which they wish had stayed here at home.

            A constitional monarch in an elected democracy has no such power. Parliament is the new sovereign, acting in the name of the people and dismissable by the people.  Parliament gave away important powers by first enacting the European Communities Act 1972, and then by subsequent enlargement of the areas of competence of the EU by ratifying and enacting subsequent Treaty changes. The powers were no longer the monarch’s to give away, and the monarch played no active part in doing so.

           Parliament consulted the people in a referendum in 1975 under the then Labour government about the transfer of sovereignty. Many now say fairly they were not around for such a vote. Some who were then voters  say that if they had read and understood the Treaty of Rome at the time, instead of relying on reassurances offered by various politicians, they might have voted against. The fact remains that the UK did vote to stay in the EEC. At no election since our joining has a pull out party won.  In the last decade the official Opposition, the Conservatives, opposed the major transfers of power at Nice, Amsterdam and Lisbon. They spoke against them and voted against them in the Commons.  This made no favourable difference to General Election outcomes for the Conservatives.  They finally did better in an election in 2010 without offering repeal of the Treaties they had rightly voted against in the preceeding Parliaments, though individual Conservative candidates and MPs did wish to repeal these measures.

               Over the next few days I wish to explore more the damage done to our sovereignty, and the options we have for redeeming it.

 Eurostat has produced an interesting document comparing the tax policies of the various EU countries. It begins with the stark conclusion:

          ” The European Union is, taken as a whole, a high tax area”

   It points out that in Japan and the USA taxes are 40% lower as a proportion of GDP. Tax levels in the rest of the advanced world and in the developing world are usually lower than the EU by a considerable margin.

           The UK is in the middle of the EU pack for overall taxation, at 38% of GDP. Where the UK is at the dear end within the overall high tax area is the taxation of income and capital.

            The UK is the second highest when it comes to the share of income  taxes in the total tax take. The UK gets 44% of all its revenue by taxing earnings and enterprise, where France gets just 26%and Germany 29%. There are only five countries with a higher top rate of Income Tax  than  the UK’s. The UK also has the third highest implicit tax rate on capital, at 37%.

          So all those why say the UK is too Anglo Saxon, and would do better if it had tax rates of a more egalitarian kind as on the continent, should rejoice. The UK is already leading the pack of high tax EU countries when it comes to the proportion of tax revenue that comes from  taxing income and capital, and is near the top when it comes to tax rates on the rich and successful.

          The problem for the EU as a whole is the high cost large government model is not delivering the same faster growth and rising living standards that lower tax and smaller government models are delivering elsewhere.

The latest figures for manufacturing show more weakness expected in orders and output.

It’s not just from exports but also from weak domestic demand.

It is a reminder that the tax and inflation squeeze on incomes is hitting demand for manufactured products.

Speculation from the Treasury that they might raise taxes on cars is far from helpful if you wish to stimulate the purchase of new vehicles made in the UK.

Everyone agrees the main aim of Labour’s Bank of England was to get inflation down to 2% and keep it there. Most also agree that the Bank has been singularly unsuccessful at doing so.

Inflation as measured by the last government’s second choice of target, the CPI, surged to 5% in 2008. It has been above 2% for most of the last three years, often by a significant margin. Throughout that period the Bank has published fan charts showing inflation coming down quite quickly to the 2% level or below. The Bank has usually argued that the prospect is finely balanced between an overshoot and an undershoot. So far it has always overshot.

The Bank has argued that much of the inflation has been “imported” and so not so susceptible to control by changes in domestic interest rates. However, the period is characterised by a major devaluation of the pound.  By the end of 2008 the pound was around one quarter below its 2007 highest  levels.  The surge in world commodity prices at the end of the last decade did not  induce the same big increases in inflation in Euro and US markets that it helped induce in the UK. Subsequent falls in many commodity prices did not get UK inflation back down to target. A devaluation may well have something to do with the quantity and price of money.

The Bank in its defence is right to point out that the UK has not suffered a wage/price spiral in recent years, so  inflation has not soared above the 5% level. It is right that fighting recession requires looser money anyway – the problem with that argument is they did not deliver it at the right time as we discussed before.

The Bank is trying to control price rises in an economy which is vulnerable to import prices on  weaker sterling, vulnerable to energy and raw material prices, and vulnerable to state price rises and tax rises as the government battles to get the deficit down by increasing state revenues.

If the bank had moved interest rates higher in 2005-6 it would have curbed the inflation that broke out, and would have restrained some of the excess credit creation that followed. If the government had not run such a large deficit before the recession boosted spending  and cut taxes, that too would have helped keep price rises under control and would have given the state more flexibility in the downturn. If the government did more deficit reduction by controlling costs in the public sector, and less by pushing up taxes and charges on the private sector, that too would cut the inflation rate.

          The Bank’s remit includes assisting in promoting sensible growth, after ensuring price stability.  In 2008 Gross Domestic Product fell by 7%. It recovered a little in 2009-10, but has recently been hovering around zero growth. On current Bank projections it will not be back to the 2007 peak levels until 2014.

           The Coalition government forecast better growth in its first plans in the summer of 2010. Since then it has revised these down sharply for the first three years of the period, but reckons with the Bank that growth should be at much better levels in 2014 and 2015.

             The Bank’s main way of trying to assist recovery is to inject more money into the economy by creating it and buying government bonds. When it buys a government bond from the private sector, that frees cash for the private sector to spend or invest in something  more risky than a government loan. That should, according to the Bank, stimulate more activity.

                  It has certainly kept down the interest rate on government borrowing. This has been most helpful to the public sector, where additional  borrowing remains at high but reducing  levels. It allows more of the extra cash spending by government to go on goods and services rather than on additional debt interest.

                   It has not been so successful in keeping down private sector interest rates. The market in money between banks remains damaged. The leading banks all have to raise more capital or curtail their loans to comply with the much stricter cash and capital rules now in place, and to position themseleves for the even stricter ones coming in later.

                          The approach of the Bank of England is different from that of the European Central Bank. That has made much more money available to the commercial banks, to stimulate them and their lending capability directly. The Bank of England was keen to avoid lending to businesses through the corporate bond market, doing very little in its first programme of Quantitative Easing, and ruling it out in subsequent programmes. 

                            Some now think the Bank should intervene more firmly in the inter bank markets, to get private sector interest rates down closer to official rates to enforce its will for easier money. Others think the QE programme will in due course prove inflationary, and are concerned about the continuing run of inflation numbers well above target. The Review should ask why GDP has behaved so erratically, why it is now so low, and why it is taking so long to get it back above previous peak levels. The Reviewers need to answer why such a huge QE programme has had so little effect on the private sector.  It should ask if banking regulaiton is offsetting much of the QE impact outside the public sector.

           The collapse of Northern Rock and RBS, and the rapid sale of Alliance and Leicester and Bradford and Bingley were worrying and unusual events.  Pictures of people in queues trying to withdraw their money from Northern Rock have become the iconic pictures of the most severe financial crisis to hit the UK since the 1930s or even longer.

            The typical explanation is that these banks went down thanks to the greed of their senior executives and the “City”. The Regulators had only a bit part, it is argued,  as they had been rendered ineffective by “light touch” regulation. Testosterone fuelled lending was reacklessly pursued in the interests of earning more bonus, paid on profits taken long before the full outturn of the lending was known. It was a rotten City model. The answer is ban or tax bonuses, put in much stronger regulation, and buttress banks with large increases in capital in case they do it all over again.

               Recalcitrant facts get in the way of this comfortable explanation for the politicians and regulators who presided over this mess. Surely the main aim of all the regulation in place should be to stop just such a crisis happening? If the regulators thought they lacked the powers they should have asked the government to do something. If the government thought the regulations were too light they should have taken action. In  the UK, after all, the whole system of banking regulation was revised and new under the incoming Labour government.

                   The truth is the regulators had the powers to demand more cash and capital under the law as it stood. It was their call. They decided that they could allow the ballooning of balance sheets. They resisted anyone who argued for less debt in the economy, buying into the thesis that banks could now manage risk much better.

                 It is also true that in the UK the Labour government was keen for understandable reasons to promote large banks from parts of the country that had not traditionally flourished in the financial service area. The two largest ones that got into difficulties were from the North and from Scotland. Their rapid growth had full government support. The Bank of England allowed it to happen,no doubt understanding the political pressure for it to happen.

              The FSA has apologised for its part in all this. It had the prime responsibility for individual banks. The Bank of England, however, should not excape all blame. It was a central part of the tripartite arrangements for regulation. It had a duty to keep the system safe. The problems at troubled banks soon upset the system in a major way. It had the ability to monitor and the duty to understand the consequences of expanding bank balance sheets on money and inflation. It is difficult to say it did well in these areas. When RBS got into trouble, its balance sheet was larger than the entire annual GDP of the UK. Surely the Bank had to take an intelligent interest in its solvency and liquidity, as it was so crucial to the whole system.

I have argued for some time that the UK has gone above the tax saturation level. A country which does this finds that increased taxes become very unpopular, and may collect less not more revenue.

Mr Osborne wisely cut oil company taxes in his latest budget, realising that the tax increases of 2011 on this sector had depressed exploration and development.

He has now wisely changed the pasty and caravan taxes, and offered some compensation to churches for the VAT on historic building repairs.

The changes to Income Tax and National Insurance made by the outgoing government were wrecking amendments which are reducing the revenues. Mr Osborne has promised some changes in 2013 but will lose output and tax revenue in the meantime.

Some of you have rightly argued that it was not just or mainly the Bank of England to blame for the crash  of 2008-9. Under the tripartite Labour scheme of regulation the main blame rested with the government as the convenor of the tripartite system and the most powerful of the three parts. The government was removed from office by the voters, mainly for their economic and banking failings.

The FSA was also to blame. It has been the subject of review and agreed it made important mistakes in the way it regulated banks. The purpose of these blogs is to do the same for the Bank which so far has escaped review.

          The most serious issue that the  Enquiry into the Bank should raise is its role in the collapses of Northern Rock and RBS. We have seen that it failed to influence the tripartite regulators into controlling the surge in bank balance sheets in the years of expansion. In the two years of collapse it failed to make enough liquidity available in time to avoid a run on one bank and a near cessation of trading at another.

            One of the prime tasks of a Central Bank is to be the lender of last resort to banks in its system. All banks are meant to be solvent. The banking regulator supervises them and certifies they are. The Central Bank has to ensure they are also liquid. A strong bank may have a lot of its money invested in high grade loans. If too many depositors want their deposits out at the same time it may not have the cash to pay them. Given time it can sell its loans on to someone else and free the cash. The Central Bank is meant to step in and lend to bridge the gap.

                In the torrid banking summer of 2007 some of us were urging the Bank of England to make the banking markets more liquid by injecting cash into the system. The Bank refused. The inter bank markets dried up as banks lost confidence in each other. Northern Rock depended on a lot of inter bank borrowing to support its large mortgage business. It was obviously at risk. The Bank of England argued that it would induce moral hazard if it lent more to Northern Rock or other banks short of liquidity. The result became well advertised when Northern Rock ran out of cash.

                   After the collapse of the Rock the Bank of England did inject more liquidity into the system, showing it could do so. It repeated this performance on a larger scale with RBS a year later.

                            The Review needs to ask why didn’t the Bank act as a lender of last resort to a greater extent earlier to ward off bank collapses?  Wouldn’t it have been better if the Bank had made cash available to prevent these collapses? Wouldn’t short term loans have been cheaper and better for taxpayers than forced purchase of shares? Wouldn’t such action have staved off the worst but forced the banks to cut costs and sell assets to repay the loans? Isn’t that the new system they say they now wish to operate in a future crisis?Why didn’t they do it when they had a live crisis? If living wills are good for a future crisis, why didn’t they use a controlled form of administration, where the authorities kept the main deposits and payment systems going?

            The Bank’s review of its conduct needs to ask could the bubble have been forseen in say 2005? If so what action could they have taken to rein it in before it became damagingly large?

              There were several commentators and the Opposition parties saying in the middle of the last decade that the government was allowing far too much debt to be extended. Meanwhile, the Bank of England cut interest rates sharply in 2001, cut them further in mid 2003, raised them modestly to mid 2006, only to   cut them  a little again. As we advanced in 2007  the Bank belatedly started to take the inflation threat more seriously, and hiked rates to 4.75%, finally reaching 5.75% in 2008, by which time the crunch was obvious to its critics.

                    It is a fair comment to say the Bank did too much too late on interest rates. It by general agreement did too little for much of the gathering boom.  It should have sent a stronger signal against credit and money expansion in the middle 2000s than it did with higher rates, when others were worried. It then raised rates too much and kept them too high in 2008, when the banks were already in serious trouble and the system was deflating.

                    The FSA for its part put forward more and more detailed rules affecting banks, but was lax over the amounts of cash and capital banks had to hold. In the 1980s and early 1990s when I was a financial regulator as a Minister, it was thought prudent to keep a commercial bank balance sheet to less than 20 times its core capital. By the time the Credit Crunch hit well over 30 times was thought normal and acceptable.

                           When I asked regulators in the  2000s why they thought banks could gear themselves so much more than before, I was told that thanks to a wide range of new fianncial products they could carry more risk with the means to offset it through futures, options and derivatives. It did not prove to be like that. Indeed, as some of us feared, the large positions in special instruments often increased the exposure to dangerous markets, and increased the geared impact of a fall in markets.

                        There was no new paradigm which allowed banks to magic more money into the system without extra risk.

                   The Banking regulator and the Competition Authority made the problem worse by allowing or even encouraging mega mergers so large banks emerged with hugely geared balance sheets. Some of us argued against allowing the RBS/ ABN Amro merger. Many more of us opposed the LLoyds/HBOS merger. The authorites allowed these through, ensuring that if  a bank did collapse it would be a very large one. They thought it cut banking risk. Some of us thought it concentrated banking risk, and meant strong banks would be pulled down by weak ones within the new enlarged groups.