Monday, 31 August 2009

Spain And The Euro

In my Moneyweek column this week, I've been writing about Spain and the euro. Here's a taster.

Almost one year on from the credit crunch, one verdict at least seems reasonably settled. The euro had a good crisis. Despite all the warning, particularly in this country, about the fragility of the system, the single currency sailed through the collapse largely unscathed. The banking system didn’t implode. The European Central Bank dealt with the challenge smoothly. There were no rioters on the street demanding the return of the deutschemark or the franc. If the key test of a currency is its ability to deal with tough times, then the euro appears to have acquitted itself with credit.
But hold on. Maybe it is too early to tell. The euro still has to deal with the unfolding horror story of the Spanish economy.
Spain always looked like the weakest link in the chain. It had the biggest property bubble of any of the major euro-area economies – only Ireland came close. It had the fastest expanding banking sector, and the most spectacular economic growth. Now it also looks like facing the deepest downturn of any of the main developed economies, with soaring unemployment, crashing property prices, and a crippling dependence on foreign capital.
In truth, they key test for the euro over the next five years is going to be how it deals with the Spanish patient. If Spain can recover, then the euro can survive most shocks. But don’t be surprised if a long and grinding recession tests its faith – and at some point people start clamouring for the return of the peseta.
Right now, the economic figures coming out of Spain look wretched. It has been hit harder by the global recession than most of the euro area, and shows no sign of sharing the modest recovery currently being enjoyed by Germany and France. In the latest quarter, the economy was still shrinking at an annual rate of more than 4%. Unemployment has already climbed to a staggering 18% of the workforce and will inevitably climb higher still before the economy recovers. According to forecasts by the OECD, Spain will be the third worst-performing nation of its thirty members this year. Only Hungary and Ireland will do worse. Already the government is running a budget deficit of 9.5% of GDP, almost as bad a Britain: the big difference is that the UK isn’t supposed to be keeping its deficit to 3% of GDP as required by the euro rules.
And that is just the surface. Look underneath, and the picture doesn’t get any better. Spain now has as many unsold homes – more than a million - as the US, even though the American economy is more than six times size of the Spanish. About a third of the new homes built in the EU since 2000 were built in Spain, even though it accounts for only about 10% of the euro area economy. Most of that was with money borrowed from the rest of Europe: there are now close on 500 billion euros of loans outstanding to Spanish developers and construction companies. It is hard to believe that very much of that money is going to be paid back.
“Spain is set for a long, painful deflation that will manifest itself via a spectacularly high unemployment level for an industrialised economy, a real estate collapse and general banking insolvencies,” argued analysts at the economic consultancy Variant Perception in a recent report.
Much as it might like to, the rest of Europe won’t be able to ignore Spain’s problems. Between 2003 and 2005, 39% of the growth in the euro-area came from Spain. Without it, the euro area would have hardly grown at all. Banco Santander, now a familiar name on British high streets, is the biggest bank in the euro area, measured by market value. BBVA is one of the top five euro area banks.
Without a Spanish contribution, Europe will hardly grow. And if the Spanish banking system collapses, it will take blow a hole in the euro’s hull that could easily capsize the whole vessel.
So far, the banking system has sailed through the crisis largely unscathed. None of the big Spanish banks have collapsed. Indeed, Santander has taken the opportunity to expand, taking control the UK’s Abbey and Alliance & Leicester at what might well prove to be the bottom of the market.
But the troubles may well be hidden. The Spanish banks are estimated to have been raising around 40% of their funds abroad at the peak of the property boom, and it is hard to believe they will find it easier to rollover those loans when the time comes. True, the banking system in Spain is generally held to have been more prudent than elsewhere. A system of ‘dynamic provisioning’ forced the Spanish banks to salt away more money when the times were good: other countries, such as the UK, may well end up copying that. Even so, it is unlikely that the banks have built up enough of a cushion to pull through a property collapse on the scale Spain now faces without some serious losses. They may be hidden for a time by lax accounting rules, by artificially inflating the value of assets, or by expanding abroad to raise more money. But banks can seldom hide their losses permanently: the market always catches up with them in the end.
The outlook of Spain is now dire. Traditionally, a country in that fix would devalue its currency sharply, as Britain has in effect done. But that door is now shut. Instead, Spain faces a protracted slump, and one that will test its social fabric to breaking point. Unemployment could go as high as 25%: that’s a lot of punishment for any country to take.
In truth, Spain remains the euros key testing ground. Without doubt, the next few years will be tough for the Spanish economy. If it can pull through, and start to grow again, the currency will have survived its biggest test. Investors will conclude, quite rightly, that it can survive just about everything. But it is far from certain. And it is too early too conclude we won’t be hearing calls for the return of the Spanish peseta in the next few years.

Wednesday, 26 August 2009

The Same But Different

Over on The Curzon Group blog I've been discussing the issues involved in writing a series of book. But you can read it here as well....

I was having lunch with my publisher, Martin Fletcher of Headline, last week. I was congratulating him on the cover of ‘Fire Force’, the sequel to ‘Death Force’, which will be out next year. It establishes a common identity with the first book, whilst being a great cover in itself. “The same, but different,” I observed.

It struck me that “the same but different” was a good way of describing how to approach writing a series of books. Increasingly, publishers want series because the characters can be established over time and the writer can build up an audience. But, of course, it poses challenges to the writer. You need to think about your characters and how they care going to develop over four or five books: in my case ten characters which is especially difficult. And then you need to keep the basic structure of the books similar, while also having sufficient variation to make them fresh and exciting.

There’s nothing wrong with “the same but different”. Mozart wrote 41 symphonies to which that description could be applied, but that doesn’t mean that most of them aren’t masterpieces. Of course you can take it too far (Take Van Morrison, for example. A genius, as well, but many of his albums could be described as ‘the same but, er, the same). The trick is to get the balance right.

I’ve just started work on ‘Shadow Force’, the third in the series. As you can see from the title, I’m keeping one word the same…while the other one is different.

Monday, 24 August 2009

Krugman vs Ferguson

On Bloomberg last week, I was writing about deflation, and in The Sunday Times yesterday I was writing about the battle between the economist Paul Krugman and the historian Niall Ferguson. What interested me about both pieces was how much of mainstream economics is turning out to be pretty useless at explaining both how the world got into this recesssion, and more importantly how we get out. My own instinct is that the prescriptions of mainstream economics - more stimulus spending, printing money - are going to turn out to be the wrong ones, which is why people are so willing to listen to the few people such as Ferguson willing to challenge the prevailing conventional wisdon.

Saturday, 22 August 2009

How To Fix The Bonus Culture

The bonus culture is back, with the bank awarding mega-bucks to their staff again. That seems crazy. But how can you fix it without legislating for top pay. In my Money Week column this week I explain how. Here's a taster.

Any reasonable person listening to the increasingly furious debate over City bonuses probably finds themselves in the odd position of agreeing with both sides of the question, even though they are miles apart.
It is bonkers that only a year after the financial system virtually collapsed, and with many banks still effectively on life support, that big bonuses are back, say the critics. And most of us nod and say, yup, sounds crazy.
Against that, plenty of voices from the City pop up to say that you can’t legislate for pay. That isn’t so much a slippery slope as a one way ticket back to the Soviet Union. And again, most of us will nod and say, yup, that does sound like a bad idea.
We end up agreeing with two contradictory arguments. But actually, there is a way out of this dilemma.
True, it doesn’t make any sense to legislate for pay. But it does make sense to legislate for the structure of financial firms. Indeed, we have done for decades. And if we got the structure right, we could start bringing bonuses back under control again.
It isn’t hard to see why the debate on bonuses has become so heated.
A year ago, following the collapse of Lehman Brothers, the financial system went into meltdown. Banks started collapsing all over the world. Billions had to be poured into the system to keep them afloat. And yet the people who had created the mess had been being paying themselves vast bonuses over many years, usually on top of salaries that were already extravagant by comparison with most other careers. Even worse, it seemed to many people even within the financial system that bonuses – particularly the ‘heads-I-win-tails-you-lose’ bonuses that were rampant in the City – had played a big part in encouraging the excessive risk-taking that had created the collapse in the first place.
Now, less than a year later the bonus culture is back in full swing again. For the left, that is an opportunity to attack high pay in general. The centre-left Compass Group has just launched a campaign for a High Pay Commission that would regulate wages at the very top of the ladder in much the same way that the Low Pay Commission regulates pay at the bottom. Both the Chancellor Alistair Darling and the business secretary Lord Mandelson have said they might legislate to curb bonuses.
But it is not just restricted to the left. The shadow Chancellor George Osborne has said it is wrong that banks with any state support should be paying out huge bonuses. Nor is the argument restricted to this country. Proposals to cap bonuses have been put forward in France, Germany, and even in the United States.
In truth, this isn’t a right/left, free market/regulation argument. The banking sector has just effectively exempted itself from the free market. Plenty of banks are still being effectively proped up by the governments, either through direct shareholdings, or else through schemes to insure toxic assets. Even when the support isn’t explicit, it is still implicit. After all, how many of us would be willing to put our money into a bank any more if it weren’t for the fact the state ultimately guaranteed the deposit? Probably none of us.
Bonuses are, in reality, the one bubble that didn’t burst. No one can explain why they are so huge, nor can they provide any convincing economic rationale for them – there are as much as bubble as dot com stocks in 2000 or house prices in 2007.
So how should we bring them back under control again?
In fact, the answer is very easy.
It doesn’t make any sense to legislate for pay. There is no way any regulator can know what the right level of remuneration might be. You will drive firms offshore. And, for those firms that remain, innovation and competition will be stifled. Salaries are a price, and we know from a hundred years of experience that any form of price control ends up doing more harm than good.
But we can legislate for the structure of the firms that operate in the financial markets. That has always been the case – and if we have the wrong structure then it makes sense to change it.
The problem with bonuses are the way they encourage bankers to take big risks with other people’s money. If you were given a stack of free chips, told to go to a casino, and told you could keep any money you won in the next hour, whilst not having to bear any of the losses, you’d make some pretty wild bets as well. That, in effect, is what the bonus system does.
Two things need to be done to stop that.
First, there needs to be a division between investment banking and retail banking, as there used to be on Wall Street, and in the pre-Big Bang City of London. It is the retail banks that can’t be allowed to fail, since the consequences for the rest of the economy are too severe. It is the investment banks that take the big risky bets and pay the big bonuses. The two should be split up again.
Next, the investment banks should be turned back into partnerships, or, at the very least, companies that were majority owned by their staff. Just take a look at the hedge funds and the private equity houses. Despite all the warnings of instability, they didn’t blow up in the crisis. That is because they operate much more as partnerships. The staff have their own money tied up in the firm, and their long-term wealth is bound up with its future.
Instead of taking short-term bets with other people’s money, they are taking long-term bets with their own. That instantly creates a very different attitude – and a far healthier balance between risk and reward.
What you would end up with, of course, is a City that looked a lot more like the one that existed before the reforms of the mid-1980s. But maybe that would be such a bad thing.

Wednesday, 19 August 2009

The Uselessness Of Mainstream Economics...

I'm increasingly struck by how usless mainstream economics is at explaining how we got into this recession and how we are going to get out of again. I wrote a column for Bloomberg yesterday about deflation, wondering if it was as bad as it is made out. I got a huge response, nearly all agreeing with me. And yet this is a view that virtually doesn't exist in mainstream economics. There is something puzzling about how the profession has got so out of touch with commmon sense, particularly when you consider that common sense is usually right.

Tuesday, 18 August 2009

The Curzon Group Red-Eye....

I've just got back from The Curzon Group's airport tour. You cna read about it in this blog I did for The Bookseller.

Monday, 17 August 2009

Will Stocks Survive September?

In my Money Week column this week, I've been looking at whether there is going to be a correction to the stockmarket rally in September and October. Here's a taster....

The autumn has always been a scary season for the stock market. From the Great Crash of 1929, in October of that year, to the crash of 1987, also in October, to the collapse of Lehman Brothers, in September last year, it has always been the season when investors step up to the abyss, look down, and for some odd reason decide to hurl themselves straight into it.
And this year? Get ready for a September Surprise. After the strong rally of the last six months, the markets are poised for a brutal autumn correction. Companies are going to be looking to the markets for vast quantities of cash; the boost provided by stimulus spending is going to fade; the emerging markets are about to come juddering back down to earth; and, in the UK at least, there is likely to be a renewed bout of political turmoil as Gordon Brown’s dismal premiership enters its last, rockiest months. All four factors are likely to be make the next two months a bumpy ride for investors.
No one can have failed to notice the strong performance of the markets in the last five months – even if plenty of people were too slow to take advantage of it. In the US, the S&P 500 index has rallied by 49%over that period. Most of the other markets around the world have performed just as strongly. China’s Shanghai Composite Index, the best performing major index, is up by 78% so far this year. Even the UK’s FTSE, which hasn’t been one of the better performing markets for years, is up by 11% over the last six months even though the British economy shows few real signs of climbing out of recession. The MSCI World Index, probably the most accurate gage of global sentiment, has climbed 54% from a 13-year low touched in March.
But can it last? The historical precedents aren’t good. September has always been the worst months for US stocks: taking an average of every year since 1928, stocks have fallen by 1.3% during that month. The only other month that is such a consistent loser for investors is February. Some of the Septembers along the way have pretty scary. Last year, for example, the S&P fell by 9% following the collapse of Lehman Brothers. Back in September 1931, as the depression started to acquire that rather frightening looking ‘great’ in front of it, stocks fell by 30 percent, wiping out all the gains from the bounce back after 1929.
Even if you happen to get through September unscathed, there is always October to worry about. The precedents of 1929 and 1987 suggest that can be just as brutal a month for investors.
Of course, those are all just co-incidences. Just because the autumn has often been hard on the markets in the past doesn’t mean that it will be this year. Still, there are four reasons for thinking there is a surprise in store for investors this September, and it won’t be a pleasant one.
First, companies are desperate for cash. Lloyds Bank suggested last weekend it would be tapping the markets for money to replace the state as a shareholder, and that is just one example among many. There are lots of battered balance sheets out there, and the stock market is just about the only place where funds can be raised to put them back into shape. Already there have been 315 IPO’s this year as deals frozen in the credit crunch get bought back to life. But all that extra stock coming onto the market is going to soak up available funds, and will stop prices from rising as fast as they have been.
Next, the initial impact of the stimulus programmes put in place by governments around the world will start to fade. Even a patient near death will perk up if given a massive injection of adrenaline, but that doesn’t tell you very much about their underlying health. It would be a surprise if big increases in government spending, central banks printing money like crazy, and record-low interest rates, had not revived the economy. But governments can only shift spending from one period to another. They can’t permanently increase it. Over the next six months the impact of all those stimulus programmes is going to fade out of the system, revealing economies that are very weak underneath it. When that happens, investors are going to have a nasty fright.
Thirdly, this rally has been led upwards by the emerging markets. It is the Chinese, Brazilian, Indian and Russian markets that have led the upswing, the so-called BRIC economies. No surprise there. With high-saving rates, rapid industrialisation, and hard-working labour forces they look a far better bet than the developed economies of Europe and North America. Yet they remain volatile, and gains of 70% or more in a year are likely to be checked. When they are, investors around the world will take fright. Without the BRICs to drive it, there are very few reasons for feeling optimistic about the global economy.
Lastly, the UK has some political turbulence ahead. Gordon Brown’s government will limp miserably into the last political season before its demise. Don’t assume that Brown will survive: the Labour Party shows little will to live right now, but it must know it is being led to slaughter. Even without a change of Prime Minister, as he election campaign gets underway, as it will once the party conference season opens, the currency and gilts market may well wobble. Neither party shows much willingness to discuss the scale of the fiscal crisis the UK faces, and at some point that will make anyone holding assets in sterling feel nervous.
Whether the last five months were just a bear market rally, as the sceptics will tell you, or whether they were the foothills of a genuine bull market, no one can say for certain. There are good arguments on both sides of the issue. But one thing is for sure. Market never move either up or down in a straight line. Whichever it is, there will be bumps and reversals along the way. This market is due a correction. And September is the most likely time for it to kick-in.

Tuesday, 11 August 2009

The Book Is Dead....

Over on The Curzon Group blog there's an interesting debate going on about the future of the book. I've chipped in my thoughts today, but its worth reading the whole thing.

Anyway, here's what I posted...

Clem and Tom both seem worried about the future of the book. But a blog is nothing without debate, and I'm not so sure. True, the Kindle and the new generation of e-books are potentially a threat, and one we should take seriously. And, also true, the music industry was effectively killed by the web, and the newspaper industry looks like being next, so we shouldn't be complacent.

Still, there are some important differences.

In both music and newspapers, the technology dictated the form. The 40-minute LP happened to be the length because that's what you could fit onto 12-inches of vinyl. The once a day mix of news, business, sport, crosswords and features that we call a newspaper came about because that was worked when printing presses and trains were the only way of distributing information. In both cases, the product itself was, to a large extent, created by the technology.

And so, when the technology changed, there wasn't much point to the product any more.

I don't that's true of the book. Okay, it's printed and bound, but it's just a narrated story and there have never been any technological rules about length (a novel, by the way, is a similar length to a dream) or format.

My point is that while digital music and digital news are in many ways superior products that isn't true of books.

A digital book might be cheaper, if the publishers choose to make it so, or free if there is file-sharing, but it isn't better.. And that's a crucial distinction.

To me the big challenge to writers and novelists isn't the e-book. It's the compter game. This is a completely new narrative form, and one that can be far more immmersive for the reader/player. But that isn't a threat. It's an opportunity.

Sunday, 9 August 2009

The Impact Of Public Spending Cuts...

Not many people have started to think much yet about the kind of impact the inevitable and huge cuts in public spending are going to have. In my Money Week column this week, I've been looking at the effect it will have on the regions, but it will go much wider than that. Here's a taster of the piece.....

If there is one phrase that David Cameron would like people to associate him with it is probably ‘one nation conservative’. Ever since Benjamin Disraeli coined the term in his novel ‘Sybil, or The Two Nations’ in 1845, it has stood for a brand of compassionate, inclusive Conservatism that Cameron would like his government to embrace.
The trouble is, he is likely to be savagely disappointed.
The now almost certain 2010-2014 Tory administration is going to see Britain become two nations again, probably more savagely than even under Mrs Thatcher, and certainly much more so than under Disraeli.
So far Wales, Northern Ireland and the North-East have been largely protected from the recession. The juggernaut of public spending that had fuelled their recent prosperity is still rolling. But whilst the prosperous South of the country may well bounce back from the recession reasonably quickly, the regions are about to be tipped into a brutal economic whirlwind. The result will be a vicious social and political battle that will mark much of the first term of the next Tory government.
Under twelve years of a Labour government, regions that were once a by-word for depression and unemployment have prospered. Old industrial centres such as Tyneside, Belfast and South Wales have been re-invigorated. Smart new apartment buildings have sprouted along the banks of gloomy old canals. Sparkling new shopping malls have sprung up on derelict factory sites. Stern, redbrick warehouses and mills are now trendy bistros and coffee bars. To an extent that hadn’t been true since the 1950s, the UK became, economically at least, one nation again: the South might have been a bit richer, but the gap wasn’t widening.
There were some solid underpinnings to that. In Northern Ireland, for example, the troubles came to an end, and peace is always a lot better for economic growth than war. In the North-East and Wales, the savage if necessary process of de-industrialisation that started in the early 1980s had come to an end. The ‘destruction’ bit of capitalism’s constant ‘creative destruction’ had ended, and the ‘creative’ bit had started.
And yet, it was also in the most part a mirage. The prosperity of the regions was about as solid as a wobbly jelly. Whilst there was some genuine economic development, it was mainly a tidal wave of government spending that lifted them up.
Over the last few years, many parts of the UK have become as totally dependent on the state as any of the old Soviet satellites before the Berlin Wall came down 20 years ago. According to calculations by the Centre for Economic and Business Research, public spending now accounts for 67.9% of the Northern Irish economy, 67.3% of the Welsh economy, and 61.6% of the economy of the North-East (Scotland, despite its image as a subsidy economy, comes in at a slightly more modest 57%). By contrast, in the South-East, the state accounts for only 38% of the economy, and in London only 39%. Those are vast differences – the state is almost twice as dominant in Wales and Northern Ireland as it is in London and the South-East. With the recession, it is only going to get worse. The Treasury’s own figures show the state accounting for almost 70% of GDP in Wales and Northern Ireland by 2010-2011. For a comparison, in the same year, state spending will only account for 60% of Cuba’s output. On any meaningful definition, these have become fully socialised economies.
That was fine so long as the money was there to pay for it. But the public spending taps are about to be turned off. The IMF warned last month that Britain had the worst budget deficit in the developed world, and that much of the shortfall was structural. Regardless of whether it pulls out of recession – and with the current policies it probably won’t – there will have to be huge cuts in public spending. That is going to hit hardest in those areas where the state spends the most.
London and the South-East may well be able to bounce back relatively quickly from the recession. Free market economies are always flexible. The south of the country has benefited from a huge depreciation of the pound, stimulating new export industries, as well as massive injection of cash from the Bank of England. By next year, it could well be growing at a reasonable clip again. If Gordon Brown’s catastrophic decision to lift the top rate of tax to 50% is reversed, there won’t be much to hold it back.
But the regions are going to fare much worse. So far, they have been protected from the worst of the recession. Public spending is still growing at a steady rate. The government payroll is still expanding, wages are still going up, and generous pensions and perks are still protected.
But from 2010, that all starts to go into reverse. Spending will start falling. And that is going to hit the areas that depend on the state very hard.
Over the last decade, the state has expanded so fast in those areas, there is virtually no private sector left to speak off. There aren’t any industries that workers can switch into. Nor are there any clusters of entrepreneurial innovation. The government has employed so many people, and paid them so much better than the private sector, that it has crowded out all other activity.
In the 1980s, Northern Ireland, Wales and the North-East suffered hardest from the collapse of big, old-fashioned industry. In the next decade, they will suffer most from the collapse of big, old-fashioned government. The results are not going to be pretty. You don’t need to know much about economics to realise that when an entity that accounts for 70% of GDP cuts back, it brings everything down with it. House prices will plummet. Shops will be shuttered up. Unemployment will soar. What few private businesses remain will struggle.
At some point, the regions will develop new industries, just as they did in the nineteenth century. But in the meantime, Britain is going to be two nations again – one fast recovering and growing more prosperous while the other is stuck in a deep, permanent slump.

Tuesday, 4 August 2009

The Supermarkets Take Over The Book Trade

Over on the Curzon Group blog, I've been disucussing whether the increasing power of the supermarkets in book retailing is good or bad for authors. Here's the post...

According to this report in The Bookseller, the supermarket chains now account for 20% of the UK book market. It has trebbled in the last five years, and the shares, not very surprisingly reflect the position of the chains - Tesco lead the way, with Asda and Sainsbury's huddling in second place.

It's traditional among authors to moan about the rising power of the supermarkets. But I'm not so sure. They may well be doing a lot of good.

I might be biased because my own book has been doing well at Asda - it has spent about six weeks now in their books chart.

But the supermarkets are doing two things that are really good.

One, they are making books really cheap. You'll pay less than £4 for a paperback in a supermarket, and that isn't just achieved by cutting the money going to publishers and authors (well, the author at least - they drive a hard bargain with the publisher). The supermarkets just don't need the same kind of margin that bookshops do - a 10p profit looks pretty good to Tesco, and is more than they make on a litre of milk, which weighs more, takes up more space and goes off after a couple of days as well. You don't need to know much economics to know that a cheaper a product gets, the more people buy it - and the more books get sold, the better for everyone.

Next, they introduce books to people in new settings. Most people go to the supermarket at least once a week. They can browse among the books, and occassionally find new things. We might like to imagine they'd spend an hour every week doing that at Waterstone's, but they truth is, they probably wouldn't.

For both reasons, the supermarkets are almost certainly increasing book sales in the UK.

Of course, there are some downsides.

They have a limited range, and they only stock a few books from the big publishers. The concentration of power is going to make it harder for new writers to break through.

And the publishers have become obsessed with them. When I was ghost-writing for Random House, all they cared about was 'what Tesco would think'. They even changed one writer's name becasue they didn't think Tesco would like what he was called. I thought they were being silly. Tesco would be happy with anything that sold, but they had become neutrotically obsessed with finding the perfect Tesco book.

But, that said, authors have to get out to where the books are. Personally, I'd love to be signing books and talking to customers and readers in Asda or Tesco. In fact, once we've got our aiport tour out of the way, I might make a 'supermarket tour' the Curzon Group project.

Monday, 3 August 2009

An Economic Conspiracy....

One of the interesting things about the recession is how there is a conspiracy of economists talking complete nonsense. The mainstream opinion is presented in most of the media, which says we have to slash interest rates, and print more money...although most ordinary people can see that is plain wrong. Anyway, I touched on some of the alternatives in my Money Week column last week. Here's a taster.

There are plenty of things from the early 1980s we’d rather not revive. No one really wants to drive around in a Ford Sierra, or watch the early episodes of Dynasty. But there is one thing from a quarter century ago that could be usefully bought back from the dead: Reagan-omics.
In the UK, there is a stultifying consensus among economists and pundits that the historical lessons we need to be learning are all from the 1930s. We need massive government spending, and the printing presses need to keep churning out new money, we are constantly told.
But, in truth, the decade the UK should be learning from is the 1980s. And the policy prescriptions should be the same ones that Ronald Reagan pushed through after moving into the White House in 1982: dramatically lower taxes and higher interest rates.
It is the exact opposite of what most experts are arguing for the UK. But it is the only mix that will get us out of the recession.
In the early 1980s, the US faced a global recession. Unemployment was rising fast, and so was inflation. Output was in decline. The government budget deficit was soaring out of control. Nobody appeared to have much of a clue how to pull the country out what looked like a severe economic downturn.
The conventional response, pushed by Keynesian economists, was to raise government spending on public works, let taxes steadily rise to keep the deficit under control, and get the Federal Reserve to push interest rates down to make money cheaper.
Sounds familiar? It is just about the same mix the UK is following today. In response to a global recession, the budget deficit is being allowed to soar out of control. The Bank of England is keeping interest rates at all-time lows, as well as printing money. A consensus across all parties is emerging that taxes will have to rise: all the Conservative Party can promise is that it will raise them a bit less. Indeed, from next year, the British top rate of tax will rise to 50%, one of the highest top rates in Europe. Many other tax rises are likely to follow.
Reagan’s genius was his ability to rip up consensus views, and try something radically different instead. And that’s precisely what he did on the economy.
Ignoring the Keynesian consensus in academia, and on Wall Street, Reagan radically cut tax rates. The Economic Recovery Tax Act of 1981 pushed down average income tax rates by a quarter: the top-rate came down from 70% to 50%, whilst the bottom rate dropped from 14% to 11%. At the same time, allowances were legally tied to inflation, and capital gains taxes were slashed.
But to make sure all those tax cuts didn’t spark inflation, the Chairman of the Federal Reserve under Reagan, Paul Volcker, also pushed up interest rates. From 11% in 1979, rates in the US went all the way up to a peak of 21.5% in 1982.
Most of the economic and business establishment thought Reagan was crazy. It was precisely the ‘voodoo economics’ his vice-president George Bush had complained about on the campaign trail. There were plenty of predictions of catastrophe. But it turned out to be right. Within a few years, not only had the US pulled out of recession. It had laid the foundations for what turned out to be a quarter century of growth, new jobs and rising prosperity.
In truth, what Reagan had done was create what supply-side economists call an ‘enterprise recovery’. The tax cuts stimulated entrepreneurs, whilst higher interest rates encouraged saving, allowing the deficit to be funded, and creating wealth that businesses could draw upon. Over the next decade, the American economy was re-built. Sure, there was some pain involved, but the policy was a resounding success.
There are plenty of lessons in that for Britain in 2009, if only we were open-minded enough to learn them.
Right now, we have cheap money, and the inevitability of rising taxes. The chances are that isn’t going to do much good. There is already evidence the tax rises needed to fund Gordon Brown’s so-called ‘stimulus’ will end up stunting the recovery instead. The Taxpayer’s Alliance produced a report this week showing that effectively money would be taxed at 92% before entrepreneurs got a chance to invest it. "Politicians are promoting a huge range of schemes to try and hold down unemployment but they aren't paying nearly enough attention to how their policies affect entrepreneurs, who create the vast majority of new jobs,” argued the Alliance’s research director Matthew Sinclair in the report.
True enough. Not just entrepreneurs are deterred. Ordinary consumers are nervous of future tax rises, and that will dampen both consumer and business confidence, two vital ingredients for any recovery. At the same time, interest rates are so low, it is virtually pointless for any sane person to save money. And what money is saved is going to be sucked up immediately by the government’s vast borrowing.
If Britain wanted a radical change of direction, it should do precisely what Reagan did in the early 1980s.
Step one, cut taxes dramatically.
A country with Swedish tax rates and Zimbabwean-style public services isn’t going to be able to compete. With the state consuming 50% of GDP there is no chance of sustained recovery. True, in the short-term the deficit will rise even higher. But if tax cuts are part of an ‘enterprise recovery’, the tax revenues will come along in due course to start paying down the debt, just as they did for Reagan.
Step two, let interest rates rise back to a normal, long-term
Once taxes are cut, monetary policy will need to be tightened to stop inflation running out of control. And the UK needs to start restoring a savings culture – and the only way to do that is to start rewarding thrift again. Tight money and low taxes, contrary to what the Keynesians will tell you, are naturally bedfellows, creating sustainable, non-inflationary growth.
For the UK economy to start recovering, it needs to save more, work harder, and create new industries. Reagan understood that was the only lasting recipe for economic success – and at some point, the British will need to re-learn it as well.