In my Money Week column this week, I've been looking at the the UK as a monetary union, like the euro....and concluding that doesn't work either. Here's a taster.
What does the euro need to make it work better? The most common answer is that it needs to be turned into a fiscal union, with large-scale transfers from the richer regions to the poorer. It is the conventional wisdom of every editorial, and City pundit. Until it becomes a ‘transfer union’ it doesn’t stand a chance of succeeding.
A caveat or two is usually thrown in. The political obstacles are formidable. The Germans might never agree to their taxes being sent to bail-out Greece or Portugal. The treaties might need to be re-written, and that would require the agreement of all the European Union’s members. Still, if only those obstacles could be overcome, a fiscal union would smooth out most of the problems.
The trouble is, no one seems to have stepped back and questioned the fundamental assumption. The evidence suggests it may well be wrong. Europe has another monetary union between countries at very different stages of economic development. It is called the UK, and the currency is sterling. Reverse the polarities – the UK has a rich south, and a poor north, rather than a rich north and a struggling south – and the sterling area has many similarities to the euro area. It is made up of group of countries with very different levels of prosperity. And it has huge transfers between the richer regions and the poorer.
And the result? It doesn’t do any good at all. True, it holds the currency area together. But it only does so at the cost of creating regions that are ever more dependent on state aid. The truth is, a transfer union won’t save the euro even if it was politically feasible. Nothing will. The project is doomed.
That doesn’t stop people from trying, The most common critique of the single currency is that is an economic union without a political union. George Soros has argued for a year that without a single government the currency won’t survive. The President of the European Central Bank Jean-Claude Trichet has called for a European finance ministry.
The UK’s experience, however, suggests that even if it happened, it wouldn’t work. Britain used to be a fairly homogenous economy, with wealth relatively evenly spread out across its major industrial centres, much as it is in modern Germany. Not any more. Post-industrial Britain has a very, very prosperous capital, surrounded by equally wealthy suburbs. The Midlands and East are doing fine. The rest of the country has been falling behind at an increasingly rapid rate. The result is that there are huge disparities between output per head in the South and Wales, Scotland and Northern Ireland. It isn’t quite as dramatic as the gulf between Germany and Greece – but it isn’t that far off.
That gets fixed by fiscal transfers. The UK, which has of course a single government, and single finance ministry, shuttles large sums of money from the richer regions to the poorer. Oxford Economics, the consultancy firm, has calculated the amount the British government spends per person employed – per taxpayer, in other words - for the different parts of the country. In the prosperous South-East, the government spent £14,100 per working person. In Northern Ireland, it spent £21,200. Wales, Scotland and the North-East were all way above average. The East, East Midlands, and London were all below average – although London, which has pockets of real poverty amidst its wealth, not by as much as you might think. It also looked at expenditure relative to gross value added, that is the actual output of the region. Taking the average for the UK as 100, Northern Ireland scored 155 and the South-East just 84. In other words, a lot of the wealth from the South-East gets sent to the ‘periphery’.
The UK is, therefore, a monetary union with very significant transfers between its richer and poorer regions. The trouble for the euro’s would-be fiscal unifiers is that there is very little evidence that it fixes the problem. Northern Ireland for example has had a consistently lower growth rate than the UK as a whole – this year, it will grow by 1.1% compared with 1.7% for the UK according to estimates by Northern Bank. Much the same is true of Wales and the North-East. The regions with the biggest fiscal transfers have grown consistently more slowly than the rest of the UK, with the result that the ratio of state spending relative to their local economies has grown steadily over time. Between 1999 and 2010 state spending rose from 50% of the Welsh economy to 69%, according to calculations by the Centre for Economics and Business Research.
Fiscal transfers can hold a monetary union together. There is no sign of the sterling area breaking up, although the Scots might eventually decide to go their own way. But they won’t close the gap between the richer regions and their poorer neighbours. They are a permanent subsidy – and one that will probably grow over time.
If anything, the fiscal transfers probably make the problem worse. They crowd out private investment – after all, why would anyone in Northern Ireland set up a business when they are relatively few industries where it has much strength, and when they could just get on a plane to London, or else get a secure job in the public sector? It creates whole regions where the fiscal transfers are the only thing that keeps the economy afloat.
That just about works in the UK. It has been a unified state for several hundred years, and has close ties of language, culture and family between its regions – although it remains to be seen whether the Tory voters of the south-east will accept the deal forever. But it is very hard to see it working for the euro zone. Voters in Munich and Eindhoven already seem outraged by paying for the Greeks and Portuguese. When they get told that the transfers are permanent, and will rise steadily over time, they will surely refuse to pay. The scary truth is that even the one plausibly fix for the euro crisis doesn’t work.
Showing posts with label uk. Show all posts
Showing posts with label uk. Show all posts
Saturday, 2 July 2011
Tuesday, 24 August 2010
How to Read the Uk Economy....
In my Money Week column this week, I've been discussing how we need to look at a different set of indicators to get a feel for how the UK economy is doing. Here's a taster....
Is Britain about to face a double-dip recession? The media and the economic forecasters in the City have been in a flap about that much of the past month. House prices have stalled, and may be falling again. Consumer spending is sluggish. There are big cuts in government spending coming down the track. It isn’t hard to make the case that the reasonably robust bounce back from the collapse of 2009 we are witnessing right now might be about to go into reverse, and that another recession is just around the corner.
Then again, perhaps we are looking in all the wrong places for signs of life from the British economy. Over the last twenty-five years we became used to watching house prices and the retail sales figures to get a sense of where the economy was going. That worked perfectly well during a property, debt-fuelled bubble. But that economy has vanished forever. The British economy of the coming decade will have to be based on exports, small businesses, and making things. And to get an idea of how that is going we will need to get used to a very different set of indicators – the trade balance, the savings ratio, company formations, and private sector job creation. Those are the numbers that will tell us whether the economy is showing signs of life or not.
For most of the past couple of decades, you could get a pretty good idea of where the economy was going just by looking at the monthly mortgage approvals figures. If people were borrowing more money, pretty soon they’d be buying a new house, and a few weeks later house prices would go up. All the people who’d bought new houses would soon be loading up their credit card with all the stuff they needed to put into it. And everyone else would see how much their house had gone up in value in the past year, book themselves a winter holiday to celebrate, then head down to the shopping mall to buy some new clothes for the trip.
The sequence was pretty simple. In an economy based on property and ever rising levels of debt, if you just kept an eye on house prices, and the sales figures from a couple of the big high street chains, you’d have a very accurate idea of how the economy was doing.
But along with the rest of the developed world, the UK has reached the end of that road. The easy-money days are behind us. The credit has all dried up. The British economy might do well or badly in the next decade, but the one thing it won’t do is go through another house price, retail spending led consumer boom. If it is to have any chance of prospering, it needs to create real wealth in the private sector instead.
So what indicators should we be looking at instead?
The trade balance is good place to start. It used to be headline news every month, but has been largely forgotten about in the last twenty years. But with a big depreciation of the pound, the British should be making things and selling them around the world. They should be importing a lot less as well, as they tighten their belts and concentrate on repairing their balance sheets rather than getting a bigger flat-screen TV to put on the wall. Both should result in an improving trade balance.
The savings ratio might be another good indicator. The UK needs to save more and spend less, and much of that saving needs to be directed towards re-building the economy so that it is less reliant on financial services and government spending.
So too is the rate of company formation, and the rate of bankruptcies. Again, the numbers of new small companies getting started, and the percentage of them that fail or flourish, will be a clear measure of whether a fresh wave of entrepreneurs are establishing new industries. The rate of private sector job creation will be important as well. For most of the last decade nearly all the new jobs were in the public sector. In the next ten years, it will be private companies, and mostly small ones, that have to create the jobs.
As it happens, most of those figures are looking pretty good right now. The trade gap is indeed starting to narrow. Last month, exports rose by more than 4%, and imports by only 1%, producing an unexpected narrowing of the deficit. Exports to non-EU countries were the highest on record. Our car exports were up 11% month on month. That’s pretty encouraging.
Manufacturing is currently up 4.1% year on year, with the biggest increases in the machinery and equipment industries. Company formation figures are not regularly produced (and many new companies are just tax reduction vehicles). But company winding up orders in the court s are down 17% year-on-year, according to the latest figures from the Office for National Statistics. That’s a good sign as well.
Unemployment is down slightly, and more jobs are being created. Most importantly they are in the private sector. The numbers of people employed in the public sector fell by 7,000 in the first quarter of this year, whilst private sector employment rose by 18,000. It is a small step, admittedly, particularly when you remember that 29 million people have jobs in the UK. But a small step is still valuable when it is in the right direction. Britain needs a lot more private sector job creation in the years ahead.
The important point is not whether those numbers are looking good or bad. Sometimes they will be up, and at other times down. They are, however, the numbers that count.
None of the pundits writing about house prices or retail sales or government spending are adding anything to the debate. They are referring to an economy that’s vanished. There are a whole different range of indicators we need to pay attention to now.
Is Britain about to face a double-dip recession? The media and the economic forecasters in the City have been in a flap about that much of the past month. House prices have stalled, and may be falling again. Consumer spending is sluggish. There are big cuts in government spending coming down the track. It isn’t hard to make the case that the reasonably robust bounce back from the collapse of 2009 we are witnessing right now might be about to go into reverse, and that another recession is just around the corner.
Then again, perhaps we are looking in all the wrong places for signs of life from the British economy. Over the last twenty-five years we became used to watching house prices and the retail sales figures to get a sense of where the economy was going. That worked perfectly well during a property, debt-fuelled bubble. But that economy has vanished forever. The British economy of the coming decade will have to be based on exports, small businesses, and making things. And to get an idea of how that is going we will need to get used to a very different set of indicators – the trade balance, the savings ratio, company formations, and private sector job creation. Those are the numbers that will tell us whether the economy is showing signs of life or not.
For most of the past couple of decades, you could get a pretty good idea of where the economy was going just by looking at the monthly mortgage approvals figures. If people were borrowing more money, pretty soon they’d be buying a new house, and a few weeks later house prices would go up. All the people who’d bought new houses would soon be loading up their credit card with all the stuff they needed to put into it. And everyone else would see how much their house had gone up in value in the past year, book themselves a winter holiday to celebrate, then head down to the shopping mall to buy some new clothes for the trip.
The sequence was pretty simple. In an economy based on property and ever rising levels of debt, if you just kept an eye on house prices, and the sales figures from a couple of the big high street chains, you’d have a very accurate idea of how the economy was doing.
But along with the rest of the developed world, the UK has reached the end of that road. The easy-money days are behind us. The credit has all dried up. The British economy might do well or badly in the next decade, but the one thing it won’t do is go through another house price, retail spending led consumer boom. If it is to have any chance of prospering, it needs to create real wealth in the private sector instead.
So what indicators should we be looking at instead?
The trade balance is good place to start. It used to be headline news every month, but has been largely forgotten about in the last twenty years. But with a big depreciation of the pound, the British should be making things and selling them around the world. They should be importing a lot less as well, as they tighten their belts and concentrate on repairing their balance sheets rather than getting a bigger flat-screen TV to put on the wall. Both should result in an improving trade balance.
The savings ratio might be another good indicator. The UK needs to save more and spend less, and much of that saving needs to be directed towards re-building the economy so that it is less reliant on financial services and government spending.
So too is the rate of company formation, and the rate of bankruptcies. Again, the numbers of new small companies getting started, and the percentage of them that fail or flourish, will be a clear measure of whether a fresh wave of entrepreneurs are establishing new industries. The rate of private sector job creation will be important as well. For most of the last decade nearly all the new jobs were in the public sector. In the next ten years, it will be private companies, and mostly small ones, that have to create the jobs.
As it happens, most of those figures are looking pretty good right now. The trade gap is indeed starting to narrow. Last month, exports rose by more than 4%, and imports by only 1%, producing an unexpected narrowing of the deficit. Exports to non-EU countries were the highest on record. Our car exports were up 11% month on month. That’s pretty encouraging.
Manufacturing is currently up 4.1% year on year, with the biggest increases in the machinery and equipment industries. Company formation figures are not regularly produced (and many new companies are just tax reduction vehicles). But company winding up orders in the court s are down 17% year-on-year, according to the latest figures from the Office for National Statistics. That’s a good sign as well.
Unemployment is down slightly, and more jobs are being created. Most importantly they are in the private sector. The numbers of people employed in the public sector fell by 7,000 in the first quarter of this year, whilst private sector employment rose by 18,000. It is a small step, admittedly, particularly when you remember that 29 million people have jobs in the UK. But a small step is still valuable when it is in the right direction. Britain needs a lot more private sector job creation in the years ahead.
The important point is not whether those numbers are looking good or bad. Sometimes they will be up, and at other times down. They are, however, the numbers that count.
None of the pundits writing about house prices or retail sales or government spending are adding anything to the debate. They are referring to an economy that’s vanished. There are a whole different range of indicators we need to pay attention to now.
Monday, 23 November 2009
Electioneering Over The Economy
There is yet more electioneering over the economy today. But as I point out in my coilumn for Money Week this week, that is the last thing the UK economy needs...
It is now almost two years since the credit crunch stuck, more than a year since Lehman Brothers collapsed, and almost twelve months since the British economy plunged off a cliff, sinking into the deepest recession since records began. And yet to listen to the political debate you’d think nothing much had changed.
During conference season, the Prime Minister Gordon Brown reeled off a whole new list of spending commitments. In the weeks since, not a single tough decision has been announced on spending. Indeed, as Money Week went to press, the Queen’s Speech looked set to unveil yet more public spending.
Unfortunately, that is a foretaste of what is in store for the next six months – populist, pointless electioneering that just postpones the task of rebuilding the British economy.
And yet, the economy is still stuck in recession whilst the rest of the world recovers. Its budget deficit is spinning out of control, and a single word from the ratings agencies could still be the cue for the bail-out from the IMF. Rather than tackling the problems, the political class is still just scoring cheap points of one anther. The longer the UK delays tackling the real problems with its economy, the worse and worse it will get – and the more painful the eventual treatment.
In the past year, there has been no sign of the government facing up to the challenging economic circumstances the country now faces. Instead, we get some populist banker-bashing, such as the latest promise to tear up contracts the government doesn’t like.
None of it comes close to the debate the country needs. Britain needs to re-think its dependence on financial services. And it needs to come up with ways of regulating banks that stops them from holding the country to ransom. But futile measures to micro-manage contracts – which will be impossible to implement anyway - are just a way of avoiding the real debate.
As for yet more spending, there has so far been no recognition that the government is already spending wildly more than it can afford. For the last decade, British politics has been largely about bribing the voters with their own money. Now, it is about bribing the voters with printed money. One in every four pounds spent by the government is borrowed, and since the main purchaser of government debt is the Bank of England using money magically created in its computers, that really is the economics of the Weimar Republic.
Regrettably, the opposition isn’t much better. The Conservative Party might have a better idea of the tough economic medicine that is going to be needed. But it is still too nervous of the electoral consequences to spell out the pain ahead. It has gone along with the increase in the top rate of tax to 50%, even as it becomes painfully clear that it is fast driving entrepreneurs and companies out of the country.
We can expect much more of this in the six months or so until the election is finally called. Gordon Brown’s government will carry on spending money as if the stuff was going out of fashion (which, as quick glance at the gold price will tell you, it already is). Pre-election bribes will be frittered around the place. There will be lots of talk about making tough choices on the budget. Yet don’t expect any of them actually to be made. The opposition parties will be just as bad. They are too nervous to talk about real cuts, for fear of alienating the voters. Instead, they will offer a few headline-grabbing reductions in spending – scrapping the Trident missiles system, or reducing the number of MPs.
And yet Britain remains firmly stuck at the bottom of the global growth league, despite a thirty percent devaluation in the pound, massive government spending, and a central bank that has printed more money than any other in the world.
The stimulus might just about prevent the economy collapsing into a full-blown depression – although only at the cost of storing massive debts for future generations, and weakening the currency. But it is now clear that it is not going to restore the UK to a decent level of growth. The best the UK can hope for under current policies is to repeat the experience of France over the last decade – a state-dominated economy, incapable of growing by much more than 1% a year, and so unable to create enough jobs to maintain its prosperity.
In reality, the UK needs massive structural reform.
It needs to bring its tax rates down to competitive levels. The UK doesn’t have great infrastructure, or skill levels, nor, apart from finance, is it dominant in many industries. It can’t compete when it has the highest personal tax levels in Europe. The only way it can start re-building its economy is by cutting taxes to levels that will draw in a new wave of foreign investors, and encourage a new generation of entrepreneurs.
The budget deficit needs to be slashed. Even if you blieve the markets will fund a budget deficit of 12% or more of GDP (and there remains a big question mark over that), don’t forget that counties with big debts don’t grow. Look at Japan and Italy – the two most indebted countries in the world, and the slowest growing as well. Big budget deficits crowd out investment from the private sector: and yet it is only private sector investment that will restore growth.
Finally, it needs to stop printing money, and make sterling competitive again. There is no evidence to suggest that devaluation is stimulating exports. The UK does best when sterling is strong, not the reverse. What Britain needs to do is get the savings ratio back up, and get investment flowing into business – and you can’t do that when you are trashing the currency.
It is a tough programme. But, in the medium term, it is the only one that will work. And the longer it is put off, the harsher the medicine will have to be when it is eventually delivered.
It is now almost two years since the credit crunch stuck, more than a year since Lehman Brothers collapsed, and almost twelve months since the British economy plunged off a cliff, sinking into the deepest recession since records began. And yet to listen to the political debate you’d think nothing much had changed.
During conference season, the Prime Minister Gordon Brown reeled off a whole new list of spending commitments. In the weeks since, not a single tough decision has been announced on spending. Indeed, as Money Week went to press, the Queen’s Speech looked set to unveil yet more public spending.
Unfortunately, that is a foretaste of what is in store for the next six months – populist, pointless electioneering that just postpones the task of rebuilding the British economy.
And yet, the economy is still stuck in recession whilst the rest of the world recovers. Its budget deficit is spinning out of control, and a single word from the ratings agencies could still be the cue for the bail-out from the IMF. Rather than tackling the problems, the political class is still just scoring cheap points of one anther. The longer the UK delays tackling the real problems with its economy, the worse and worse it will get – and the more painful the eventual treatment.
In the past year, there has been no sign of the government facing up to the challenging economic circumstances the country now faces. Instead, we get some populist banker-bashing, such as the latest promise to tear up contracts the government doesn’t like.
None of it comes close to the debate the country needs. Britain needs to re-think its dependence on financial services. And it needs to come up with ways of regulating banks that stops them from holding the country to ransom. But futile measures to micro-manage contracts – which will be impossible to implement anyway - are just a way of avoiding the real debate.
As for yet more spending, there has so far been no recognition that the government is already spending wildly more than it can afford. For the last decade, British politics has been largely about bribing the voters with their own money. Now, it is about bribing the voters with printed money. One in every four pounds spent by the government is borrowed, and since the main purchaser of government debt is the Bank of England using money magically created in its computers, that really is the economics of the Weimar Republic.
Regrettably, the opposition isn’t much better. The Conservative Party might have a better idea of the tough economic medicine that is going to be needed. But it is still too nervous of the electoral consequences to spell out the pain ahead. It has gone along with the increase in the top rate of tax to 50%, even as it becomes painfully clear that it is fast driving entrepreneurs and companies out of the country.
We can expect much more of this in the six months or so until the election is finally called. Gordon Brown’s government will carry on spending money as if the stuff was going out of fashion (which, as quick glance at the gold price will tell you, it already is). Pre-election bribes will be frittered around the place. There will be lots of talk about making tough choices on the budget. Yet don’t expect any of them actually to be made. The opposition parties will be just as bad. They are too nervous to talk about real cuts, for fear of alienating the voters. Instead, they will offer a few headline-grabbing reductions in spending – scrapping the Trident missiles system, or reducing the number of MPs.
And yet Britain remains firmly stuck at the bottom of the global growth league, despite a thirty percent devaluation in the pound, massive government spending, and a central bank that has printed more money than any other in the world.
The stimulus might just about prevent the economy collapsing into a full-blown depression – although only at the cost of storing massive debts for future generations, and weakening the currency. But it is now clear that it is not going to restore the UK to a decent level of growth. The best the UK can hope for under current policies is to repeat the experience of France over the last decade – a state-dominated economy, incapable of growing by much more than 1% a year, and so unable to create enough jobs to maintain its prosperity.
In reality, the UK needs massive structural reform.
It needs to bring its tax rates down to competitive levels. The UK doesn’t have great infrastructure, or skill levels, nor, apart from finance, is it dominant in many industries. It can’t compete when it has the highest personal tax levels in Europe. The only way it can start re-building its economy is by cutting taxes to levels that will draw in a new wave of foreign investors, and encourage a new generation of entrepreneurs.
The budget deficit needs to be slashed. Even if you blieve the markets will fund a budget deficit of 12% or more of GDP (and there remains a big question mark over that), don’t forget that counties with big debts don’t grow. Look at Japan and Italy – the two most indebted countries in the world, and the slowest growing as well. Big budget deficits crowd out investment from the private sector: and yet it is only private sector investment that will restore growth.
Finally, it needs to stop printing money, and make sterling competitive again. There is no evidence to suggest that devaluation is stimulating exports. The UK does best when sterling is strong, not the reverse. What Britain needs to do is get the savings ratio back up, and get investment flowing into business – and you can’t do that when you are trashing the currency.
It is a tough programme. But, in the medium term, it is the only one that will work. And the longer it is put off, the harsher the medicine will have to be when it is eventually delivered.
Sunday, 21 June 2009
Will Brown Quit in January?
The Mail r that Gordon Brown is planning to step down in January, rather than fight an election. It sound plausibe. In case anyone hadn't noticed, Gordon doesn't do elections. He's run away from them all in the past....and, in fairness, fighting Cameron in 2010 when you are averging 22% in the polls isn't where you'd want to start.
Thursday, 21 May 2009
Great Timing
I've done a piece for The Spectator this week on the threat of a ratings cut for the UK. And, on the same day is comes out, S&P downgraded the UK's debt.
Tuesday, 28 April 2009
A Tax Catastrophe For The City
Wednesday, 22 April 2009
Respect to FT Alphaville
Over at FT Alphaville they are linking to my Bloomberg column today about the big mnistakes the UK economy is making, and how it is turning itself into the New France. They headlined the link, 'Welcome to Frengland'. I wish I'd thought of that.
Saturday, 18 April 2009
How To Fix The British Economy
In MoneyWeek this week, I've been writing about how to fix the British economy. Here's a taster.
A banking system so bankrupt, half of it has had to be taken into state control. A regulatory system exposed as a shambles. Monetary policy in a state of confusion. And public finances shot to pieces.
Take all those together, and there can be little debate that the system Gordon Brown, and his main intellectual adviser Ed Balls, laid down for running the British economy in 1997 have been shot to pieces. If it was a house, it would have been condemned.
Now, the first signs of a debate about how to formulate a new set of rules is starting to emerge. The shadow Chancellor George Osborne made an important start last week, questioning the relationship between the Bank of England and the Financial Services Authority, and the size and role of the banks.
But the debate is going to have to go a lot further, and the policies put forward will need to be a lot more radical, if the hard work of putting the UK economy back together again is to start.
Let's start with what went wrong. In truth, just about everything. Brown mis-understood the way the City needs to be regulated. He put too much faith in inflation-targeting. He allowed the banking system to run out of control. And he mis-managed public finances. The results are plain for everyone to see -- the worst financial crisis of the major developed economies, and probably the longest and most painful recession as well.
By now, just about everyone outside of the Ten Downing Street bunker accepts that the system needs to change. But how? Here are four places we should be making a start.
One: The Monetary Policy Committee, created by Brown in 1997, needs to start targeting asset prices along with conventional measures of inflation. In retrospect, it clearly made a mistake in allowing house prices to run out of control. True, Mervyn King, the Governor of the Bank of England, issued plenty of warnings. The alarm was sounded. But, looking back, through 2004 and 2005 the MPC should have been steadily raising interest rates to whatever level was necessary to get house price inflation back to zero. Sure, it would have been painful - but not nearly as painful as what we are experiencing now.
We need to learn the lessons of that. As well as targeting retail prices, the MPC has to be told to target asset prices. If not, we are simply doomed to repeat the same mistakes.
Two: The Financial Services Authority has clearly failed. A zealously bureaucratic organisation, it focussed relentless on petty rules rather than the big picture. So, for example, it made it virtually impossible to open a bank account without producing birth certificates (in triplicate) for ancestors stretching back to 1700. But if you wanted to bankrupt the whole country, that was fine.
In reality, splitting out financial supervision from the central bank was a bad decision. In a crisis, they are the same thing. The central bank can't stand by and watch a major bank collapse – as we discovered last autumn. But if it has responsibility, it should have power as well. The Bank of England should be handed back the final say over the regulation of the banking system. The small, petty rules should be ripped up, and the replaced with broad principles designed to protect the system as a whole. Banks are full of clever, hard-working people thinking of new ways to blow up the system – only a regulator very close to the pulse of the market can be fast and flexible enough spot problems early enough to tackle them. The Bank of England is the only body that can do that.
Three: A clear strategy for the nationalised banking system should be set out. We don’t want to create the British Leyland of financial services, offering up the Morris Marina of accounts, and the Austin Princess of investments. The small, state controlled former building societies such as Northern Rock should re-mutualize: as soon as they are in decent enough shape, they should be handed back to their account holders (which would be a great way of increasing deposits as well – it would be carpet-bagging in reverse). After all, the mutual have done well so why not create more of them?
The two big state-controlled banks – Lloyds HBOS and Royal Bank of Scotland –
should be split up: Lloyds back into Lloyds and HBOS and RBS into RBS and NatWest. By themselves, NatWest and Lloyds would do fine. HBOS could be re-mutualized as soon as possible, and RBS left to whither, as a warning to other banks that get too ambitious. The important task is to create an open and competitive banking system as soon as possible – not one dominated by two nationalised giants.
Four: Public spending has to be bought under control. The ‘golden rule’ that Brown created in 1997 to keep debt under control is a joke. A rule isn’t a rule when you change it every time it looks likely to be breached. The rule that Britain needs is that public spending should be capped at a maximum of 40% of GDP over an economic cycle (which means it shouldn’t be any higher than 35% at the peak of a boom). All the evidence shows that once the state sector climbs above 40%, economic performance declines dramatically. The cuts needed to achieve that might be painful – but are surely preferable to years of French-style stagnation.
No doubt there will be plenty of other reforms needed as well. But a new inflation target, a re-regulated City, and slimmer, privatised banking system, and a shrinking public sector would give the UK economy at least the chance of relatively quick recovery.
A banking system so bankrupt, half of it has had to be taken into state control. A regulatory system exposed as a shambles. Monetary policy in a state of confusion. And public finances shot to pieces.
Take all those together, and there can be little debate that the system Gordon Brown, and his main intellectual adviser Ed Balls, laid down for running the British economy in 1997 have been shot to pieces. If it was a house, it would have been condemned.
Now, the first signs of a debate about how to formulate a new set of rules is starting to emerge. The shadow Chancellor George Osborne made an important start last week, questioning the relationship between the Bank of England and the Financial Services Authority, and the size and role of the banks.
But the debate is going to have to go a lot further, and the policies put forward will need to be a lot more radical, if the hard work of putting the UK economy back together again is to start.
Let's start with what went wrong. In truth, just about everything. Brown mis-understood the way the City needs to be regulated. He put too much faith in inflation-targeting. He allowed the banking system to run out of control. And he mis-managed public finances. The results are plain for everyone to see -- the worst financial crisis of the major developed economies, and probably the longest and most painful recession as well.
By now, just about everyone outside of the Ten Downing Street bunker accepts that the system needs to change. But how? Here are four places we should be making a start.
One: The Monetary Policy Committee, created by Brown in 1997, needs to start targeting asset prices along with conventional measures of inflation. In retrospect, it clearly made a mistake in allowing house prices to run out of control. True, Mervyn King, the Governor of the Bank of England, issued plenty of warnings. The alarm was sounded. But, looking back, through 2004 and 2005 the MPC should have been steadily raising interest rates to whatever level was necessary to get house price inflation back to zero. Sure, it would have been painful - but not nearly as painful as what we are experiencing now.
We need to learn the lessons of that. As well as targeting retail prices, the MPC has to be told to target asset prices. If not, we are simply doomed to repeat the same mistakes.
Two: The Financial Services Authority has clearly failed. A zealously bureaucratic organisation, it focussed relentless on petty rules rather than the big picture. So, for example, it made it virtually impossible to open a bank account without producing birth certificates (in triplicate) for ancestors stretching back to 1700. But if you wanted to bankrupt the whole country, that was fine.
In reality, splitting out financial supervision from the central bank was a bad decision. In a crisis, they are the same thing. The central bank can't stand by and watch a major bank collapse – as we discovered last autumn. But if it has responsibility, it should have power as well. The Bank of England should be handed back the final say over the regulation of the banking system. The small, petty rules should be ripped up, and the replaced with broad principles designed to protect the system as a whole. Banks are full of clever, hard-working people thinking of new ways to blow up the system – only a regulator very close to the pulse of the market can be fast and flexible enough spot problems early enough to tackle them. The Bank of England is the only body that can do that.
Three: A clear strategy for the nationalised banking system should be set out. We don’t want to create the British Leyland of financial services, offering up the Morris Marina of accounts, and the Austin Princess of investments. The small, state controlled former building societies such as Northern Rock should re-mutualize: as soon as they are in decent enough shape, they should be handed back to their account holders (which would be a great way of increasing deposits as well – it would be carpet-bagging in reverse). After all, the mutual have done well so why not create more of them?
The two big state-controlled banks – Lloyds HBOS and Royal Bank of Scotland –
should be split up: Lloyds back into Lloyds and HBOS and RBS into RBS and NatWest. By themselves, NatWest and Lloyds would do fine. HBOS could be re-mutualized as soon as possible, and RBS left to whither, as a warning to other banks that get too ambitious. The important task is to create an open and competitive banking system as soon as possible – not one dominated by two nationalised giants.
Four: Public spending has to be bought under control. The ‘golden rule’ that Brown created in 1997 to keep debt under control is a joke. A rule isn’t a rule when you change it every time it looks likely to be breached. The rule that Britain needs is that public spending should be capped at a maximum of 40% of GDP over an economic cycle (which means it shouldn’t be any higher than 35% at the peak of a boom). All the evidence shows that once the state sector climbs above 40%, economic performance declines dramatically. The cuts needed to achieve that might be painful – but are surely preferable to years of French-style stagnation.
No doubt there will be plenty of other reforms needed as well. But a new inflation target, a re-regulated City, and slimmer, privatised banking system, and a shrinking public sector would give the UK economy at least the chance of relatively quick recovery.
Sunday, 5 April 2009
Is the UK Heading For Meltdown?
Wiht all that G20 nonsense out of the way, and no doubt forgotten about in a few days, we can get back to looking at the UK economy. And the prospects remain pretty dire. In my MoneyWeek column this week, I've been looking at the potential for meltdown. Here's a taster....
Take A Deep Breath, and Examine The Meltdown Options For The British Economy:
Disaster Planning is meant to be a core discipline for any responsible organisation. If you were running an airline, you’d want to know what would happen if both engines on a plane failed, in freezing fog, on the same day some terrorists decided to launch a bomb attack on the airport. If you were running a hospital, you’d want to know how you might cope if there was an outbreak of bubonic plague, then an earthquake, and all in the middle of a flu epidemic.
None of those events are very likely, and certainly not at the same time. But, all the same, it’s good to have some idea of what you might do if they did. After all, there won’t be much time for thinking about it when a catastrophe strikes.
Has anyone in the Treasury been sketching out disaster scenarios for the British economy? Given the lamentable state of preparedness for the recession – it’s not long since we were being told our economy was the best placed in the world to withstand the downtown – it seems unlikely.
They should be. True, the chances are that it won’t happen. A mixture of a devalued pound, historically low interest rates, and the Bank of England printing money, should pump enough demand into the economy to keep it on its feet.
But there are three meltdown scenarios for the UK. And we should be thinking about them now – if only to concentrate our minds on how to avoid them.
One, an attack by the bond vigilantes.
We got a taster of what the bond markets can do a government last week, when an auction of gilts failed. Finding buyers for the mountains of debt the British government is going to have to issue will be a huge task. Capital Economics estimates that the budget deficit will run as high as £200 billion annually over the next five years. In fact, even that might turn out to be too optimistic. “It is not implausible that annual borrowing rises towards £300 billion,” it concluded in its most recent analysis of the public finances.
Whether the markets are willing to finance deficits on that scale remains to be seen. Of course, the Treasury might think the problem is fixed. The Bank of England’s new policy of ‘quantitative easing’ means that if it comes to a crunch, the Bank will simply print fresh money to buy up the gilts and pay for the government’s debts.
The real pain will come in the currency markets. If the government starts printing money to the tune of 10% to 15% of GDP annually, the pound can be expected to plunge. Britain imports the majority of its food and manufactured goods. Our ability to do that depends on people abroad accepting sterling as hard currency. If confidence in the pound collapses, there will be no choice but to jack up interest rates to whatever level is necessary to get foreign investors buying into sterling again. A base rate of 15% would probably be the minimum necessary – a rate that would crucify businesses and mortgage holders. In the worst case, we might even need import controls.
The chances? Probably about 10%.
Two, a return to hyper-inflation.
Forget all the chatter in the City about deflation. There are a couple of thousand years of economic history to show that once you start printing money the result is usually inflation. Cynically, policy-makers probably know that perfectly well, and have decided to accept it. A burst of inflation – say 30% over a period of five years – will effectively wipe out much of the debts of consumers and companies. It will be de-leveraging by stealth.
The trouble is, a bit of inflation is bit like having a smidgen of cocaine. It is a lot easier to start than it is to stop. The assumption right now is that all the freshly printed money can be quickly withdrawn once the economy has steadied. If it can’t be, the UK could be heading for hyper-inflation, a 20% to 30% annual increase in the price level. Savers will be wiped out, industrial unrest will be rampant, and the currency will start to lose any reliable value.
The chances: About 30%.
Three, stag-flation.
Much of the commentary on the British economy right now assumes that it was in pretty good shape until a collapse in the credit markets caused a sudden drop in demand.
Of course, that isn’t really true. The UK has been on a downward trajectory for several years. Taxes have been raised to levels incompatible with rapid growth. All the historical evidence suggests that once the state consumes more than 40% of GDP growth stagnates. The burden of red-tape and regulation has grown steadily year by year and remains the only part of the economy that shows no signs of slowing down.
In short, there were plenty of problems already – on top of which the credit markets have collapsed. So even when we fix that, the underlying economy will still be a lot weaker than it has been for the thirty years or more.
The net result will be stag-flation: a combination of moderate, persistent inflation and sluggish growth, probably never more than 1%. Interest rates will have to remain high for many years, business confidence will remain weak, there will be little incentive to save or invest, and unemployment will rise steadily because growth is too weak to create new jobs.
The chances: About 80%.
We keep being told that this recession is so threatening , governments and central banks have to throw everything they can at it. But it is worth keeping in mind that the UK now runs the risk of meltdown – and the cure might even turn out to be worse than the disease.
Take A Deep Breath, and Examine The Meltdown Options For The British Economy:
Disaster Planning is meant to be a core discipline for any responsible organisation. If you were running an airline, you’d want to know what would happen if both engines on a plane failed, in freezing fog, on the same day some terrorists decided to launch a bomb attack on the airport. If you were running a hospital, you’d want to know how you might cope if there was an outbreak of bubonic plague, then an earthquake, and all in the middle of a flu epidemic.
None of those events are very likely, and certainly not at the same time. But, all the same, it’s good to have some idea of what you might do if they did. After all, there won’t be much time for thinking about it when a catastrophe strikes.
Has anyone in the Treasury been sketching out disaster scenarios for the British economy? Given the lamentable state of preparedness for the recession – it’s not long since we were being told our economy was the best placed in the world to withstand the downtown – it seems unlikely.
They should be. True, the chances are that it won’t happen. A mixture of a devalued pound, historically low interest rates, and the Bank of England printing money, should pump enough demand into the economy to keep it on its feet.
But there are three meltdown scenarios for the UK. And we should be thinking about them now – if only to concentrate our minds on how to avoid them.
One, an attack by the bond vigilantes.
We got a taster of what the bond markets can do a government last week, when an auction of gilts failed. Finding buyers for the mountains of debt the British government is going to have to issue will be a huge task. Capital Economics estimates that the budget deficit will run as high as £200 billion annually over the next five years. In fact, even that might turn out to be too optimistic. “It is not implausible that annual borrowing rises towards £300 billion,” it concluded in its most recent analysis of the public finances.
Whether the markets are willing to finance deficits on that scale remains to be seen. Of course, the Treasury might think the problem is fixed. The Bank of England’s new policy of ‘quantitative easing’ means that if it comes to a crunch, the Bank will simply print fresh money to buy up the gilts and pay for the government’s debts.
The real pain will come in the currency markets. If the government starts printing money to the tune of 10% to 15% of GDP annually, the pound can be expected to plunge. Britain imports the majority of its food and manufactured goods. Our ability to do that depends on people abroad accepting sterling as hard currency. If confidence in the pound collapses, there will be no choice but to jack up interest rates to whatever level is necessary to get foreign investors buying into sterling again. A base rate of 15% would probably be the minimum necessary – a rate that would crucify businesses and mortgage holders. In the worst case, we might even need import controls.
The chances? Probably about 10%.
Two, a return to hyper-inflation.
Forget all the chatter in the City about deflation. There are a couple of thousand years of economic history to show that once you start printing money the result is usually inflation. Cynically, policy-makers probably know that perfectly well, and have decided to accept it. A burst of inflation – say 30% over a period of five years – will effectively wipe out much of the debts of consumers and companies. It will be de-leveraging by stealth.
The trouble is, a bit of inflation is bit like having a smidgen of cocaine. It is a lot easier to start than it is to stop. The assumption right now is that all the freshly printed money can be quickly withdrawn once the economy has steadied. If it can’t be, the UK could be heading for hyper-inflation, a 20% to 30% annual increase in the price level. Savers will be wiped out, industrial unrest will be rampant, and the currency will start to lose any reliable value.
The chances: About 30%.
Three, stag-flation.
Much of the commentary on the British economy right now assumes that it was in pretty good shape until a collapse in the credit markets caused a sudden drop in demand.
Of course, that isn’t really true. The UK has been on a downward trajectory for several years. Taxes have been raised to levels incompatible with rapid growth. All the historical evidence suggests that once the state consumes more than 40% of GDP growth stagnates. The burden of red-tape and regulation has grown steadily year by year and remains the only part of the economy that shows no signs of slowing down.
In short, there were plenty of problems already – on top of which the credit markets have collapsed. So even when we fix that, the underlying economy will still be a lot weaker than it has been for the thirty years or more.
The net result will be stag-flation: a combination of moderate, persistent inflation and sluggish growth, probably never more than 1%. Interest rates will have to remain high for many years, business confidence will remain weak, there will be little incentive to save or invest, and unemployment will rise steadily because growth is too weak to create new jobs.
The chances: About 80%.
We keep being told that this recession is so threatening , governments and central banks have to throw everything they can at it. But it is worth keeping in mind that the UK now runs the risk of meltdown – and the cure might even turn out to be worse than the disease.
Tuesday, 24 March 2009
The UK Takes A Step Closer to Meltdown
Although the chances of it are not more than 10% or 15%, there is a meltdonwn scenario for the UK. It is that inflation rises sharply, the currency collapses and the Bank of England has to hike interest rates sharply to control inflation. Then the economy would be in real trouble. It came a step closer today with the news that inflation roese despite the recession. Could it happen. Probably not. But it is a scary prospect, and even it doesn't, 1970s stag-flation is the best the UK can look forward to right now.
Friday, 6 February 2009
Devaluation Doesn't Work
There is a lot of nonsene out there being pushed as economic wisdom. One of that worst is that the collapse of the pound will lead to the revival of the UK ecomomy. It's not going to happen. Today's terrible industrial production figures make that clear. Output fell by another 2.2% in December, and is now 10% down on its peak. Of course, it is hard to export when the whole world is in recession, but there should be some signs of stability by now. If Britain could devalue its way out of trouble, we would have been booming all through the 60s and 70s. In reality, the UK needs a strong currency, and it is not going to have that until the government gets to grip with taxes and spending.
Monday, 2 February 2009
Reykjavik On The Thames
Britain isn't quite Iceland yet but it's economy looks in more and more trouble by the day. There has been a lot of glib talk about how the collapse in sterling will help out the British economy. But that ignores our reliance on imports. I noticed today that both Ford and Carlsberg said they were planning to raise their prices to take account of the fall in the value of sterling. We'll see a lot more of that in the year ahead. The net result is that inflatin will remain stubbornly high even as we move into a full-blown recession. One result will be to lower consumer spending even further, hitting demand. Another is that the Bank of England will have to think twice about lowering interest rates any furher. In a worse case scenario, it might even have to raise them. If that happened, the economy really would be plunged into a full-scale depression.
Wednesday, 21 January 2009
Sinking Pound, Sinking Brown
On Ladbrokes you can get 40/1 on Jack Straw being Prime Minister by the end of this year. I reckon that is a pretty good bet. The pound is sinking like a stone, and the markets have turned negative on the UK economy. It doesn't look like Gordon Brown understands just how dependent on foreign cpaital the British economy, or indeed his own government, has become. And who wants to lend money in a currency that is collapsing?
In my Bloomberg column at the start of the year one of my predictions for 2009 was that Britain would have to call in the IMF to bail it out. I was, to some degree, kidding around. Now it is looking more and more likely all the time.
If it happened, I don't think Brown could stand the humiliation. He'd have to resign as part of the rescue package. In those circumstances, Jack Straw would be the most likely person to takeover as a caretaker Prime Minister, holding the fort until an election the following spring. So, in effect, the bet is 40/1 against the UK going bust. Those odds look too generous to me. After all, the figures say we are.
In my Bloomberg column at the start of the year one of my predictions for 2009 was that Britain would have to call in the IMF to bail it out. I was, to some degree, kidding around. Now it is looking more and more likely all the time.
If it happened, I don't think Brown could stand the humiliation. He'd have to resign as part of the rescue package. In those circumstances, Jack Straw would be the most likely person to takeover as a caretaker Prime Minister, holding the fort until an election the following spring. So, in effect, the bet is 40/1 against the UK going bust. Those odds look too generous to me. After all, the figures say we are.
Thursday, 8 January 2009
The UK Economy Keeps Sinking
The Bank of Ireland's statement this morning that it was running down its UK mortgage business - with a total of £29 billion in outstanding loans - is a small but telling illustration of why this is going to be a very tough recession for the UK. It is precisely those flows of forign capital that have kept the UK so bouyant. Thirty billion here and there soon adds up. But those taps are now being turned off. With sterling getting pummelled it will be a long time before anything replaces it. The UK will have to re-balance itself more towards exports but it will be a long hard struggle.
Sunday, 21 December 2008
Britain's Economic Mess
I liked Thomas Friedman's column in the New York Times this morning. You can read the whole thing on the link, but here's the key passage. "China is not going to rescue us or the world economy. We’re going to have to get out of this crisis the old-fashioned way: by digging inside ourselves and getting back to basics — improving U.S. productivity, saving more, studying harder and inventing more stuff to export. The days of phony prosperity — I borrow cheap money from China to build a house and then borrow on that house to buy cheap paintings from China to decorate my walls and everybody is a winner — are over." Spot on. But it applies even more forcefully to Britain than it does to the US. More borrowing, more state-aid, none of those are the answer. The UK economy needs to re-structure, which will involve some pain. It is extraordinary how few of the economic commentators in the UK are making this point.
Thursday, 24 July 2008
The British Recession Gets Worse
The Irish Independent has picked up my Bloomberg column this morning about the recession that is looming for the UK. The news today is, of course, even worse, with a 3.6% drop in retail sales, the worst monthly figure since 1992. The point is that the economic news keeps surprising us on the downside. So long as that is true, the outlook is grim. And, as I keep saying, we haven't seen the attack on sterling yet, which is where it really get nasty. But I think we can be sure that the turning point hasn't been reached until there is a significant devaluation of the currency.
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