Monday, 12 January 2009

If now, why not then?

If I am presented with a problem I think it's a good idea to look at what has caused the problem in order to identify the solution. A drip coming from a water pipe seems to me to be evidence of a hole, so my first investigation aims to identify where the hole is. The solution is then to close that hole. An insufficiently tasty sauce seems to me to be evidence that an essential ingredient has not been added in sufficient quantity. It is necessary to identify that ingredient and add more. Unless the solution is suited to the problem you might as well not bother because at best you will make no difference but more likely you will make things a lot worse. Putting a new washer on a bathroom tap will not cure a leaking radiator, so no further harm done but no good done either. On the other hand, adding more salt to a sauce that has enough results in a ruined dish.

Now that recession is confirmed we stand on the brink of a depression deeper and more painful than any in British history. The steps being taken by government to deal with the problem trouble me because they are such a mish-mash of contradictory measures, lacking a coherent strategy and aiming to be all things to all men. That is not the role of government. The role of government is to give a lead, to have a clear strategy so that we all know what is being attempted and why. Only if their plan is made clear can it be improved by debate and discussion. The 2.5% reduction in VAT is a fine example. Had that been proposed in a Commons debate the pros and cons would have been examined in detail and the shambolic mess it turned into could have been avoided.

As far as I can tell the current strategy seeks to address three elements of the economy, banking, housing and retail. Yet there is no overall strategy for all three, each has its own and they are in the starkest conflict.

The government tells us it wants to act to kick-start bank lending to businesses. It does not seem to be in dispute that many businesses rely on overdrafts to provide cash-flow for wages and other expenses pending receipt of money owed by customers. Starving them of credit will cause some, perhaps many, to fold. What stands in the way of the banks making those credit facilities available at the moment? Three things, it seems to me: first the banks themselves do not have as much money available to lend as they did even a year ago, secondly the risk they take in lending to any business is increased in a recession and thirdly they are required to keep their capital high.

If government wants to increase the amount of money banks have in the safe it can lend to them at sensible rates - rates that allow a profit margin when they then lend it on to customers. This cannot happen because government simply does not have money available at such rates. An alternative is to take steps to encourage greater deposits from the banks' customers, yet the Conservatives' plans to reduce tax on savings income for basic rate taxpayers has been dismissed as a gimmick, so the government is giving no encouragement there. A further option is to relax the rules on the amount of capital the banks have to hold. Capital essentially means money the banks are required to have but are not allowed to lend, they must keep it to act as security for the banks' own liabilities. For good reasons the capital requirements were made more stringent after Northern Rock and Bradford & Bingley hit the skids, but they cannot have it both ways, they cannot insist on more capital and them complain that money is held as capital rather than advanced to customers.

Now they claim to be preparing to force banks to lend to worthy customers. That is an absurd proposition. The government cannot assess the risk involved in lending to Fred Bloggs' Flooring Ltd, only the banks can do that and even they have to make educated guesses as to what the future might hold. The only positive step the government can take is to provide additional security to make it more attractive for the banks to lend to Fred Bloggs. This has been discussed for months, having been dismissed out of hand when the opposition first suggested it, but we still seem to be some way away from a workable plan being put into place. In the meantime there is simply nothing the government can do other than relax the capital requirements, and they show no sign of being willing to do that.

Housing is an area where the government really is coming into its own. The level of incompetence and waste in their various proposals is quite breathtaking. On the one hand they want the banks to lend more for house purchases, on the other hand they want the banks not to take action when a customer defaults. It does not take a genius to understand that defaults by customers undermine a bank's capital. Nor is superhuman mental agility required to see that a falling housing market requires the bank to lend a smaller percentage of the estimated value of a house for fear that it will fall below the amount of the loan if a high percentage is advanced. And one might expect even a primary school pupil to appreciate that lending money to someone at risk of losing his job is not sound business. So how can the banks lend more? To be fair there is, in part, an answer to that question. It might be that the banks are being over-cautious at the moment, that certainly seems to be the view of some commentators. Perhaps they are looking at potential loans as being more risky than they are in fact. But even if that is the case, there is nothing government can do about it because Mr Darling doesn't have the time to examine individual mortgage application forms and point out that the bank could lend £5,000 more than it is offering at the moment. These are decisions for the banks. After all, the banks don't want to be bust, they want to make profits and they know they have to do business to achieve that. It will take time for them to assess how deep the recession is likely to be and how it will affect particular types of businesses and particular areas of the country. Diktats from the Treasury cannot change the need for the banks to take time to form their own lending strategies.

The retail sector is being hit like never before. Major retailers are folding with the loss of thousands of jobs and those that stay alive have to reduce costs dramatically to cope with falling income. So far the only substantive thing the government has come up with is the 2.5% cut in VAT, which did nothing to help sales. Poor Gordon is telling us all to spend spend spend but it is a futile message because people everywhere are retrenching. Those who can get credit are choosing not to do so or are spending it propping up their businesses rather than shopping. Far more feel the need to pay back existing credit rather than take on more.

Every week we hear statements from the government about their desire to "stimulate" the economy. I find this a quite ridiculous concept. A stimulant is something that wakes you up and gets you moving forward and can be likened to the accelerator pedal on a car. The problem is that the economy is not moving forward, it is in a fast reverse gear. Attempts to keep people in work through bringing forward future government expenditure on such things as school building and road repairs are not stimulants, they can help to slow the reverse speed by dabbing gently on the brakes but they cannot depress the clutch and engage a forward gear. And all the time more money is borrowed against future taxes, which will then slow the rate of acceleration once the bad times have been exhausted.

We know that government expenditure is not a stimulant, we know it as a cast iron fact. If it were a stimulant it could be increased without limit and there would be nothing but benefits. When the economy is moving well, government could just spend more to make it move even faster. But that does not happen. Government expenditure in good times slows rates of growth, it does not increase them. If it is not a stimulant then, it cannot be a stimulant now.

If I had enough spare, I would tear my hair out at the willful failure of the government to acknowledge the central problem facing the British economy today. For many years we have been living beyond our means. Now we have been caught out and have to retrench. Millions are retrenching all over the country. They are doing so because they know they have to in order to get back to a position where they live within their means. There is no escaping this fact, we have been living on money we did not have. The same is true of many other countries but that does not change the fact that it is the position here. The economy is shrinking because it has to shrink to get back to a sustainable size. Not once has the government acknowledged this. If they did, they would find it a lot easier to build a strategy and the greater chance they would have of providing a helpful strategy.

Trying to prop-up the housing market and encouraging people to spend in the shops how they did a year or two ago it utterly misconceived. There needs to be a humble acceptance that we are a Waitrose country not a Fortnum & Mason country (perhaps I mean a Lidl country not a Tesco country). You cannot plan for the new, realistic, state of the economy by pretending that it will be just as it was before. Living beyond our means did not work before and it will not work now. Government expenditure as a means of furthering economic growth did not work before and it will not work now. We should be preparing for a new economy of severely restricted credit and living standards that only improve with real wealth creation.


Lola said...

Nice article, well written and argued. But a precis could be 'cut taxes and government spending and borrowing and the economy will recover of itself. But even when we do this we will have to get used to a lower standard of living'. Exactly. Next?

TheFatBigot said...

Thank you for your kind words Mr Lola. I've followed your comments with great interest on a number of sites, welcome to mine.

james1071 said...


Your analysis is completely wrong.

The private sector will have to reduce its debts for years. Without extra aggregate demand from a fiscal stimulus, the economy will fall into a prolonged slump with mass unemployment.

This is well understood by policy makers, which is why every major government has adopted Keynesian policies.