Monday, 9 March 2009

Lost, one plot, if found return to 10 Downing Street

A feature of someone having a job beyond their capabilities is that from time to time they will expose their true limitations. We see it in every walk of life. So many couples have bought pubs with a view to a blissful life of serving pints and ploughman's lunches, only to find they cannot manage staff or cope with the paperwork. As barman and cook they might be stars, as proprietors they go bankrupt. The jobbing builder who has earned a decent living for years by replacing roofs, laying patios, fitting doors and painting houses can find himself a fish out of water when he takes on his first house conversion. And in my own field of work, many a barrister is outstanding at one or two days trials in which the issues are limited but simply cannot maintain the high level of concentration required to present a month-long case to a good standard. It's all a matter of horses for courses. Each of these people, having failed in the bigger tasks, can still perform an excellent service and earn a good living by reverting to the individual jobs they do well. There is no shame in trying something, finding you can't do it and reverting to what you can do.

What is very rare is to find someone who held a substantial position for a long period of time and appeared to know what he was doing, only for it to become apparent later that he really didn't have a clue all along. It happens with fraudsters, but they deliberately set out to deceive and laugh all the way to the bank while their victims pay them. They know they will be exposed some day and just hope the victims will be so embarrassed by their own gullibility that they won't involve the police and will just put it down to experience. It happens also when very skillful managers are given executive responsibilities they cannot cope with themselves, they delegate and take advice and ride through on the seat of their pants. One day they get put on the spot and have to think for themselves, then they are exposed. It has never happened in senior government circles in my lifetime until now. Yes, there were people I didn't rate who held senior ministerial appointments, but that's different, that's just my opinion. Now we are seeing clear objective proof that the man who was Chancellor of the Exchequer for ten years and is now Prime Minister really didn't have the foggiest idea all along.

There have been hints since the beginning. His famous pensions grab, stripping pension funds of their long-standing exemption from tax on the income from dividends on shares, was criticised as something that would lead to shortfalls in funds. Yet there were arguments in favour of what he did - he removed an anomaly, over time the funds would be able to recover, it was necessary to pump money into the NHS and schools so it was a price worth paying. It was possible to excuse it as a political decision regardless of the effect it had on pensions. Nonetheless the criticism remained. Even in 1997 insufficient provision was made for pensions, to take a big chunk out of the pensions pot each year seemed likely to add to that problem. It raised a question about his ability to see the bigger picture.

Money was pumped into the Department of Health and the Department for Education. Eye-watering amounts of money. He called it "investment" and boasted of it as a great thing for the country. The improvements in service for the little people were small in the NHS and almost non-existent in schools. So much was pumped in at the top and so little reached the bottom that questions were asked about the efficiency of the system. Still he boasted that it was all "investment" for the future and (too) many believed him, thinking that "investment" must produce a long-term benefit even if we can't see it yet. He was "investing" so he received the benefit of the doubt. Now it is clear beyond argument that the vast majority of this additional "investment" was wasted on form-filling bureaucracy and pointless, expensive gimmicks. It was not spent on health and education but on exercises designed to make the government look good. And it worked, they won elections, so they carried on with more of the same.

The whole structure of banking and financial services was changed. The single most significant consequence was "light touch regulation" which left the banks and finance companies at liberty to undertake high-risk transactions with no questions asked. They did undertake such transactions and, for a while, appeared to be making a lot of money. That resulted in them, and their employees, paying lots of tax. A double-whammy. Under poor Gordon's stewardship of the economy the financial sector was hugely profitable and he had ever expanding receipts to spend on yet more of his "investments".

Once it all started to unravel we learned a lot about the brilliant man with his hands on the steering wheel. There was something he said late last year which troubled me enormously, although I only touched on it in passing at the time. The decision was taken to ban short selling of shares in financial companies. Short selling is the practice of agreeing to buy shares on a date in the future at a price lower than their current market price. It is done when the market price is expected to fall but it can also cause the price to fall because people infer that those who have made those deals know something is wrong and that the price will fall, so they offload their holdings and supply exceeds demand causing the price to fall. The ban was put in place for fear that an artificial fall in the market price of shares in financial institutions would be manufactured by speculators. Fair enough. Poor Gordon clearly did not know what short selling was because he referred to it as "short term selling". Although I can't remember when I wrote about this, I recall saying that no one who knew anything about the financial world would refer to "short term selling". He could only have said that because he did not have the faintest idea what he was talking about.

And now I finally arrive at the point of this missive. News has broken that poor Gordon had one of his hissy fits on the way to America to be given the type of reception by President Obama that would be given to the Prime Minister of a bankrupt African dictatorship. It is reported that poor Gordon got wind of the intention of the press to suggest he should apologise for getting the country into recession and decided to challenge the reporters who were travelling on the plane with him. He is reported to have put forward three arguments to defend himself: (i) it all started in America, (ii) every previous British recession was created by high interest rates and high inflation whereas the UK had low interest rates and low inflation during his time as Chancellor and (iii) house prices were high because of lack of supply.

When people get angry they say what they really think. It is reported that poor Gordon was angry when he assailed the press contingent. There is every reason to think he believed what he said. Let's see what it shows about him.

His first point is fair. It did all start in America. If truth be told it started in the late 1970s when they were nutty enough to require banks to lend to the indigent, but we can concentrate on more recent times. It started in America because thirty years of bad lending built up a huge portfolio of losses which had never surfaced. They were bound to surface one day and when that day came it would affect the economies of all developed countries. No matter how well or badly each country had been run it would be affected somehow. That goes without saying, but that does not mean that every country would be affected in the same way. The mere fact that it started in America is neither here nor there. No one is blaming poor Gordon for that. He seemed to put forward "it started in America" as meaning he cannot be subject to legitimate criticism for the way our economy has been able to deal with the problem. That is patently absurd. True though his first proposition is, it is nothing by a red herring. He should be able to understand that.

His second point is just breathtakingly stupid. Recession is a continued fall in Gross Domestic Product (GDP), usually defined as a fall in GDP for two consecutive quarters but there is nothing magical in that formulation. GDP can fall one month and pick up the next, generally that isn't a problem. There is only a problem when there is a sustained fall in GDP, yet the problem is not the fall in GDP itself, after all that is just a measure of current economic activity, the problem is that a sustained fall in economic activity bites into wealth. I really don't think poor Gordon understands wealth.

Wealth is stuff that makes life comfortable. We are wealthy in the UK because we have houses to live in, electricity and/or gas to provide light, heat and cooking facilities, we have enough food and clothing to sustain us, we have motor vehicles and trains to allow us to travel, we have facilities in our homes and our towns to provide entertainment and information and we have lots more other stuff besides. Somewhere like Zambia is not wealthy because it does not have these things on anything like the scale we have them. Our lives are comparatively more comfortable, therefore we are wealthier. Wealth is stuff.

In order to maintain our level of stuff we have to maintain GDP because an awful lot of stuff gets used up every day. Tomorrow we need more food, more gas, more electricity, more petrol, more paper, and more of all the things that we consume. A fall in GDP means we can't maintain our level of stuff and, therefore, can't maintain our level of comfort. Over a short period this is just part of the normal swings and roundabouts of life, but over a sustained period it leads to significant problems which affect the living standards of millions because it means a lot of people cannot afford the amount of stuff they previously enjoyed.

So, now we know recession is all about a reduction in the amount of stuff we can afford. What have interest rates and inflation got to do with it and how can they be the only causes of previous recession? I say "the only causes" because that is the substance of what poor Gordon said. His defence is that previous recessions were caused by high interest rates and high inflation and because we did not have high interest rates and high inflation he cannot be blamed for the current recession. That necessarily involves three propositions: (i) it was high interest rates and high inflation that caused previous recessions, (ii) because high interest rates and high inflation caused previous recessions it was not possible to predict any other cause of future recessions and (iii) no matter what changes happened to the economy the first two propositions would remain true.

The first proposition is utterly unsustainable. Interest rates and inflation can contribute to the pressures that cause a sustained fall in GDP but they cannot cause it all by themselves. If his proposition were correct all that would be needed is for the government to direct a cut in bank base rate and recession could be avoided. That is absurd. A highly developed modern economy is a complex web of corporate and individual transactions. Those transactions are decided on by people, real people with all the good and bad qualities people have.

The recessions in the 1970s, 1980s and 1990s were not caused by interest rates and inflation, interest rates and inflation merely reflected underlying problems in the economy. The major cause in the early 1970s was a sustained rise in oil prices which increased the costs of business and caused widespread cut-backs. There were other causes too. The early 1980s saw another sustained rise in oil prices combined with massive stagnation in nationalised industries. There were other causes too. In the early 1990s the recession was almost entirely a result of a false boom creating a credit bubble that popped rather sooner than anyone expected. It popped because other factors caused interest rates to rise, but interest rates did not cause the recession they merely brought out into the open the fact that apparent increases in wealth financed by credit were unaffordabe.

Because the first proposition is unsustainable the second necessarily falls. Yet the second also falls independently of the first. Even if the first proposition is correct, the second does not follow. Even if high interest rates and high inflation caused earlier recessions, it does not follow that other factors could not cause a future recession. Once we recognise that a recession is a sustained reduction in the amount of stuff we can afford, it is obvious that all sorts of factors can cause a recession.

And that leads to the third proposition inherent in the second part of poor Gordon's panicked outburst. Acts of government that change the structure of the economy have the capacity to do more harm than good. They also have the capacity to do more good than harm. What they will actually do depends on factors wholly outside political control. Those external factors are infinitely variable and that fact, of itself, gives the lie to his third proposition.

The final part of his outburst was that house prices rose purely because of lack of supply. At this point it is simply impossible to take him seriously. That argument would not have gained a pass in A-Level economics in the 1970s (yes, it would get a starred A grade today, but that is a different matter). Let's look at the most basic analysis. Price is a product of supply and demand. If supply exceeds demand the buyer is in the driving seat and price falls. If demand exceeds supply the seller is in the driving seat and price rises. OK, fair enough, that's readily understandable. Now let's look at what drives demand. What drives demand is the amount of money buyers have at their disposal. The more they can borrow, the more they can pay. If it is right that supply exceeds demand the seller is in the driving seat but the price he can achieve is limited by the amount potential buyers can pay. Lend them three times their gross salary and they can pay less than if you lend them five times their gross salary. It's not a difficult concept. You would think someone who was Chancellor of the Exchequer for a decade would be able to understand it.

And so we can now see the twilight zone that is poor Gordon's understanding of real everyday economics. Recessions can be imported and destroy our wholly sound economy. Only interest rates and rates of inflation can cause recessions. The only factor affecting house prices is the volume of supply. Does he really believe this nonsense? If he does we are in an even deeper hole than we thought. If he doesn't we now have the final proof that he is so deeply dishonest and mendacious that he is unfit for any governmental position.

But we needn't worry. He'll say something even more stupid in the next week or two.


Anonymous said...

An excellent posting. I do hope the journalists who were cowed by his jabbing finger on the plane read this and find the courage to do their jobs properly. I am an optimist by the way, as is I believe, the FB.

Roger Sowell said...

Mr. FB, you outdid yourself on this one! Mighty fine prose.

May I offer Poor Gordon a few other items that bear on the price of housing:

1. Speculators who flip houses over very short periods, using zero-interest loans. (creates a rising price and becomes a self-fulfilling circle of rising prices)

2. Zoning changes; in the U.S. we have HUD (Housing and Urban Development) which can and does depress prices quite quickly for adjacent neighborhoods.

3. Major infrastructure announcements -- case in point the Bush Intercontinental Airport north of Houston, Texas -- where formerly low land and home values skyrocketed after that.

4. Closing a major source of employment -- case in point, too many to name them all. See Enid, Oklahoma, after Champlin refinery shut down in 1980s.

5. Landmark court decisions, such as Brown v Board of Education from U.S. Supreme Court -- with forced busing of students. The White Flight syndrome depressed inner city home prices and increased prices in the suburbs.

6 - 100. Not listed; my fingers are tired of typing...

Best to you, Mr. FB!

Anonymous said...

I will tell everyone who will listen to read this blog.
Can not wait for the next installment

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