24th November 2008
The Pre-Bust Report: a prelude
‘Too little, too late’ is an easy charge to make against any Government as this world economic crisis continues to drag us headlong into a deepening recession. The Conservative critique, incredibly, seems to be that the Government is doing too much and almost appears to be suggesting that ‘nature be allowed to take its course’. This is familiar territory for those of us old enough to remember the Geoffrey Howe budgets of the early 1980s when the Conservative Government actually did cut spending in the middle of a recession to ‘purge’ the economy of waste and inefficiency. Conservative rhetoric this time is also coming dangerously close to those ‘quack’ doctors in the Middle Ages who advocated the practice of ‘cupping’ – removing pints after pint of blood to purge the body – and nine times out of ten killed their patient in the process. For the rest of us, a return to mass unemployment is not a very attractive prospect.
Outside of the Conservative party and the dwindling Chicago or Austrian school of economists most of us would argue that fiscal stimulus is a very necessary response to stave off the kind of deflationary spiral that currently envelops us. But is the Government about to do the right kind of thing but in the wrong way and for the wrong reason. What do I mean by that? Well, there are a number of reasons for supporting fiscal stimulus (extra spending or tax cuts):
1. Directly compensate pound for pound for the shortfall in demand in the economy
2. Shield the vulnerable from the worst effects of the downturn
3. Provide a psychological boost in confidence to get consumers and businesses spending again
4. Take advantage of spare capacity in the economy to bring forward socially useful investment e.g. on housing or renewable energy
The last three reasons all make absolute sense. The problem is that if the Government plumps for a reduction in Vat of 2,5% as its principal policy lever it is obviously opting for policy approach number one which is the Keynesian caricature of ’spending one’s way out of recession. There are a number of problems with this approach. First up, scale: to plug the gap caused by the shortfall predicted next year by the bank of England the Government would need an immediate package of extra spending and tax cuts worth about £30 billion – the VAT cut represents just about a third of that. Secondly, effectiveness: will cutting the price of something that costs £4.99 today to £4.87 unleash a wave of mass consumerism. Unlikely, and it will do nothing for the business-to-business market which will be unaffected by the change. There is a case for a tax cut but the purpose must be to change people’s long-term expectation about the economy - not so much to create a feel-good factor but at least to take away their fear. Only that will begin to change the prospects for the housing market. Cutting VAT by this minuscule amount – to make a modern medical analogy – is a bit like putting a patient on a drip when he really needs CPR. There is a need for tax cuts but a better approach would be to raise the tax allowance by £2,000 which would have an immediate and more visible effect on people’s take home pay and take millions out of tax altogether. It would also cost more or less the same as the VAT proposal. Cutting VAT more substantially – to 5% as we have suggested in labour-intensive sectors like construction and tourism – could also have a noticeably beneficial effect.
The other problem with the Government’s proposed tax cuts is how they’re funded which in the short-run at least looks likely to be added borrowing. There is a big risk that this will drive up long-run interest rates – because of the need to offer higher yields on Government bonds. This will make the Government’s stated policy of getting the banks to start lending again by offering more attractive terms to its customers much more difficult to achieve. The fiscal stimulus package should, at least in part, be funded by higher tax rates on the very wealthy today not just tomorrow, as well as a windfall tax on energy companies and the scrapping of unnecessary commitments like Trident and ID cards.
On the socially useful spending front there are a number of important initiatives the Government could take including creating a Citizen’s pension of a £100 (boosting the Basic State Pension will be necessary anyway because of the massive collapse in pension funds) and also introducing free social care for the elderly as in Scotland. Capital investment programmes should include housing, renewable energy and public transport infrastructure – all overdue and beneficial to future generations who will be saddled with the debt.
The fear is that the Government will end up spending and borrowing a lot of money but which will have negligible or indeed even a negative effect.
An even more worrying thought is that the Government’s action on the fiscal front will obscure the need for urgent changes in monetary policy. The underlying roots of the current crisis are after all monetary in nature, as are the solutions. The Bank of England needs now to cut interest rates to 1%. The Government needs to issue a clear ultimatum to the banks that if they do not pass this cut on to their customers then the semi-nationalisation of some of some of the banks will become a full-scale nationalisation.
Even a cut in interest rates might not work on its own of course, which is why the Government has to embrace the prospect of ‘quantitative easing’ which is the nice technical word for ‘printing money’, economic heresy only a few months ago but now possible the one thing that can prevent deflation becoming a depression. In practical terms that would mean the Bank buying up corporate debt and boosting the money supply. At a time of falling prices, where there a literally too little money chasing too many goods, the normal rules of conventional economics are turned on their head. I am not sure the Government has grasped that. The wheels of contraction in the economy are spinning out of control. It remains to be seen if what the Chancellor will announce in a little under an hour can halt that process let alone shift it to reverse.
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cardiff west walian says:
January 25th, 2009 at 12:03 am
I disagree with your dismissal of the Austrian School. Mnay have predicted this mess years ago, and have disapproved of the monetary policies of the US and UK from the time of Reagan and Thatcher.
Simplified, one of the great sayings i’ve read from the Austrian school is that “the scale of a Bust is directly proportional to the delusion that preceeded it.” So what form did the delusion that preceeded this bust take?
1. Anglo-American politicians of all colours (Labour, Conservatvie, Democrat, Republican) castigating the world for not adopting their “free-market” ways. The economic miracle in the US and UK is now seen as nothing other than a debt-fuelled binge built on the twin delusions of zero-regulation (fuelling excessive risk-taking by banks) and low interest rates (fuelled by an insane expansion in the money supply). So for Nationalists like me, the last 30 years have been like most of the last 1000 years, with the English-speaking world preaching to the rest how they should structure their societies. This arrogance and over-confidence now gets it’s come-uppance as we enter, probably, the Second Great Depression. There’s no schadenfreude intended here, just anger at the human misery that the coming years will unleash.
2. The Economic Miracle in the UK was only ever built on the unfettered expansion of credit. To fuel the expansion, interest rates were lowered by increasing the money supply, allowing banks to lend more. The more banks lent, the lower the credit rating of their customers became as the quality of borrowers from which they could make money diminished (there’s only a finite pool of credit-worthy people). To allow them to lend to people who should never have been lent money (the sub-prime borrower), the banks therefore devised off-balance sheet instruments (Collateraised Debt Obligations (CDOs) to pretend that they had solved the problem of risk in the banking sector. Incidentally, a major driver of lending to sub-prime borrowers was a misguided policy by Bush to get Americans at the bottom end of the income ladder to own a house – it was government interference in the housing market, allied to a lack of interference in the money markets of it’s allies in Wall St. that laid the foundations of this crisis.
As an ignorant and unsuspecting public kept borrowing, idiotic governments, who owed their mandates to re-election platforms boasting the “end of boom and bust” and “fiscal responsibility”, used the blunt tool of interest rates to attempt to quell inflation – inflationary pressures brought about ultimately by the increase in money supply that drove down long-term interest rates across the planet. Low interest rates are a function of government interference in the money markets, bad lending from banks due to too little – it’s an idealogical mish-mash, utterly confused, totally disastrous.
Unfortunately, the public were already over-indebted, and small increases in the interest rate were able to collapse the house of cards (if Bernie Madoff’s hedge fund was a Ponzi Scheme, the US and UK economies have been the world’s biggest Ponzi scheme driven by our idiotic fixation on property.)
3. Property, the mere mention makes my skin crawl with mental images of vacuous TV presenters eagerly persudaing us to become developers, eulogising the myth that “in the long terms, the property market never loses.” (I wonder if they’ll ever make a series called, “Repossession, Repossession, Repossession”?
In fact, property and associated government interference through interest rate and taxation policies lie at the heart of our boom and bust. The Left, unfortunately Plaid now peddles this nonsense, believes in the resdistribution of income through taxation of personal and corporate revenues. The Right (Labour and Tory alike) believe that interest rates are the sole way to manage an economy. Neither is right.
Let’s take taxation to start. Why tax personal and corporate income? Working people, not the fat cats but your Average Joes, sacrifice their time to keep their families fed and sheltered, to get meaning from their work, and to add value to their employer. The thanks for this value-adding activity is the legal robbery by the state of their income. People work for this money, if it wasn’t forcefully taken from them, we wouldn’t need the massive bureacracies that administer social security, tax credits, and a communist system of health care. Before you get all liberal and moral, bear with me!
But the country needs to raise money, income tax is the only way! Wrong! We have made our private wealth communal by the practice of income tax! It is an evil that robs hard working people (i’m not talking about the handful on £>150K nor the idle on tax-free benefits) of the ability and dignity to care for their families without the interference of the state.
However, the wealth we receive from the land is totally private. We are not taxed on the capital gains on the sale of our main homes – yet in this case we do not work for it. Our wage income is as a result of effort (getting out of bed, adding value), our property income is the result of idleness (the price of property rise or falls irrespective of whether we choose to get out of bed). What if we swapped our taxation lenses? What if we taxed land and not income? Studies show we would raise more income for the country this way – MORE not less! This would mean barely any income tax, less governement, more freedom! Also, greedy landowners (not your average mortagee) like supermarket and large builder land banks would have to pay their fair share for the profits that they make from land (remember, land profits aren’t earnt, it’s idle income).
So what!? How would this stop the kind of mess we’re in now?
It wouldn’t stop it all, Governments actually have to interfere in the Banking sector so that ALL capital risk is brought back onto Corporate balance sheets in full view of auditors and regulators – they must be prevented from hiding debt and risk using complex financial instruments that all but a few hundred people understand.
**** Government must also bring the hidden debt of unfunded public sector pensions and PFI onto its balance sheet. All final salary public sector schemes should be shut, and PFI should be banned – it’s about stopping the state from burdening our children and grand-children with our profligate debt ****
But, imagine you tax land, which stops runaway property booms. Banks would not lend as irresponsibily, people would not be repossessed, income would be retained, finally in the UK landowners would have to pay for their birthright.
Most improtantly, interest rates would not be used as a blunt weapon. Because of property appreciation, interest rates rise, depriving companies of capital and driving them out of business. When interest rates fall, land prices rise, diverting company capital into mortgage repayment or rental payments, leading to reduced capital investment. A massive, debt-fuelled, vicious circle. It’s crazy!!! Far from being the economic saviour fof the UK, the financial services sector, through moronic interest rate policy, diverts money from capital investment (companies) and personal expenditure / savings (individuals) into interest payments. Note that a mortgage is defined as “a transfer of an interest in land (or the equivalent), from the owner to the mortgage lender…..” – as such it is the banks who really profit from property booms, and it is individuals and non-financial companies who suffer when the banks are bailed-out.
This is truly criminal , and should lead us to ponder the true nature of our so-called democracy. As such, Wales, with her manufacturing base suffers disproportionatley from South-East interest rate policy – far from subsidising the parochial provinces, the South East enriches itself AT THE EXPENSE OF those regions of the UK who value manufacturing. Who subsidises who?
Individuals who cannot meet mortgage payments are taken to court and evicted like criminals, whilst the true criminals in Westminster and the City remain untouched – moral subsidy of the vilest kind. To paraphrase Churchill, “Never in the field of economics, was so much misery inflicted on so many by so few.”