So what is wrong in the economy?
We are currently borrowing nearly 40p for every £1 we generate.
Our interest rates are too low to enable a reasonable level of saving to generate a pension after 45 years.
Our housing prices are too high.
Our Government debt is excessive.
Does not seem much, does it?
How lucky we are there are, only four problems to deal with.
So why all the wailing and gnashing of teeth?
Our biggest question is how much pain can we bear. The politicians will try and tell you that they have solutions without pain.
We have had enough smoke and mirrors.
Yes there is going to be pain … not least as people get into negative equity on their mortgages as housing prices fall to their natural level. More important, can we construct a safety net for those who will be at risk of loosing their homes?
How do we get out of the borrowing cycle? Obviously we need to increase our exports and reduce our imports so that we are generating a surplus and have less dependence on foreign borrowings. Can't be done overnight … but it can over time!
Obviously creating the interest rates that provide for a stable pensions environment is going to precipitate the pricking of the property price bubble. Alas if we don't do it we will slowly get ourselves into a deeper morass.
The morass that our politicians are trying to create … I mean all the political parties! They are all hell bent on re-creating the Japanese exercise which resulted in 10 years of agony for Japan. Zero interest is around the corner … believe it or not people are not stupid, maybe politicians are, but not the ordinary people! The lower the rates of interest the stronger our squirrel instinct, the more I am going to have to save for the rainy day … or so Japan discovered as they suffered deflation.
We can see that to give us time to grow our exports and shrink our imports we are going to need a continual flow of money from the outside world. How do we encourage that flow of money? We have slagged off “The City”, blaming them for the failure of our regulatory system to control money supply and curb the excessive growth credit by the banking sector, yet they were the goose laying the golden eggs!
Well, two problems start getting solved by the same action … increase our interest rates! This will actually give the world, who have effectively cut off our credit line, a reason to restart using “The City” to handle their investments again. Of course this confidence will only come back as they see that we are addressing our problems in a responsible way. It will also end the spectacle of a bunch of politicians flapping about like hens that have just had their heads chopped off.
Oh dear Gordo, you make such a sight!
Now, how can we deal with the collapse in property prices or more particularly negative equity where it arises?
I would suggest something along these lines.
If the value of a house, bought for £150k with a mortgage of £120k and lets say the full mortgage capital amount is still outstanding, falls to £100k. Lets adjust the mortgage outstanding to £80k with the Govt. being issued a preferential second charge over the house of £40k at an interest rate of say 2%. This preferent lien would only be redeemable against the sale or disposal of the house, any portion that is unsatisfied in the sale would be carried on as a lien over that property until eventually satisfied out of future disposals.
This wont have changed the negative equity situation of the individual, but, will have adjusted the persons repayments to a level commensurate with the actual value of the property. Without any pressure for the repayment of the government portion of the debt.
Clever people can work out the detail, but this is a framework that will allow us to deal with three of our priorities:
Maintaining a flow of foreign money as we adjust our productive economy to bring about a surplus on current account.
Bringing about an environment where people can safely save for their ultimate pensions. Without having to gamble.
The looming property price crash, which is going to happen regardless of what we do in the meanwhile, just a question of when.
For the short term all we have left to deal with is Government Debt.
The level of Government debt has never worried me per se. All that is of concern is it's rate of expansion as this implies the rate at which we are increasing money supply. The natural level to which we can increase money supply is no more than the rate at which the population is growing let us say 2% of GDP. Any increase of money supply beyond the rate of population growth will prove inflationary or result in increased imports and increased deficits on the current account.
However we should make some structural changes so that we limit the ability of Politicians to gerrymander with fiscal policy and try and create some transparency. Off Balance Sheet manoeuvres must not be allowed. There is no harm in borrowing for infrastructural projects that are going to bring about future benefits to the economy. So why hide them away. There is a major danger in borrowing to fund current expenditure as it brings about the situation we are in.
This is what I would do:
Start with the unfunded state pensions, simply issue Government Bonds at 3% real interest rates for the existing liability and thereafter all new liabilities must be pre-funded. We would hand the control of that money and future administration of the fund to a new body under cross party control. The fund must be managed on a normal basis, like any other conservatively managed pension fund.
I would do something similar with Social Pensions and force a proportion of NI contributions into the fund. Similarly I would ring fence the remainder of the NI contributions for the NHS, possibly creating an independent body to manage its funds outside of parliament.
All the PFI liabilities should be brought back into the books with some type of amortization scheme in place.
These are really only accounting measures aimed at creating transparency they change little except show that we are facing up to our responsibilities, and are in fact creating a financially secure environment for all the people of the country, including the aged.
We still need to deal with increasing our exports and reducing our imports so that the dependence on borrowing is lessened. Which, I will deal with later, as I explore the Euro and/or a new Bretton Woods type of agreement.
I have tried to show that the issues are not all that awesome, but that we must not put our heads in the sand. I have also tried to show that however one might attempt to stimulate the economy there are inherent risks. For the UK, increasing Govt. Expenditure is likely to widen our current account deficit making our dependence on foreign borrowings even greater.
What is actually needed to kick start the economy?
Oh dear, we need an answer to that question …. Confidence in what?
It needs the people to be confident in the future!
The future you say … but that's not ours to see … surely its better to be confident that Gordo will find a solution? Alas no he put you where you are!
I think we are fools if we think that normal people would have confidence in the future when its patently obvious that future taxes are going to need to rise, we actually need our politicians to understand that the people are not a herd of sheep, that can be led wherever they desire, but that they are innately intelligent.
What would give us confidence in the future? … certainly not a bunch of hens flapping about with their heads chopped off.
We need to be talking about a framework that can give us a secure future, we need to be talking about a framework that can be understood, we need to be talking about a framework that provides a sound safety net for the unfortunate or aged. We need to be talking about not needing to play in the casino in order to secure their futures. We actually need to be talking about our problems and not blaming every thing on “the world” out there.
Perhaps in this context a biblical quote is appropriate:
“You cannot remove the splinter in someone's eye, when you cannot see the log in your own eye.”
We can only gain confidence in the future if we set about creating a politico/economic framework that is going to work.
I believe that means we want to know that the freedom of our politicians to be rash has been limited. We are wont to talk about democracy … democracy can only exist where there are sound checks and balances.
Perhaps this has always been my reason for being attracted to the Euro. Here is a framework which limits the scope of politicians to be reckless. The Euro countries are allowed to run annual budgetary deficits of only 3% of GDP … depending on the level of unemployment within the country. This is a bit higher than my population growth theory but still a level of money creation that is unlikely to cause major price inflation.
Budget deficits generally amount to money creation. Although, with a strong independent Central Bank, it is possible to neutralise that effect.
When we see Gordo throwing about billions, we instinctively know that at some stage in the future tax is going to have to rise to repay that debt.
We know the hard times are ahead … regardless of what he says.
This is what caught Japan … the people reacted in a different way to what the politicians and economists expected. They became squirrels totally unimpressed with near zero rate interest and in fact cut their consumption expenditure. The low interest rates meant it was going to require even bigger savings to cater for their future.
The only thing that can kick-start an economy … is increasing consumption within the economy.
Thus far I have tried to show that the situation we are in, is primarily due to the vacillation of the government and the paucity of ideas. I have tried to show that it is and was possible to take a different route, that the counter intuitive increasing of interest rates was not necessarily wrong. I have tried to show that injudicious increases of Government expenditure/reduction of taxes will usually only result in an illusory benefit as either inflation or devaluation must follow (with a time lag) making the situation worse in the future.
So let's look at the UK economy rationally taking a closer look at our problems and potential solutions. Most of my economic theory and attitudes relate to developing economies and sustainability, thus while I may see things as unsustainable, the amount of fat in UK economy could well allow it more leeway than would be the case in a developing economy.
Structure of UK economy
Services and Trade 54%
Exports of goods £ 256 billion
Imports of goods £ 364 billion
Net Income from Service Sector £ 61 billion
Net Trading Deficit £ 47 billion
Inward Investment £6729 billion
Outward Investment £6347 billion
Current Deficit on International Account £ 382 billion
Govt. Expenditure £ 651 billion
Consumption out of non State Incomes £ 532 billion
Change in Inventories £ 8 billion
Trading Deficit £ -47 billion
Capital Formation £ 257 billion
GDP £1401 billion
Private Borrowing £1350 billion
Government Borrowing £1500 billion (including pension deficit)
These figures are derived from the Blue and Pink books and in several instances require interpolations as all the figures are not easily available, however for the purposes of this exercise should be accurate enough to illustrate some of the issues in the UK economy. Although the figures do not actually tie up with the CIA numbers which I used earlier they are close enough to suggest they are probably right.
The International account actually represents a picture of our Banking system, which is roughly 3 to 4 times the size of the rest of the economy. The deficit on this account, as best as I can make out, is made up of Foreign deposits in Sterling with our Banks.
The banking sector appear to have made counterbalancing investments in foreign assets to balance their foreign currency liabilities. The deficit therefore represents the amount of money flowing into the City that has been monetised (used in the UK economy). At 27% of GDP or 28% of private borrowings, it represents a major risk. Should there be a loss in confidence by the outside world in our banks or “The City”, it would be cataclysmic for our economy. I refer to all my previous comments about besmirching “The City”.
Just to give context to to what I am saying, I quote from the 2008 Pink Book.
“ Except for 1990, the UK’s external assets exceeded external liabilities in every year until 1995; however, since then external liabilities have exceeded external assets. Since 1995, there has been a more than fourfold increase in both the levels of external assets
and liabilities with the latter reaching £6.7 trillion at the end of 2007. Since 2004, the net liability position has increased steadily to end 2007 at £381.6 billion.”
If we look at our trade figures we see that the service sector (fundamentally the City) is vitally important to the economy, without it we would really be up queer street … or more precisely in a canoe approaching Niagara falls without a paddle. So the main thing we should be worrying about is the outside world's confidence in the city.
Fundamentally “the city” is our lifeline and we have set about wrecking it's reputation … all for the sake of being able to say “Gordo it was not your fault, there was nothing you could do about it”.
If we continue to hear Vince Cable standing up and complaining that the banks are not lending to small business, or Gordo insisting he will ensure the flow of funds into the mortgage market must continue unabated then I am afraid we will see the flow of money into the city dry up and Niagara falls beckoning.
Just so that we understand the numbers; the total gold and foreign exchange reserves of the Bank of England amount to a whole £30 billion. Not much with which to curb a run on Sterling.
The reserves of HSBC are more than twice as big as those of the Bank of England. National guarantees are pretty meaningless, the foreign deposits in our banking sector are four times the GDP, so they can be likened to a guarantee from a man made of straw.
“There is a hole in the economy … dear Gordo, dear Gordo … a hole!
Then fix it … dear Alistair, dear Alistair … fix it!
With what shall I fix it … dear Gordo, dear Gordo … with what!
With a straw … dear Alistair, dear Alistair … with a straw!”
The other item that gives me cause for concern is the level of inventory increase since 2000. Most financial analysts will tell you that a continuous upward growth of inventories in a company is usually the first sign of “something wrong in the state of Denmark”.
Businesses operate to generate cash and not stock, modern business operates on a just in time principle with supermarket chains achieving stock turn of 20 times a year and higher (no more than 12 days stock) … if we assume that 60% of consumption is goods and the general supply chain of the country is 60 days it would imply an inflation rate of 5.7% for the year to April 2007 and not the the 2% used as an inflation adjuster for deriving the 2007 growth … if we used any figure higher than 3.3% we would have admitted that our economy was either stagnant or in decline throughout 2007!
Had we started addressing issues then we would not be in our current pickle.
I have never agreed with the so called measures of inflation. As they are simply a statistical representation of retail price increases, which is one of the symptoms of inflation not inflation itself. Whether I use Keynesian, Classical or Monetarist formulae I get one answer prices will rise to absorb the increase in money supply if such increase is not balanced by a rise in outputs.
It can manifest itself in several places;
1. Retail Prices.
2. Housing Prices
3. Other Capital Prices (Stock Exchanges et)
The Inflation targeting policies adopted in the 90's and this decade placed a total focus on retail prices and wages. The true measure of inflation is simply the increase in money supply less population growth. Any increases in money supply above population growth will manifest itself at some later time in one or other of the areas of inflation.
The use of interest rates to curb consumer price rises and excessive wage increases, as used by Margaret Thatcher in the UK and Volker in the USA, proved so successful that we lost sight of how tightly money supply was controlled during that era. We told The Bank of England to control retail price inflation with interest rates and not to worry about money supply we would look after that. We, being the Treasury and FSA.
My earlier quote from the pink book shows fairly clearly, that certainly since 2004 Gordon's policies have had one natural result. Our current position.
Returning to our trade figures I have moved the travel and transport sectors out of services into trade in goods so that my Services section was closer to showing the City and allied consulting businesses on their own … here we see that the surplus being generated by this sector actually exceeds the gross exports of any other sector of the economy.
Also of interest is the fact that we run a deficit of £17 billion on International travel. Further digging highlighted that we spend some £30 billion on overseas holidays.
Perhaps it is worth stating now, that we … the people … can have a far bigger impact on our economy than any of Gordo's manipulations!
If over the next year we give up half of those overseas holidays, and spend the money on local holidays the following effects would come about;
Trading Deficit down by £15 billion … which is automatically an increase in GDP
That money would once again be spent within the economy purchasing goods and services, or paying wages. Which would in turn be spent and so on and so on. Probably increasing GDP by a further £45 billion or more over a year.
So who will make a decision to start solving the problem?
“Not I said the butcher.
Not I said the baker.
Not I said the candlestick maker.”
Well if no one wants to start making the adjustments …
I don't want to go into any analysis of the fiscal stimulation package announced by Alistair Darling this week, at this stage. However I think that it leaves us a bit closer to the edge of Niagara Falls. There is still time, but time is not on our side, the solution is in the hands of the British people … not the politicians, they are not worth relying on!
To finish this section, and to show that most of the attitudes I have been expressing are not out of step with mainline economic thinking, I want to quote from an article that appeared in the Telegraph during January 2006.
“The BIS's (Bank of International Settlements) leading economist and head of monetary policy, William White, said growing levels of personal and corporate debt, both in the UK and internationally, were signs that while the fight against inflation may have been won, it has been at the cost of unbalancing the world economy.
In a new BIS report he said: "In a number of English-speaking countries what has been observed is a decade-long reduction in the household saving rate and a significant increase in consumption.
He said that the battle with inflation had been waged since the 1960s and 1970s. "Perhaps the first heretical point to raise is whether this should always be the objective of policy. The issue needs to be addressed again."
Despite the fact that low inflation and relatively high economic growth have been achieved across much of the western world in recent years, analysts are increasingly concerned with "imbalances" or cracks in the economic system. The US current account deficit is at a record level of almost 7pc of the country's economic output, meaning an unprecedented amount of money is flowing out of the country.
Mr White said: "Those countries with the biggest external deficits the US, the UK, Australia and New Zealand also tend to have the biggest internal imbalances. Rising asset prices in such countries (recently, for housing in particular) have led to higher perceptions of wealth, and more spending." However, he added, far from managing
these worrying build-ups, inflation targeting can encourage them.
Mr White also suggested ditching the current system of floating currencies and replacing it with "a small number of more formally-based currency blocks". He claimed that because of the record rate at which Asian central banks have been buying dollars in
order to keep their currencies artificially low, "we do not really have a freely floating rate system".”
The currency blocks he suggested were Dollar, Euro and Renminbi or the Yen.
I will continue and explore some of the things said by William White, which echo many of my sentiments, albeit from a different perspective, before returning to the UK economy, where we have been dished up a plea to spend, spend and not worry about tomorrow … it may never come.
I do agree that consumption is the key, but tried to show that with judicious use of our spending power we can have a significant impact on digging ourselves out of the mess that politicians have landed us in … it is not just a case of buy British regardless, but wherever possible, without the penalty of increasing our costs, we should try and buy British (if we simply accept goods because they are British regardless of price it would be self defeating) … we should be trying to create a climate that encourages British entrepreneurs to start producing the goods that will help narrow the trade gap. It is not enough to provide a short term stimulus … that will only reduce inventories not encourage investment by industry … it is Investment that is required, not a dose of ENO's fruit salts!
"Well Gordo we have a lot to thank you for, although you didn't do it on your own, but between you and Georgie Porgy across the water you have managed to bring the worlds fragile monetary system crashing down around our feet. Admittedly is has been waiting to happen ever since Nixon tore up the Bretton Woods agreement in 1971, but Al Qaeda not in their wildest dreams imagined they could achieve what the two of you have."
You have spoken about a world problem … yes it has become a world problem because two major players in the world economy have thought that they could simply take, take and then take some more. You forgot that even Keynes, whose theories were aimed at creating employment, espoused prudent management of the external trade account and Bretton Woods of which he was very much the architect was very much based on prudence … with fixed exchange rates and balanced economies, at least in terms of the International position. You have created a position where the UK's net foreign debt is now greater than one years imports … to simply stand still we would need to decrease our imports by 7.5% and you would have to desist from monetising foreign deposits. The feel good factor … rising housing prices … low interest rates would have to come out of Govt. borrowing … oh dear, you would have to confess just how imprudent you are!
Under Bretton Woods you would have needed to devalue … now it is happening anyway, and you wont be able to stop it. A large part of the cash flows into the UK have come out of the surpluses generated by high oil prices for the oil producing countries … with falling oil prices those flows are going to dry up anyway … the question you are not addressing is how are we going to stop haemorrhaging. Your package of so called fiscal stimuli are not designed to encourage investment by business throughout the UK, they are aimed at making it easier for business to finance inventories … but business will cut production in preference to borrowing in the hopes that things will get better … inventories will simply start falling.
Any increase in consumer spending will simply widen our trade gap aggravating our position further. Neither our exports nor imports are price elastic to any large degree so the benefits of devaluation are minimal … we are virtually Oil independent so we will see no real benefits from the reduction in oil prices … the consumer may pay a bit less but there will be a fall in profits from the oil companies reducing our tax intake from that source … increasing our budgetary deficit.
The light you told everyone was coming once the whole world embarked on your fiscal stimulus packages … is simply a train in the tunnel … it has blown its whistle, it is time for you to get off the line!!
What is required?
A reduction in our trade deficit, we need to be living to our original Bretton Woods obligations!
Gordo you have been the strongest anti Euro proponent! Why? Because it would have required you to have real fiscal discipline?
But, surely that was your obligation anyway?
It is known as “fiduciary duty”.
Well the Euro is a political non starter … we don't want to give up sterling, is that just out of sentiment or do we actually believe that in the long term we can be undisciplined and get away with it?
The Euro might yet be necessary to save us!
However lets look at your idea of a new Bretton Woods agreement.
Bretton Woods in essence placed obligations on governments to manage their economies, The USA would maintain sufficient reserves to allow convertibility into gold of its currency. Governments would keep their external trade account in a reasonable semblance of balance. Their failure to do this would result in the need to devalue their currency. A fairly simple system that would work if all parties abided by their obligations.
The French sending their warships in 1971 to redeem their dollars and collect their gold sent shock waves through the Americans and convertibility into gold was ended. Free Floating exchange rates invented. These would have worked provided Governments kept to the discipline of maintaining their foreign trade account in some semblance of balance.
So when you call for a new Bretton Woods agreement, we presume that you mean that you will enter into an agreement where the government takes its responsibility of managing the economy seriously. It should be clear to all that any agreement that regulates the worlds financial system requires discipline, discipline by governments to ensure that they build reserves so that their economies can weather the storms that periodically will blow.
lets look at William White's thoughts of three major currencies with all minor currencies joining one or other of the blocks. This would work if trading blocks were created which maintained an overall trading balance between the three blocks, the currencies would need some re-alignment as the Eastern Currencies are artificially weak resulting in their economies being totally export led. Alternately the Dollar is too strong.
The blocks would need to find some sort of discipline to keep their partners more or less in line … similar to the Euro.
Blocks would obviously no longer be using Interest Rate as the primary monetary tool. Instead fiscal policy would be used to create movements of cash into the areas with most need. In theory of course the Euro zone does just this, rebates etc. to the areas in need of stimulus. In truth this is far more effective than Interest rate policy as a stimulus for growth and has been the main attraction for the Eastern countries wanting to join the EU. There is little doubt that the Danes will shortly give up their currency and join the Euro, should we still be dragging our feet?
This suggestion of three trading blocks is workable and could in fact bring about some stability in the world's monetary system, particularly, if the exchange rates between the blocks are relatively fixed at levels aimed to bring about a better balance in world trade. It would remove from our banking world a lot of the speculation that we have now come to fear.
Perhaps if some mechanics were created where re-alignments between the currencies took place in such a way that existing debts between the blocks were not affected or the balances automatically adjusted to reflect the new exchange rates. The new exchange rates would then affect new transactions and not the past.
Fixed or relatively fixed exchange rates bring about an environment where longer term business decisions are much easier to take. When we have too much volatility in the market, then it simply becomes a casino with large fortunes being made and lost on a daily basis.
All my economic theory used to be aimed at creating models that would project exchange rate movements on the assumption that countries would stick to their Bretton Woods obligations and steer their economies clear of either large surpluses or deficits.
These models worked throughout the 80's and probably 90's once I had placed a factor for the propensity of the Japanese people to save. However I doubt whether they would have stood up in the current decade with both the USA and the UK not giving a fig leaf's consideration for deficits, be they budgetary or trading!
Should we not adopt the block approach suggested by William White, then I would look towards a theme I was developing in a novel I started writing a couple of years back. I had to stop when events overtook me at a rather alarming rate … I was projecting financial melt down in 2012 and a Dollar collapse a few years later. We are at the financial meltdown stage already.
I have always believed that when you try and fix something you don't only address symptoms (paper over the cracks) but try and create something much better, stronger, something that addresses all the issues for the long term.
I saw that globalisation was largely a sham aimed at extending the markets of the Industrialised nations, while maintaining indirect barriers to imports from the second and third worlds. That fundamentally it was aimed as means of perpetuating the status quo. We see this with continually stalled trade talks as each tries to protect his cabbage patch while maintaining a right to invade next doors. I see flaws in foreign aid, I see the USA creating vast food surpluses, then preventing third world countries from developing their own markets by ensuring the supply of aid food makes it impossible for a local market to develop and grow strong. I see the Euro Zone subsidising food production and then exporting the surpluses into the third world at below cost of production. I see trade barriers in the form of regulation of markets.
If we truly believe in Adam Smith's wealth of nations, we should see that this parochial approach to world trade has no place in an enlightened world. Trade is only right if there are no winners and losers, everyone should be a winner as a result of trade!
My novels approach, was to use the BIS as the channel for all money transfers around the world. All transfers would be deemed to have been an export by the recipient country, the Bank of International settlements would withhold 5% of the currency being transferred and issue the recipient country with certificate of deposit for that amount … similar to the special drawing rights of the IMF but with a sound basis for this amount to grow.
Countries would then be able to use these certificates as the main backing by their central banks to their own currencies and be as free as their own political systems allow to create money within their economies to stimulate growth.
The BIS would then set aside up to half of this inflow of funds for developmental aid to the deprived areas of the world … such aid directed to countries as nominated by the General Assembly of the United Nations. Note my emphasis is on developmental aid … things that improve infrastructures, education and health. Not a means for developed countries to subsidise their armaments industries, in the guise of aid and pat themselves on the back for all the aid they give.
I believe that this is a structure that will allow trade to grow, will ensure that countries over time would have a well backed currencies … with the ability to withdraw funds from the BIS to address short term imbalances in their economies or in a dire situation us the BIS as a lender of last resort. The BIS reserves will grow at a net rate of 2.5% of total foreign trade and possibly at some future point we could change the rate at which it is increasing.
The system does work and achieves an equitable form of redistribution of wealth around the world, at what I believe will be a sustainable rate. Yet does not penalise any country, for, it is entirely within their power to decide the extent to which they monetise their certificates of deposit within their economies. Obviously, if they are excessively inflationary their currencies will devalue and their buying power decrease. Which is roughly what Bretton Woods set out to do!
Nixon ended Bretton Woods as he rationalised that the supply of gold was insufficient to sustain the growth of the world economy … well I don't think that a certificate based on that very growth could ever be insufficient.
And just think, wouldn't it be nice if the strength of our economy was helping to provide growth around the world, that we were actually contributing to that idea … “let's make poverty history”
Strange to think that doing good … could perhaps be the route to climbing out of the mess we are in!
Before returning to the UK economy and why the current measures are doomed to failure I would like to refer to some of the other things William White said.
While he didn't say, as I do, that inflation targeting is only dealing with one of the symptoms of a disease .. he did say and I quote again;
“Those countries with the biggest external deficits the US, the UK, Australia and New Zealand also tend to have the biggest internal imbalances. Rising asset prices in such countries (recently, for housing in particular) have led to higher perceptions of wealth, and more spending. However, far from managing these worrying build-ups, inflation targeting can encourage them.”
What I have said earlier in this discourse is that inflation has found another outlet … housing prices and the stock exchange. I would like to return to my concept of a natural level of housing price, being that the median house price should be a multiple of four to four and a half times times the median wage. When it reaches that point, sensible bank lending of no more than 3 or 3.5 times annual wage will allow the average person or couple on to the housing ladder.
My real question has always been, why not prick that bubble and get it over and done with! I also gave a proposal that would provide a safety net against the negative equity that would arise, for no government has the right to simply sacrifice its citizens on the alter of its excesses! No sense in just dealing with the current problem if we are going to restructure we may as well deal with that thorny pensions issue as well. It is no good to keep skeletons in the cupboard, it is far better to expose them all to the light of day where actually they may not be as big as we believe.
The Government has consistently said it will not ring fence Revenue … what it is saying is that it wont accept any constraints, it wont subject itself to any discipline, it wants to be able to do as it pleases. I am afraid that it is those very attitudes that have landed us in our current mess. Well, governments are not a law unto themselves they are elected by the people, are responsible to the people and must be held to account by the people! If the people fail to hold them to account then the people deserve whatever they get.
All solutions to the world monetary system require governments to be disciplined. No matter if it is to re-adopt Bretton Woods, explore some of the possibilities suggested by William White or even consider my ideas … they are all based on countries keeping a semblance of balance in their international trade.
Keynes theories and equations were largely aimed at dealing with an unemployment issue … where unemployment was 25% and greater, all his theories suggested that maximum employment would be somewhere between 90% and 95% of the workforce, in the UK this suggests between 1.5 and 3 million unemployed.
We are still in that area where the application of increased money supply has only a marginal benefit in increasing levels of employment and a far bigger impact on prices … inflation.
The natural consequence of what has and is being done now will be unemployment of 3 million and over before we can start turning the corner using simple fiscal stimulus.
When the USA decided that they needed $700 billion to rid their banking system of the bad mortgages, it was fairly close to my cigarette box exercise on the maximum exposure to sub-prime mortgages. I think that Paulsen's original proposal for the USA government to pick up the bad mortgages and effectively inject the funds into the banking system was right … I think Gordon's ideas of rather nationalising Banks, guaranteeing interbank loans and massive fiscal stimulus is wrong. We should simply clear out the dross clogging the banking system.
The UK is rapidly approaching the point where there will only be one independent bank, and possibly two foreign owned ones the rest will be under government control.
The City will be gone! … nationalised
Can you imagine hard headed businessmen from around the world handing their surplus funds to Gordon to manage?
Well it's not much different giving them to a bank that he directly controls … in the back of the businessmans mind has to be the question “will they be making commercial decisions with my money or will they be making political decisions?”
The only consequence of what has been done so far is seriously undermine both the independence and the world's confidence in “The City”. When you turn your cash cow into your whipping boy don't expect the milk to continue flowing.
Our trading deficit will rapidly rise to around £100 billion
Our GDP will start shrinking … not only in real terms but in monetary terms as well …
unemployment will cross that 3 million mark where we enter the area not called recession but depression.
There has been a lot of talk about the excesses of the market … not least Mandelson this morning saying that the market has shown that it needs regulation. If you have followed the gist of what I have been saying you should realise that all that has been wrong is the failure of the government to regulate money supply within the economy, leaving the markets or at least the money market awash with cash, flowing in from the rest of the world, battling to find a home where it could earn a return for its owners.
Needless to say, if the government did not sterilise this excessive liquidity the policies adopted by the banks would become more reckless as they battled to earn a return for their investors. So who should we blame? The failure of the government do fulfil its primary role within the economy … or the markets for trying to deal with the excessive money supply? Yes there were excesses in the markets, but,only because the government, the FSA and The Bank of England were failing in their regulatory role. Put another way we have been shouting about a symptom, we need to root out the cause … bad government!
Why do I think Gordon Browns stimulatory package wont work?
There are some elements that will … those that bring forward major capital works because they are working on the supply side of the economic equation. The remainder are aimed primarily at the hope of stimulating consumption expenditure and are doomed to failure.
It is a reaction to seeing a fall in demand.
While people, continuing their expenditure pattern, might give some breathing space it is difficult to see, given the existing debt burden of the public, that they will comply. Gordon is actually asking you to bail him out by increasing your borrowings as well as accept the consequences of his wild borrowings in a few years time when taxes go up.
From the very structure of our economy, with imports representing more than 30% of total consumption, it should be clear that any stimulation of demand is actually going to widen our trade gap making the situation far worse, the devaluation of the pound will gather pace.
So far everything can only have one consequence … faster and faster devaluation of Sterling, ultimately bringing about inflation and a collapse of the economy.
Currently we are running into a stage, where business is desperately reducing inventories and output.
Reduction in output always has the effect of increasing costs … while we may think supply and demand fix prices, ultimately cost of production is the most important determinant … no business can survive by selling it's goods at below cost of production.
The chicken or the egg?
Encourage increased consumption to stimulate demand and hope that output will rise.
Or should we be concentrating on the supply side?
Reaganomics as they were dubbed … playing with the supply side instead of demand, to the consternation of people like me, appeared to work! The correction that the UK economy needs is to increase output thereby reducing the dependence on imports to satisfy our demand. This can only be achieved through fiscal measures aimed at stimulating investment … tax reductions to business … tax incentives for increased employment and maybe even tax holidays for new start ups. Instead of playing games, we would be creating an environment that encourages growth of entrepreneurial endeavour.
A last look at that stimulation package … carefully thought out over a week or two with strategic leaks to media to gauge response. Then barely 10 days later … oh shit! We forgot to take into account that we are likely see 75000 mortgages foreclosed over the next year … so here is another billion! What will we see or hear next week?
In conclusion I would like to summarise.
The UK (and USA) economy is in trouble because of the lack of government to fulfil it's basic obligation in terms of Bretton Woods.
Gordon Brown has run our economy with scant regard for the consequences, we should have seen when he dug a hole for the pensions industry, we should have seen that his PFI's were but a way of pretending all was well … what the eyes don't see the heart wont grieve for.
He has seriously damaged the reputation of our Banking sector which is still the very heartbeat of the economy on which we are almost totally dependent. In fact he has put a third of it into the intensive care ward, from which they may never recover.
We need a new Bretton Woods agreement … if only to force governments to live up to their obligations under the original agreement. But, even if we had one would Gordon obey the rules?
I have tried not only to criticise but to offer some constructive ideas as to solutions to the pickle Gordon has landed us in.
We might have Bank of England overnight rates down to less than 2% but our banks wont be able to raise deposits at those rates.
Before Gordon had his latest rush of blood to the head, I was projecting a Dollar/Sterling exchange rate of 1.35, I imagine that when the Government goes to the market with a bond issue to cover all those wild promises it will be lucky to achieve a long term rate of less than 6% simply because of the exchange rate risk he has built into the economy.
I tried to look at the consequences of the current position rather than the symptoms, the biggest consequence is that housing prices are going to fall … until they reach cost of production or my “natural price” whichever is the higher.
I then constructed a safety net for those who will be caught in the negative equity trap … a safety net that would not require increased taxes but would be self funding.
The consequence of this would be an injection of funds into the banking system that would have allowed them to climb out of their own little liquidity trap without the need to re-capitalise.
I proposed that we create an environment that encourages savings and hence investment for it is only out of true Investment that economies can grow. Increased Interest rates would underpin the value of Sterling, and we would be able to look to a brighter future.
I have shown that a relatively minor adjustment to our behaviour could have a far larger impact on the economy than any of the shenanigans of the last month or so … without costing the taxpayer anything.
I have suggested that the correct way to stimulate an economy, is in fact by action on the supply side … a three year tax holiday for new business start ups that meet certain criteria does not cost the taxpayer … they would not have got anything without it starting … but we will gain out of the taxes paid by the employees of that business. Incentives for increased employment by business could also be designed to have no impact on the exchequer. While Incentives for Investment will ensure that our economy starts on a pattern of growth.
I acknowledge that Bretton Woods need re-visiting, but hopefully shown that all that is really needed is for governments to re-affirm themselves to the principles of prudent management. I have suggested that if we do revisit we should take the opportunity of making the world a better place … it does not have to cost anyone.
Money is only an illusion, so lets make the illusion work for all and not make it our jailer!
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