I guess it is always easier to criticise, however this is not meant as a criticism of Alistair Darling’s budget, which under the circumstances was about the best he could do.
He was faced with a quandry similar to the nursery rhyme which went something like this;
“Old Mother Hubbard went to the cupboard,
but the cupboard was bare
so she whipped them all soundly and
sent them to bed!”
Perhaps this is what Lord Liverpool had in mind in 1817, when following the Napoleonic Wars, Britain entered a steep recession. With Government Debt already at 250% of GDP there were very few options open. His choice was to suspend “habeus corpus” and take a more austere approach. An informal Gold Standard was adopted and the Gold Sovereign came into being. His recession lasted only one year, had a severe deflation approaching a 20% drop in prices and Britain began a long period of growth without inflation.
Having read the 270 odd pages of the budget several times I am still no nearer to a conclusion on its soundness. Projections into the future are difficult at the best of times and when all your models are misfiring your chances of being right become more and more tentative. However in looking at the numbers it is clear that there are very few options open, very much a case of old Mother Hubbard finding the cupboard bare.
Here are the points that struck me about the budget:
1. Public Debt is set to rise from an estimated £609 billion at the end of last financial year to an estimated £1130 billion by April 2012.
2. Exports are set to fall by 8% while imports are set to fall by 9% and our deficit on international trade current account will in fact grow from £44 billion to £56 billion over the coming 2 years, indicating that both our exports and imports are relatively price inelastic and that any gain to the economy from devaluation is likely to be small.
3. The drop in VAT receipts are indicating a severe fall in the purchase of durables and discretionary expenditure like restaurants, while purchases of zero rated goods (foodstuffs) have increased. In this we are mirroring events in Japan during the 90’s.
What are the risks we are facing?
1. Falling house prices
2. Increasing unemployment
3. Falling Consumption.
Falling house prices carry the threat that the Banks, we have taken over, will show bad debts, which will then impact on the exchequer as losses in those Banks would become our responsibility.
There is also the chance that further reduction in housing prices will impact further on falling consumption which in turn will increase the rate of business failure and therefore aggravate the unemployment situation further.
Logic would seem to tell us that it is best to attempt to keep housing prices up. That has been the route that has been followed this far in the crisis and as yet there is little evidence that it is succeeding, however it does add a new risk namely inflation.
While I don’t rule out money creation as a part of the solution, it should be done with clear motives and openly so that people can understand.
Economics is the science of recognising “unintended consequences of policy decisions” (von Mieses), keeping artificially high housing prices creates distortions within the economy that ultimately precipitated the crisis we currently face. The consumption led boom that preceded the crash was always artificial and we should not be trying to perpetuate that situation.
Our current budget does little to create a new platform for sustainable growth and wealth creation. It does little to give people a vision of the future where they can see a return for effort, where they don’t need to visit the casino in order to provide for their futures.
Here is a Budget for a future Great Britain that Alistair Darling was unable to give:
People of Britain … I have no tidings of joy to bring you.
We have misjudged the economy and misunderstood “free markets”.
The model that we have used to make our predictions of the future is seriously flawed and as a result my previous statements and projections were no more than wishful thinking.
GDP in sterling terms is set to fall by 3.5% this year, although others like the IMF believe 4% to be closer to the mark.
Because Government expenditure represents 40% of GDP this 3.5% contraction actually means a to nearer 6% contraction in the non-government sector. If this contraction were to continue at a rate of 1% through 2010 with real recovery beginning in 2011, we will see unemployment rise to well over 4 million.
On International account we are currently running a deficit on current trade account of £44 billion which we are currently projecting to rise to £50 billion over the coming financial year and £56 billion in 2010. However I must warn that these figures are based on recovery beginning in the last quarter of 2009, outsiders like the IMF are projecting 2011 as the earliest point of recovery.
Our current budget deficit is £103 billion and projected to rise to £178 billion over 2009 and £175 billion in 2010. These figures exclude the costs of the banking bail outs which we are projecting at £60 billion, the IMF, however, believes that, that cost will be closer to £200 billion.
Should our projections prove wrong and those of the IMF correct, our budgetary deficit in 20o9 could top £250 billion. This is all dependent on the recovery or otherwise of our banks investments in the USA, and other esoteric pieces of paper, many of which may yet turn out to have been “bets” and are currently illiquid.
In common with the USA, our failure to regulate money supply within our economies resulted in a speculative boom in housing and stock exchange prices. The contraction we have already seen places many people in a negative equity situation and we are seeing an increase in mortgage foreclosures, without action on our part this will accelerate.
Under the circumstances I have no option but, to choose a change in direction.
So far our reaction to the crisis has been to try and rekindle consumption, while attempting to prevent any further falls in housing prices, in the hope that the negative equity which would arise from further falls could be avoided, both protecting peoples homes and preventing bad debts in the banking sector (toxic assets).
I believe that interference in a natural correction to the markets can only prolong the agony for our economy and with this in mind we will cease the current strategy of quantitative easing. It is already apparent that this strategy is more likely to fuel the speculative markets, than plough money into the business sector or consumer’s hands with the possible exception of large corporations. However small business represents some 70% of employment outside the government sector and if our policies and strategies result in wide scale failure of these businesses we will see all the most dire predictions come to life.
It is clear, that outside of protecting against failure of the large businesses on which we are dependent, we need to create an environment where the small and medium sized businesses are able to weather the storm and flourish once the corner is turned.
With all this in mind.
I announce that we are calling a moratorium until 2011, on mortgage foreclosures where the mortgagee’s income has fallen as a result of the situation we are in.
This announcement is coupled with the following package aimed at nullifying the effects of negative equity and dropping property prices.
The Bank of England will provide a special form of 2nd mortgage financing on all properties which were either purchased or had mortgages registered subsequent to 2001. These mortgages will carry an interest rate equal to 1% and will only be redeemable pro-rata out the proceeds of a sale of the property. These mortgages will be available on a sliding scale with a peak applicable to properties bought or mortgaged in 2007 of 35% of the original purchase price of the property or valuation of the property where a mortgage was taken out on an already owned property.
Redemption of this mortgage will take place on the sale or transfer of the property and will be at the rate of 65% of the proceeds exceeding the amounts due to pre-existing mortgages, being attributed to the BOE mortgage and 35 % to the property owner, with this proportion reduced as the property owner reduces the liability on pre-existing mortgages. Failure to liquidate this mortgage on a sale of the property will result in it being carried forward on the property to be redeemed out of future transfers.
The result of this measure will amount to creating £250 billion of new money in the economy with the benefits flowing directly to the consumer or man in the street as it is projected that this measure will result in a further drop in instalments on his mortgage.
The Banks which will be the primary recipients of this new money will be required firstly to re-pay all the government funds advanced and invested during the bail out of Banks. Secondly all banks will be required to substantially increase their deposits with the Bank of England, and will in the future be required to hold a far greater proportion of deposits as reserve assets with the Bank of England. The bigger the Bank the greater the proportion of reserve assets it will be required to hold, this is aimed at encouraging Banks to split up into smaller specialist operations.
Regulation and oversight of the Banking sector will be passed back to the Bank of England who will be under a charge to aggressively intervene in the markets where either the Sterling exchange rate moves outside the targets I will set, or inflation exceeds 1.5% which is not our inflation target but the maximum we would like to see.
I anticipate that these measures will result in the Bank of England overnight rate rising to some 7% and possibly higher.
While it is easy to talk about how we intend structurally changing the Banking sector we need to address the issues of growing public debt and increasing Government deficits, which are not sustainable in the long term and for that matter even the medium term. Popular wisdom is that there should not be a reduction of government expenditure during a downturn, I would like to banish this thought to the realms of science fiction. Yes the government needs provide targeted fiscal stimulus to the economy it cannot however allow its share of the economy grow unabated.
With this in mind, we will impose a freeze in public sector wages until 2011.
I expect this decision will be adopted by the private sector as well, and in this regard I will also announce measures to create a surcharge on companies NI contributions in respect of increases in wages, where the average per employee wage level exceeds £20000 pa.
For the purposes of calculating these averages, employees earning below £12000 pa. will be ignored.
Details of this proposal will follow this budget and will come into effect no later than 30th September this year.
This measure is aimed both at persuading the private sector to follow our decision to freeze wages, and to encourage them to increase the number of people employed and/or to dissuade them from creating redundancies because of a short term downturn.
There has been much talk about the evils of deflation, however I would remind you that the 1800’s saw growth of the economy and an increase in the overall wealth of the nation without inflation, and the Japanese economy has grown in spite of deflation.
The correct strategy for a business when faced with declining markets is not to simply do a head count and cut jobs, but to diversify its product range and find new markets.
It is up to the nation to show it’s enterprise and increase it’s overall efficiency and ability for innovation. Growth in the 1800’s was attributed to the Industrial revolution and we need a revolution in the way business thinks and reacts to changing circumstances. It is no good to simply live in the comfort zone where we increase prices by 3% a year and try to peg wages to around 2%.
We need to improve efficiency, just like we did in the 1800’s.
In this vein we will require all Government Departments to produce zero based expenditure budgets for our next expenditure review. We are looking for these budgets to result in a cut in Government expenditure, in absolute rather than real terms, of 5%. We believe that this can be achieved without any reduction in services.
This will have the effect of maintaining next years deficit before borrowing at the current level.
bringing about a reduction during 2011.
We believe that this action is needed as a corollary to the money creation outlined above, as failure to do this is tantamount to burning the candle at both ends and will increase inflationary pressures.
It is our objective to aim for a fully balanced budget, excluding infrastructural development projects, by no later than 2013.
Therefore … people of Britain … it is time to put the word Great back into Britain.
That if … we … grant a Banking License … we will ensure through regulation and oversight, that, that bank does not embark on reckless policies and maintains reserves at a level that will ensure solvency. We will therefore honour any amounts that are due on any British Assets that were securitised and sold in the secondary markets.
We also look to other countries to back the assets sold by their Banks. The credit crisis cannot end until people throughout the world know where they stand when they deal with our Banks.
To ensure that we are able to meet all our obligations both now and into the future, the Bank of England will begin building its foreign exchange reserves on the following basis.
1. Where foreign deposits are taken by our Banks they will be required to place a minimum of 5% of such foreign currency with the Bank of England.
2. The Bank of England will further increase its foreign exchange holdings at a rate equal to 5% of our export earnings.
It is our belief that our currency should be backed by more than a simple Government promise.
As some 44% of our International trade is with the EU zone we will target a stable exchange rate against the Euro at around 78p to the Euro. The impact of this 12% revaluation of the £ would have the effect of a 3.5% reduction in prices through the economy.
Direct measures aimed at stimulation of the Economy and employment.
1. All new business start-ups, that employ 5 or more people will be granted a 3 year tax holiday up to 10% earnings on total assets employed in the business, and a 50% reduction in NI contributions for period of this holiday.
2. Investments in any of the businesses that start under these rules will be permanently exempt from Capital Gains Tax.
3. To re-stimulate the building sector, renovation of buildings older than 15 years will attract the same VAT exemption that new buildings do, where such renovations are undertaken by registered contractors.
It is estimated that this measure has the potential to create/save some 15000 jobs in the UK.
Measures aimed at improving competitiveness of the Economy.
1. The current excise duty on Diesel will be dropped and converted to a higher rate VAT reclaimable only by registered transport companies. This will impact favourably on the cost of transportation which is an element in the cost of all goods. We expect to see this cost reduction pass down the chain to the consumer.
This measure will be paid for, by returning the VAT rate to 17.5% and ultimately increasing the VAT rate to 20% in 2010.
The overall impact on the consumer when coupled with the price reductions that should result from the revaluation of Sterling should be neutral to marginally beneficial, while strongly beneficial in the area of zero rated VAT items.
It should also place our transport industry on a more competitive footing with that of Continental Europe.
Our export industries will also benefit as we are removing the tax component of fuel cost for transport from their cost equation.
Measures to improve our infrastructure.
We will float a new company to be known as UK Developments. This company is to be financed by way of a series of 25 year Bond issues, which will be guaranteed by the government. These bond issues apart from being index linked and carrying a 3% interest over the increase in value based on the index will entitle the initial investors to 50% of the initially alloted share capital of the company at no additional cost. The other 50% will be alloted to the government in exchange for the guarantee given by the government on the companies bond issues.
The purpose of the company will be to finance capital works programs that are aimed at improving the infrastructure of the UK.
Initial projects will include;
1. The building of nuclear power generating plants with the objective of reducing the UK dependence on fossil fuel based electricity generation to 25% by 2020.
2. The covering of the whole of the UK with a fibre optic network extending to every household capable of delivering high speed synchronous broadband by no later than 2015. It is our intention to ensure that the UK has the best infrastructure in the world regarding the digital age.
3. The resurfacing of all roads throughout the UK that currently in a rundown state.
4. High speed rail connections between all major centres.
This is a budget aimed at correcting the bad effects of past policy and creating a platform where we can grow out of the recession in which we now find ourselves.
We have provided incentives for new business starts and increased employments as well as disincentives to reduction of employment levels.
We have created a monetary environment where bank balance sheets can be restructured and solvency restored.
We have eliminated measures which have tended to create distortions, and placed certain sectors of the economy on a more competitive basis.
We have created a vehicle for the future financing of infrastructure development and redevelopment that will provide pension funds with a secure inflation proof investment as a part of their investment strategy.
We are backing sterling with;
1. The future value of homes in the UK
2. Ever increasing foreign currency reserves.
and an undertaking to maintaining a stable exchange rate environment.