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Monday, 26 January, 2009 
Last week, Jim Rogers, one of the world’s leading investors, gave his views on the situation the UK economy faces. He said his advice to investors was to sell sterling because the country was effectively broke. His view is that the liabilities of the banks, which the Government seems intent on taking on, will effectively, bankrupt Britain. He went on to say that this is because the Government will not clarify how much, and for how long the British taxpayer will carry this burden, and that means that potential investors from overseas do not know if the UK can ever repay this debt. In this situation his advice is to sell sterling because of the risk of national bankruptcy. We have seen a run on sterling over the last few months, and it continued last week with the publication of the highest unemployment figures for a decade and Gordon Browns refusal yet again to say how much potential bad debt there is in the banks he is proposing to bail out again. David Cameron repeatedly pressed him on this question at PMQs on Wednesday 21st January but got no answer.
In a sense, I think Jim Rogers is voicing the concerns that all of us have that we are immensely fearful of just how much debt we are getting into. However, we are not mere investors in our country, we live here and we have more than money invested in our country. The scale of debt is frightening, we know of at least a £1 trillion worth, and that was before the second bailout of the banks announced last week. The simple fact is that no one knows how much bad debt is in the complex financial instruments that the banks have used over the years but what we do know is that a huge debt bubble that has grown up in the last decade. There are figures banded around that debt levels could be as much as two or three times Britain’s GDP.
So what does a £1trillion worth of debt mean?
And as the bailouts continue, and the Government potentially assumes more and more debt the rest of the world is beginning to ask can we ever repay this? That is why sterling is falling and there were even rumours last week that Britain could lose its Triple AAA debt rating. People ask can Britain go the way of Iceland? Will Britain be forced to go to the IMF like we did in the 1970’s?
Of course Britain is not Iceland and it is important not to let hype and rumour make the situation worse. I think what is really spooking the markets, causing the fall in sterling, are the facts that, first, we do not know just how much debt is building up, and second the Governments response is seen as ineffective, haphazard and unsustainable in the long run.
As I have blogged before, the banking and credit crisis is a symptom, it's not the disease. The problem is debt, we and by 'we' I mean 'most of the Western world', but particularly the UK, have been living way beyond our means. We couldn't afford it so we've borrowed it, both individually, and the Government. But now we have reached the end of our credit line and the bill is due. Much of this money came from overseas, sucked into our borrowing and spending spree. It is akin to spending up to your limit on your credit card, and then getting another one and doing it again, spending and not worrying about how you will pay it off.
So how do we try and get out of this mess?
If you start with the view that this is about debt, then debt levels need to be reduced. What you should not do is continue on the path of ever-higher debt levels. The solution to me over reaching myself on a credit card is not to get another credit card, but to adjust my spending (and income if possible) to live within my means.
There are three ways of dealing with the debt levels, two that the Government share with individuals and a third method that is unique to Governments.
The first method is to pay off the debt to get it to more sustainable level. However as anyone who has watched ‘Your Money or Your Life’ will know, the first step is to work out how much you owe. This is why it is important for the Government, and banks, to come clean about how much potential debt, and the risks of it being bad, are in the system. Then a recovery plan can be mapped out to reduce these debt levels. Taxpayers need to know the effect this has, both in terms of the potential risk they are being exposed to and the amounts. Next we need to set out how this debt will be brought down, and that will involve public spending restraint as we cut out waste and unnecessary activity whilst protecting core services. In the meantime to get credit going again the Conservative proposals for a National loan Guarantee scheme should be implemented properly and not in the overly complex and half hearted way that Labour have. Longer term we need a new regulatory regime, which includes monitoring debt levels as the Conservatives have suggested, that will prevent another debt binge happening. If a clear acknowledgement of the debt levels being borne by the taxpayer, and if a clear plan of how this debt will be managed were set out, then confidence may start to return.
Do not be in any doubt but, that this is pain free, spending, both by Government and individuals will be constrained by the need to pay of debts, and it will not grow again at the same rate as before. This will have a knock on effect in jobs and businesses, and the good times may be many years off.
The second method would be to let the banks go bust and let the market clear the bad debt. In this scenario, suggested by Jim Rogers for example, the debts are not taken on by the taxpayer but are kept by the banks. Some banks would then go bust, the bad debts would be written off and the good parts of the banking sector sold off. The economic damage caused by this could be great, as banks go bust then so will businesses and you would be relying on the market to provide new lenders in the gap created by the banks that have gone bust. A new regulatory regime would still be needed, as well as changed spending behaviour, for new lenders to have any confidence to re-enter the UK market.
The big questions of this approach is the effect it may have on international confidence in the UK as well as the fact that the collateral damage to the economy, caused by the shock of potentially most banks going bust, could be greater than the costs of paying the debt off in a managed way over time. The flip side is that it could be a quicker though deeper recession than the option above. This is the point that Jim Rogers was making.
I mentioned earlier there is a third way open to only Governments and that is to devalue the debt levels by printing money, or ‘quantitative easing’ (see earlier blog entry). If inflation was increased, then the value of the debts would decline, and thus the bad debts would be less of an issue. It seems a like a cunning plan, make your debts smaller by devaluing your currency, but like all cunning plans it has some serious failings which I explain in the previous blog entry on 12th January 2009. Such ‘Mugabe’ style economics is really not an option, for if adopted, Britain would face years of fighting inflation and restoring confidence in our economic governance reputation.
Economics is about choices, and really it is a choice between a longer but hopefully shallower recession (bail out) or, a quicker but potentially much deeper recession (let the banks go bust).
Not much of a choice really, it’s a bit like being asked if you want to lose your leg or your arm!
Remind me how we got into this mess again?
Thursday, 15 January, 2009
Monday, 12 January, 2009
The press recently has been full of stories about how the Government is considering ‘quantitative easing’ as its latest attempt to help counter the recession. This is a phrase that not many of us had heard, in fact, despite the fact I studied economics (a long time ago) it wasn’t one that I had heard of either. So what is ‘quantitative easing’, how do you do it, how is it supposed to help, what are the risks and will it work? ‘Quantitative easing’ is a monetary policy term, the ‘quantity’ being referred to is the money supply, and ‘easing’ is another term for increasing. So to put it another way it means increasing the quantity of money in the economy.
So how do you do this?
One way is to simply print more bank notes, a method employed in the Weimar Republic in the early 1930’s and in Zimbabwe nowadays. A more ‘advanced’ method is even simpler and you don’t have to print any extra bank notes. What the Government, via the central bank (Bank of England) does is buy assets, such as government debt, from the high street banks in exchange for money. How does the Government pay for this and where does it get the money from? Believe it or not but it just creates money out of thin air.
Let me explain with an example I read in the Financial Times: suppose a trader, employed by the central bank, buys a government bond for £1000 from an investor such as a pension fund. To settle the trade, the pension fund’s cash account with a commercial bank is increased by £1000 from the central bank, and to settle this payment the commercial bank’s reserve with the central bank is in turn increased by £1000, matching the £1000 increase in central bank assets. In other words the pension fund sees £1000 appear on its bank statement from the sale of the Government bond, but for the Government it has merely created the money through an accounting entry in the central banks books.
It may sound complicated but it is nothing more than creating money out of nowhere and despite the complicated route in the example it’s just the same as printing more bank notes, so you could be forgiven for mistaking it for forgery!
The reason this drastic measure is being discussed is because all the other attempts by the Government to revive the economy have failed. The bank bailout was supposed to save the banks and restore lending to pre credit crunch figures, it hasn’t. The pointless and wasteful VAT cut was supposed to boost spending, it hasn’t, and the successive interest rate cuts were supposed to boost lending but they haven’t. The idea is now that by creating extra money, the banks will lend it out and the credit crunch will be eased.
To understand why, we need to go back to the Quantity Theory of Money, which I discussed on this blog on 28th November 2008. This theory holds that MV=PT, where M= the money supply, V= Velocity of circulation of that money, P= the general price level and T= the number of Transactions or output of the economy. It is postulated that in normal circumstances V and T are relatively fixed, so any increase in M would lead to an increase in P because the equation must always equal. The credit crunch means that V has fallen so we are seeing falling prices and output (P and T). The logic is therefore by increasing M you can counteract this and make up for the fall in V.
So will it work?
The risk is that such an increase in the money supply will result in higher inflation once more normal circumstances return. Referring back to our formula, MV=PT, if V increases again in the future, then this, added to the increase in M will result in P and T increasing, but because T is relatively fixed in the short term, for UK producers at least, then we will see either rising inflation (increase in P) or an even bigger balance of payments deficit. Due to the low level of the pound, this increase in imports would lead to inflation also because imports will be relatively more expensive. Furthermore, the evidence of ‘quantitative easing’ from Japan, where it was used throughout the 1990’s is that it did not work.
I think that ‘quantitative easing’ is treating the symptoms of the credit crunch and not the causes. The real question is why there is no credit available and the solution must be to tackle the underlying problem. I think this is about confidence and debt. Debt because, for far too long debt levels were allowed to rise, until they became unsustainable and the bubble burst, and confidence, because borrowers and lenders, who have had their fingers burnt, are reluctant to embark on another debt fuelled binge.
Instead the solution to the credit crunch should be in two parts, short and long term and must be focussed around reducing debt and increasing confidence.
In the short term, which is mainly about restoring confidence, we need to get credit moving for businesses that are failing through lack of money. We can do this by adopting the Conservative proposal of a National Loan Guarantee Scheme that will allow banks to lend to businesses, by sharing the risks with Government. Second we should look at the Bank capitalisation again to do something about the fact Government lends money to the banks at 12% but expects it to be passed on at base rate (1.5%), and third, we should be honest about why we are in a mess, and be honest about how we get out of it because only this will start to restore confidence. I believe that this Government cannot do this and that is why one of the biggest steps we could take to restore confidence is by having a change of Government to one that can be honest about the causes of this recession.
In the long term, it’s about debt levels and we need to build our future prosperity on wealth creation and not debt and borrowing. We need a better regulation system to ensure that banks, borrowers and Government behave responsibly, and we have to revitalise the competiveness of our economy with less regulatory bureaucracy and lower taxes. In the longer term debt levels need to be brought down for individuals, businesses and Government, and that means not stacking up excessive borrowing now which mean higher taxes in the future.
Crucially, we should not embark on a course which could put inflation back into the system. Those with long memories will remember the insidious effect this had on people in the 1970’s and early 80’s, and the long and hard fought campaign to bring it under control.
So rather than ‘quantitative easing’ being the solution to our problems, the inflation it could bring will be another toxic legacy of labour’s rule, to add to the record debts, higher taxes and broken economy.
Monday, 05 January, 2009
Happy New Year to all. I have just read the reports of the actions in Afghanistan over the last few weeks. A massive British led operation has seen 1,500 troops involved in two weeks of fierce fighting in rain and mud to successfully secure a large area of Central Helmand province previously under Taliban influence. Looking at the pictures of heavily laden Royal Marines advancing through the mud is reminiscent of pictures from the Great War.
It is a sad indictment of our celebrity and gossip obsessed culture that their exploits are largely unknown to most people. For all the people who despair about young people today, or for those searching for a role model, look to our brave service men and women in Afghanistan. They are the best our country has and they do us proud.
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