At this moment in time the world economy is facing severe difficulties as we see problems in places such as Greece, Ireland and Portugal which have now spread to Italy and Spain as well. Indeed the last weekend has shown the depth of the problems with the International Monetary Fund confessing that its resources may be inadequate in the face of this crisis.Our own country the UK is suffering from weak growth and persistent inflation that I have labelled stagflation. Just to reinforce the element of gloom even booming China is showing signs of a slowdown.
Our priority should be to reform our banks
However I feel that we can learn from what we did in 2008/09 and it is important for us not to repeat the same mistakes we made then. In essence we let via the “too big to fail” strategy, problems for banks become problems for the nations which bailed them out. What those in favour of this strategy did not foresee at the time was that whole nations would be crippled by such a plan and that many others would be seriously affected. They hoped that the debt can could be kicked into the future by which time economic growth would solve their problems. Accordingly I would argue that some obanks may in fact be “too big to save”. So we need to change both our course and our plans.
This change of course would involve a fundamental reform of our banking system that would as a starting point thoroughly audit it to identify as far as we can the non-performing assets. At this point many have been shoved to the outer region that has been called off balance sheet and ignored. This ruse allows banks to declare profits on the remaining on balance sheet items and the bonus and high salary carousel begins again.
Going forwards the banks would be limited to banking and related areas. If they wished to undertake the highly risky derivative trading that they cliam is so profitable I would have no trouble with them doing that as a partnership i.e. with their own money! After all they are telling us it is profitable. I have argued for some time the shareholding joint-stock company with its concept of limited liability has problems in this area. One of the problems is that whilst liability is limited for shareholders it would appear that there is no liability at all for directors and managers who after even the most negligent decisions tend to walk away not only scot-free but also well remunerated. By contrast the taxpayer has found him and herself facing what seems to be unlimited liability for others mistakes and this needs to change. I would allow the partnerships to get outside capital but the capital would have to be equity capital so that if losses build up it would be wiped out.
Another feature of this is that I would introduce a new law for gross negligence for directors of companies as it shame us all that some have got away with what has been in effect financial terrorism.
Quantitative Easing is not a solution at this time
There were many ways suggested that this particular policy would help us. The Bank of England in particular produced reason after reason only to abandon them and replace them with a new one as reality contradicted theory. In my opinion they should instead have abandoned the failed theory of the “output gap” instead! The reality in spite of the Bank of England’s protestations was that what became called QE caused much more inflation than it caused economic growth.
Indeed there is a logical contradiction in the current claims for more QE. If it worked we would be in a better position than we are now and the suggested QE2 would not be required. However adherents of such a policy feel that success is always just around the corner and that we need “More,More,More” as they pursue a policy which for them is more an article of faith than many hold to a religion. The problem for them is that many economic plans rely on an element of psychology (You could argue all Keynesian economics does…) and that faced with QE2 most will respond with the words of Peter Townsend.
We don’t get fooled again
Don’t get fooled again
Meet the new boss
Same as the old boss
Why inflation is a problem
Some argue that the inflation produced by the QE experiment where the Bank of England bought £200 billion of debt is not a problem. And they have suggested also that letting inflation continue is a way out of our problems. With this theory I disagree completely. And it is not only me that disagrees it is the facts. Two years ago the Retail Price Index stood at 214.4 and now it is at 236.1 so we have had plenty of inflation but our economic situation has improved little. Why should we repeat a failure?
In fact as wage rises continue to be much lower than price rises I expect a continuation of inflation to make things worse and not better. A gap has arisen between wages and prices. If we look at the figures for Average Weekly Earnings produced by the Office for National Statistics we see that over the past two years they have risen from £445 per week to £462 per week. So whilst average wages have risen by 3.8% average retail prices have risen by 10.1% so real (inflation-adjusted) wages have fallen substantially. Accordingly is it any surprise that people are spending less? It is my contention that this fall in real incomes has offset the potential gain to consumption from the cut in official interest-rates from 5% to 0.5%. And it was always my contention and a theme I have long pursued on here that in the liquidity trap between 0% and 2% there were few gains anyway presenting the possibility that we may have gone backwards rather than forwards in that range. So there is the logical consequence for supporters of QE that the inflation it helped generate eroded the gains from their interest-rate cuts and they have shot themselves and our economy in the foot.
Also letting inflation persist would further punish those on fixed incomes and savers. We are back to the moral hazard of getting out of a debt problem by bailing out debtors and punishing savers. It is my contention that punishing savers has also had the unintended side-effect of them reducing their consumption by more than was expected which again has reduced the impact of our stimulus measures. So it is time for the Bank of England to start to take its mandate seriously and begin to haul inflation back on path
If Karl Marx was alive he would tell us that capital was winning and labour was losing and so far in the credit crunch he would be correct. By the numbers I have used above somewhere around 6% would be the measure over the past two years alone. However I do believe that he would be surprised by the way that “capital” has metamorphosed from mill owners and industrialists etc. to bankers like Goldman Sachs who according to an interview published by the BBC yesterday genuinely seem to think they do rule the world! Mind you if you look at the evidence with so many of their alumni in important positions. Although a little care is needed here in this particular instance as this individual may have pulled the wool over the BBC’s eyes as he looks more of a self-publicist than a trader..
Does monetary policy have any power right now?
You may have spotted that I feel that monetary policy right now really only has the power to reduce or increase inflation and that its ability to influence economic growth is low at best. Indeed I can see scenarios where it might make things worse and not better. Regular readers of this will be aware that I argued back in late 2009 for some modest interest-rate increases to help combat inflationary pressure. As events have developed it is quite plain to me that we would have been on better economic course if we had taken that route as some of the problems I have outlined today would have been helped by it.
There is a scenario where monetary policy will regain power
In some ways it is all about timing. In a genuine situation where we might be heading into a depression with both deflation (falling aggregate demand) and disinflation (falling prices) monetary policy would regain some effectiveness and I would use it. “Helicopter Shaun?” Perhaps! The problem that we now face is that resources to deal with such a situation have already been used when we were not facing this and so not only did they not work we will be weaker if we actually do face a return to the 1930s.
My argument today is that we have failed over the credit crunch to undertake what was the most important measure once interest -rate had been cut and fiscal stimuli were in action. We should have then begun to reform our banks and we would then not find ourselves in a situation where we have wasted much of the last 3 years. Indeed I would argue that with bail out after bail out the influence of the banking sector has grown and not weakened.
By contrast pulling levers to influence the economy are getting less and less effective and may actually make things worse. One of the worst human influences is the pressure at times like this to “do something” but our politicians and central bankers seem incontinent in this regard. Sometimes it is better to hold your nerve and do nothing than to act incorrectly. Indeed here is my last theme for today, in these times it matters whne you do something as much as what you do and