A plan for reforming the UK economy, start with the banks right now!

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
No, no!

And maybe

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.

Conclusion

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

This entry was posted in Banking Reform, Banks, Economy, General Economics, Quantitative Easing and Extraordinary Monetary Measures, UK Inflation Prospects and Issues. Bookmark the permalink.
Subscribe Find an Adviser
  • Anonymous

    Shaun, I do sense that things in Europe are now reaching their end game, though a slow motion car crash is a pretty good analogy. At some point the Germans will have to limit their exposure to incompetents like Papandreou, whose special pleading is becoming just a little tedious. They will also have to ignore Obama, who has the cheek to preach while the USA is one of the most disastrous examples of bad financial management on the planet. 

    How did the Greeks manage before the Euro? Were they all starving? I think not. Indeed, whole sectors of Greek society did very well indeed (shipping, arms dealing, tourism, most professionals…). I hope the Germans get round to clear action to disconnect some time soon. The Greeks can go back to their previous existence which, may I mention, is probably rather like our current existence. In 2010 their GDP per capita was estimated at $29600, close to Israel and Italy. That is not a poor country!However, the very concept of reforming the UK banks is, I fear, pie in the sky. Power in the UK at the moment rests with the financial industry, who are to use the cliché, too big to fail. With their close connections to government, they have us over a barrel. This will not last for ever, and one day we may find a senior politician who is not up to his neck in financial connections who is prepared to sort things out. That will not happen with the present crew, whose backgrounds are only too well known. But as the UK public slowly realise what has happened to them and how the appalling, enormous bail-out of the banks will cost everyone a great deal for decades, pressure will grow for the prevention of any further disasters of this sort. Cameron and Osborne have with total predictability, kicked that can well down the road, but they will not be in power for ever. 

  • JW

    Shaun, there is a lot in this that I agree with.
    I don’t agree that QE has a direct inflationary effect as it just swops low interest rate liquid asstes for higher rate less liquid ones. However it has had a very clear indirect inflationary effect by stoking up commodity bubbles to which the UK economy is particularly vulnerable. Its also completely useless as a ‘real’ economy tool, as we have a demand not a supply ( credit, interest rates) problem. Too much consumer debt and total lack of confidence has drained demand and will continue for many years.
    I totally agree that the Banks and institutions like Goldmans need neutering. Although I wonder how its going to be done as the 1% or so global elite have the rest of us by the proverbials. The guy interviewed on the BBC might have been a self-publicist, but you only have to look at the presenters to realise what a mistake was made to have someone on the MSM news that said it as it is.
    The question is , who does rule the world? Can it be elected governments, or are they all controlled directly or indirectly by the global elite through the financialisation of economies? I hope it can be the former but increasingly I have doubts.

  • Anonymous

    Shaun – this is probably the best overview of past events and the way forward that I have had the pleasure of reading in many a long year. Looking solely at the UK, my view is that bankers (and by extension, politicians) regard “people” as molecules of gas. Individually we count for nothing but given sufficient numbers they can extrapolate how and where we are heading and are probably quite pleased with their “work”. I applaud anything that brings miscreants to justice as you know; a cull of those who have used their positions (but lack of accountability) to feather their own nests to the detriment of the vast majority is, alongside reform of the finance industry, a prerequisite for a) overcoming the problems of the past and b) creating a durable foundation for future success. 

  • Anonymous

    Shaun,
     
    I believe the Bank’s objective with QE is indeed inflation and that they see inflation, rightly or wrongly, as an essential element in preventing the UK’s public finances getting out of control.
     
    By the way, the ONS has discontinued the RP02 table, which facilitated RPI comparisons over time, such as the one in your post. I find it hard to see this as an innocent move.
     

  • http://www.facebook.com/jason.aris Jason Aris

    I agree I didn’t particularly like the individual interviewed on the BBC (and his ‘advice’ was peculiar no mention of physical assets such as gold and silver but pushing people to USD and US Treasuries) however, what he said in the latter part of the interview was astounding to hear on mainstream TV exp the BBC! Bottom line he is correct, much of what we consider a valuable (stocks & shares, property) is vastly overblown and the coming shake-out will reduce a lot of the middle class to penury. I almost think this has been deliberately stretched out to ensure those in the know are safely out of the markets when the crash comes.

  • http://www.facebook.com/jason.aris Jason Aris

    The problem is the GDP per capita figure is completely ficticious, Greece does not have the economic viability to maintain its population at Northern European standards (not sure most of the North does either but that is another argument).

    The Euro has enabled the Greeks to have one long ten-year party of low near German interest rates and they have basically blown the lot, now the creditors want their money back and hey presto Greece cannto do that.

    They need to start taxing their populace properly (could start with shipping magnates) and then they may be in with a chance at the moment though they have done precisely nothing since this blew up

  • Anonymous

    A central bank implements quantitative easing by purchasing financial assets from banks and other private sector businesses with new electronically created money.[3][4][5][6] This action increases the excess reserves of the banks, and also raises the prices of the financial assets bought, which lowers their yield.[7]   I draw your attention to this excerpt from Wikipedia, especially the bit that says “with new electronically created money”.    Surely this would be inflationary?  And it does seem at odds with your contention that it is a simple swop.

  • Anonymous

    Hi Shaun,
    One little quibble with a very interesting article. You say that we should start by auditing the banks, but who on earth is going to do that?
    1. There are only four audit firms with the capacity to do the work and they have all audited banks and given clean audit opinions just before they went under or were bailed out;
    2. The accounting profession is so far up itself with rules that no-one understands that it has
    a) completely lost sight of reality; and
    b) allowed itself to hide behind its own rules so that it cannot be blamed even when clean audits are immediately followed by going bust.
    3. The accounting firms have absolutely no understanding of the businesses that they audit. I nearlt fell over laughing today when one of the big four rejected the Labour party idea of hiving off the audit function as this would reduce the understanding of the audit companies.

    I write as a fellow of the institute of chartered accountants in England and Wales, trained at a big four firm with expreience of auditing major banks.

  • Rob

    The BBC were scammed (again) by the Yes Men..Have a look on You Tube.

  • Anonymous

    Hi Jason

    I have often argued that Gross Domestic Product figures are not entirely reliable as measures of economic performance. Rather oddly support for this has come from an economist at the US Federal Reserve who has argued that GDP figures presented at the time gave the US the wrong idea about the impact of the credit crunch (too small).

    Without going into too much detail there are 3 ways of measuring economic activity which are output (GDP), expenditure and income.The research suggests that income was a much better guide and begs the question of whether it should be used much more often.

    However I am afraid the main stream media has something of an obsession with GDP.

    I had been thinking of applying this to the UK but will also take a look at figures for Greece.

  • Anonymous

    Hi diogenesxz

    Actually they have changed the earning figures too which metamorphosed into average weekly earnings index from the average earnings index in the autumn of 2010.

    You would think that they were trying to muddy the waters or something….

  • Anonymous

    Hi Berlioz

    I never said it would be easy…. However I do believe that one could find accountants willing to do the job.

    Dealing with the big 4 accountancy firms would come later, after all aren’t oligopolies supposed to be a bad idea?

  • http://www.facebook.com/people/Walt-Kowalski/100002706283065 Walt Kowalski

    Hi Shaun– a question. This Thursday’s vote in Germany is just to allow the EFSF to recap banks, right ? It’s not for the Geithner Plan, is it ? Anywho, here’s some news about Greece from the FT that I know will shock you {and all who believe in the accuracy of Greek accounting methods}: http://www.zerohedge.com/news/ft-report-greek-bailout-package-verge-collapse-after-surge-greek-funding-needs-sends-stocks-plu

  • Anonymous

    Hi Mr.K

    Thanks for the link. I had been following the FT news story which is why I imagine the Dow retraced about 150 points earlier from its highs.

    The German vote is to increase the size but only to give the EFSF a nominal firepower of 440 billion. So Germany will be liable for an extra 90 billion Euros or so. The numbers get complicated here as the fund will be heavily over-insured but as Greece Ireland and Portugal have fallen off the list by my maths they will still only get to approximately 410 billion if they stick to the agreed formula but I guess for them that is quite near the target.. So 2 trillion is a long long long way away!

    The other changes are from the 21st July agreement as you imply…

  • http://www.mindfulmoney.co.uk/wp/shaun-richards/credit-easing-in-the-uk-might-be-required-due-to-the-accelerated-withdrawal-of-a-previous-scheme/ Credit Easing in the UK might be required due to the accelerated withdrawal of a previous scheme | Mindful Money

    [...] banking remake of the Night of the Living Dead! Here are my thoughts in this area from last week. http://www.mindfulmoney.co.uk/wp/shaun-richards/a-plan-for-reforming-the-uk-economy-start-with-the-b… This entry was posted in Banking Reform, Banks, Economy, General Economics, Quantitative [...]

  • http://www.mindfulmoney.co.uk/wp/shaun-richards/the-dangers-to-uk-public-sector-borrowing-are-weak-economic-growth-and-our-struggling-banks/ The dangers to UK public-sector borrowing are weak economic growth and our struggling banks | Mindful Money

    [...] http://www.mindfulmoney.co.uk/wp/shaun-richards/a-plan-for-reforming-the-uk-economy-start-with-the-b… This entry was posted in Banking Reform, Banks, Economy, General Economics, Gilts, Stagflation, UK Inflation Prospects and Issues, Yield. Bookmark the permalink. GA_googleFillSlot("MindfulMoney_BLOG_MPU"); /* [...]

  • http://www.mindfulmoney.co.uk/wp/shaun-richards/jp-morgans-difficulties-remind-us-that-there-is-still-something-rotten-in-the-state-of-world-banking/ JP Morgan’s difficulties remind us that there is still something rotten in the state of world banking | Mindful Money
  • http://www.mindfulmoney.co.uk/wp/shaun-richards/refining-and-improving-adam-posens-proposed-plan-for-credit-easing-reform-our-banks-now/ Refining and improving Adam Posen’s proposed plan for credit easing. Reform our banks now! | Mindful Money
  • http://www.mindfulmoney.co.uk/wp/shaun-richards/what-has-happened-to-the-uks-housing-mortgage-and-banking-markets/ What has happened to the UK’s housing, mortgage and banking markets? | Mindful Money
  • http://notayesmanseconomics.wordpress.com/2012/11/02/is-there-still-something-rotten-in-the-uk-banking-system-i-think-so/ Is there still something rotten in the UK banking system? I think so « Notayesmanseconomics's Blog

    [...] I have managed to get to this point without revealing that due to the commercial property losses not fully revealed on our banks and likely derivatives losses that I think that they could easily be insolvent. Adding this to the list of problems above shows the scale of the problem that we face I think especially as there is little or no sign of a genuine change of culture. I gave my views as to what we should do just over a year ago in the article linked too below. http://www.mindfulmoney.co.uk/wp/shaun-richards/a-plan-for-reforming-the-uk-economy-start-with-the-b… [...]

  • http://www.mindfulmoney.co.uk/wp/shaun-richards/what-is-wrong-with-the-worlds-banks-and-their-regulators/ What is wrong with the world’s banks and their regulators? | Mindful Money
  • http://www.mindfulmoney.co.uk/wp/shaun-richards/the-uk-economy-is-now-in-danger-of-an-economic-depressionhow-do-we-avoid-it/ The UK economy is now in danger of an economic depression,how do we avoid it? | Mindful Money