How the City can Play a Future Global Role
June 30, 2009
Mark gave a political perspective on the economic crisis during a debate organised by Candlewick alderman, Fiona Woolf. Other speakers included Stuart Fraser (City of London’s Chairman of the Policy and Resources Committee), Sheriff Roger Gifford (Chairman of the Association of Foreign Banks), Simon Morris (CMS Cameron McKenna) and Anthony Belchambers (Chief Executive, Futures and Options Association).
Let’s face facts, no one can confidently predict what the future has in store or suggest exactly how the City can best play its hand to ensure it maintains and strengthens its global role. So instead let me offer a brief analysis of what has occurred and cautiously anticipate what problems the City is likely to encounter on the road ahead as Britain tries to rebuild itself in a world where correcting the global imbalances of the past decade or so set a template for the future.
Technically the worst of the economic recession may now be behind us though fears of ‘double dip’ remain especially as the effect of the fiscal stimulus fades. Yet amidst some of the glib green-shoots commentary, we should understand that the banking crisis represented nothing unusual. Indeed it signalled the end of another in a long line of boom/bust cycles (positively commonplace in the second half of the last century) caused by speculative euphoria and an excess of credit.
It is true that the global nature of the economic crisis has made things worse. But it is only the extent of the economic downturn, not its cause that is so very different. Indeed there are clear lessons we can learn from the past in this regard. One of the grand old names of British banking, Barings, collapsed owing £780 million only fourteen years ago; today RBS survives courtesy of a £26 billion bailout.
The UK economic downturn began when household debt and housing bubbles simultaneously burst. The toleration and promotion of these debt bubbles alongside the growth in financial services and property industries was an integral part of the government’s narrative of creating an economic miracle. As the level of private debt reached dizzy heights the financial risk to the general taxpayer of widespread default suddenly got a whole lot more serious. As we now know there was good cause for retaining the distinction between retail and investment banking, which in the US at least existed for over six decades until the repeal of Glass-Steagall in 1999. Little did we know that the inherent risk of investment banking was to be transferred not to retail banking depositors but to global government balance sheets. Instinctively bankers understood this and once their institutions became too big to be allowed to fail, they had precisely zero incentive to minimise danger. On the contrary the short-termist bonus culture positively encouraged reckless risk taking.
The abiding lesson of the global banking bailouts is that in future no institution should be allowed to become so large that it cannot be allowed to fail. That way lies the madness of ever more public exposure to financial calamity. An effective regulatory regime requires eradication, rather than reward, for risk taking. It must avoid the creation of barriers to entry that favour large established corporations over entrepreneurial start-ups.
Despite the increased scrutiny of the City, there is an uneasy feeling that banking is fast returning to ‘business as usual’. Public anger at the proposed £10 million bonus package for the new top team at RBS would perhaps be better directed towards ensuring that risk-taking in future is better managed. Indeed the crisis of the past nine months has seen those banks that have not collapsed, disappeared or been nationalised suddenly become markedly more profitable as competition has fallen away. Yet whilst money flows again into the hands of bankers the essential structure of the industry remains intact – in short, the taxpayer will be the lender of last resort if all goes wrong. Small wonder that support is growing for the notion that banking as a sector whose failure threatens the entire economy must have some added costs and restraints imposed upon it. After all, the debt now facing future generations of taxpayers courtesy of this banking-led credit catastrophe is more than was ever racked up to fight two world wars. Let’s not even speculate at the inflationary prospects ahead if Quantitative Easing proves overly effective or the UK government loses its nerve and decides an old-fashioned dose of inflation will help bring down the debt burden more conveniently.
Turning to the wider issues that will affect the City’s prospects, the colossal trade imbalance between the West and China will no doubt make its mark on future competitiveness. This has been made worse by the ending over recent decades of both the gold standard and capital controls, the mechanisms by which trade imbalances were traditionally kept in check. Consequently since the late 1970s the UK and US have borrowed incrementally more and exported ever less whilst China, especially over the past decade and a half, has built up a huge current account surplus.
Arguably it is these imbalances rather than inadequate regulation that have been the cause of the economic calamity that has beset the global monetary system. A new international framework to secure stability in the management of global trade and the flow of money within the world economy is now overdue.
Given that this economic downturn is unique only in scale rather than cause, the solutions to it do not require – whatever our government may tell us – a bewildering racking-up of unimaginable levels of debt for future generations of taxpayers. Indeed nothing will more certainly hinder our prospects of economic recovery and a sustainable return to improved living standards.
The biggest threat in the years ahead is that the indiscriminate pumping of money by the Bank of England into the economy will bring with it an unsustainable mini-boom. Thereafter a combination of inflation, rising unemployment, weak growth and diminished competitiveness will produce a toxic mix of stagflation – truly a ‘back to the 1970s’ phenomenon. The worst case scenario here is that a future government may regard a sustained dose of inflation as the quickest and politically easiest way of helping bring down the level of public debt.
Any UK government that is regarded as popular in 2011 and 2012 is probably not administering the right economic medicine. To do the right thing in the years to come will not be a politically easy option.
This year, if we follow the government’s almost certainly optimistic predictions, we shall be borrowing – I repeat, borrowing, not spending – £450 million each and every day. That means for every £3 raised in taxes, the government is spending £4. This cannot remotely be regarded as investment – it is consumption plain and simple. The billions being borrowed will be repaid by future generations in the form of higher spending, higher inflation and reduced living standards. If public services begin to be cut and taxes rise, the clamour for a less favourable taxation regime for the financial services and those with lucrative jobs in the banking sector will surely intensify. This could make the City an increasingly unattractive option for the globally mobile financial services industry.
In cold reality, as a medium-sized economy primarily reliant on a hitherto booming financial services industry, our nation will remain vulnerable for some time to come. This vulnerability will, of course, significantly affect the City’s ability not only to play a global role in financial services but its chances of operating relatively independently of the state. The price for our collective indebtedness may be for the UK to watch with increasing impotence as it becomes our turn to suffer as the rules of the global trading game are changed to our detriment.
In the long term it may prove necessary for the government to make a strategic decision as to the direction of our economy; whether to gamble our future on the possible resurrection of our financial services industry; going it alone as a beacon of dynamism, or whether to diversify our economy and – implausible as it may sound today – tie our future more firmly to Europe in the hope that the strength in numbers approach will partially shield us from the stiffest of economic competition from the East. In looking at both of these options, the City will play a crucial role. But it is likely that in either scenario, the strictures of our domestic situation and the colossal changes that have taken place in the UK banking system will make it ever harder for the City to dictate the terms of its place in the British and global economy.