Uneasy calm settles over the financial markets
February 4, 2010
Over recent months, global financial markets have been enveloped by an eerie stillness. The fear remains that this calm is unlikely to last – our fundamental economic imbalances have not been solved, merely parked. The recent indication from the Chinese government that it is to put a firm break on bank lending to ameliorate the effect of speculation is just one sign that points towards the likely return of market turbulence. The most negative effects of the crisis may well be most painfully felt in the stagnant aftermath of statistical recession.
As things stand, the global economic patient lies in an induced coma. Over the past eighteen months we have had near zero interest rates and governments worldwide have gone on an unprecedented spending spree – whether through quantitative easing, car scrappage schemes or bank bailouts – that has filled the gap left by the ailing private sector. The absence of an immediate market reaction to this, and the lag from credit ratings agencies in adjusting their assessments, has given rise (with the exception of Iceland, Greece and Ireland) to unwarranted complacency. But past economic experience reminds us that the State is not infallible to debt crises of its own. Sovereign default may not be the outlandish prospect we believe and the notion that huge deficits can be racked up without any medium term implications as to the cost and availability of credit may prove desperately naïve.
Remove the measures taken by governments to stem the downward spiral and our economic fundamentals do not look too smart going forward. There remain deep structural problems that may see our economic woes become harder to deal with once induced low interest rates, quantitative easing and enthusiastic investment in government bonds are removed from the equation.
For one, Britain’s labour market is looking sickly. This recession has been characterised by graduate and youth unemployment and experience suggests that prolonged unemployment early in ones career risks longer term productivity. Not only that, but I have long feared that our nations’ much-vaunted ‘skills training’ is failing to deliver a flexible and competitive workforce to face up to the challenge of competition from the millions of young Chinese and Indians graduating into the global marketplace.
In this post-crisis period, the temptation towards protectionism is likely to rear its head in the guise of demands for employment creation and retention schemes – the uproar over the Cadbury takeover will be just the beginning. Politicians need to make the case that any short term gains from this activity would inevitably involve longer term loss. Let us not forget that Britain has benefited significantly from the inflows of foreign capital over the past two decades.
We also face an increasingly powerful anti-capitalist sentiment. In every recession, a society inevitably wishes to punish those who have apparently precipitated the economic downfall. In our case, it is the banker. I understand the appetite for revenge but we must separate sensible measures to curb excess and risk to the taxpayer with punitive measures designed only to twist the knife. Amidst this feverish pre-election political atmosphere, let us not ignore the case for the UK’s imperative, competitive advantage in financial services. To be frank, we may wish in future for a ‘more balanced economy’ but no other sector will be a world beater any time soon on the scale of banking for UK plc. Nor should we forget the complementary industries of law, insurance, retail and entertainment – to name but a few – which all benefit massively from this sector when it thrives.
In this respect, I believe there is an urgent need for reliable, qualitative and quantitative evidence about the exodus from the City of London and the impact on London’s financial markets following the imposition of a 50% higher rate income tax band from April this year. The Mayor of London has understandably taken it upon himself to defend the Capital’s key role as a global financial centre. He, like me, has received plenty of anecdotal evidence in recent months of individuals and institutions already leaving these shores at the mere prospect of higher marginal rates of income tax.
Nevertheless, it is equally important that politicians refrain from bandying around figures in a way that can all too easily be regarded as hysterical. Indeed it can all too often be seen as special pleading from an industry that wishes to exempt itself from any form of restraint yet, in spite of the colossal sums of taxpayers’ money spent to underpin, gives little indication of how the landscape of financial services should look in the future. Whilst recognising the potential for catastrophe if we delay the review of these matters until tax cuts are politically palatable, similarly little would be more undermining for the place of financial services in London as to be seen to be crying wolf about the numbers leaving. A robust case needs to be made and only reliable empirical evidence proving the effects of changes in tax rates can support it. For my part, as the MP for the City, I shall be working with the City of London Corporation to amass such evidence in advance of this autumn’s pre-budget statement.
President Obama’s attack on Wall Street excess comes at an especially dangerous time. The astonishingly rapid bounce-back in profitability this year for those banks still operating is a function of a diminution in competition in much of the sector and the effect of low-to-zero interest rates as easy government money has lubricated the system. These factors will be unsustainable even in the short term, so it is unwise to construct the terms of trade in global banking on the basis of this unusual period of super profits.
Nevertheless, the Conservatives here are right to press for a global accord to ensure that banks are no longer too big or interconnected to fail. Historically the City of London has benefited from arbitrage with Wall Street from withholding tax under President Kennedy (which precipitated the creation of the Eurodollar and Eurobond markets) to Big Bang in the mid-1980s and the effects of Sarbanes-Oxley (2002) in the aftermath of the Enron and Worldcom scandals. This time we must have an international agreement on the future landscape of the financial services world.
As I have written before, the rise of hedge funds owed much to stricter regulations post-Enron to control off-balance-sheet activity. Hedge funds were often the special purpose vehicle of choice created to bypass the culture of stifling regulation which always favours existing institutional players. Whilst asset management (whether hedge funds or private equity) has not been directly implicated in this global financial crisis, I believe that Obama’s proposals may as an unintended consequence help promote a further explosion in less regulated investment, which may prove the cause of the next financial crisis. As ever, too much political and regulatory energy tends to be expended in solving the last crisis rather than looking far enough ahead into the future.
For this reason, Conservatives must continue to impress upon the nation that the end of the recession will not inevitably herald the beginning of recovery. This is not the Opposition talking Britain down. We are merely facing up to the reality that the avoidance of bitter economic medicine for some years to come is not an option. To coin a phrase, when it comes to the recovery, and repaying the nation’s vast collective debt burden, the Conservatives at least will not stand by as the Do Nothing Party.