It is not only the Eurozone kicking the can down the road
June 19, 2012
As the Greek economic tragedy reaches yet another climax, it remains fashionable from these shores to decry the Eurozone for its schizophrenic lurching between hapless inaction and spurts of frenetic, if misguided, activism.
However, with this critique in mind, it might also be wise to examine carefully what is happening closer to home.
For so long as global financial markets remain flooded with cheap money, courtesy of government underwritten bailouts, then political consideration will continue to outweigh sound economics.
Conservatives are right to dismiss the Opposition claim that the UK economy currently faces a binary choice between growth and austerity. But nor should the coalition fall into the trap of thinking that preserving historically low interest rates is an adequate compensation for sluggish economic growth.
Last week’s Mansion House dinner was notable for the coordination in message between the Treasury and the Bank of England over the coalition’s emergency ‘funding for lending’ proposal. In truth the past three years have been characterised by an unspoken bargain between George Osborne and Bank Governor, Sir Mervyn King. Each has provided the other with political cover – the Treasury’s increasingly unpopular austerity programme has been underwritten by the Bank’s steadfast reliance on monetary tools well beyond a time when conventional wisdom and common sense would suggest undertaking renewed fiscal stimulus (i.e. tax cuts) would be the wisest course.
I suspect that their joint plan now amidst such uncertainty is no more ambitious than to keep the show on this road until the next General Election – and that means maintaining ultra low interest rates to ensure that most voters are not overwhelmed by mortgage and personal debts this side of May 2015. For the stark reality is that any sensible UK government has to soften the electorate up for a decade ahead of diminished living standards, whilst having an eagle eye on the remorseless logic of the electoral cycle.
The Governor has plenty of critics in the City of London where few will mourn his retirement next year. In Mervyn King’s defence his voice was one of the few warning of excessive leverage before the crash. At the Mansion House dinners of 2006 and 2007 he observed both signs of overheating (his desire to raise interest rates was outvoted by the MPC) and the deeply compromised role of credit ratings agencies. When the history of this era is written I believe his reluctance to rush into bailouts for Northern Rock and RBS (almost universally derided as ‘dithering’ at the time) may yet be seen as the correct response of a wise central bank governor, keen to stress moral hazard.
Much more questionable, however, has been King’s support for continued Quantitative Easing. As the economy has deteriorated since May 2010 we have taken the path of racking-up ever more debt, rather than imposing greater savings on the public accounts. Yet the real purpose and impact of the Bank of England’s intervention has not (as commonly assumed) been to ease the path for small business borrowing. Instead the Governor has encouraged banks to mop up a substantial proportion of the gilts being issued (currently one-third are now back on the government balance sheet). Whilst this has enabled UK banks to begin the long journey back to prudent recapitalisation, these actions will not be sustainable in the medium term without a very real risk of inflation. Indeed last week’s £140 billion emergency scheme is an implicit recognition that global conditions in the years ahead may make it far more difficult to finance our current levels of debt.
Whilst I take the Chancellor’s announcement of emergency loan facilities as a welcome recognition that much of the QE has to date failed to reach the ‘real economy’, it is also a timely step to stay ahead of the game as the Eurozone enters a new, dangerous phase.
But will it work? The trouble is that most thriving small businesses are battening down the hatches. The global economic outlook is desperately debilitating to business confidence – for solvent businesses the issue around extending credit is less one of supply than of demand. By contrast those struggling businesses eagerly seeking credit will probably still find it difficult to access funds as (for now at least) the Treasury’s new bank loan scheme has not been designed to transfer underlying risk from commercial banks to the public purse. Like all too many government initiatives designed to kick-start borrowing, take-up is likely to be derisory. Yet if there is one thing worse than government presuming to pick winners, it is surely the prospect of the Treasury subsidising known loss-making ventures.
This new initiative was unveiled in the week that the coalition restated its intention to implement the Vickers’ review on banking reform, whose centrepiece is the goldplating of already enhanced capital requirements under Basel 3. One of the causes of the paralysing strategic uncertainty that has enveloped the UK’s big banks is the mixed messages from the Treasury and central Bank alike over the dual requirements to recapitalise (and thereby reduce risks of future taxpayer bailouts) whilst being ready to lend to credit-starved UK Plc as if it were 2007 all over again.
The nagging doubt must remain that in these increasingly desperate economic straits meaningful credit will only flow into the veins of the UK economy if it is underwritten by the government. I reckon that last week’s announcement was laying the groundwork for whatever eventuality may emerge from the Eurozone in the troubled months and years ahead. In setting out its plan, the Treasury implicitly recognises that we are all but powerless to prevent the consequences of the potentially perilous next phase of global economic events.