What Happened to the Money?
Larry Elliott is right to ask in Tuesday’s Guardian why 16.5 billion of quantitative easing made available by the Bank of England to the commercial banks through the funding for lending scheme has failed to show up in increased lending to the small and medium-sized businesses which desperately need a boost to their available funding. He is also right to dismiss the lame excuses offered by both the Bank of England and the commercial banks to explain why such lending has actually fallen rather risen since the same time last year.
We are, of course, all paying the price, in a slower recovery from recession, higher unemployment, less investment and more business failures, for the fact that this resource, rather than being used, languishes in the banks’ coffers – so we all have an interest in why it has happened. The bad news is that the reasons for it are part of a much wider and longer-term picture.
The excuses trotted out include the age-old claim by British banks that the comparatively low level of their lending to business does not evidence any reluctance to do so, but merely a shortage of demand – or, to put it another way, a shortage of suitable projects on which to lend. But no sense of this can be made unless we know not only how much is available to lend but also – and more importantly – the terms on which the banks are offering to lend.
And that is precisely, of course, what we are not allowed to know. The banks are always very coy about the terms they offer. But, in the absence of information made available by the banks, we are entitled to make some assumptions on the basis of what is known of the long-term attitude of the British banking system to lending to industry.
The information that is available shows that, by comparison with other and more successful economies, our banks lend over a shorter term – the repayment period, in other words, is shorter. This means that the annual repayment costs of bank loans for British firms over the life of the loan are much higher, the adverse impact on cash-flow is therefore more severe, and the need to make an immediate return on investment (and a quick boost to profitability) is much greater.
My colleague, George Tait Edwards, has shown that annual repayment costs that are two, three or even five times lower are a large part of the reason for the greater amount and ease of bank borrowing enjoyed by businesses in, for example, Germany and Japan, and in the new powerhouses of China, Korea and Taiwan – and that is, of course, why they are able to buy and make a profit from our failing assets.
This is the fons et origo of the much-lamented British disease of short-termism. For many British firms, short-term cash-flow or liquidity is at least as important as longer-term profitability, because it is literally a matter of life and death. It is a factor that both inhibits the willingness to borrow (and therefore the access to essential investment capital) in the first place, and – if the loan is made – greatly increases the chances that it will not and cannot be repaid in accordance with the loan period and terms insisted upon by the banks.
If, as is all too likely, a business borrowing on these terms runs into difficulties before the return on the investment funded by the borrowing becomes available, the news gets worse. British banks, unlike their overseas counterparts, show little interest in the survival of their customers. Their sole concern is to recover the loan and interest payments due to them over the short period specified in the loan arrangement. If that means receivership or liquidation – even if the business had a good chance of survival were the investment plans funded by the loan allowed to proceed – so be it. The banks can console themselves not only with the return of the loan and other payments due to them sooner than if the business had been allowed to survive but also with the money to be made from the disposal of the assets (sometimes to foreign buyers) and the receivership process.
Many people are vaguely aware of these factors but our lack of interest in what makes competitor economies more successful than ours – indeed, our conviction that we have nothing to learn from them – blinds us to these truths. It is time we opened our minds and demanded better from our banking system. And shouldn’t these decisions in any case be taken in the public interest and not those of self-interested bankers?
Bryan Gould
4 June 2013
History’s Judgment
As he finds himself sailing into increasingly choppy waters, it is perhaps not surprising that the Prime Minister’s thoughts might turn to the judgment that history might make of his term in office. There have been several occasions recently when John Key has speculated on that matter; and, amongst other predictions, he has confidently forecast that he will be remembered as having left the economy in a stronger condition than when he took over.
It is hard to conjure up much by way of statistical evidence to support that assertion. Indeed, the contrary seems more likely – that history will regard the Key government as having been responsible for a further and possibly decisive relapse in a long-term comparative economic decline that might even threaten New Zealand’s viability as an independent, self-governing state.
Could such pessimism be justified? Surely, it may be argued, in a world that is likely to provide an ever-expanding market for premium food and other primary products, New Zealand’s expertise in this area will guarantee a rosy future?
That should certainly be the case; our advantages as a primary producer, coupled with our political stability, our freedom from corruption and our access to expanding markets should mean increasing prosperity. But optimism on this account has to be tempered by our government’s insistence on pursuing policies that we know from hard experience will hold us back rather than take us forward.
Despite the advantage of conditions, like a stable banking sector and buoyant export markets, that are more favourable than most other countries have enjoyed, we have spent the last four years or more bumping along the bottom of recession. Even more worryingly, as a recovery of sorts gets under way, it is driven by factors that make it inevitable that we will compound the very problems that have dogged us for decades.
Far from resolving our economic problems, we are about to intensify them. The long-awaited “recovery” is a function of increased domestic consumption and a building asset inflation. We are heading straight back into the same old familiar vicious circle, and each time we do a circuit, yet more escape routes are closed off.
The Auckland housing bubble and the consequent diversion of savings and bank-created credit into property rather than the productive sector means that our manufacturing and other productive industries are denied the investment they need to compete in international markets.
The inflationary stimulus produced by rising Auckland house prices will mean higher interest rates – rates that are already offering a premium to “hot money” speculators – and that in turn will mean that the dollar remains over-valued.
High interest rates and an over-valued dollar will further handicap our manufacturers and exporters and will knock the top off the returns we are able to make even on the products we can still sell overseas – ask the dairy farmers.
The over-valued dollar will also trigger an orgy of imported consumer goods, worsening our balance of trade, necessitating more borrowing and therefore a higher premium to overseas lenders to induce them to lend to us, and the constant temptation (to which the current government willingly succumbs) to sell off more of our dwindling assets into foreign ownership so that we can balance the books.
The costs of increased borrowing and repatriated profits made by foreign-owned businesses have to be paid across the foreign exchanges, thereby worsening our indebtedness as a country and weakening our ability to control our own destiny. The damage to our productive sector means that, far from developing new products, our productive base has become dangerously narrow – and as the assets of, and income streams from, even that narrow base pass into foreign hands, we will look in vain for the national wealth to re-invest in our future.
Indeed, John Key sees overseas ownership (often given a positive gloss by being termed “investment”) as not just a painful necessity but as the most promising path to future prosperity. The short time horizon of a foreign exchange dealer does not apparently equip him to ask what will happen when the profits and assets of our shrinking productive base are in foreign hands, and foreign owners (think Rio Tinto) have extracted what profits they can from our mineral resources.
To paint this picture is not to speculate in pessimism; it is merely an extrapolation of trends that are already long-established. Those who resist such a scenario should ask themselves which part of it is not already familiar. If these trends are allowed to continue for much longer, our national future is grim. We would have lost any possibility of deciding our own future. The only question worth debating then would be whether we become an economic satellite or colony of China directly or whether we are first absorbed into a greater Australia on the way.
But none of this – either the inheritance left us by our forefathers or the mortgaging of our future – seems to matter to New Zealanders today. History’s verdict on today’s economic policy is likely to be harsh. But that will not be our concern; history, after all, is written by winners.
Bryan Gould
17 April 2013
This article was published in the NZ Herald on 19 April.
George Osborne’s Non-Event
George Osborne’s budget was driven by an obvious political imperative but was, in economic terms, largely a non-event. The major interest, such as it was, lay in the minor adjustments offered to long-suffering consumers in the forlorn hope that they would be cheered up by cheaper beer and marginal concessions on income tax, and might not therefore notice that their jobs, services and living standards are still under constant threat.
In terms of the wider economy, the Chancellor’s stance was “steady as he goes”; after nearly three years of his stewardship and in the sixth year of recession, nothing much, it seems, needed to change.
There was no recognition that austerity as a response to recession had not only been invalidated by experience, both in the UK and in Europe, but had also, as a consequence, been rejected – following a review of their earlier recommendations – by the IMF. The Chancellor was apparently unconcerned that output still lagged behind its pre-recession peak, and that the government borrowing, whose reduction he had identified as one of his primary goals, had continued – reflecting the depressed level of economic activity – to grow as a percentage of GDP.
So little account was taken of the most obvious and pressing problems facing the economy that one must wonder whether the Chancellor’s focus is political and social, rather than economic. It may well be that his unstated agenda is to take advantage of the recession to unleash forces and drive through measures that will change the balance of advantage between rich and poor, private business and the public sector, for a generation.
The Chancellor may well be, in other words, an (perhaps – if one is being generous) unwitting heir to a long and dishonourable tradition, epitomised by Andrew Mellon, the multimillionaire US Treasury Secretary, who called upon employers in the depths of the Great Depression to “liquidate labour”.
Austerity, and the withdrawal of government, represent, after all, increased space for private enterprise (though the Chancellor seems not to have noticed that manufacturing is so enfeebled that it is unable to take advantage of any supposed opportunities); and even the resulting failure to get the economy moving has a silver lining, in that it guarantees that unemployment remains an actual and potential restraint on wage growth.
What was needed from the Chancellor in his Budget speech was so far removed from what was in his mind that there seems scarcely any point in rehearsing it. But the Budget speech would have made a positive difference if it had signalled the abandonment of austerity and its replacement by a strategy to recruit government, banking and industry in a joint effort to raise the level of demand, to provide finance for productive investment, to coordinate an industrial strategy focusing on those areas of manufacturing that represent the best possibilities for growth, and to frame a macro-economic policy with competitiveness rather than inflation control at its heart.
Bryan Gould
31 March 2013
This article was written for Palgrave Macmillan’s newsletter.
George Osborne’s Deep Hole
Whatever George Osborne may say on Wednesday in his budget speech, he cannot extricate himself from the wreckage that now surrounds him. He may be just about the last person in Britain to believe that austerity offers a credible path to recovery from recession – and it may be doubted that even he remains a true believer. The repeated fall back into recession, a government deficit that goes on rising, and the loss of the country’s top credit rating are surely enough to shake the confidence of even the most arrogant and obtuse practitioner of the dismal science.
The Chancellor’s continued commitment to austerity has made a significant personal contribution to the digging of an economic hole from which there now seems no discernible path to recovery. Perhaps his only saving grace is that he should not be left to bear the burden of that responsibility alone.
As a long-time critic of British economic policy under successive governments, I hear the flapping wings of chickens coming home to roost; for the truth is that the current difficulties – and the imminent prospect of long-term economic decline – are the inevitable consequences of decades of mistaken policy choices and the worship of false gods.
It is hard to grasp, even now, just how thoroughly and comprehensively the favoured nostrums of the last four decades – those nostrums that have guided our fortunes over the whole of that period – have now been disproved and discredited. Let us look at some of them in turn.
Take the propositions that the market (and especially financial markets) can be accurately predicted on the basis of mathematical models, that they are self-correcting and do not therefore need regulation, and that any intervention in unregulated markets will automatically produce results that will be worse than if they had been left alone. As Keynes warned, and experience in the form of the global financial crisis has confirmed, markets – and financial markets in particular – are all too likely, if unregulated, to lead to excess and collapse.
Or, what about the belief – maintained for more than three decades – that macro-economic policy is not a matter for government but is a simple matter of restraining inflation – an essentially technical task through setting interest rates that can safely be entrusted to unaccountable bankers? Do we still believe that monetary policy is all that is needed for a healthy economy? Or that it is any more effective than pushing on a piece of string as a means of escaping from recession? Or – when we look to more successful economies overseas – that there is no role for government?
And what about the related confidence displayed in the expertise and objectivity of bankers in running our economy? Do we still believe that bankers have the common interest at heart and do not make decisions to suit themselves? Are we happy that they continue to enjoy the astonishing privilege, as private monopolies, of creating money out of nothing, thereby exercising hugely more power over our fortunes than do elected governments?
What do we think of the faith placed by successive governments, not least by New Labour, in the financial services industry as the means of paying our way in the world? Do we still accept that the huge fortunes made by a few in a largely unregulated City represented real and sustainable wealth-creation in which the rest of us would share?
Even more importantly, what do we think of the careless assumption that focusing on financial services made it unnecessary to concern ourselves with our manufacturing base? Do we now understand that the loss of manufacturing means – now that the chips are down – that we are denied the most reliable way of maintaining our standard of living, the most important source of innovation, the most substantial creator of new jobs, the most effective stimulus to improved productivity and the provider of the quickest return on investment?
Do we understand that globalisation has meant, with the removal of exchange controls, that major global investors can now move huge volumes of money – totalling as much in a single day as the total annual production of most economies – from one country to another, and have thereby disabled democratic governments from doing anything to protect us?
And do we understand that the combined effect of all these policies has been to create a huge mechanism for shifting wealth and resource from the poor to the rich, and that it is that which is responsible, rather than any great ability or virtue on the part of the rich, for the widening inequality that weakens and disfigures our society?
Underpinning all of this is a fundamental failure – an obstinate refusal to recognise that the world has changed and that, with the rise of newly efficient economies around the globe, we have no innate right to have a privileged standard of living delivered to us on a plate. The fact is that the UK has been a fundamentally uncompetitive economy ever since the 1970s, but we have preferred to avert our gaze from this uncomfortable truth.
The issue of competitiveness is not recognised, let alone discussed in Britain; yet much more successful economies use measures of competitiveness as their guide to what is required from macro-economic policy. We, on the other hand, have preferred to take refuge in a range of nostrums that we can now see have little merit.
George Osborne’s budget will be scrutinised for signals that tiny changes in direction might be forthcoming and that salvation might lie therein. But the budget will be a minor factor in an economic dilemma which George Osborne – and his predecessors – have spent painstaking decades in creating.
Bryan Gould
17 March 2013.
Bryan Gould’s new book Myths, Politicians, and Money will be published by Palgrave Macmillan later this year.
This article was published in the online Guardian on 18 March.
A Litany of Errors
George Osborne may be just about the last person in Britain to believe that austerity offers a real path to recovery from recession and the resumption of growth – and it may be doubted that even he remains a true believer. The repeated fall back into recession, a government deficit that goes on rising, and the loss of the country’s top credit rating are surely enough to shake the confidence of even the most arrogant and obtuse practitioner of the dismal science.
We now know for sure what Keynes and commonsense always told us – that responding to recession by cutting spending is akin to the medieval practice of blood-letting as a treatment for disorders. The Chancellor’s continued display of commitment to failed policies may, of course, be for public consumption only and it may be that his real purpose is not economic but political and social. His undeclared goal may well be to drive home – at whatever economic cost – changes in the balance between private and public sectors, and rich and poor, that will take a generation to undo.
What is undeniable, though, is that in economic terms he has dug himself – and the rest of us – into such a deep hole that there is now no discernible way out. But while his may be the most egregious of all the errors made by successive Chancellors, it would be wrong to overlook the fact that others have also contributed their efforts to digging a hole that has grown ever deeper over four decades or more.
My own interest and involvement in these issues goes back to the mid-1970s, when – as a young Labour MP – it seemed clear to me that Britain’s real but unacknowledged economic problem was one of declining competitiveness. We refused to recognise then, and have done ever since, that the world has changed and that the rise of newly competitive economies has meant that we cannot rely on some kind of natural law that guarantees us a higher standard of living than others should enjoy.
The competitiveness issue thrust itself centre-stage in 1976 in the form of a fully-fledged sterling crisis; but, true to form, and rather than concede that sterling was then overvalued, the UK exhausted its reserves and virtually bankrupted itself in trying to defend sterling’s parity.
The resultant need for an IMF bailout did not arise, as popular (and an oxymoronic right-wing) wisdom often has it, because the Labour government profligately allowed public spending to rise out of control, but because it was determined to defend sterling at all costs. That same determination then dictated our (literally) counter-productive response to the course that the IMF suggested we should follow in order to overcome the crisis.
The IMF recommended that monetary policy (which was already assuming greater importance as monetarism became fashionable) should be conducted in terms of Domestic Credit Expansion (DCE); we were free, in other words, to grow the economy as fast as we wished, provided that a credit-fuelled domestic inflation was restrained. This recipe for export-led growth was an explicit recognition that our problem was one of competitiveness and an implicit recommendation that the exchange rate should be lower.
This advice was, however, under the influence of advisers like Terry Burns and Alan Budd, rejected by the Treasury who persuaded Denis Healey to go on protecting sterling and to frame monetary policy in terms of sterling M3 rather than DCE. In line with this decision, and as Denis Healey was forced by the crisis to turn back from the airport, Jim Callaghan told the 1976 Labour conference, “you can’t spend your way of recession.”
The statement was of course a nonsense. There is no remedy for recession that does not involve spending more. Callaghan’s statement would have been more accurate if he had said, “we can’t do what is required to escape from stagflation because our fundamental lack of competitiveness means that spending more would make our inflation and balance of payment problems even worse.” The problem he was trying to describe was really one, in other words, of competitiveness rather than anything else.
By the time Margaret Thatcher came to power, supposed monetarist certainties[i] were the order of the day and – with sterling floating and exchange controls removed – the much-heralded benefits of North Sea oil were confidently expected to resolve any balance of trade problems and to usher in a new era of prosperity.
But North Sea oil, combined with monetarism and a floating exchange rate, proved a toxic combination. The monetarist prescription made it inevitable that, as North Sea oil output became available, some other area of production should decline – and manufacturing duly obliged. The theory predicted that the discovery of a new source of wealth would inevitably drive up the exchange rate so that other sectors of production were priced out of markets both at home and abroad. It was never explained why this should be inevitable in Britain but not apparent in the case of Norway, a smaller economy where the advent of North Sea oil was proportionately even more important, but where steps were taken to protect the rest of the economy. The Norwegians in fact found ways of insulating the domestic economy against the boost produced to overseas earnings by oil exports and import saving.
Many monetarist economists at this time went so far as to work out the level of demand for money of a given economy (incidentally ignoring the significance of the velocity of circulation, which can vary substantially over time). This approach necessarily fixes a given economy in a given condition. The British economy was assumed to have a lower demand for money than the German economy and if this was exceeded, increased inflation was inevitable. This assertion, which was unexplained or unsupported by argument, was necessary to explain the fact that growth in the German money supply ran at a significantly higher level than the British money supply while at the same time permitting the Germans to maintain a stronger growth rate and a lower inflation rate. No attempt was made to explain why this supposedly immutable condition of the British economy should apply.
In the same way, each economy was assumed to have a naturally occurring rate of unemployment which could not be changed by policy. A NAIRU, or non-accelerating inflation rate of unemployment, was ascribed to each economy. In the case of the United Kingdom, it was assumed to be relatively high and, more significantly, impervious to attempts to bring it down. In fulfilment of this prophecy, unemployment rose sharply through the 1980s, despite the repeated attempts to massage the statistics downwards. The number of claimants of unemployment benefit jumped from just over 1 million in 1979 to over 3 million in 1986.
The UK balance of payments remained in substantial deficit throughout the period, reaching record levels at times in relation to GDP. The deficit reflected, of course, the decline of manufacturing and the deterioration in the balance of trade in wide areas of the productive sector. That in turn reflected the loss of competitiveness, which was shown – but ignored – by the various indices used to measure competitiveness.
John Major’s government, supported by Labour, sought to address the continuing economic problems by taking refuge in the Exchange Rate Mechanism, thereby handing responsibility, in effect, for restraining inflation over to a foreign central bank and avoiding – it was hoped – any opprobrium for the price to be paid for such “discipline”. But, true to form, an inappropriate parity and the mistaken analysis that identified inflation rather than a lack of competitiveness as our fundamental problem wreaked such damage that we were eventually forced out of the ERM.
By this time, our policymakers were running out of options. There was some respite as the UK, freed from the shackles of the ERM, performed a little better than most of our European partners. But we had long since surrendered ourselves to the belief that we could no longer – in the face of newly competitive developing economies – compete as a manufacturing economy.
Instead of addressing that problem, and exploring appropriate remedies for it, however, we determined to find an alternative way of paying our way. I was the Opposition spokesperson on financial matters in 1986 at the time of the so-called Big Bang – the removal of effective regulation from City institutions – and had led for the Opposition in the Committee stage of the Financial Services Bill.
I had argued in vain that self-regulation would be ineffectual in restraining excesses and maintaining prudential supervision. But an essentially unregulated financial services industry was – with heroic optimism – advanced as the ideal substitute for our declining manufacturing; it had the advantages of requiring a great deal of capital (which could not be replicated because it was not at that time available to most developing economies) but little by way of real skill, and it also offered the political bonus to Thatcherite politicians of disabling the large industrial trade unions.
These dazzling prospects seemed for a time to be delivered. As recently as 2007, and as evidence of how thoroughly New Labour welcomed these developments, Gordon Brown, in his annual Mansion House speech – his swansong after a decade at the Treasury – heaped praise on the financial services industry developed by the City of London, and predicted that “it will be said of this age, the first decades of the 21st century, that out of the greatest restructuring of the global economy, perhaps even greater than the industrial revolution, a new world order was created”.
We now know, courtesy of the global financial crisis, that financial services did not provide the secure base for economic development that had been hoped for, and that such benefits as were delivered went in large volumes to a very small proportion of the population. Even more seriously, our neglect of manufacturing as a wealth-creator has meant that we are denied the great advantages that manufacturing alone can deliver – as the most important source of innovation, the most substantial creator of new jobs, the most effective stimulus to improved productivity and the provider of the quickest return on investment.
George Osborne, and his dwindling band of supporters, seem bereft of any understanding of this sad history. Their insistence on austerity as the cure for recession is just the latest instalment in a total refusal by a long succession of Chancellors to face the reality of our long-standing difficulties – so that we are now facing the probability of permanent economic decline.
We now seem to have run out of options. We have tried qualitative easing and low interest rates, apparently unaware that using monetary policy to promote recovery is like pushing on a piece of string. We reject an expansionary fiscal policy in favour of cutting spending, refusing to acknowledge that this has meant, inter alia, a larger rather than a smaller deficit. Even if we now wished to take the commonsense path, and focus on rebuilding our long-neglected productive industries, we would find that we have lost much of the technological lead, the workplace skills, and the available markets that were once ours. Without the political will to change tack completely and to plan and make provision in the long term to rebuild our industrial strength – learning to think, in other words, as a developing economy and eschewing short-term fixes – the future looks grim.
George Osborne, in other words, is heir to a long and dishonourable tradition. He is not the only person who must carry the can. But the immediate challenge is not just to escape from recession but to recognise and deal with the long-term problems. The Chancellor has shown that he is not the man to do it.
Bryan Gould
10 March 2013
[i] See Monetarism or Prosperity by Bryan Gould, John Mills and Shaun Stewart, Macmillan, 1981