Tag Archives: Financial Crisis of 2008

What is required today is a return to the economics practised in 1968

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The storm clouds are gathering over the economy, yet our political leaders seem oblivious to the approaching storm. These are some of the gathering clouds, inward investment has fallen 80% since 2016, the investment in national infra structure is at levels similar to Greece and in consequence economic growth fell to 0.1% in the last quarter. As a nation our trade deficit is the highest, as a proportion of GDP in the developed world. A trade deficit of 5.9% of GDP is only reduced to 2.2% through the contribution of financial services. A situation in which the U.K. is over dependent on recycling foreign cash invested in the U.K. to pay for imports. This gives an incentive to government to ensure that the City of London remains the largest money laundering financial centre in the world. Dirty money is as acceptable as clean money for paying our debts. This situation cannot continue indefinitely, if politicians cannot take action to resolve some of these problems, they will resolve themselves. This resolution will come in the form of an economic crash which will make us all much poorer.

A useful comparison can be made with the 1960s and 1970s a period of frequent balance of payment crises. In the 1960s the trade deficit never exceeded 0.6% of GDP and in the crisis year of 1976 it rose to 1% of GDP. These deficits always called for remedial action such as devaluation and economic policy measures to reduce the demand for imports. Now this ever rising import bill is never considered a problem for the U.K. Its role as one of the world’s financial centres ensures that it always has ample reserves of foreign currency to finance its debts. What never troubles the world’s governments is that one of the world’s largest financial centres lacks the strong economy to sustain it in that role. In the 19th century Britain’s strong economy enabled it to fulfil its role as the world’s banker. Now with a significantly diminished role in the world’s economy it still tries to be the world’s banker. This mismatch cannot continue, we as a country are unfortunately heading for a crash that could wreak havoc with the world’s financial system. The catalyst could well be Brexit when Britain begins to lose its role as the EU’s banker and uncertainty develops about the UK’s future this could precipitate a flight from sterling similar to that which happened on Black Wednesday. This time there will be no easy strategy for quickly resolving the situation. There is no ERM to leave and no easy currency devaluation to make. The pound will crash and the only remedy will be a large IMF loan and the imposition of a Greek like austerity programme.

Whatever criticisms the politicians of the 60s and 70s deserved, they were at least pragmatists. Unlike today’s ideologues they can recognise that there was a reality that existed beyond the world as seen from Westminster. The Labour government of 1976 could embark on an incomes policy that would alienate its supporters, knowing that this was necessary to restore the economy to health. This programme of income cuts was the only way that the government could reduce the high level of inflation and reduce the trade deficit. This programme was so successful that by 1979 the trade deficit had been converted into a surplus. These politicians were pragmatists who listened to the advice of outsiders and adopted an economic programme that was contrary to their political instincts.

Unfortunately this government of pragmatists lost the election to a party led by radical minded ideologues. They advocated a policy of Neo-Liberalism, which included as part of its policy manifesto the recommendation to adopt supply side economics. This meant freeing up resources from the less productive parts of the economy by closing them down. Capital and labour would them be freed from being shackled to old inefficient industries and be freed to be used by the new dynamic industries that would replace them. This it was they claimed would boost economic growth. What was talked about was the so called ‘weightless economy’ an economy largely devoid of manufacturing industry instead one based on the finance and industries such as the entertainment industry. These new industries would replace the jobs lost caused by the closure of the old manufacturing industries. The economy never developed in a way that these new economic prophets claimed.

At the beginning of their period in government these Neo-Liberals were warned by economists that there policies would lead to depression and the damage British manufacturing industry. Yet they were ignored by the new radicals, who knew this was outmoded thinking. The British manufacturing sector lost 20% of its capacity, with the consequent widening of the trade deficit. A deficit temporarily covered up by the wealth generated from the exploitation of North Sea oil. The old manufacturing centres declined, there was no rush of new money to so called new industries to compensate for the lost output from the old manufacturing industry.

What was damaging to the country’s economic prospects was new understanding in politics that the economy no longer mattered. Free marketers in government believed that economy was a largely self regulating mechanism that could be largely left to itself. All that was required was the occasional light touch on the tiller in the form of interest rate changes. What was once a major department in government, that of Trade and Industry now became a mere sideshow. Now industry could be left to run itself, no longer would government try to pick winners.

What these politicians had forgotten was the words of Maynard Keynes, there would be times when the government would be needed to save capitalism from itself. That happened in 2008/9 when the world financial system was only saved from the consequences of the financial crash by timely action of governments. Politicians learnt little from this crisis and continued the policy of non intervention. When I was a child one popular ornament was the China or brass three monkeys who epitomised the motto ‘hear no evil, see no evil, speak no evil’. This is the government’s current approach to all matters economic. No matter what wrong doing is practised by managers and directors, as in the example of Carillon, they do nothing. Even if individuals can do wrong, the belief is that the market as a whole can do no wrong.

In the now much discredited 60s and 70s there was a belief amongst politicians that the welfare of the nation was dependent on the well being of the economy. Whatever the political conviction of the politicians, they believed an interventionist economic policy was necessary to maintain the well being of the economy. When the economy was in danger of over heating it for example imposed restrictions on demand to prevent that happening. Perhaps the most famous is Selwyn Lloyd’s 1961 credit squeeze. Unlike today’s politicians they did not see inflation in the housing market as a good thing. This contrasts markedly with all governments of the past twenty years who regarded house price inflation as a good.

One consequence of this is the unfortunate lending programme of the banks. Today only about 6% of bank lending goes to manufacturing industry. In 2008 almost 80% of bank lending went to the property market, a figure which it is approaching today. The U.K. remains an economy in which the main driver of economic growth remains property speculation, while manufacturing industry the real creator of the wealth that matters is neglected.

Whatever experts might say or write contemporary politicians remain impervious to economic realities. Nothing of what I have written impinges on their consciousness. They now seem to inhabit a hermetically sealed world into which no outside thought intrudes. The leadership of the main parties are locked into an increasingly complex debate in which each of them strives to deliver the most authentic Brexit. That the Brexit promised by each of the leaderships is a fantasy, that fails to acknowledge any economic reality is of no concern to these politicians. In the words of one leading Brexiteer, the people are tired of experts and don’t what to hear what economists such as myself say. All that matters is the authentic voice of the people as interpreted by the Brexit politicians no matter how fantastic that interpretation.

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Is there a possibility that events such a Black Wednesday will occur more frequently in the future?

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The short answer to my question is yes. There will always be that occasion when that combination of human folly and arrogance will lead to a repetition to the economic disasters of the past. As an economist I can reconcile myself with the knowledge that such crisis are but a once or twice life in a time occurrence. Unfortunately I believe that I will be unlucky enough to experience a third life time economic crisis, but one of such damaging dimensions that it has the potential to make the crisis of 1992 and 2008 seem relatively insignificant.

Recently I read an article in ‘The London Review of Books’ which expressed an opinion which I share and that is, that for the first time in recent history we have a group of leading politicians who want to do ill to a substantial number of their fellow citizens. These politicians are the ultras of the Conservative party. It is not just the turning back of the clock to disadvantage those groups that have profited from modernity, but desire to impoverish large numbers of their fellow citizens. Now some of them are beginning to openly admit that leaving the EU will not deliver any of the benefits they claimed in the referendum campaign. In fact they recognise that there will be a significant loss of national income as a result of Brexit.

There are those who believe that the economic downturn consequent on ending our free trade deal with the EU, will lead to a modest reduction in living standards.  They believe that the stoicism of the British will enable them to weather this temporary storm. Britons endured worse during the Blitz and so they believe they will the people demonstrate a similar stoicism in seeing out this downturn. Just as in 1940 they will see this deprivation as a price worth paying  to be free of this new tyrannical continental behemoth that is the European Union. They seem to want to replay the 1940s, but with a contemporary twist.

However what they do not seem to realise is that the various predictions of a 3% or 8% in future income growth are the cautious predictions made by economic statisticians. The  economy is not some mechanical creation such as a car that can be tinkered with to produce a slightly more modest performance, it’s a dynamic social organisation that is capable of volatile, unexpected and sudden changes in direction. An economic slowdown is quite capable of turning into something much worse.

The British economy as with many others includes within it many economic fault lines that if triggered would wreak tremendous damage to the economy. What these foolish politicians have forgotten is “Black Wednesday’ in 1992, a day in which speculators effectively bankrupted the country.  All the weakness in the economy that existed then, still remain today. One such is the massive private sector indebtedness, which includes that of the banks. Britain is one of the world’s bankers and as such it holds a large proportion of the world’s cash reserves. The banks assets are moving towards a position whereby they total nine times the county’s GDP, that is about £18 trillion. Just as in 1992 the British banks are borrowing short and lending long. In plain English customers deposit money on short term notice, money that they can withdraw on demand or with a few days notice. Banks lend this money long term, it is invested in property or some other asset, which either cannot be quickly changed back into cash if needed or if cashed in it will return a value much less than that for which it was purchased. British banks have reserves that they can use to fund cash withdrawals in normal circumstances, so this is never usually a problem. However it becomes a problem when the abnormal happens and investors lose faith in the banks and want their money back. The abnormal occurred in 1992 and 2008. On the first occasion the central Bank was almost bankrupted and in the second if was the entire banking system that suffered the same experience. Nobody that is not a fool or an arrogant politician with little understanding of economics would do anything to provoke a recurrence of these past crisis.

One of the triggers of a depression is falling business confidence, once that is lost the economy is in the doldrums. The maladroit government negotiations with Europe over Brexit is leading to a loss of business confidence, as businessmen are increasing uncertain of what the future holds for them.  Whenever politicians are informed on problems tor business that are developing because of Brexit, they are either ignored or dismissed. Such behaviour is further draining confidence out of the economy. In such febrile circumstances a run on the pound could easily be triggered. One such trigger point occur at the port of Dover. The government has made no preparations for the reintroduction of customs barriers at Dover, yet free trade with Europe will end in the near future forcing the government to reintroduce customs barriers. New staff are not being recruited and it no preparations have been made to introduce new  IT systems to processing the import and export trade tariffs, such checks are unnecessary while Britain remains in the single market. It seems to assume that they can introduce a seamless system of tariff collection, when they or nobody else in the world knows what such a system will look like or even if such a system is possible. After March 2019, when Britain leaves the EU and chaos prevails at Dover and other ports, it will be a demonstration of government incompetence. When the government is demonstrating such a degree of incompetence investors could take fright and take their money out of British banks. Our banks are quite incapable of funding such a large and sustained flight from sterling and the UK would have to turn to the IMF for help. The resultant crash would turn the British economy into an economic basket case resembling that which is contemporary Greece.

However there are a minority of Tory Ultras who would welcome such a collapse. The consequence shortfall in government finances would mean that many of the institutions of modernity, such as the welfare state and the NHS could cease to exist through lack of funding. They like the medieval doctors who let blood to purge the body of noxious vapours, believe that an economic crash which destroyed the welfare state would lead to a similar purging of the British character.  Such a purging would be the purging of the welfare dependency virus, no longer would the British people be able to look to the same for welfare or health care. This purging of the British character would lead to a rejuvenation of the British, they would become like their independent 18th and 19th century forebears who created the largest empire the world has seen. Some ultras are even speaking of the Empire 2.0.

However they show little awareness of history, the Greek political parties that dominated the Greek political scene prior to the crash of 2008 that is New Democracy and Pasok have disappeared from the political scene, as the people blamed them for the decimation of their incomes and economy. Although these Tory ultras are careful to remain in the background pulling the strings to ensure that the government commits to their desired hard Brexit, they would not be unable to avoid ‘ownership’ of the post Brexit economic crisis. They were members of the party of government that caused the economic crash and in any election many would be voted out by an angry electorate.

Greek tragedy provides a metaphor which can demonstrate the reality of the crisis facing Britain. In Greek tragedy the God’s raise the hero up, only to later destroy him. It is as if the God’s of the economy have raised the Brexiteers and Conservative Party Ultras to power only to destroy them. The Gods seem to have chosen the least capable and those least fitted for the role to lead the Brexit negotiation, knowing that their incompetence will be the cause of their downfall. It is tempting to refer to Winston Churchill wartime speeches in this context, because they see themselves in the Churchillian role of standing up to the continental tyrant. He said the Nazi’s would reap what they had sown, the same applies to the Brexiteers who will reap the consequences on what they have sown. Not the whirlwind of mass destruction but the whirlwind of economic destruction. Quite possibly the Conservative party, as with the conservative Greek New Democracy party will disappear from history.

Any prediction made by an economist is never more than a probability or a possibility. When the Bank of England predicted economic meltdown if Brexit occurred, it was widely assumed that they had made a terrible mistake, when this never happened. However this scenario was avoided through the prompt action of the governor of the Bank of England, who fearing a downturn in the economy, pumped billions of pounds of extra money into the economy to prevent that downturn happening. Similarly it is possible that the realists in the Conservative party regain control and instead of going for a decisive break from the EU with all it’s damaging consequences, they will negotiate a ‘soft Brexit’ which will minimise the damage to the British economy which will result from leaving the EU.

Bankers the unruly and uncontrollable children in the family

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Politicians seem to think that as they can manage their own family budgets, they have all the knowledge necessary to manage the economy. This results in statements such as the government needs to balance its books or that the country has maxed out its credit cards. Such statements demonstrate an appalling ignorance of the economy and how it works. However there is a competence that is lacking at the most elementary of levels,  as too many MPs are appalling at managing their own finances. Disraeli one of the greatest leaders of the conservative party was always on the verge of bankruptcy because of his extravagant lifestyle. Fortunately he had a rich wife and friends ready to bail him out. Politicians are as likely to follow his example as they are that of his prudent rival Gladstone. The recent expenses scandal when it was demonstrated that most MPs used their expense account to finance their comfortable lifestyle. People still remember the MP who used his expense account to pay for a duck house. If financial rectitude is not characteristic of many MPs This should give pause to any claim that they are capable of managing the economy.

If the analogy of family finances is to be made it should be said that the government resembles the nominal head of an unruly family, whose views are largely disregarded by the family members. The unruly children in the family take little notice of the head of the family, only listening to them and accepting their authority when they get into trouble. The banks are the obvious example as they pay minimal heed to the authority of the government except in times of crisis such as during the financial crisis of 2008.Once the crisis passed the banks forgot their need for government support and showed a lack of gratitude to the governments actions for bailing them out during the crisis. They successfully prevented the government from introducing a reform which would have separated their retail banking activities from those of investment banking. If a bank fails  in future the government is still on the hook, as it can’t protect the individual customers of the bank without bailing it out for the much larger losses incurred by its speculative investment banking arm.

This is no small matter as the combined assets of the banks are in total ten times the value of our national GDP.    Our national GDP is the country’s national income. There are four large banks in the UK and it is not unreasonable to suggest that the assets of each is in total a sum near to, equal to our GDP or greater than it. In the event of a failure of one of the large banks the government could be called on to raise a sum equivalent to our national income to bail them out. At one time during the crisis of 2008/9 the government of Gordon Brown had to pledge a similar figure to our banks creditors to prevent a run on their finances. Fortunately the banks creditors did not call on our government to make good this pledge, they were satisfied with the the pledge alone. When the next crisis occurs the country may be less fortunate.

When I describe the banks as unruly children over whose actions their parent has little control, there are numerous examples I can cite of such behaviour. Britains biggest bank is HSBC and Standard Chartered is its branch in the US. This bank almost lost its licence to conduct banking in the USA because of its money laundering activities. Only the pleas of the British Chancellor of the Exchequer prevented the American financial authorities from withdrawing its banking licence. It had lost its licence to bank in the USA, its parent bank HSBC would have been in serious financial trouble and it would have had to ask the British government for financial support to enable it to cope with the crisis.

The family finance analogy of which so many politicians are so fond of using describes so well the activities of the banks. The banks are the prodigal children who can behave as badly and irresponsibly as they wish as they know that their parent the British government will always come to their aid no matter how badly they behave.

In Britain as in most countries the politicians are content to remain in ignorance of these unpleasant truths. They believe that their homespun economics all they need, or they are ideologues who believe that the great prophets of economics Hayek, Friedman and Rand said all there is to be said about economics and the managing of the economy. This last group believes that all the answers to matters economic are to be found in books such as ‘The Road to Serfdom” (Hayek) or ‘Atlas Unchained’ (Rand).

There are a small group of politicians who understand the problems of which I have written, but they are only too willing to pretend that all is well in return for government office or employment as well paid lobbyists for the financial sector. Money is incredibly effective balm for soothing fear.

I am not the first person to express concern about the appalling ignorance of our politicians. Leo Amery looking around at his fellow politicians in the 1920’s said that the country would be better served, if there was  separate parliament consisting of industrialist and trade unionists to manage the economy and industrial policy.

Alice in Wonderland Economics

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The book that I would recommend to anybody wishing to understand the economy is Lewis Carroll’s ‘Alice in Wonderland’. Not as a book to replace all the books that can be found in the economics section of any library, but as a first text which to give a good grounding in all things economic. What any budding economist needs to know about the economy is that things are not as they appear.  Alice is able to get through a door for which she is to tall by drinking from a bottle labelled ‘drink me’. After drinking that she shrinks in size to such an extent she is now able to walk through the door. She can be both giant and of normal stature in Wonderland. Later in the book she meets the Cheshire cat, who not only can become invisible but is able to become visible in place other than that in which he first appeared.  What the good economist should do is to be prepared to surrender their belief in a world of common sense. Just as for Alice the rabbit hole is a portal to another world, so a public corporation can equally be a portal to a world in which strange behaviours predominate.

One good example of this strange new world of economics is the strange behaviour of Starbucks. I was puzzled when I read that Costa Coffee a British coffee shop chain was more profitable than Starbucks. Starbucks seemed to be everywhere and I could see no evidence from what I observed that the business was doing badly. Then on reading more I realised that is was yet another example of a company not wanting to earn profits. Yet all the textbooks state that all businesses are profit maximisers. Profits earned are subject to corporation tax, so companies will do all they can to minimise their profits and tax bills. This is usually done by having a head office located in a low tax country such as Eire and that head office then imposes such a high level of charges on the business (for services provided) that the profits are reduced to such  a low level that the company is either ceases to be liable for tax or it only has to pay a minimal amount.

However the process becomes stranger and stranger the more it is examined. Usually the ‘charges’ that are paid to the Head Office are through a chain of offshore companies remitted to the multinationals homeland. Yet the profits declared then are only small part of the companies income. Such companies sit on vast cash piles which are located in various tax havens. This cash pile increases the companies wealth and the price of its shares. Shareholders are in many cases happy to have a reduced dividend but a reduction more than balanced by an increase in the value of their shareholding. Banks recognise that the shares held in such as Starbucks, Apple. Google etc. are extremely valuable assets. They will then lend large sums of money to these people against the security offered by there shares. These loans which are rolled over from year to year and which can be increased in line with the increase in the value of these shares. Loans have the advantage of not being income and are therefore exempt from tax. Many shareholders are content to enjoy their income in this way. Although there are a significant number who would still want to enjoy a cash return from their investment.

There is a passage in ‘Alice in Wonderland’ where Alice comes across a group of the Red Queen’s servants painting white rose red. This because the Queen wanted red roses and they mistakenly planted white roses. They hope that the Queen won’t notice the red paint. Similarly there is the many thousands of financial advisers who role in life is to paint earned income as anything but earned income. Anything that is either not liable for tax or which is taxed lightly. Unlike the Red Queens gardeners they are very successful in that the tax authorities never see through the disguise.

Apple is described as the world’s largest business. Although they are  the company with the largest sales revenue are not necessarily the most profitable. Much of the profit earned is changed into something quite different, such as a charge to Head Office at least in all the European countries. What profit Apple declares is largely resting in some offshore tax haven beyond the reach of the US tax inspector.

What any economist needs to realise is that to understand the behaviour of multi-national companies,is that the economics textbook is of little use. The book describes the behaviour of an ideal and imagined company, not a real one.

I could go further and relate other features of the book to the real economy. There are frequent examples in the book of nonsense verse, such as the song of the Walrus and the Carpenter. What the economist needs to know is that in the real world economy there are plenty such similar examples. All too often when a company goes bankrupt it is usually one that has received a successful audit. The auditors seem unable to notice those gaping black holes in the company accounts. This is because they use a set of industry agreed accounting conventions when analysing the companies accounts, conventions that serve to conceal rather than reveal mismanagement and a shortage of funds. While company accounts are not nonsense verse, they are often intended to deceive as often as they are intended to reveal the true state of a company’s affairs.

Politicians come the nearest to uttering nonsense verse on the economy. They are found of uttering what seem to be profound mantras on matters of the economy, but which are in fact meaningless phrases. Phrases such as the country has ‘maxed out its credit card’ a phrase uttered by a politician, when his government was doing all it could to encourage a borrowing binge to kick start the economy back to life.

Why I recommend Lewis Carroll’s book for any budding economist is that it reveals to the reader a strange world that is and is not ours. It prepares for them recognising the unfamiliar and strange amongst the familiar and it is often the strange and unfamiliar that make seemingly inexplicable behaviour explicable. Conventional or bad economists are unable to see beyond the fog that is the received economic wisdom. This is why these economists were unable to see the financial crash of 2008 looming in front of them, when all the danger signals were showing red.

Scapegoating the dominant economic policy of our times

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There is a difference between the economics practised by politicians and the economics taught in the universities. One commentator has called the former macromedia (Professor Wren-Lewis) meaning that politicians have developed their own unique understanding of economics. The politician’s economics is a mish mash of economics, common sense and prejudice. While the economy is doing well this misunderstanding of economics matters little, however the problems occur when this misguided economics is the basis of policy making in the time of crisis. This is seen in the various crisis that have afflicted Europe since the crash of 2008/9. Greece is perhaps the most notable policy failure, although even the one self proclaimed success story the UK, if far less successful than claimed by its leaders. The Central Bank interest rate remains at crisis level of 0.5% as even a modest increase will derail the recovery.

The consequence of this misguided economic practice is that all governments can now do is hope that the next crisis will not occur on their watch, as they have little clue as to how to tackle it. Political economics is informed by prejudice as with many a primitive religion and always looks for scape goats to blame for provoking the anger of the Gods. If they can identify those who have angered the Gods, they can deflect blame from themselves. This policy means the government won’t have to undertake of those difficult policy measures that would mean taking on those powerful interests that would oppose change. In Europe a convenient scape goat has been found in the people, much as in many a fundamentalist religion it is the misdeeds of the people that has brought suffering on them. God punished the people of Sodom and Gomorrah by turning their cities into salt, while the God of the market punishes the people by making them poor. In the case of Sodom and Gomorrah it was the sexual licence that brought down on them the punishment by God. In Europe it was the greed of the people. They were not content with the modest income the market allocated them, they wanted more. More generous wages, sick pay, benefits of all kinds, the greed of the people know no bounds and forced the governments into borrowing more and more and forcing the government into greater and greater debt. The God of the market punished the people with the great crash of 2008/9 and his angr could only be appeased through an act of penance. This penance was to intended to get the people to reject their greedy lifestyle by embracing austerity. Since the people would not willing do this themselves government would have to act to compel them to do  penance. Penance was enforced through cutting people’s incomes, such as by welfare cuts, wage cuts or wage freezes Once people had learnt the error of their ways after a period of suffering, prosperity would return.

(Using ‘The Old Testament’ to explain the practices of contemporary politicians might seem strange. However once it is realised that the sophistication of policy making by the political leaders has advanced little since the time of ‘The Old Testament’; this use of ‘The Old Testament’ stories as a metaphor to explain contemporary political behaviour is  valid.)
One consequence of this is that it is hard to make a reasoned defence what is an irrational policy so the opponents of the austerity programme must be labelled as deviants, to prevent their policies being given a hearing. Politics can be divided into the sensibles and the foolish. The upholders of the agreed of consensus of policies are the sensibles and their opponents are as but foolish children, who know no better. One notable sensible is Christine Lagarde of the IMF who described the Greek politicians who opposed austerity as children. In Britain since the Labour party members elected a leader opposed to austerity he has been subject to a constant stream of abuse by the media and the austerians of his own party. This last group have pledged that they will do all in their power to prevent a move away from the agreed policy consensus. In terms of ‘The Old Testament” metaphor the guilty people are asking to practice again those bad habits that got them into trouble in the first place. Only the superior people that is the austerians in parliament understand what is best for the people.

When the next crash occurs the austerians will tell the people it is because they did not willingly embrace poverty. They again are at fault and the only solution is to subject more of the people to increasing poverty so they learn the error of their ways. Only in that way can the God of the market be persuaded to relent and ease the suffering of the people. How long this policy approach will work is unknown. It will at some stage be challenged by an equally irrational ideology or belief system that cannot be discredited by upholders of the dominant austerian ideology. Perhaps the ideology of the Neo Fascist Golden Dawn in Greece will be that of the group that successfully challenges the dominant irrational belief system with that of a more compelling narrative, but one that is equally irrational.