The Times’ Anatole Kaletsky was on stage at a conference I attended last week. I can report that his picture tells only one lie: in real life he does indeed bear a passing resemblance to a famous comedian, but to a somewhat older Jasper Carrott than implied by his mugshot in the Times.
So I made a particular point of having a look at Kaletsky’s column this morning. In an article where he undermines his credibility by committing the cardinal sin of arguing “first” and then “Secondly” (at my school such a mistake would have resulted in a high velocity blackboard duster aimed right between your eyes), Kaletsky supports the government’s recent VAT giveaway, arguing that: “for every saver there has to be a borrower”. In the 5 words the Times comment facility allows me, I tried to point out that the real issue is leverage.
Savings and borrowings can go round and round. I might use an overdraft facility at my bank to borrow from Anatole’s savings to go to Woolies to stock up on sweets at firesale prices. This money would then go into a bank account belonging to Deloitte’s (Woolies’ receivers) and could be used to support lending to someone else. This process can continue indefinitely.
However – and isn’t there always a “however”? – all this lending has risk associated with it. I might suffer amnesia after an attack on my way home from Woolies by some sweet-mugging hoodies and never pay off my bank overdraft. Banks need a buffer – let’s call it “shareholder capital” – to cover the risk of people not paying back their loans. This limits the amount of borrowing and lending that can be undertaken via that institution. The total amount of lending and borrowing that can take place in the economy is obviously the sum of the lending by all banks and other risk-taking intermediaries – including the state, a point I’ll try to get to later.
The primary problem is not, as Anatole imagines:
“…that private citizens and businesses are in a panic and have suddenly decided – or been forced – to cut back their borrowings and increase their savings to an equally unprecedented degree.”
The problem is that, due largely to the US sub-prime crisis (and the complete and utter madness of no recourse loans), but also other cock-ups that have exacerbated the original problem, such as permitting banks to conceal the real extent of their leverage by the use of off-balance sheet vehicles, and the insanity of mark-to-market valuation of bank assets, a huge hole has been blown in the capital of banks worldwide, including in the UK. This has meant they can lend less, and has initiated a process of deleveraging, which, due to various feedbacks (such as knock-on bankruptcies) resulting from less willingness to lend or a higher cost of capital to individuals and firms, tends to feed on itself.
Now, the only way to arrest the deleveraging process is to increase the capital able to support lending. This would happen, for example, if you could persuade Anatole and a few thousand other Jasper Carrott doppelgangers to withdraw their savings and instead invest the money in rights issues by banks. The banks would still have the actual cash, but could use it to support – or leverage – the merry-go-round lending I have described, rather than just lend it out once as was the case when it was on deposit.
We should therefore assess government policies on the basis of how effectively they counter the deleveraging process, not on the simplistic basis of how much money they put into the economy. Let’s have a look, then, at what’s on the table:
(1) Recapitalising banks: obviously very effective (but see below).
(2) A reverse auction for “toxic assets” (e.g. the original idea of the US $700bn TARP programme): this might have been very effective as a price-discovery mechanism, since banks may be perceived by the market (despite any suspension of mark-to-market accounting rules) to have less capital than they really do have, and their lending therefore restricted. Although it may seem more expensive than (1), this measure may be necessary on a limited scale.
(3) Reducing VAT or other taxes: such measures simply encourage spending, which may go on imports, increasing the overall debt (private + public), and leverage, of the nation. On the plus side, tax reductions may keep some retailers and suppliers afloat, saving jobs and resultant bankruptcies and loss of bank capital. But is this really the best way to reduce the risk of future bad debts and arrest the deleveraging process? I seriously doubt that tax reductions are going to prevent large numbers of personal bankruptcies, since the main driver of these is unemployment.
(4) “Public works” programmes: would directly prevent personal bankruptcies, so would give more bang per buck than tax reductions. They take longer to implement (not attractive to politicians facing elections), but in my opinion this delay should be accepted. We may not be fighting a battle that will be “over by Christmas”. The government could also spend money effectively by investing in housing, for example, indirectly, by lowering costs for housebuilders. In the UK they could reduce the indirect taxes on “planning gains”, e.g. Section 106 deals, such as to produce “affordable housing” alongside housing for sale. Surely it would be better to build just private housing than none at all?
(5) Prevention and minimisation of the direct or indirect impact of personal and corporate bankruptcies. This requires a book in itself, but I can’t help observing that spending a few £bn on the insurance needed by suppliers to at-risk businesses might well have saved jobs at Woolies, MFI and other suppliers (and, just as important, the capital losses to the banking system from such bankruptcies) far more effectively than a VAT reduction.
Kaletsky suggests that “the Government is right to borrow on a scale almost never imagined”. Maybe, but there is a risk to savers with governments (i.e. purchasers of government bonds). It seems to me that this risk should always be minimised, just in case things get even worse. It would therefore have been much better, as well as fairer, for example, as I’ve argued several times for months, if the government had acted to encourage or allow private recapitalisation of the banks, not spent public money. Whilst talking down the pound and using interest rate policy to achieve a limited devaluation (among other things) might be a good idea, the danger is a loss of confidence in the currency. Public borrowing costs would increase, and we could end up importing inflation or living under IMF strictures.
So my verdict is not as positive as Kaletsky’s. The government has already gambled once by putting more public money into the banks than necessary. It’s now throwing our chips into trying to encourage a spending binge. I suspect this will be a last gasp before coming out of denial and starting to take the longer term measures necessary to arrest the deleveraging process. In particular, as I wrote yesterday, we have to accept that house-prices are going to fall much more, and that over the next few years we must reallocate some of the borrowing that can be supported by the economy. To investment, rather than speculation.
The government is being too impatient and making the error of targeting lending and spending directly, rather than the underlying cause, the deleveraging process that is causing lending to be reined in. Rather than reduce VAT, the government should accept that the next few months are going to be grim, and invest in trying to pull us out of the nosedive in a controlled manner in spring 2009. Brown and Darling, I suspect, are flapping their wings ineffectually. Even if they manage to stimulate a Christmas spending binge, that won’t save us.
When you’re in a room full of unexploded bombs, it’s much wiser to take the time to defuse them all carefully than to start throwing the furniture around in the hope that everything will land safely in a more ergonomic arrangement than before.