In Tuesday's
Independent,
Frank Field, the thoughtful and independent-minded Labour MP for Birkenhead and minister in Blair's first term as PM,
knocked it so far out of the park that I think he accidentally hit an orbiting satellite.
This crisis demands a new politicsPoliticians must learn to get off the backs of families and communities
Wrote Field, "Our indebtedness enfeebles the range of our responses to what are cataclysmic forces." This is the key problem. We have pulled the debt and inflation lever too many times, and a gilt strike is a real danger now. If we cannot issue new debt, then highly inflationary policies beckon, the result of which will be serious and structural economic pain:
Let us put aside that all this borrowing is about a Keynesian reflationary package. The plans are to borrow 10 per cent of GDP. Keynes would be apoplectic at deficit financing on this scale. Unless resolute action is taken here, there is a very serious possibility of a sterling crisis (a real achievement with a floating exchange rate) reacting with a gilt strike of such severity that the British economy will be permanently damaged.
Field proposes five policy goals to be pursued in the short-run—at the next Budget, he says:
1. Increase taxes.2. Cut government expenditure.3. Return parts of the State's functions to civil society, notably pensions.4. Increase savings.5. Change the relationship between the State and individuals so that the people are freed to work together for common goals, and "to improve the conditions of their families and friends."Field is arguing that we need to save more in the middle of a recession, and he really means it: "Increased savings is what the banking system is crying out for." He is absolutely brilliant, absolutely right, and absolutely not going to be listened to because most politicians are in love with big government "solutions".
12 comments:
Hmmmm
1) Increase taxes - this would extend governmental control over the economy, not decrease it. This is being in love with big Guv "solutions", not the opposite. It also means that people's disposable incomes will be reduced, meaning that they spend less, meaning that demand in the economy falls, meaning that suppliers then contract further by reducing supply, meaning that it puts us deeper into recession. Not brilliant.
2) Same as 1 - means that government will take more, with recessionary effects, and give even less back. Decrease it by all means, but as long as taxes decrease as well!
4) Again, without the banking sector sorted out, investment does not equal savings. Furthermore, investment contributes less to aggregate demand in the economy than consumer expenditure does. Encouraging saving when there's deflation on the way also means that the economy will stagnate even further, with extreme deflation, and any outstanding debts would be worth masses of money.
Increased savings is the same as increasing a banks' debt when they're trying to reduce their debt by deleveraging. Not smart. The banks need their debts reduced or else covered to cover for the reduced value of assets. Banks only increase savings when they can increase their assets by an equal or greater amount (the same vice versa, but if they're not lending due to bad assets, it won't work that way right now).
5) How does he propose doing this? I see no economic grounding here.
Frank couldn't be more wrong.
HMG currently spends more than she takes in: what else should she do? Borrow regardless and risk a gilt strike? Do you agree with Field's observation here:
At some stage, the sooner the better, the government will have to see that putting up taxes and bringing expenditure into line, are the two conditions to ensure that extra borrowing is forthcoming for a softer landing.
I checked the fount all knowledge, and it says that the marginal contributions of investment and consumption to aggregate demand are equal, which I suspected would be the case. Increasing either investment or consumption will increase aggregate demand: point taken that investment exceeds savings. Point also taken about increasing savings during deleveraging, but banks need to shore up their capital ratios. Can't we press savings into service in some way?
On re-balancing the state and the individual, he's not talking economics but politics: not money, but power. I guess the details are something of a fill-in-the-blanks exercise, and your own party's policies on schools and healthcare would go some way to that end.
Ack. Savings exceed investment. I keep writing it the wrong way round, and this one slipped by.
Yes, I agree with the warning over a gilt strike, although I think that that's still a long way off. Inflation in the future would also contribute towards paying off this debt.
However, the disagreement is over the timing. Frank suggests doing it asap, whereas in actual fact it must be done in the future, for the reasons shown.
Agreed over marginal contributions - I was referring to net contributions. Changes in consumer expenditure are likely to be more effective than changes in investment in terms of reflating the economy simply due to its vast size (60% of Aggregate Demand I think, and Investment is only around 15%). Smaller changes that directly affect consumer expenditure will have larger consequences than if they affect investment.
Pressing savings into service? Definitely possible.
There are a number of things that need to be done. (I'd actually direct you to the SLP again for this, but here goes):
The first is to strip out the toxic assets and complete deleveraging.
Then, you need counter-cyclical steps to encourage lending, such as rescheduling banks' debts to government, reducing regulation, particularly on capital ratios, and then (and only the SLP suggests this) taxing banks above a certain capital requirement for holding onto money instead of lending or investing it.
The idea is that you don't actually generate any revenue from this tax, but it works as an incentive for banks to lend and invest as much as possible once they are actually able to (and are holding back only thanks to lack of confidence). - It's a bit like forcing them to be confident - like pushing a kid in the deep end so that they have the confidence to swim.
The prospect of inflation in the future dissuades potential gilt purchasers. Unless we're talking about the index-linked series, which would definitely not do well for us in an inflationary environment.
Your point about net over marginal assumes that one can release x% of spending or investment, rather than £y of either. If one is looking at a certain amount of money, then one should be indifferent to whether it is invested or spent with regard to aggregate demand. In other words, investment does not contribute to deflation. The lack of spending does deflate consumer goods, but the investment inflates capital goods. The net effect is zero.
As for pushing the kid into the deep end, that may work, but you could find the poor child simply drowns. You have to be ultra-confident that you know better than the collective wisdom of the City (such as it is…) before taking such a step. A step, I note in passing, which would be at least as "big government" as putting the public finances in order.
Not really - it's good for the government as it will be worth less than when they started, but for the buyer, it's only worth as much as when they buy it. The government sees a change in value over time. The purchaser however only buys for whatever the value is at that moment in time - in the same way as a holder of equity can benefit from the value of the share increasing, whereas the purchaser only thinks of the value at the point that he buys it.
You're right about the index-linked gilts. According to wikipedia however, that appears to be a quarter of Guv's debt.
Yes, you're tight over the second post. Touche.
The other factors will still come into play here though, such as savings being greater than investment.
Yes, as you can see, it's our last suggestion, and really only to be used in an emergency, when all other measures don't appear to be working. It would however work effectively - I doubt the kid would drown, especially when they're so big!
It doesn't go against any collective wisdom as far as I can tell - taxes on hoarding are taxes on hoarding, and as long as deleveraging is complete, it should work fine.
Yes, it is a "big government" step unfortunately - but I would justify it as an economically acceptable tax that disincentivises damaging behaviour (in this case hoarding by banks) without affecting the incentive to work, to employ, to trade, to buy, etc. A bit like a Pigovian tax.
Are you really saying that gilt investors are indifferent to the inflation rate? A given gilt offer (term and coupon) becomes less attractive as inflation looms larger, surely.
The collective wisdom of the City is that lending is not profitable at the moment. That's what I mean you'd be going against. I happen to agree that there are almost certainly profitable opportunities out there (wherefore I am lending through Zopa) but I would not dare to force anyone else to follow my personal judgment call.
You're right, the demand for it falls. I don't think that low inflation would precipitate a gilt strike though - you'd have to have seriously high inflation to really dissuade gilt investors to that extent. Either that, or government defaulting.
Lending is unprofitable due to failing businesses and people with no available credit, which in turn is due to lack of credit. If you inject credit back into the economy - e.g. tax the banks into doing so, but only after they are able to (e.g. fully deleveraged), then businesses recover, consumers recover, and lending becomes profitable again.
The measure can't be done on its own, but it does stop part of the vicious downward cycle.
Furthermore, the tax only forces lending by making it less profitable to hoard than to lend/invest. If it's still more profitable for the banks not to lend, then they won't! It's a whole different kettle of fish from just ordering more lending (as Guv seems to have tried with its "asking banks to lend more and pass on the interest cuts"). The conventional wisdom will then be to lend - it restores confidence in the markets.
Where I think we really differ is on the judgment of how near exhaustion the market is for HMG's paper. It's in a boom at the moment, but with a £7bn over-spend in the news, further £13bn forecast and more on its way (not to mention an increased exposure to foreign-denominated liabilities through the banking sector), investors may become very wary very quickly of UK national debt. I would suggest that the tolerance for inflation is currently weakened.
Spreads on UK gilt CDS are at historic highs, gilt prices are starting to weaken, and one analysis of market figures was, "Friday's sell off in Gilts may be instructive for a world increasingly awash with Government debt. Markets are certainly betting that the UK may not be able to afford to support its ailing banking sector, and that its attempts to do so will be inflationary." (TTN)
That's the chatter from the markets, I'm afraid, and it could well become more than just chatter.
That sounds pretty bad.
I'm not sure what they could do then, do you?
I can't think of many available options, other than plunging the economy deeper into recession by increasing taxes and reducing spending (Oh, and don't be fooled by California's actions today - notice that they did it in order to qualify for the massive federal stimulus plan).
Inflation would certainly lead to government being able to repay their debt as it will be worth less, but as you say, the prices of gilts will still plummet as a result.
I'm not sure, but doesn't Quantitative Easing help slightly? E.g. it's the BoE buying up gilts, and printing more money to do so, so is essentially the long way round of one branch of government paying off the debts of another branch of government. I don't know if that really has that effect though...
Then again, maybe that's what the article means by its attempts to do so being inflationary...
On the other hand, with increased inflation, interest rates will be higher, thus making the gilts more attractive. I suppose it all revolves around which effect manifests itself first!
Yes, that's the point. One wrong move and we're toast, basically. Glad I'm not the Governor of the Bank of England.
You're right to identify plummeting gilt prices (not strictly the government's worry) and rising interest rates (very definitely their worry) as the effects of any diminution in the appetite for gilts. It is clearly too early to say definitely that the market is exhausted, but if I were anywhere near the top of the Treasury I'd be absolutely terrified—and I mean a gibbering wreck—at the prospect of a gilt strike. Not only would we be unable to finance any new borrowing, but we would be highly unlikely to be able to roll old borrowing over. We have about £18bn coming up for redemption next year, £44bn the year after and £50bn the year after that (DMO). If we cannot afford to repay it out of our ample surplus [hollow laugh], we shall have to roll it over. If we have a gilt strike, we shall be unable to roll it over, and shall need quantitative easing for real. It won't just be a monetary exercise if that happens, it'll be print or default.
Serious times need serious people, we're told repeatedly. This is serious: the country's fiscal position has been shot to pieces by we-all-know-who, and I know that taking the necessary action will be painful. But if Gordon had kept a fiscal grip in '01-'07 instead of urinating our money into the prevailing, we would not be in the position of absolutely needing, as a matter of economic life or death, to take stern action in the middle of the worst recession for sixty, maybe a hundred, years. As it stands, we have no real choice. We either skirt a bout of major inflation, or we rein in the public finances in the middle of the storm. Inflation worked so well for Weimar, didn't it?
Yes, we will be skirting inflation. The alternative is certain deflation and depression.
The balance is so incredibly fine - I suspect their best option will be to go ahead with QE, but to simultaneously increase interest rates to the point where they can only just afford it. The increase in rates would restore the currency at least a little bit, and would pre-empt any hyperinflationary effects, as well as improving the value of gilts.
They'd then need to provide assurance after assurance that they'd be able to pay off the government debt, even at this higher interest rate - hence only increasing it as far as they can stomach, as otherwise they'd see a panic and a run from gilts despite their higher value and with the increased risk of default.
It's a fine line indeed.
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