First published in the Telegraph on 11 June 2009
In their unguarded moments, policymakers at the Bank of England and the Treasury like to compare themselves to MI5. The tools of the trade may be different – interest rates and taxes, rather than wires and guns – but the purpose is the same: to keep everyday public life as boring as possible. No credit is received when a potentially horrendous disaster is averted; people carry on as normal, ignorant of how close they came to the edge.
We are at one of those junctures now. The recession is almost certainly over. The economy will return to growth imminently, if it isn’t doing so already. The evidence surrounds us: surveys show that the services sector, worth three quarters of our national output, is growing again, and it emerged yesterday that the manufacturing sector is doing the same. Having slimmed down, and cut costs and inventories, companies are making money once more; banks are even starting to lend more freely to households and businesses.
The weak pound is making holidays abroad less manageable this year, but it is also helping to squeeze exports out of the country and lure foreign shoppers in. Earlier this week, I did something I dread: I went shopping, to a retail outlet in Oxfordshire. It was unpleasantly mobbed (“Credit crunch, what credit crunch?” remarked my companion) but even more remarkable was that a vast chunk of the shoppers were luggage-laden tourists, who were deposited there by the coachload to pour cash into our economy, before jetting straight off again from Heathrow.
All of this is happening because of what the Bank of England and, to a lesser degree, the Treasury have done – not in spite of it. Were it not for the interest rate cuts in the latter half of last year and the cash being printed and pumped directly into the financial system by the Bank, we would still be mired deep in recession, and would remain so for some months, if not years, to come. The Bank’s radical action triggered a chain reaction that pushed the pound lower, reduced mortgage costs for millions of households and alleviated the credit crunch.
For those innocents who saved throughout the debt bubble, these have been uncomfortable and perverse times: they have suffered undeserved punishment. But the most profound lesson from the Great Depression was that permanent, crippling damage can be done to an economy if a recession is allowed to run its course and ravage at will. For a period at the turn of the year, we witnessed what this looks like. An effectively insolvent banking system stopped lending, house prices plunged, households stopped spending and the economy became trapped in a vicious circle that resembled the 1930s.
All that has been arrested, and Britain is probably the first major economy out of recession. But even though this is a major victory, the Bank and Treasury deserve only one cheer – first, because the problem was largely of their making and, second, because the long road to recovery that lies ahead is littered with perilous obstacles.
The reason is simple: we have not dealt with the massive overhang of debt racked up by individuals and governments over the past decade or so. In the 1930s, the flipside of mass bankruptcy, bank failures and record unemployment was that in a relatively short time private debt dropped back down to manageable levels. This time, we have avoided the bankruptcy; the consequence is that we still need to repay the debt.
The slow reinvigoration of the financial sector is down to the Faustian pact it made with the Government: the public sector has assumed its enormous debts, on the proviso that the banks will operate on a shorter leash. Even amid signs of recovery, those banks remain nervy, paranoid institutions, unwilling to take even mild risks. In the immediate future, they will remain zombie banks.
Barring another disaster of some sort (which should not be ruled out), the Bank of England will at some point in the next year start raising interest rates. All those households which have only survived because of near-zero borrowing costs will hit a massive financial wall. They are zombie households.
Then there is the Government. As George Osborne pointed out in his speech to the Association of British Insurers this week, the biggest challenge in the coming decade is how to bring down the national debt. Britain has three options: default on the debt (fatal for our long-term prospects), inflate it away (near-fatal, but feasible) or pay it back through a long period of austerity.
The latter course is by no means easy. The Tories insist it can be done through spending cuts, but they will almost certainly also have to raise taxes to get the books back in order. Don’t be surprised if VAT is higher than 17.5 per cent before long. This week, London has been crippled by Tube strikes that presage the next few years, which will be peppered with clashes between heavily unionised public-sector workers and a government with no choice but to bring down costs.
It really is 1979 all over again – and perhaps even worse. I don’t know whether that is something David Cameron is relishing or dreading, but I hope he knows what he’s in for.