First published in the Telegraph on 9 January 2009
Time for a controversial statement: the economic medicine might just be working. The Government and the Bank of England’s drastic attempts to rescue the financial system from collapse and the economy from a depression could actually succeed.
This is, it has to be said, hardly a fashionable idea. For all the noises of doom and gloom generated by economists, politicians and clergymen alike, you might have assumed we are already heading into the mother of all slumps – the big one that will end capitalism as we know it. Hand in hand with this has gone the fear that we are powerless to stop it. There are some who would have you believe that the only solution is to put on the helmet, stock up on tinned goods and set the radio to the World Service. None of this is true. It is not only disingenuous but dangerous.
Yes, the UK is in recession, as indeed is the rest of the Western world. The slowdown is likely to be the most severe and protracted in the post-war period. Hundreds of thousands more will lose their jobs and, unfortunately, more familiar names will join the ranks of Woolworths, Waterford Wedgwood and Viyella in calling in the administrators. The fact that the Bank of England has now cut interest rates to the lowest level since it was founded in 1694 only serves, understandably, to compound the sense of dread – even though it will ultimately provide relief for homeowners.
There will be more bad news in the coming months. Like the proverbial supertanker, a large, unwieldy economy takes a long time to turn around. The UK is still trapped in a credit crunch, which is unlikely to end without some more government money. It seems an obvious point, but the mood has dipped to such depths in recent weeks that we are at risk of despairing that we are destined for an inevitable depression.
It is not difficult to appreciate why. The cuts in VAT don’t yet seem to have made any difference whatsoever; the banks remain mired in trouble, despite having enjoyed a direct pounds 50 billion infusion of taxpayers’ cash into their accounts; rates on many mortgages and credit cards are rising even faster than the Bank of England’s benchmark rate is falling. Indeed, from here on in, any further cuts in the Bank rate are likely to have a diminishing effect as lenders resist passing them on to their customers. And with homeowners still struggling to get hold of mortgage funding, repossessions are likely to soar even higher in the coming year.
But the stream of miserable tidings will not last forever, particularly now that something is being done about it. To assume that none of the measures are working, or are likely to succeed, is simply wrong. Yes, it could all have been done better; yes, more will need to be done in the coming months to ensure the economy’s continued survival; yes, the chance of another nasty lurch into financial crisis is a real possibility. Nonetheless, this is precisely the wrong time to reject the drastic measures propounded by the Government and the Bank. This is not an easy admission for a free marketeer. No one who believes that this country’s future lies in the hands of companies rather than the state – that individuals and businesses should decide their own future as free as possible from government interference – can look with anything but disgust and despair on the fact that the Government deficit is about to hit the highest level since Denis Healey was bailed out by the International Monetary Fund.
However, the alternative is too disturbing to contemplate. This country has never endured a proper banking crisis, as the US did in the Great Depression, nor indeed a similarly protracted period of debt deflation. But if Britain avoided a Great Depression in the Thirties, it came awfully close to one last October. In the wake of the Lehman Brothers bankruptcy, there were moments at which the entire British banking system was within hours of collapse. The aim of the pounds 50 billion recapitalisation of Royal Bank of Scotland, HBOS and Lloyds TSB was to avert this prospect. It succeeded, though at the unpalatable cost of bringing the banks into part-nationalisation.
The stated aim had never been to increase the amount the banks were lending to businesses and individuals, although this was the misleading impression given by the Chancellor and the Prime Minister. For that, there will have to be a further round of bank bail-outs, which could well result in these institutions becoming completely nationalised.
So, to suggest that the bail-out failed is wrong. Not only did it prevent a widespread banking shutdown, it has also calmed the waters in the money markets, where interbank borrowing rates have dropped back towards less panicked levels.
Almost as disturbing as the proposal to inject billions of pounds of taxpayer’s cash into the hands of culpable bankers is the idea that the Bank of England could soon be readying the printing presses, following in the dubious footsteps of Robert Mugabe and the Weimar Republic.
Quantitative easing, as it is called, is what central banks are forced to do when interest rates hit zero. According to George Osborne, who spoke out against it earlier this week, it is the “last resort of desperate governments”. This is half true: pumping money directly into the economy is the nitroglycerine of monetary policy which, in the wrong hands, can spark hyperinflation.
At the moment, though, the greater threat is deflation. Although we have some experience of wrestling our way out of inflation, we simply do not know how to extract ourselves from deflation. Economists suspect that Japan might have escaped from its spiral of falling prices in the Nineties, or likewise Depression America from its own deflation, had their governments acted more decisively, but no one knows this for sure. So, the objective must be to avoid extended periods of deflation, even at the risk of generating some inflation that will have to be dealt with in the future.
That printing-press moment has not yet arrived but, if and when it does, Britain will hardly be facing it alone. In the US, the Federal Reserve has been engaged in various forms of quantitative easing for months, and it may be paying dividends. The stock of money flowing around the American system has started to rise, and many experts now suspect that the US will be the first major economy to emerge from the recession.
The euro area, where policymakers still appear to be steadfastly resisting such nuclear measures, is likely to suffer even more than the Anglo-American economies. Indeed, it may already be happening: a raft of data on euroland’s economic circumstances released yesterday suggests it is undergoing its worst slump since 1945.
We must remain alert to the consequences of these policies. Borrowing hundreds of billions of pounds to inject into the banking system will push up our national debt to its highest levels since the Second World War. The effect of this, alongside zero interest rates, will be higher inflation in the years to come. The banking system is unlikely to be able to stand on its own feet for years after the recession has passed.
The financial and economic crisis, in other words, will leave one hell of a mess to clear up. But at least there will be an economy, and a financial system of sorts, left at the end of it. Whether this would be the case in the absence of these emergency measures is less clear.
No countries have been spared by this crisis. Just as in the Thirties, some will emerge from it in relatively good shape, while others will suffer unduly. Their fate depends on how fast they react to the slump. In the Thirties, the UK escaped relatively lightly after slashing interest rates and allowing the pound to plunge.
Punishing the economy now with higher-than-necessary interest rates, or by allowing the banks to collapse one by one, would only guarantee that we would not escape this time.