Tuesday 24 February 2009

Optimism and Denial

I read in the news this morning that nearly half the UK population are optimistic about their personal finances. Yet the experts predict nothing but gloom for the next year or two, and all the evidence (for once) seems to be on the experts' side.

Why is this, I ask myself. Why this unwarranted optimism - if unwarranted it is? And the only answer I can think of is denial. Everyone agrees that the recession is bad, and likely to get worse. But until it strikes us personally, in the form of a credit squeeze or unemployment or a falling-off in sales or client requests, we don't want to believe that it's going to be as bad as the experts tell us. Because that would mean engaging with the possibility that we too will be affected. For some, of course, that's fair enough. If you work in a business that isn't directly affected by the downturn, or in a job that's always struggling to find enough people qualified and experienced enough to do it, personal optimism is justified. And while interest rates are low, many people will continue to spend (that was part of the idea, wasn't it, Bank of England?), and to feel safe - their mortgage payments and their credit card bills are smaller, and so they can pay for what they need.

But wait a moment! Aren't those with debts, whether mortgages or credit card owings, the ones who for a while felt so panic-stricken and under threat when the Credit Crunch bit? And aren't at least some of them the people who lied about their income to get a bigger mortgage, and spent money they had no hope of repaying? All they have as economic actors is a willingness to spend. I suspect that in the short term this may be useful, and stave off the looming recession - which is of course exactly what the government want. But in the long term we need those who have prudently saved their money for a "rainy day", and who are now being penalised by those same low interest rates, many of them older people who depend on income from investments to raise their pension to a reasonable level. Banks need these savers, to provide the capital with which to lend - they can't rely on government bailout for ever. And unfreezing lending is important, if only to prevent more viable businesses going under simply because they have done what the taxation system and the zeitgeist encouraged them to do, and become over-leveraged for their everyday financial needs. If banks don't pay higher interest rates on savings accounts, the savers will go elsewhere, and the banks will be reliant on inter-bank loans (currently non-operational) and government help (soon to be unaffordable in terms of public debt). And the savers themselves may give up saving and start spending on their credit cards (for their credit rating will be high). But can a recovery be based entirely on credit? Isn't that what we did before, with such spectacular failure? Doesn't this recovery need to be based more securely, on real money, real savings that represent stored wealth? All of us are going to be paying for the current mess via taxation for many years to come. Once the existing savers have spent their capital because it isn't worth saving it, hard-pressed younger people will have to take their place. And the more public debt is created by bailouts, the longer the economy will take to recover, and the longer it will be before savings levels recover, too. Or have I missed something somewhere?

In any case, if I were a bank I think I'd be more willing to lend to other banks and to individual customers and businesses if the interest rates were high. Then I might get a return on my money. As it is lending is just giving money away, really. Banks have had their fingers burned doing that with all the invested money that came their way from the booming Chinese and Indian economies where saving surpluses is the norm. If we are to go back to more traditional banking and more transparent accounting, surely we need to start with a sensible set of interest rates and encouraging saving. Anything else risks a continual cycle of consumer-led spend followed by painful economic contraction. Which is what I fear we are in for, unless government policies change soon. The pain is unavoidable, and stimulating consumer spending is only putting off the evil hour.

I'm usually an optimist, or at least an optimistic realist. But not this time. Sorry, folks, but this one is going to be bad. You ain't seen nothing yet.