Friday 28 January 2011

Banks and Lending: Optimism and Denial II

This is my first post of 2011, so Happy New Year to anyone who is reading this. I have made a resolution to post a blog at least once a month, so hopefully this will be the first of a more regular sequence of political, moral and spiritual reflections.

I've called this posting Banks and Lending: Optimism and Denial II. In February 2009, under the title Optimism and Denial, I pondered the fact that most people, including most economists, appeared to be in denial over the state of our economy in the wake of the Credit Crunch. For a while in 2010, there seemed to be something approaching a recoery in the economy, and doomsayers such as myself looked to have been a little over-pessimistic. It seemed to me, however, that all the ingredients were in the mix to create a really bad recession, either all at once or in two or more sections, and I didn't (and still don't) see how we could escape. And the latest economic figures are dire, and suggest that there really is a double-dip recession in the making.

It really isn't any use blaming the pre-Christmas weather (surely most people shopped online instead?) or the Coalition's policies (which are necessary to save us from the situation Portugal, Greece and Ireland have faced). George Osborne is probably correct to lay most of the blame at the door of the spendthrift Labour government of the Noughties, though to be fair to the latter they were fools rather than knaves - not least in believing their own rhetoric about the end of Book and Bust. However, the ingredient in the mix that I hear very little about is the part played by the Bank of England.

Low interest rates and quantitative easing were (or should have been) a short-term emergency' fix' to steady the economy after the Credit Crunch, and to prevent the very series, Twenties-style recession that loomed in 2008/9. But two years later surely it is madness to continue with this policy, particularly in the face of fairly alarming inflation figures? Higher interest rates would at least help to control this incipient rise in prices, even if some of it is being driven by external shocks such as higher oil and food prices. One of the reasons the Bank of England was given independence was so that it could concentrate on keeping the economy balanced between Boom and Bust, using interest rates among other tools - a role it seems in danger of forgetting.

In addition, what we need, and what the government recognises that we need, is access to crredit for businesses - and especially small businesses, that bedrock of growth, which often cannot expand without borrowing. No private-sector recovery such as the Coalition is banking on will be able to proceed without this credit, which is why David Cameron and his cohorts exasperatedly berate the banks for not lending more freely. But all investment, whether bank-led or not, requires a return. Without a good enough return, lenders will put their money metaphorically under the bed. And an important prerequisite for investors getting a return on their money is to have interest rates at a reasonable level. Push them too high, and you choke off growth by making credit for business too expensive. Let them get too low, as they are now, and lenders will not invest because they cannot get a decent return on their money. In the situation we now have, banks are struggling to provide products for savers that will attract money, while borrowers are paying ridiculously little for their loans - itself a source of banking income. Meanwhile those borrowers are cushioned from the harsh realities of today's economic conditions, and would-be savers, along with pensioners living off investments put by during their working lives, are discouraged from investing their money where it would be most needed. No amount of haranguing wil make banks lend more money than is financially sensible and in their own and their shareholders' interests - and indeed, if we want them to learn the lessons of 2008/9 it makes no sense to ask this of them.

This brings me to the question of Western versus Eastern economies, particularly Europe and the USA as against China. The main difference (put very simply) between these two economic blocs is one of credit and thrift. In the West we have become used to spending more than we earn and borrowing the shortfall - and both governments and individuals have become so used to this that we don't realise that the era of Big Borrowing has come to an end, perhaps for a generation. The bubble has burst, but we are still pretending that recovery can be retail-led, that if interest rates are low this will encourage people to spend more. On the other side of the world the oppositye is true. Chinese entrepreneurs have made large sums from export production, and banked it. Thus the Chinese economy is in surplus, its currency overvalued, and enjoying double-figure growth.

Surely there is a straightforward and obvious lesson to be learned from this? You can only borrow so much before the debt comes back to haunt you. Working hard and saving the profits is the way to make an economy grow. The mechanisms are complex, but the conclusion obvious, and for us in the West, stark too.

What happens, then, if we continue as we are? The first thing we shall get is Seventies-style stagflation - always a danger in the wake of such fiscal policies as quantitative easing anyway. I suspect that this cannot now be avoided. But if we do not quickly get the economy back into balance, even if it means a double-dip recession, we risk another crash. And this time there isn't a country in the West that can afford to pick up the pieces. Iceland's experience should be a terrible warning, but have we taken heed? Are we really so blinded by the terror of change that we cannot see the greater disaster brewing in front of our noses?

Ordinary people, in the main, are trying to be sensible. They are saving rather than borrowing, paying back debts, restraining their buying, trying to live more simply and cheaply. This should be encouraged by government and economists, not criticized or bemoaned. Raise interest rates a bit and the prudent would be better off, because they could get a better return from their savings. The over-indebted, to be brutally honest, are in trouble in any case, and staving off the evil hour for them will not help the rest of us. It will only make that hour, when it comes, much harder for everyone.

So George, I beg you, stick to your guns, and Mervyn, please persuade your fellow conspirators at the Bank of England to raise interest rates. In the end it will have to be done. For the moment we are keeping our heads above water, out of our depth, by swimming very hard. But if we don't find a place to put our feet down on the bottom - which means accepting the Cuts, and cutting our own individual aspirations to match, changing our mindset so that we save rather than spend, the lesson that has to be learned may be more painful than we can yet imagine. It is not too late for the Coalition to lead us in the right direction without a further disaster - but one day it may be. And that day may be sooner than we think.