• What Happened to the Money?

    Larry Elliott is right to ask in Tuesday’s Guardian why 16.5 billion of quantitative easing made available by the Bank of England to the commercial banks through the funding for lending scheme has failed to show up in increased lending to the small and medium-sized businesses which desperately need a boost to their available funding. He is also right to dismiss the lame excuses offered by both the Bank of England and the commercial banks to explain why such lending has actually fallen rather risen since the same time last year.

    We are, of course, all paying the price, in a slower recovery from recession, higher unemployment, less investment and more business failures, for the fact that this resource, rather than being used, languishes in the banks’ coffers – so we all have an interest in why it has happened. The bad news is that the reasons for it are part of a much wider and longer-term picture.

    The excuses trotted out include the age-old claim by British banks that the comparatively low level of their lending to business does not evidence any reluctance to do so, but merely a shortage of demand – or, to put it another way, a shortage of suitable projects on which to lend. But no sense of this can be made unless we know not only how much is available to lend but also – and more importantly – the terms on which the banks are offering to lend.

    And that is precisely, of course, what we are not allowed to know. The banks are always very coy about the terms they offer. But, in the absence of information made available by the banks, we are entitled to make some assumptions on the basis of what is known of the long-term attitude of the British banking system to lending to industry.

    The information that is available shows that, by comparison with other and more successful economies, our banks lend over a shorter term – the repayment period, in other words, is shorter. This means that the annual repayment costs of bank loans for British firms over the life of the loan are much higher, the adverse impact on cash-flow is therefore more severe, and the need to make an immediate return on investment (and a quick boost to profitability) is much greater.

    My colleague, George Tait Edwards, has shown that annual repayment costs that are two, three or even five times lower are a large part of the reason for the greater amount and ease of bank borrowing enjoyed by businesses in, for example, Germany and Japan, and in the new powerhouses of China, Korea and Taiwan – and that is, of course, why they are able to buy and make a profit from our failing assets.

    This is the fons et origo of the much-lamented British disease of short-termism. For many British firms, short-term cash-flow or liquidity is at least as important as longer-term profitability, because it is literally a matter of life and death. It is a factor that both inhibits the willingness to borrow (and therefore the access to essential investment capital) in the first place, and – if the loan is made – greatly increases the chances that it will not and cannot be repaid in accordance with the loan period and terms insisted upon by the banks.

    If, as is all too likely, a business borrowing on these terms runs into difficulties before the return on the investment funded by the borrowing becomes available, the news gets worse. British banks, unlike their overseas counterparts, show little interest in the survival of their customers. Their sole concern is to recover the loan and interest payments due to them over the short period specified in the loan arrangement. If that means receivership or liquidation – even if the business had a good chance of survival were the investment plans funded by the loan allowed to proceed – so be it. The banks can console themselves not only with the return of the loan and other payments due to them sooner than if the business had been allowed to survive but also with the money to be made from the disposal of the assets (sometimes to foreign buyers) and the receivership process.

    Many people are vaguely aware of these factors but our lack of interest in what makes competitor economies more successful than ours – indeed, our conviction that we have nothing to learn from them – blinds us to these truths. It is time we opened our minds and demanded better from our banking system. And shouldn’t these decisions in any case be taken in the public interest and not those of self-interested bankers?

    Bryan Gould

    4 June 2013

  • Sin and the City

    Twenty three years ago, the City was excitedly awaiting the Big Bang – the moment which would usher in a new era of self-regulation of the financial services industry. I had a grandstand view of the impending arrival. The legislation to prepare for the Big Bang was called the Financial Services Bill, and I spent several intense weeks leading for the Opposition as the Bill was taken through its Standing Committee stage.

    Mrs Thatcher’s government, in line with its free-market philosophy, was very clear that the City could in essence be trusted to regulate itself. They resisted all attempts to give the regulators some teeth. The next few years of what some called self-regulation but which was in reality a free-for-all saw a huge expansion in financial services, in the size of the institutions providing them, in the sums of money involved, and in the rewards “earned” by those who worked in the City.

    For those of us who argued at the time that the “free” market was not infallible, and (in line with Keynes, who had warned that financial markets were peculiarly prone to excess) that the City would require substantial regulation, subsequent events have come as no surprise. Even we, however, could not have foreseen the size of the money-go-round, spinning ever faster, that produced outrageous fortunes for a few and, eventually, crash and ruin for many.

    Nor could we imagine that it would be a New Labour government that would become the most enthusiastic cheerleaders for the new lords of the universe. So dazzled were Ministers by the riches generated in the City that they did not think to enquire as to how many of those they claimed to represent actually benefited from the new wealth – wealth largely gouged out of the pockets of the rest of us.

    The current revulsion at City excesses – the inflated bonuses, commissions, salaries and perks – is understandable; so, too, the anger at the growing evidence that nothing has changed and that those responsible for the mess will be paid mega-bucks for (allegedly) cleaning it up.

    But the reaction to the greed and irresponsibility of the financial free-for-all, while natural, is a diversion from the real point. The reason for the government’s continuing genuflection to the City is that, after 23 years of unregulated City operations, and a growing reliance on financial services to keep the economy moving forward, the collapse of the City means that there is nothing much left.

    The game is given away in the Chancellor’s statement this week on his plans for future regulation of financial services. His constant references to the importance of the City to our economy should be seen, not as an endorsement of the course followed over the last 23 years, but as a confession of failure. It is an admission of how far governmental indulgence of City excesses has distorted our economy and how big has been the price that the rest of us have had to pay for the rewards that City operators have milked from that same economy.

    The real damage suffered as a consequence of the City’s domination of our economy is not to be measured, in other words, only in terms of the current crash and financial meltdown. The weight given to the City’s interests over a long period has seriously distorted our economic performance – and the more successful the City seemed, the more important its earnings to our national accounts, the more other parts of the economy were allowed to wither away.

    The problem is not a new one; it was Winston Churchill who, as Chancellor of the Exchequer, remarked in 1925, “I would rather see Finance less proud and Industry more content.” An excessive attachment to the interests of those who hold and manipulate existing assets, at the expense of those who want to create new wealth, is – after all – a characteristic of mature economies which have substantial assets to protect – and we have been a mature economy for 150 years.

    But the era of self-regulation and the demands of the global market meant that this policy bias became magnified many times over. Economic policy as a whole was tailored over this period to serve the City’s interests – so consistently, and over such a long time, that it was no longer recognised as abnormal. There was, we were assured “no alternative”; the global market meant that if the City were not given free rein, others would muscle in on their territory.

    So, monetary policy was given centre stage. The policy itself was handed over to bankers, so that it was no longer subject to scrutiny and Ministers were no longer accountable for it, but so that it could be decided for a limited purpose that – arguably – primarily served the purposes of one part only of the wider economy.

    Macro-economic policy was largely abandoned. Keynes was dismissed and forgotten. Interest rates were pressed into service to maintain the value of the currency and to underpin financial assets that might otherwise have been regarded as of dubious value. Little or no attention was paid to the competitiveness of the rest of the British economy, so that any thought of following an exchange rate policy that would stimulate exports, employment and investment simply never occurred to our policy-makers; manufacturing in particular was allowed to continue its relentless decline. Most of our economic eggs were placed in the financial services basket and only City operators had access to the golden eggs amongst them.

    That is why the global crisis has hit the United Kingdom harder than anywhere else. The financial meltdown has meant that we have nothing much else to fall back on. And that is why the government has gone back – cap in hand – to the authors of the great misfortune, to ask them to dig us out of the hole. There is no better hole to find.

    Millions will pay the price of the financial collapse with their jobs, homes and taxes. But many more – and over a much longer period – will suffer in ways that they do not even recognise as a result of the policy priority given to City fat cats whose primary focus remains their own privilege rather than the British economy. Whether through indifference or cowardice, our politicians seem intent on perpetuating a 23 year-old error.

    Bryan Gould

    6 July 2009

    This article was published in the online Guardian on 9 July

  • Governments As Banks

    The G20 summit seems certain to demonstrate that for most world leaders the conversion to Keynesian economics is no more than skin-deep. The global crisis may have compelled some re-assessment of the “free” market doctrines previously thought to be unchallengeable, but many of those attending the summit are reluctant to accept the responsibilities that a Keynesian approach would require of them.

    It is worth rehearsing therefore what the global recession now demands of governments if we are to avoid a further plunge into full-scale depression. Like so much of Keynes’ approach, the prescription rests on common sense rather than ideological prejudice or mathematical models.

    The key feature of a recession is a shortage of demand or purchasing power in the economy. The danger is that, once that condition applies, it feeds upon itself. Despite the urgings of politicians, individual actors in the economy – both in their personal lives and in their businesses – understand that times are hard and that the economy is flat or shrinking, and they act accordingly in their own self-interest. They cut their personal spending and their business costs. They employ fewer people and they invest less. Their concern is entirely for their individual or family or business interests.

    They cannot be criticised for this. Their behaviour is entirely rational. The problem is that the sum total of all these individual decisions is that the economy shrinks further – a kind of multiplier in reverse.

    An economy left to resolve this for itself will take a long and damaging time to come right. If the process is to be short-circuited, and depression is to be avoided, there is only one agency that is capable of taking effective action. That agency is the government.

    Only governments have the capability and the duty to act in the wider interest, to take decisions that would be directly contrary to their self-interest if they were individuals or businesses, and to act consciously to defy market logic by spending when others can and will not. Governments can afford to do this, if they choose, because their ability to borrow to fund investment for the future is – by the standards of any other agency – virtually unlimited, and their responsibility is not to particular economic actors, like banks or shopkeepers, but to the economy as a whole. They alone can afford to take a long view – long enough to live with a growing deficit while the economy regains its buoyancy.

    It is governments in the end, not banks, who are the funders of last resort. If there was ever any doubt about this, it must surely have been put to rest by the collapse of the banks in most parts of the world, and the taxpayer-funded bail-outs that governments have had to organise. Why, then, are political leaders still so reluctant to recognise that is they, not the banks, who must provide the kind of stimulus to spending that is needed if we are to turn the recession round?

    The reason is that they are still prisoners of the same intellectual straitjacket that created the crisis in the first place. Despite all the evidence to the contrary, they are still convinced that the major decisions in the economy should be taken by banks – or the private sector more generally – rather than governments. Even when they have spent billions on bail-outs, and the billions have disappeared into the banks’ balance sheets, they still somehow expect that the banks’ self-interested pursuit of their shareholders’ interests will revive the economy as a whole.

    Old habits die hard. Privately owned banks have been allowed to develop a virtual monopoly of credit creation for more than 200 years. It is such a familiar feature of our landscape that it has been scarcely remarked, even when bank credit became by far the most significant element in the rapid growth of the money supply – and therefore the greatest factor in inflation. The banks’ impact on monetary policy – and the exclusive focus on that monetary policy – was itself a huge abdication of responsibility in favour of private interests. But just to make absolutely sure that the banks would not only monopolise credit creation but would also control monetary policy itself, governments surrendered the task they had been elected to fulfil by handing monetary policy over to an “independent” central bank.

    Our politicians are still at it. We are told that we must give the banks some “breathing space”. That is after they have walked away with billions of our money. It does not seem to have occurred to our political leaders that it was not the interests of bank shareholders and the survival of banks as institutions that mattered. The focus of policy should have been, first, the security of deposits, and secondly, a re-thinking of whether the banking function should remain a private monopoly or should be seen properly as a public responsibility – as, de facto, it has become. If governments – for which read us – have had to put up the money, why should we not call the shots?

    Bryan Gould

    30 March 2009

    This article was published in the online Guardian on 30 March

  • Lessons from the Crisis

    As the global crisis unfolds, the great gurus of the world economy – those who have presided over its fortunes for much of the last two or three decades – have largely ducked for cover. Some – like Alan Greenspan – have had the courage to admit that there was a “flaw” in his thinking. Others – like Gordon Brown – have made an apparently effortless overnight conversion to Keynesian economics after decades of monetarist orthodoxy. A few – like Bernard Madoff – have been unmasked as fraudulent, as well as foolishly irresponsible. But most have watched from the sidelines, silent and confused, as the results of their handiwork have become apparent.

    The immediate task and focus of governments around the world is, of course, to put in place measures which will limit the damage, avoid a depression, and restore the world economy to some semblance of health as soon as possible. In this endeavour, the supposed experts of yesterday necessarily have little to say. It is, after all, their nostrums that have driven us to this point, and the crisis has cruelly exposed the limitations of the monetary policy which they said was all that was needed. What does liquidity matter if no one wants to borrow and spend?

    But, once the authorities have done their best, and the course to recovery of a sort is (hopefully) set, the debate will move on. The issue then will be not so much the steps needed for recovery as the lessons to be learned if the disaster is not to be repeated in the future.

    At that point, we can expect the champions of “free” markets to re-enter the debate. The battle will then be on to write (or re-write) history, and what now seems undeniable will again become hotly contested. There will be no shortage of explanations and excuses for what has happened, ranging from the nonchalant (the crisis was a minor blip in what has otherwise been a triumph for the “free” market) to the aggressively ideological (it was the failures and mistake of governments that frustrated and distorted legitimate market operations).

    It is vital, therefore, that – while reality still imposes itself on perceptions – an account is drawn up of the lessons we must learn from this disastrous episode. Some of those lessons will be widely accepted, but others – even for those who are most critical of the errors of recent times – will be more difficult to digest.

    The crisis has been so damaging and so all-engulfing that it might be argued that virtually nothing of past doctrine can survive. There are some particular lessons, however, that absolutely demand attention. I would select six leading contenders.

    The first and most obvious is that “free” or unregulated markets are extremely dangerous mechanisms which inevitably go wrong. All markets, left unregulated, will produce extremes, and that is particularly true, as Keynes pointed out, of financial markets, because of their inherent instability. The case for regulation cannot be disputed, but even so, the counter-attack will certainly come. The merits of self-regulation, the salutary effects of competition, and the advantages of a “light hand” will again be rolled out in order to deflect any real attempt at disciplining market operators. That is when our public authorities must be strong-minded, and remind themselves that is their responsibility to the public interest that demands effective regulation.

    The second lesson is that government involvement in the management of the economy is essential. After decades of being told that the only thing we should ask of government is that it “get off our backs”, we can now see that it is governments – not banks or the private sector – that, as the authority of last resort, maintain the value of the currency, guarantee appropriate levels of liquidity and credit, and make irreplaceable investments in essential infrastructure. We must not wait again until the eleventh hour before we deploy the power, responsibility and legitimacy of government to keep the economy on the right track.

    The third lesson is that fiscal policy, decided by governments, is more important and effective than monetary policy. We have again been told for decades that monetary policy is all that is necessary, and indeed all that is effective, both in controlling inflation and in setting the real economy on a sustainable course. We now know that using monetary policy to ward off recession is no more effective than pushing on a piece of string and that an exclusive reliance on monetary policy to restrain inflation is just another reflection of the view – now surely discredited – that the markets always get it right.

    My fourth inescapable lesson is that gross imbalances in the world economy will inevitably cause it to topple off the high wire. The growing gap between rich and poor nations is bad enough, from both an economic and moral viewpoint. But the imbalance between surplus and deficit countries is equally damaging as a strictly economic phenomenon. The surpluses drive us toward recession because they represent resources that are hoarded rather than spent, while those countries with deficits are likely, as Keynes pointed out, to try to control them through deflating their economies, thereby reinforcing the deflationary bias. To the extent that others are willing to finance the deficits (as, for example, China’s financing of the US deficit), this simply encourages uneconomic production and an excessive reliance on credit, meaning that the world economy wobbles perilously on an unsustainable foundation.

    A related and fifth lesson is that the freedom to move capital at will around the world has exacted a heavy price. The total removal of exchange controls meant that international investors could ignore and, if necessary, blackmail national governments; this became a major factor in allowing market operators to escape and defy any attempt at regulatory controls. We have to make up our minds whether we trust accountable governments, with all their imperfections, or the unrestrained and totally irresponsible market. Our recent experience surely makes this a no-brainer. What we now need is a new international regime, negotiated between governments, to regulate exchange rate volatility, international lending practices, and the obligations of international investors.

    My final lesson is that bankers should not be trusted with the most important decisions in economic policy. No policy measure was more widely welcomed than the handing of monetary policy over to “independent” central banks. We now have good reason to know that their decisions are not only likely to be wrong, but will certainly be self-serving – no more reliable or impartial than those of casino operators who will always set the odds in their own favour. If we are truly to grapple with the lessons set out above, we need to restore the main decisions of economic policy, including the effective regulation of markets, to democratic control.

    Bryan Gould

    18 January 2009

    This article was published in the online Guardian on 19 January and the New Zealand Herald on 26 January.

  • Don’t Leave It To The Bankers

    As Gordon Brown’s tribulations mount, prompting amongst other things a reappraisal of his time at the Treasury, it is perhaps not surprising that even his most widely celebrated policy innovation – the “independent” central bank – should come under scrutiny. What is even more surprising, however, is why it was almost universally believed to be such a good thing in the first place.

    The independent central bank was of course seen as an important weapon in the monetarist armoury. Monetarism is, after all, an expression of an extreme belief in the infallibility of the market – an article of faith for New Labour. Governments cannot be allowed to intervene since any such intervention will frustrate the market’s unfettered operation. What could be more natural, therefore, than to ensure that elected politicians are excluded from the formulation of monetary policy?

    This is not, of course, quite how the independent central bank is presented to the public. The public have been sold on the idea that an independent bank is necessary if inflation is to be controlled, since politicians cannot be trusted to take the hard decisions that are necessary. But a careful study of the recent history of the battle against inflation suggests that it has very little to do with the independence or otherwise of the central bank. Inflation in the 1970s was a world-wide phenomenon, but by the mid-1980s – reflecting world conditions – it had largely been brought under control. The claim that an independent central bank is essential if inflation is to be controlled in any case looks less convincing today, with inflation running at over 4%.

    But what is really remarkable about an independent central bank is that it is a major step away from democratic government. The price we pay, in other words, is not just an economic one, but is a significant weakening of our democratic institutions. What is identified as the over-riding issue in economic policy is now the exclusive preserve, not of elected governments, but of unaccountable officials.

    How this has been accepted is even more of a mystery when one considers that the “independent” central bank is in no sense objective or neutral. It is a bank. Its main clients are banks. It is staffed by bankers. It can be relied upon always to put the interests of the financial establishment ahead of those operating in the rest of the economy. Our economic policy is, in a very real sense, made in the interests of the holders of existing assets rather than of those who live and work in the real economy where new wealth is created.

    This bias seems more extreme the longer one looks at it. Not only has the Monetary Policy Committee ensured that the productive sector should bear the burden of its counter-inflationary measures. It seems also to have deliberately averted its gaze from the factor that really is the primary cause of inflation – the huge rise in bank lending.

    How have we arrived at this remarkable situation? It is not surprising that the bankers themselves should support and welcome it. Economists, too, will naturally feel that the authority and credibility of their profession have been underpinned by this recognition that it is only the high priesthood that is competent to address these important issues.

    But why have politicians so readily accepted this substantial diminution of their powers? The answer is that it is very convenient for politicians to be able to contract out the most difficult decisions they are faced with. How useful it has been for Ministers to be able to pin responsibility on the Bank and to claim that the travails of the economy are caused by the mechanistic workings of the market and of essential monetarist disciplines rather than actual policy decisions.

    But is it not time that we reminded them of their responsibilities? If they want to exercise power in a democratic society, they should not be allowed to pick and choose which responsibilities they accept.

    There is of course an important role for an effective central bank. A central bank is essential to maintain a proper prudential supervision of banks and of the financial sector more generally – something that has been sadly missing from the scene over recent years. A central bank will regulate and enable the banks to interact in an efficient way that benefits the economy as a whole. The central bank will be an important source of advice on financial matters. But none of this requires the central bank to be immune from challenge or that its actions should be free from debate and discussion, particularly when it is uniquely entrusted with the power to give expression to a narrow and bank-dominated view of the true purpose of economic policy.

    The growing economic crisis demands that sacred cows should no longer be immune. Even in New Zealand, where the modern fashion for an “independent” central bank first surfaced, the debate is being re-opened. If we want an economy that more faithfully serves the interests of all of us, and not just those of a small self-interested minority, economic policy should be restored to the democratic arena.

    Bryan Gould

    4 September 2008

    This article was published in the online Guardian on 6 September.