• Filthy Rich

    If the “filthy rich” are no longer rich, how are we now to describe them? The question is not a new one; the role of those who gouge wealth out of the rest of us by manipulating existing assets has long been an issue of controversy. It was Winston Churchill who, as Chancellor of the Exchequer, said in 1925, “I would rather see Finance less proud and Industry more content.”

    The importance of the City of London to the British economy dates back more than 150 years. As the world’s wealthiest country at that time, it was perhaps understandable that we would develop an expertise in maintaining the value of our assets rather than in creating new ones. For good or ill, the management of financial assets became a more significant feature of our economy than of any other.

    The disproportionate influence of the City was a major factor, through issues like exchange rate policy which was always rigged to favour asset-holders rather than wealth-creators, in our decline as a manufacturing country. It was only thirty years ago, however, that the policy bias really began to bite.

    The critical development was the removal of exchange controls by Ronald Reagan and Margaret Thatcher. In one bound, international capital was free – free from the irksome business of having to comply with the requirements of governments representing democratic electorates, free to roam the world in search of the most favourable (even if short-lived) investment opportunities, free to behave quite irresponsibly since regulation had become a dirty word and a duty of care was owed to no one but the shareholders.

    The City seized upon the opportunity. An expertise in managing, re-arranging, packaging, and creating new financial assets, and clipping the ticket in the process by means of huge bonuses and commissions, became the path to untold riches. So impressed were governments – and not least New Labour – by the wealth apparently created, so dazzled were they by the super-rich, that they deferred to them in every respect, getting off their knees only occasionally to heap yet more praise upon them.

    But while the filthy became rich (and some, as witness Sir Fred Goodwin, remain so), what happened to the rest of us? Most of us were left far behind in the scramble for the goodies. The gap between rich and poor widened dangerously, and our masters were left wondering as to why society was no longer as integrated as it had been.

    And while a few became rich, our economy was left dangerously dependent on the manipulation of financial assets. As the masters of the universe topple off the high wire, we now see that the British economy is worse placed to face the crisis than any other.

    For much of the global economy, the collapse of financial institutions and services is a crisis of credit and liquidity. The impact on the productive economy – where real goods and services are produced and sold – has been real enough, but when, sooner or later, the flow of funding is restored, so too will the productive economy recover.

    For us, however, the crisis is not just one of liquidity. It is one of solvency – and the solvency (and future viability) in question is that of a major part of our economy, one that we used to think would go on providing a growing proportion of our export earnings and our real national wealth and income.

    Our problems are intensified because our reliance on financial services has meant a corresponding and catastrophic decline in our capacity to produce real goods and services. The proportionate contributions of banking and financial services to our GDP and total employment have been growing while those of manufacturing have been falling and that trend had been gathering pace.

    The collapse of our banks and financial institutions means that we are left with a gaping hole in our ability to maintain our standard of living. A whole chunk of what we thought was our capacity to create wealth has literally disintegrated. Our ability to pay our way in the world may now rest on those activities like manufacturing which have been neglected and starved of investment for so long that we simply cannot breathe life back into them overnight.

    Little wonder, as the volume of the government debt incurred to bail out the banks rises, that international commentators see a bleak future for us and advise investors to get their money out of Britain and out of British assets. Little wonder that the housing market is flat on its back and that the pound has dropped like a stone.

    Even draconian action, like leaving the banks to sort out their own solvency problems and treating the creation of credit as a public rather than private responsibility, would do little to turn things round in the immediate future. Sir Fred may continue to live the high life on his pension, but the rest of us are paying a heavy price for the greed of a few and for the failures of successive governments to do the job they were elected to do – and we will go on paying that price for a long time to come.

    Bryan Gould

    14 March 2009

    This article was published in the online Guardian on 16 March 2009.

  • So Much for Liquidity – Now Let’s Have a Serious Approach to Inflation

    The Reserve Bank’s announcement of new provisions to improve the trading banks’ liquidity in the face of the world-wide credit crisis will be widely and justifiably welcomed. It is just a pity that the Reserve Bank is not similarly proactive when it comes to the battle against inflation.

    Any liquidity problem for our banks is, of course, prospective rather than actual or immediate. It nevertheless makes sense, both for current confidence and as a practical response to the possibility of problems ahead, to ensure that the banks have a wider base of liquidity on which to operate. As the Reserve Bank makes clear in its Financial Stability Statement, we cannot assume that a banking system that relies heavily on borrowing from overseas will remain immune forever from the problems that threaten the liquidity of overseas financial institutions.

    While the Reserve Bank deserves a tick for its foresight in this respect, it is less deserving of plaudits when it comes to other areas of its operations. It is reassuring that it has moved promptly to forestall liquidity problems, but this contrasts sadly with its failure to exercise effective prudential supervision over non-bank lenders. The failure of so many finance companies over the past year or so – at a cost to investors of over $1 billion – has left the Reserve Bank seeming more concerned with the viability of the banks than with the savings of ordinary New Zealanders.

    Perhaps we should not be surprised at this apparent peculiarity in the spectrum of the Bank’s concerns. The Reserve Bank is, after all, a bank. It owes a particular loyalty to and has a particular concern for the interests of other banks. It has acted quickly, and properly, to ensure that the banks are able to maintain their operations – something that is very much in everyone’s interests of course – but it has been much less assiduous in meeting its other responsibilities.

    That criticism applies with even more force if we look at a field of operations that is even more significant than the viability of the banking sector or the prudential supervision of finance companies – the Bank’s role in controlling inflation. It is now apparent to everyone that the Reserve Bank is struggling – and failing – to keep inflation under control except at a price that threatens the rest of us with recession.

    The search is therefore on for counter-inflationary policy measures that are both more effective and less damaging than the single blunt instrument of constantly raising interest rates. The Reserve Bank went so far in 2006 as to commission a report on what it described as “supplementary stabilisation measures” – in other words, on further measures that might be taken in addition to what we are usually assured is a policy instrument to which there “is no alternative” – while the Finance and Expenditure Select Committee is currently engaged in a similar exercise in preparing its report on the future monetary policy framework.

    In neither case, however, is it likely that the Reserve Bank or those who advise them will notice what is staring them in the face – that the most obvious (and easily dealt with) cause of inflation in our economy is the high and fast-growing volume of bank lending. Private sector credit has grown by six times over the last twenty years, from $44 billion in 1988 to $266 billion in 2008; the largest and fastest-growing element in that credit growth has been bank lending on mortgage for the purpose of buying residential property.

    Current interest rate policy actually makes matter worse. As interest rates have risen, the banks have had to market their lending more and more aggressively – and they have protected themselves against the consequent risk of lending inappropriately by concentrating especially on the housing market where they can at least take adequate security over people’s houses.

    Why has the Reserve Bank not focused immediately on this and imposed limits on the banks’ freedom to inflate the economy in this way? If the key to controlling inflation is to limit the growth in the money supply, why not deal with the fastest-growing element in that money supply? If the Reserve Bank is ready to improve the banks’ liquidity at times of credit stress, why do they not intervene to restrain that liquidity at time of inflationary pressure? Why destroy the viability of large parts of our productive economy, but leave the banks free to do as they please?

    The answer is that there is a perhaps unconscious and certainly unstated bias in the way the Reserve Bank looks at these issues. They are unwilling to act against the banks, and would rather burden the rest of us with the responsibility for grappling with inflation. They see measures such as regulating capital requirements or loan-to-value ratios for bank lending – as amended and sometimes extended by the Basel II international agreement – as appropriate for prudential supervision and for ensuring adequate bank liquidity but not for controlling inflation. This point is made explicitly by the Bank’s External Monetary Policy Adviser in his submission to the Select Committee.

    The Bank gets away with this bias because the bank economists who dominate the economic policy debate in the media have a vested interest in diverting attention away from it. It is time that the darker corners of this debate saw the light of day and that the banks were brought within the purview of counter-inflation policy.

    Bryan Gould

    8 May 2008

    This article was published in the NZ Herald on 16 May 2008