The West is staring into an economic abyss deepened by political paralysis in the US and EU – but Britain must stick to its financial Plan A.
We appear to be at another pivotal moment, with Western economies once more staring into the abyss. At a conference in Frankfurt this week, Josef Ackermann, chief executive of Deutsche Bank, compared events to the Lehman Brothers catastrophe of 2008 and warned that many banks in Europe are essentially bust. His opposite number at KfW went further still and said that the present cocktail of negatives was “much more dramatic than 2008”.
Back then, governments and central banks still had the financial firepower and the will to attack the problem with massive injections of fiscal and monetary stimulus.
Today, the fiscal armoury is exhausted, while it is not clear that further monetary easing through the printing presses of “quantitative easing” would have any effect beyond adding to inflation.
Indeed, the parallels look alarmingly closer to the banking collapses of 1931, which plunged the world into prolonged depression, than the storms around the Lehman collapse.
In Europe and the US policymakers are paralysed – by growing Euroscepticism among electorates on the one hand and fierce Republican resistance to further deficit spending on the other. There is little or no consensus about what needs to be done. In Europe, governments are a million miles away from either of the two remedies likely to resolve the crisis: break-up of the euro or the establishment of political and fiscal union.
The euro debt crisis seems to have reached an intractable state of affairs, with leaders apparently unprepared to contemplate either reconstitution of the currency along lines that would allow the distressed periphery to reflate their economies out of depression, or the establishment of a United States of Europe – where ad hoc and crisis-invoked bail-outs are replaced by clear-cut mechanisms for fiscal transfers between surplus and deficit nations.
Small wonder that investors are running for the hills. Mass and disorderly default appears to be the only way in which events can unfold. The distinct possibility of catastrophic loss once more looms large across the world economy.
Against this grim backdrop, the cacophony of voices arguing that governments and central banks change tack, postpone fiscal consolidation and crank up the printing presses again grows steadily louder. To the scratched record of Ed Balls, the shadow chancellor, and the neo-Keynesian economists he takes his cue from, must be added Christine Lagarde, the newly installed managing director of the International Monetary Fund, John Cridland, director general of the CBI, and Bill Gross, head of the world’s largest bond fund, Pimco.
Little more than two years ago, Mr Gross claimed that Britain was sitting on a bed of nitroglycerine unless it took action on the deficit. He has changed his mind. Now he thinks there is scope for rescheduling of the austerity programme so as to avoid recession.
With the US economy slipping and unemployment once more climbing, President Barack Obama has launched one last plea to Republicans to agree a jobs package of reflationary infrastructure spending. His chances are about the same as those of Chancellor Angela Merkel persuading German voters to accept a joint liability union – close to zero.
What of our Government? Is it time to roll out the fabled Plan B, and back off on fiscal consolidation? In a speech to the Lloyd’s of London City dinner last night, George Osborne, the Chancellor, again made clear that he is not for turning, and he’s right to do so. Whatever action the Government takes, it will have no impact on the two underlying causes of the present turmoil – economic weakness in the US and the eurozone’s existential crisis.
The solution to these crises lies in the hands of others. The UK must participate in whatever international action is taken to fight the downturn, but it cannot tell the eurozone how to heal itself, nor can it break the political deadlock on Capitol Hill.
What’s important when policy in the rest of the world is going so seriously astray is to ensure that the UK remains in control of its own affairs, and on this front the present mix of tight fiscal policy, exceptionally accommodative monetary policy and a strongly pro-enterprise agenda looks broadly correct.
The most important thing is to keep interest rates as low as possible, for nothing would be more guaranteed to send the debt-burdened UK economy into a tailspin than a rise in borrowing costs. Amid calls for a further loosening of the purse strings, it seems to have been forgotten that even under current plans, Britain is continuing to add to the national debt at frightening speed.
Something could indeed be done to alter the spending mix, so that more money is devoted to expansionary and job-creating infrastructure investment, but there is very little scope for fiscal easing without breaking the bank. What is more, something has to be kept back for the growing likelihood of complete eurozone meltdown.
A powerful external shock of this sort might well provide the justification for a change in strategy. At that point, it would be every man for himself. By sticking to the script now, Britain earns the right to react appropriately with temporary measures to support demand when things get really tough. It would be folly to use up whatever goodwill the country has earned in markets over the past year before the hurricane has struck.
Nor is it strictly accurate to say there is no Plan B. As long as fiscal policy remains under control, the Bank of England still has the scope to react to any extreme deflationary threat with further quantitative easing. The consolidation plan is also sufficiently flexible through the “automatic stabilisers” to allow for a more drawn-out fiscal consolidation in the event that growth falls significantly short of expectations.
And for those of an optimistic frame of mind, it is still reasonable to argue that despite the headlines and evident panic, the tell-tale indicators of financial and economic distress are still not as bad, at least in the UK and the US, as they were in the immediate run-up to the Lehman crisis. Spreads are not as wide, bank funding markets remain just about open, and there is not yet the same complete collapse in consumer and business confidence as then.
Even so, nobody should be under any illusions as to what lies ahead. “Failure to tackle the imbalances [in trade and credit flows] during the seven years of plenty before 2007 threatens seven lean years thereafter,” Sir Mervyn King, Governor of the Bank of England, said in his Mansion House speech last June. “After a deep-seated banking crisis, now transmuted into a sovereign debt crisis, the need to reduce debt as the world adjusts to a new equilibrium pattern of spending and trade will mean only a gradual recovery in many advanced economies.”
It scarcely needs saying that so far we have had only four of the seven years of famine. And grim though this prognosis looks, it almost certainly understates the Governor’s true assessment. The private view will be more alarming still.
It took Europe over 40 years of economic and political turmoil to recover from the extreme over-indebtedness it imposed on itself in the folly of the First World War. Much as today, creditors and debtors tore each other apart economically in attempting to find a politically acceptable form of burden-sharing. We all know how the currency and trade wars of that era ended.
According to the Russian economist Nicolai Kondratiev, there is a much longer economic cycle of fast and slow growth lasting between 40 and 60 years that overlays the short-term business cycle. Not many modern economists believe in this theory, but it correlates quite accurately with the pattern of recent European history.
We can still hope that he was wrong – but that’s not the way it looks right now.
