How Keynesian Are You Allowed To Be: Brown's Dilemma
Wednesday 29 October 2008 at 10:25 It became much clearer late last week why the Governor of the Bank and then the Prime Minister had previously warned us so starkly of recession.
They were preparing the ground for 24 October’s announcement of ‘dreadful’ figures that signaled a deeper downturn than many had feared - a contraction of 0.5% had already taken place in Q3 2008. The markets plunged in the UK both on this and on worsening international news.
Educating the Voter
With a new awareness of the ‘Peston factor’, that is the ability of the media to generate panic, the Government is engaged in a carefully calibrated attempt to manage expectations through the phasing of announcements.
The authorities are aware, well before we are, of what is to come so they adopt a two-step preparation of the market.
First, the most senior person who is not the Prime Minister warns of something (to make sure the professionals are readied), then the Prime Minister emphasises and finesses the point (to reach the people) - and then the actual bad news comes.
It now pays to take warnings seriously when they come from people like Mervyn King and Alastair Darling. Even more seriously if they come from the Prime Minister.
Unlike the cynical manipulation of the security agenda under the previous incumbent of Number Ten, reliably indicating the facts of the matter has become an essential element in building trust between markets, government and people.
The warnings are now piling up. Similar attempts to prepare the market are taking place overseas. German Finance Minister Steinbruck said that global markets are still at risk of collapse and that turmoil in this economy (the financial rather than the so-called real economy) will continue until the end of 2009.
If so, this is very disturbing because many analysts are working on the basis that the worst in the financial system is over when it clearly is not. Steinbruck also told another stark truth – that neither his nor any other government were truly in control of the situation.
The Bank of England has been giving similar dire warnings that we may be going into a further phase of financial instability in which the survival of insurers and hedge funds become a matter of concern - the shenigans over Volkswagen in Germany may yet bring down some major hedge players.
The Bank asserts that the banking system is far from stabilized. What this means is that the ‘real economy’ model, in which a prolonged recession sees the light at the end of the tunnel in a 2010 recovery, may be optimistic.
The Politics of Globalisation
Governments are not trying to frighten us for the sake of it but because the advanced economies have a very serious political problem emerging.
Globalisation has been sold to their peoples as an unanswerable good. It has been accepted as such by most of us because it has delivered exceptional economic growth. Unfortunately, that faith is threatening to dissipate except amongst leader writers in The Economist and Financial Times.
Things have gone pear-shaped. The proponents of globalization (almost the entire political class of the West) have to explain to their voters that they have lost control of the levers of power that might have been used in any previous crisis of this magnitude.
There are no firebreaks left. This is a world without exchange controls, one that can see panicked capital moving from failed haven to presumed safe haven with no restraint. They have been reduced to relying on the IMF as 'international credit union of last resort' in an entirely new way.
What this means is that Governments, especially the British Government, are caught between the rock of needing to mount some short term Keynesian boost to the economy and the hard place of reassuring global investors who fear for the country’s fiscal stability.
If small countries like Iceland and Hungary have to go to the IMF (as we write, we hear of the $25bn loan package being provided to the latter) because their independent currencies cannot stand the heat, then what of the pound which is neither dollar nor yen – and certainly not part of the euro.
The Government is facing rising unemployment, and a round of repossessions and small business failures, in the run-up to an election on the one side - and a potential sterling crisis on the other.
Meanwhile, the population has to be persuaded that there is no alternative to Government policy and that globalization is a good thing in the long run (although, as Keynes famously noted, in the long run we are all dead).
This is a massive test of trust and political education after a decade of distrust in New Labour, indeed in the political class as a whole.
What Happens If Sterling Falls Too Far
As we write, markets are rising on expectations of global interest rate cuts.
But the critical interest rate cut must be in Japan because the safe haven thinking of frightened capitalists means that interest rate cuts in the UK merely drives them to the yen, to the dollar (simply because of the scale of the US economy) and to the euro.
There is a widespread expectation in the street that the Bank of England must now cut rates, maybe as far as 3.25% by the end of the year, from the current level of 4.5%. This is what business wants – in some cases, what it needs to survive.
But the result of this speculation (which was already suggesting interest rates at 2.5% by Q4 2009) and other factors was that sterling went into free fall, reaching $1.53 at one point on 24 October.
A rush to the dollar and the yen, if sustained, could drive down the pound so far that the expected interest rate cuts could be placed at serious risk. Iceland, the first true country risk basket case of the crisis, has an interest rate of 18% yesterday – 12% the day before.
Now that’s scary because Iceland cut rates from 15.5% to 12% to try to boost the economy and has now been forced to back-track by the IMF. This is what is at stake for British business trying to square its short term needs with global realities.
So, let’s recap. The Chancellor and the Prime Minister are now in the sticky position of trying to make the British public believe one thing and the international investment community another.
Implicit promises seemed to be given last week that the Government was going to give the economy a Keynesian boost to preserve jobs and homes and save the businesses of the men with white vans. But, wait, that was then and this is now …
Now, Brown seems to be trying to reassure international investors that public spending will not increase – or at least that he understands their concerns and that he has everything under control! Political education for the masses, reassurance for the investors.
Something has to give and, one day, if this carries on, exchange controls might be back on the agenda much as they have arrived by stealth in Iceland – and probably a day too late to do any good.
Much of this may be resolved later today when Darling is expected to revise Gordon Brown’s fiscal rules.
We were all led to expect new and higher allowances on permissible borrowing but we can imagine that the speech will be drafted and redrafted many times, right up to the wire, as the currency markets shift and change minute-by-minute.
If Darling and Brown can pull off this fine balancing act, then maybe they deserve to win the next election.
Conclusions
The UK is being stiffed by the very globalization that is the source of its competitive edge. Corporations cannot now be plundered to fill the gaps in revenue caused by banking incompetence and greed because capital is so mobile and assets less fixed.
To be fair, corporations don't have the cash to steal at this time but neither do we Ordinary Joes, yet most of us Ordinary Joes and the small business community are geographically stuck and are easier marks for post-election tax rises than the higher reaches of the financial and professional classes.
Although this Government is as pragmatic as any other, its ideology and the particular position of London as premier global centre for financial and professional services will always prejudice it in favour of the market rather than towards nationalist, populist or socialist solutions. That is just how it is.
The most probable strategy is to drive spending forward into 2009 to mitigate the effects on the real economy but then slash long term spending plans to please the international investment community.
This nicely suits the electoral timetable so that it gives New Labour a chance to recover ground for a win in 2009/2010 and then a mandate to be a ‘reet bastard’ for 2010-2013, with the 2012 Olympics being the appropriate circus to distract the population from a fairly economically flat though not desperate situation.
Well, that’s the theory!
The European Dimension
There is another factor – of interest to a vociferous minority but also to tensions within the Conservative Party. We have noted that the pound has been sliding sharply against both dollar and yen.
We have noted that the pound is becoming vulnerable to the same sort of pressures that are damaging the economies of the Icelandic Krona and the Hungarian Forint.
In Iceland, this has resulted in aggressive trades union demands that Iceland join the Euro. Similar pressures are likely from a Hungarian middle class whose mortgages are denominated in that currency. A major debate has started up in Poland about the future of the zloty.
A sterling problem that damages the English economy is likely to create major divisions within the middle classes as different narratives compete to explain loss of property value and pension income.
It may raise tensions between Scotland and England - and increase unionised working class demands for currency integration with the Eurozone.
The political class is likely to have to re-consider its position on economic independence (as in the parallel debate on an independent European military capability and on other integration plans).
The effects on the Tory Party are unknown but it could be potentially devastating. From this point on, we would be into completely new political territory – a turn as significant as the Repeal of the Corn Laws.
It could be one of those lurches forward in British politics that have always favoured modernisation. Such lurches usually represent the propertied accommodating themselves to new social forces.
This time, such a ‘lurch’ may encounter some deeply atavistic national sentiments and the eventual result may not yet be certainly predicted.
Within this coming generation, the UK may finally be fully integrated into the European Union or develop its own neo-nationalist survival strategy. Poddling along as before may not be an option.