There is an atmosphere of alarm and anxiety surrounding the economy in London. We will restrict ourselves here to the main points in a developing situation and try to draw some conclusions about why Government is finding it so hard to act decisively.

Royal Bank of Scotland and Bank Nationalisation

The current crisis has been well flagged up over recent days, but the trigger yesterday was the discovery that Royal Bank of Scotland, already majority-owned by the UK Government, was set for the biggest loss in UK corporate history - £28bn.

Fears of a full state takeover (rather than just the 70% acquired in two tranches in order to save the Bank) drove RBS' share price down 67% in a day, although there was a mild bounce-back of 6% this morning.

Nevertheless, RBS is now worth a mere £4.5bn or so – well down from £75bn two years ago. The bounce-bank only came when it became clear that the Government was resisting a full nationalisation that would force it to take on its balance sheet, a staggering $2,000bn.

We soon got clear signals from the Chancellor that banks are (or so the Commons was told) “best managed and owned commercially and not by the Government” – a somewhat moot point given the recent track record of their managements.

Sterling's Troubles

But policy legerdemain designed to avoid massive liabilities becoming fully nationalised is being played out against another drama – sterling. There were also rumours this morning that a major credit rating would downgrade the UK.

The EU has pointed out what all natives know in their heart – that price-sensitive manufacturing export is such a small part of the UK economy that sterling weakness is unlikely to be translated into a significant recovery.

All that would happen would be that the cost of borrowing would rise at a most inopportune moment, economically and politically. Yet, as we write, sterling has fallen to below $1.40 for the first time in almost a decade (against other currencies as well)

International investors have begun to appreciate that the UK economy has much less inherent resilience than either the US or the Eurozone.

Shifting The Blame

The current down turn in the UK partly results from massive overseas inward investment having funded domestic over-consumption. This created unsustainable debt without the underlying productive capacity to service it. International capitalism may now be disinclined to throw good money after bad.

The Prime Minister is beginning to reflect the anger of a population that is undertaking its own crash course in economics. He castigated (in effect) the dumb banking mentality of RBS in acquiring ABN Amro without adequate due diligence in order to push itself into the global league.

He was trying to shift public anger from the general (notably, the excessive investment of British finance in global toxicity and the easy credit that was enabled by past investor confidence in London) to the particular (the conduct of the bank). But somehow it does not entirely wash.

Bankers are not the only ones at fault. Equally at fault are stupid business plans and consumer greed. What is not stated is that this economic culture was very much based on poor political decision-making. The key decision was, of course, to ‘ride the tiger’ of global capitalism rather than to cage it.

The Impotence of Government

This was a decision to trust in everlasting global growth within the capitalist model without understanding the principle that periodic ‘creative destruction’ is an essential component in free markets. It was also one of relying on finance capital to show discretion and judgement without interference from state authorities.

In other words, this crisis was formed on the watch of the current Prime Minister. It is about time that, instead of blaming wolves (aka bankers, entrepreneurs and individuals) for behaving like wolves, he took some responsibility for failing to understand how capitalism works and how it must be managed.

Alan Budd, Margaret Thatcher’s economic adviser, speaking on the BBC’s ‘Today’ Programme this morning, mooted the temporary nationalisation of the entire banking sector as a reasonable response to an unprecedented crisis. You have to be under a certain age not to find oneself smiling ruefully at this.

Budd could offer no other policy options than that the State should do what it is doing now, that is, essentially ‘busk it’ with whatever instruments happen to be at hand. So it is pretty clear that we are in the policy soup.

One Solution - 'Quantitative Easing'

In the end, the scale of bad debt is such that it can probably only be eliminated through inflation (hence the fear of deflation in this context on a day when the headline rate fell from 4.1% to 3.1%).

Of course, a burst of Weimar inflation might solve one problem only to create devastating political problems afterwards. Nevertheless, Central Banks are getting prepared to use money supply as an instrument of economic war. One of those instruments is the simple expedient of printing money.

The jargon phrase is ‘quantitative easing’. It is already in use as part of the US Federal Reserve armoury. The Bank of England has now been given the power by the Treasury to create cash and to buy assets direct from companies and banks.

It was the unveiling of this initiative combined with the comment of a Soros executive that 'sterling is dead', rumours of a credit downgrade and fears of bank nationalisation that drove sterling down. But if 'quantitative easing' is the way forward, it does raise the question of why bank nationalisation is so bad.

The Crisis of Weak States

Why the delay in what looks increasingly inevitable – viz. the extension of the Bank of England to encompass full control of the bulk of consumer and corporate banking (aka full domestic bank nationalisation)?

Perhaps one day the question will be asked whether ‘dithering’ over this issue created the next depression. But we should be grateful for small mercies. The new Bank of England facility will allow the Bank to buy up to £50bn of high quality corporate assets that could be used to boost the money supply.

Where we are now is that we have a sovereign state that is caught between the rock of international finance capitalism and the hard place of domestic economic meltdown. One is Scylla and the other is Charybdis.

Every move to manage us out of recession unnerves the international investment community. Every attempt to accomodate that community means that the policy is half-baked, palliative and merely taking the edge off something that, quite seriously, could slip over into a full-blown depression.

Something similar is happening in Russia where a single decisive devaluation is constantly deferred and replaced with piecemeal and damaging micro-devaluations to try to square the need to retain domestic political stability with international investor support.

Never has a global crisis shown how weak governments have become in defence of their peoples ...

www.tppr.co.uk

Recent Client Notes [Subscription Only]

Global

14.01.09 - Continued Strains in Banking and in Europe
14.01.09 - Chaos in the Eurasian Gas Market
14.01.09 - Update on Israel and Gaza
16.01.09 - The Banking System Falters Again
16.01.09 - American Foreign Policy and European Resistance
16.01.09 - Update on Israel and Gaza
16.01.09 - Preparing For The Afghan 'Surge'
17.01.09 - Analysis: The View on the Global Economic Crisis from the UK
18.01.09 - Israel & Gaza: First End Game
19.01.09 - In Advance of the Inauguration
20.01.09 - Financial Times Pre-Inauguration Coverage
20.01.09 - Gaza: The Aftermath

Domestic

16.01.09 - The British Economy: A Waiting Game
18.01.09 - The UK Economy: A Point of Decision
20.01.09 - The Economic Crisis Deepens in London