Gordon Brown should learn from the Medical Doctors

The Government yesterday announced plans to “help 500,000 people into work or training.” This was my rely to John Redwood’s postingWhat do we want? Jobs. When do we want them? Now.

 

 

You are right Mr Redwood in saying due consideration needs to be given to the relative success past schemes. However, this needs to be in the context of the current realities.

 

  1. The budget deficit is already ballooning, with a very real prospect of debt running out of control. Committing to endless schemes will mean massive rises in taxes just as a recovery may be getting underway. George Osborne should make a couple of visits to the IMF to get to know the place, and practice shuffling on his knees.
  2. Any employment schemes will prove most cost effective when the recovery is underway, not while the economy is still shrinking.

 

RULES-OF-THUMB need to be used in evaluating policy. At a minimum, any stimulus, business subsidy or job-creation strategy should follow the following criteria.

 

  1. It must have a reasonable chance of generating more economic benefits that costs. Preferably it should have the prospect of having a positive impact on the Exchequer.
  2. Each project should be, at most, an annual commitment with limits imposed. Reviews should be stringent and the plug pulled if costs run out of control, or if projected benefits are not materializing.
  3. The timing is crucial. If the time is not right existing policies should be pulled. For instance, stamp duty should be re-introduced until the market has started to recover. (Lord Lamont has admitted that it did not work in 1992 and it is not working now) Similarly, if job creation schemes are to be effective, they should only be enacted on a large scale once the economy has bottomed out, when the marginal impact will be greater.
  4. The government should be aware of its own limitations. To be effective means to be shrewd, ruthless of failure and focused on realities. As with any elected government, this conflicts with pleasing popular opinion and maintaining an image.
  5. Finally, the government should limit the difficulties it is imposing. It should critically look at the regulations that have little benefits but impose onerous costs, either temporarily suspending them, or removing them off the statute book.

 

However, the Rules-of-Thumb might be too complex in these panic-stricken times. Instead consider the analogy is with a doctor who he presented with a condition that has not been fully diagnosed. The doctor will first do no harm. Then she will diagnose the best she can, after which will then try various treatments, monitering the patient constantly. If a treatment does not show positive effects, something else will be tried. But with each treatment, the doctor will study and learn. The doctor would consult with others, and not introduce two treatments that known, or likely to, conflict. She was would also be aware of the side effects of dangerous drugs, such as using pain killers that may become additive.

 

 

 

 

Now for a “Quantitative Easing”

Following the Bank of England’s MPC cut in interest rates to the lowest level in it’s 300 year history, John Redwood MP posted the following comment under “The MPC and the BBC”

 

I see and hear in today’s media that “quantitative easing” is back on the agenda as a possibility “if all else fails”. I would urge all those about to broadcast or write on this subject to take the precaution of first reading the latest Bank of England Weekly statements. These show that quantitative easing is well underway. The Bank’s balance sheet has ballooned from well under £100 billion last September, to nearly £240 billion by the year end. Just picking up tittle tattle from “sources” can be very misleading.

Actual printing of bank notes has been more limited, but these are up over the year by more than 10%, well ahead of the fall in economic activity and price increases.

 

In response I posted the following

 

“The comments by WheresMyVote on 08 Jan 2009 at 4:06 pm  and  Acornon 08 Jan 2009 at 11:14 am    about the recent banking bill proposing to scrap weekly reports reminds me of the New Classical Macroeconomics of the 1980s. A “bastardized” form (as taught by some of my economics lecturers) was that “quantitative easing” would only work on the real economy to the extent that economic agents believed that monetary changes were in fact signals of real changes. This is why, when bringing down inflation in 1980s, money supply figures were headline news, so that the real impact on the economy could be reduced.

The Government, seems to have taken on board a cynical interpretation of “The Rational Expectations Hypothesis” in so far as hiding this quantitative easing, maximizes the “real” impact. It is ironic that some of the Government as students would have marched against the monetarist policies of a generation ago, seemed to have swallowed whole this aspect.

However, the “quantitative easing” will not work, as the cause of the downturn is fact that the previous boom was carried on far too long by artificially low interest rates. Businesses will not invest until the future becomes more certain. People will not buy houses until prices have fallen to affordable levels; until the job situation is clearer; and until they have reduce debt and saved a deposit. Banks would be imprudent to lend more to businesses in order to let their overdrafts escalate out of control, or for house purchase when the value of the house could soon be less than the loan.

The government must wait until the imbalances have cleared before acting. The current action of reducing interest rates and “quantitative easing” will only work in so far as they will further delay the necessary adjustment and make the reckoning more painful and drawn out. As Mr Redwood points out, interest rates should have been raised, not lowered and government finances brought under control.”   

 

With hindsight, if the MPC has micro-managed less and if the government had not further expanded and extended the boom by a spending spree, than we would have the means to offset the downturn. But then again, the downturn would not be as steep in the first place, so would be easier to combat

 

If the British economy is not to suffer irreparable damage, the action to take now is to lay the foundations for our future prosperity. Principally, it is to learn the following.

1)                          That intervention to stimulate the economy is to be reserved for severe situations. Avoiding minor downturns will only result in a bigger bust later.

2)                          We can never know the right levels of intervention, and popular opinion will usually lead to over-reacting. Therefore, a dogmatic conservatism should be engendered in both the MPC and governments

3)                          In a boom, we governments should always run a surplus. This means that a surplus, with a falling national debt, should be viewed as the norm not a pleasant surprise for a couple of years in a generation.

Learning from the Credit Crunch in the UK

Following in from my response to Brown Tries to Sugar the Medicine on Iain Dale’s Diary on 11th December.

 

The PM evades understanding the issues, as he is to some extent responsible. However, that responsibility is shared by many, including myself, who cheered on the cuts in interest rates in 2000 and 2001 to avoid a recession.

The independance of the Bank of England was irrelevent to the issue. The vast majority believed that after the dot.com bubble burst and then after 9/11 it was necessary to reduce interest rates significantly to avoid a recession. This worked, but only at the expense of creating a credit bubble, shown in this country both by the housing market boom, and being able to borrow on credit cards at 0% interest. In the US housing market, there was a similar event, with fixed rate mortgages being granted at very low interest rates.

To blame the financial intermediaries so

The only one of the commentators who comes close (in my view) to getting things right is “not an economist”

The PM not only followed public opinion as Chancellor, but also the most respected minds in the business, lead by Alan Greenspan at the Fed.

To blame the is financial intermediaries is nonsense. The structure in which they operated by created by the Central Banks, the oversupply of the cheap money is due to the Central Banks. They followed a consensus view, climbing a roller-coaster theat  was never going to slide.

 

THE LESSON TO BE LEARNT.

 

  Central banks must be dogmatically conservative and deaf to public opinion.

 

In so far as we know how the economy operates, it is always going to be tainted by the need to please public opinion and their elected representatives. Further, a can-do approach is more popular than one that says we are not sure, or maybe it could cause trouble. But collectively, we did not see this one coming. Therefore, we need to learn some humilty. A rule will not do, as they can be circumvented. Instead need to learn the conservatism of the former Bundesbank.

 

 

THE GORDON BROWN EFFECT

 

The impact of the Brown high-spend era was to run a budget defecit when the government should have been running surpluses. Whilst talking about prudence, Gordon Brown assumed that we had done away with recessions for ever. The most important change that he instigated was changing the rule

 

FROM :-

  “Balance the budget over the business cycle”

 

TO :-

  “A deficit only for investment”

 

The “GORDON BROWN EFFECT” in public finance, is the changing of the rules to suit the moment, whilst maintaining the perception of continuity.

Just posted to Iain Dale’s Diary on the current crisis

Just posted the following is response to Brown Tries to Sugar the Medicine on Iain Dale’s Diary.

 

The PM evades understanding the issues, as he is to some extent responsible. However, that responsibility is shared by many, including myself, who cheered on the cuts in interest rates in 2000 and 2001 to avoid a recession.

The independance of the Bank of England was irrelevent to the issue. The vast majority believed that after the dot.com bubble burst and then after 9/11 it was necessary to reduce interest rates significantly to avoid a recession. This worked, but only at the expense of creating a credit bubble, shown in this country both by the housing market boom, and being able to borrow on credit cards at 0% interest. The only one of the commentators who comes close (in my view) to getting things right is “not an economist”

The PM not only followed public opinion as Chancellor, but also the most respected minds in the business, lead by Alan Greenspan at the Fed.

To blame the private banks is nonsense. The structure in which they operated by created by the Central Banks, cheered on by governments and the general public.

 

THE LESSON TO BE LEARNT.

 

  Central banks must be dogmatically conservative and deaf to public opinion.

 

In so far as we know how the economy operates, it is always going to be tainted by the need to please public opinion and their elected representatives. Further, a can-do approach is more popular than one that says we are not sure, or maybe it could cause trouble. But collectively, we did not see this one coming.

 

Gordon Brown to Raid Pensions (again)?

In one of his first acts as Chancellor, Gordon Brown raided the UK pension funds. Now as John Redwood MP points out, this might be happening again. 

Just Posted to John Redwood’s blog in response to this comment on 8th December

 

There is something else to be worried about pensions. With the government forcing down real interest rates, the returns on pensions will also go down. That is the pot accumulated to retirement will be much less (due to compound interest) and the returns that the annuity will give will be much less.

 

Those pension funds holding bonds will get a one-off boost every time the interest rates go down, but the impact of pension funds having to hold ever-larger quantities of their funds in near zero-return assets will create the following problems.

1) The pension deficits will balloon, just as companies see operating profits plunge with the recession. The government will have to nationalize the pension funds, to save the businesses.

2) Many people will try to put off retirement, just as the workforce is shrinking. The government will have to subsidize people’s pensions

3) Many financial institutions will be unable to meet existing annuity payments (if those funds are affected), so may offload this onto new annuity quotes, or ask the government to bail them out.

 

The general thinking that we should be lowering interest rates to near zero should be re-visited. With plunging house prices, and the prospect of losing their jobs, folks are not going to buy houses, or incur more debt at the moment. You are right, Mr Redwood in saying that we should reverse the VAT reduction early. However, along with a few spending cuts, this may be much too little, too late.

 

I would like to substantiate this view with a quick calculation.

How much will annuity rates be affected if the average return was changed. I did a quick spreadsheet calculation, looking at the annuity rates for a £100,000 lump sum for different rates of return.

 

I came up with this table.

 

    Return % Annuity % Income £
    1% 3.29% 3,287
    2% 3.71% 3,708
    3% 4.16% 4,159
    4% 4.64% 4,637
    5% 5.14% 5,142
    6% 5.67% 5,673
    7% 6.23% 6,226
    8% 6.80% 6,801

 

 

   

     The assumptions are listed below, but the basic point that I want to illustrate is that if the average long-term rate of return diminishes, then so will the average payout from the annuity. (The returns do not decrease as quickly, as an annuity eats up some of the capital each year.) If the weighting of lower-yielding, secure bonds is increased and the yield on the new bonds is decreased, then returns on annuities will decrease alarmingly.

In the long-term, if interest rates then go up after a few years of low rates and increasing proportions of bonds to equities, then the value of the pension funds will drop with the fall in bond values. This will more than offset the short-term boost that they got when the interest rates fell.

 

   The old fashioned method of resorting to the printing presses will come none too quick. According to Guido Fawkes the government is already laying the ground for this eventuality.

 

 

The assumptions are

1)     25 year assumed span.

2)     One payment annually and one fixed return at end of the year.

3)     Rate of return is constant.

4)     Income rises by 3% per year.

5)     Management fee of £200 rising by 3% per year.

Her Majesty’s Disloyal Opposition Commit Treason?

Comment just posted in response to this blog, at LabourHome to the idea that Her Majesty’s Loyal Opposition should be accused of treason for talking down the currency.

    To accuse the Tories of treason in talking down sterling would also imply that there comments are heard and taken into consideration. If I were a currency trader, the opinions of an opposition party I would not rate nearly as highly as specialist economists, respected journalists, the Chairman of the Fed, the IMF etc. Further, I would allow for some bias in their views.
    More importantly, I would base my judgements real factors, such as the state of the British financial sector, the current account deficit, or the ability of the government to steer the economy away from the rocks.
Is Peter Kenyon so in awe of the opposition that he believes their comments can be anything more than the splash of a small pebble against a Tsunami?

In brief, it is only a serious act of disloyalty if it has an impact. If nobody takes the oppositions comments seriously in their actions, it will have no impact on the course of sterling or the economy.