Well now, as they say in East Yorkshire where I live: here I am being skewered by my own writing.
In his response to my earlier blog item, Harry_w centrally points out:
“Over the course of New Labour’s decade, high interest policy described in the [Ramsay] article changed towards a cheap money policy which propelled rampant asset price inflation, and the collapse of that bubble has prompted bipartisan support for state intervention to prop up market values (esp. housing). Externally, these market interventions have been balanced by a passive devaluation of sterling of around 30%.”
This is true. The article of mine which is being quoted was written in 1998 and things have changed. And the story of how we got there is interesting.
In the early days of New Labour and the ‘freedom’ given to the Bank of England to set interest rates (and the duty to maintain the government’s inflation rate policy) it did seem clear that the Bank of England would take the orthodox road: keeping interest rates relatively high (compared to the euro zone and the dollar), producing two consequences: (relatively) high interest rates which would keep domestic inflation down by depressing domestic demand and maintaining enough unemployment too keep wages from rising; and keeping import prices low via an overvalued currency. This was the stability – that is price stability – so highly prized by Chancellor Brown.
This was Brown believing he had to show the electorate that Labour had learned the lessons of the mid-1970s and would never again be the party of inflation; and Brown believing he had to show the City that he had accepted the supply-side arguments from his mentors at Harvard University in his visits to America in the early 1990s: that there was nothing to be done in the global economy except maintain price stability and try to make the workforce employable through education and training.
All of which could be represented thus: the City wanted comparatively high interest rates to attract money to London (and make domestic loans profitable); and the ‘fight against inflation’, using interest rates, was the rationale which produced that end.
What nobody foresaw in 1998 was the circumstances which produced the current mess.* Brown’s policy – the City’s policy – was based on the assumption, learned in the 1970s, that the basic tendency against which the economic system has to guard was inflation. (The rejection of Keynes which the arrival of monetarism in the 1970s signified was the shift from the fear of deflation and depression to the fear of inflation.)
* But with the emergence of the economies of the developing world in the 1990s, notably China and India, and their production of cheap manufactured goods, and with the trade unions smashed in the 1980s, the threat of inflation disappeared and what we might call the Primark effect occurred: imports were cheap and in some cases getting cheaper.
* With no threat of cost inflation, the Bank of England was obliged to embark on a policy of cutting interest rates. This encouraged people to borrow. Unencumbered by any controls on their lending, the banks enthusiastically encouraged people to borrow, as well as creating and trading every more complex ‘derivative’ financial instruments, CDOs etc.
* With Labour unwilling to allow local authorities to build houses, and the private and housing association sectors unable to build enough houses to meet the demand (which was being increased by immigration, notably from the enlarged EU), house price inflation continued.
* As housing costs had never been included in the central indices of domestic inflation this did not figure on the headline inflation figure. For those in jobs and owning houses (which was 70% of the population by 2000), the house provided the collateral for loans from banks and building societies and the consumer boom of the last few years began in earnest.
Thus the British economy was on its way towards one trillion pounds sterling of personal debt – about one year’s gross domestic product.
It was also running an ever increasing external trade deficit which didn’t seem to matter. In the 1960s and 70s such a deficit would have sent the value of the pound down – the international value of the currency rose and fell with trade deficits and surpluses – but with the advent of computerised currency trading in the 1980s, currency dealers, the people who determined the international value of currencies, were less interested in the existence of trade surpluses or deficits than they were in the relative rates of return offered by currency holdings. As long as London was offering – say – 0.1 of a US cent more than other currencies on deposits, who cared about the trade deficit? The currency trading desks of the world’s banks – many of them in London – began driving the world economy.
The blame lies squarely on the regulatory authorities; and, above them, the politicians. In other words, the fault is entirely that of Gordon Brown, who has been in charge of the British financial system since 1997. He has repeatedly blamed American bankers, but many of whom are in London taking advantage of this government’s ‘light touch’ regulation.
There are two things I think of particular note. The first is something I noted in Lobster 53, Summer 2007, and I reproduce it here.
Steady Eddie blows the gaff
e learn from the former Governor of the Bank of England, Lord Edward George, that, faced with the prospect of recession ‘at the beginning of the decade’, the Bank’s Monetary Policy Committee (MPC) encouraged house prices and personal debt to rise. Speaking to the House of Commons Treasury Committee George said, inter alia:
‘In the environment of global economic weakness at the beginning of this decade……….. external demand was declining and related to that business investment was declining. We only had two alternative ways of sustaining demand and keeping the economy moving forward: one was public spending and the other was consumption….. But we knew that we were having to stimulate consumer spending; we knew we had pushed it up to levels which couldn’t possibly be sustained into the medium and long term. But for the time being, if we had not done that the UK economy would have gone into recession just as had the United States. That pushed up house prices, it increased household debt.’
In other words, the MPC cut interest rates in a situation which, by their criteria, did not justify it. This is a fairly startling admission. In acting this way the MPC was doing precisely what it was designed to prevent politicians from doing: trying to maintain demand in the economy by tweaking interest rates and stimulating consumer spending. In his letter to the Bank of England in May 1997, ‘The new monetary policy framework’, announcing the formation of the MPC and setting out its terms of reference, Brown referred to Labour’s manifesto commitment that they would ‘ensure that decision-making on monetary policy is more effective, open, accountable and free from short-term political manipulation’. (emphasis added) ‘Short term political manipulation’ is precisely what Eddie George is describing. Gordon Brown gave away the right of the chancellor of the exchequer to do this when he created the MPC. As it turns out, at the first sign of recession the MPC behaved just like any demand management ‘Keynesian’ politician of the type that was supposed to have been made extinct in the Thatcher years – with one huge difference: before Mrs Thatcher the government would have used public, state spending to create demand in the domestic economy; the MPC have used credit card debt and borrowing against the value of houses in a striking innovation in the annals of ‘Keynesian’ demand management. In 1976 Prime Minister James Callaghan became notorious on the Labour left for his speech to the Labour Party conference in which he stated that it was no longer possible to spend your way out of a recession. Lord George is boasting/admitting that the MPC did precisely that. But at what cost?Well, we know now what the cost was. (Not that this mess can be entirely blamed on that Bank of England decision.)
The second point worth noting is that a committee of the Bank of England did, in fact, warn of the impending crisis and was ignored. In the Telegraph of 30 December 2008 Edmund Conway reminded readers of an earlier Telegraph report on the Bank of England’s 2006 Financial Stability Report which warned of the possibility of a credit crunch, collapse of the housing market and destruction of bank capital.