Sunday, October 19, 2008
Bank rescue won't stop the misery index rising
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


Economic numbers will never be the same again. A trillion here, a trillion there and soon you are talking about real money. The bank rescue pales everything else into insignificance, even if it has not yet calmed jittery markets.

Gordon Brown's blueprint is big, though his critics hate any credit going to him. After all, if you take some of those critics at face value, he created the American subprime crisis, told bankers to behave irresponsibly and set up a regulatory system that uniquely failed to spot this coming.

It is about as daft as the new fashion for blaming Bill Clinton, or even Jimmy Carter, for the American subprime lending boom of 2003-7 that triggered the crisis.

Not only has the prime minister enjoyed a political triumph beyond Downing Street's wildest dreams but the Organisation for Economic Co-operation and Development (OECD), not always a friendly voice, said last week Britain's tax burden was lower than in other EU countries and the corporate-tax regime was competitive.

Brown's critics should be more charitable. Normal political service will be resumed, and British leaders who get rave reviews abroad, from Winston Churchill to Margaret Thatcher and Tony Blair, tend eventually to get pummelled at home.

Anyway, the rescue numbers are large. It is not sensible to lump together bank recapitalisations, additional central liquidity and government guarantees of bank lending. You can get some very big figures but they do not tell us much.

But just look at the scale of the recapitalisations alone long-term taxpayer stakes in organisations that until a few weeks ago would have regarded such things with as much enthusiasm as a drunk being invited to a temperance evening. If we take just four countries, admittedly the biggest four affected, America, Germany, Britain and France, they have between them announced $500 billion (285 billion) of government capital injections into their banks and the process may not be over.

Typically, government guarantees of bank lending, which are dependent on banks being adequately capitalised, are five times the amount of the capital injections.

This is a big moment. But it is not the end of capitalism or the start of a new era of nationalisation. Intent is important. Neither George Bush's Republican administration nor Brown's new Labour government wanted to part-nationalise anything. All are doing it reluctantly, and of necessity.

The aim will be to sell these shareholdings back into the market as quickly as possible, ideally with a profit for the taxpayer. It was, however, a recognition that there are times when the normal tools of central banking are not adequate.

"Lender of last resort", used by the Bank of England for Northern Rock more than a year ago, is fine as far as it goes. In this situation we had to have a supercharged version going beyond bank liquidity and into solvency and capital.

As for the death of capitalism, this is the end of an extreme version of market behaviour, built around financial engineering. We are certainly moving towards more controlled banking, but we are not heading for central planning and state control of the economy's commanding heights.

The question I am asked most often about this is: What about the public finances? How can we possibly afford all this?

Maurice Fitzpatrick of Grant Thornton points out that Britain's public debt position, which is better than in any other G7 country, is a big advantage. Even a UK debt to GDP figure of between 40% and 50% of gross domestic product, which Alistair Darling is likely to admit to in his pre-budget report next month, is half the G7 average of 93%. America is on 61%, Germany 63%, France 64%, Canada 68%, Italy 104% and Japan a huge 195%.

As for the budget deficit, John Hawksworth of Price Waterhouse Coopers, notes that partial nationalisations (taxpayer stakes in banks) should be treated in an equal but opposite way to privatisations. They do not add to public-sector net borrowing the favoured definition of the budget deficit just as privatisations did not reduce that deficit. They are, in the jargon, below-the-line financial transactions.

This means they do not put pressure on the chancellor to raise taxes or cut spending. In his pre-budget report Alistair Darling may announce some "reprioritisation" of spending bringing some capital expenditure forward. But he will not cut projected medium-term growth of current or capital spending. The Treasury, indeed, argues the recapitalisation will leave the economy less vulnerable to what could have been very abrupt deleveraging by the banks reining back debt and exposure to risk.

What will hit the public finances is the economy. Figures this Friday will show the first quarterly drop in GDP since April-June 1992. Technical recession is, as they say, "baked in" to the economy, the question being whether it will be significantly worse than that, as the stock market fears.

I have referred here before to the misery index, devised by Arthur Okun, calculated by adding up the inflation and unemployment rates. It has just risen and now stands at 10.9%, its highest since 1996.

We probably do feel more miserable and worried than then. Are we more miserable than during the last recession, when for a time both inflation and unemployment were close to 10%, meaning an index almost double its present level?

One half of the index, inflation, will fall rapidly now, particularly with the price of oil and other commodities plunging. Capital Economics even thinks that next year inflation will turn to deflation.

Unemployment, however, will continue to generate misery. Last week's reported rise of 164,000 to 1.79m in the June-August period was bigger than expected and the largest increase since 1991. It may have been boosted by the failure of students to land vacation jobs during the summer.

But the trend is unmistakeable. John Philpott, chief economist at the Chartered Institute of Personnel and Development, is concerned that his forecast of a 2.25m total by the end of next year is now looking optimistic. That measure of unemployment peaked at 3.2m in the mid-1980s and was above 2m from 1980 to well into 1997. The hope has to be that its return to those levels is short-lived. The fear is that getting back to low unemployment will take a long time.

PS: Are we taking this crisis seriously enough? This week's Sunday Times' bestseller list shows that the book-buying public is not yet getting into the crunch, preferring celebrity autobiographies. Parky, by the former chat-show host, and Dear Fatty, by Dawn French, are preferred to economic dramas. Not a single crunch-related book makes a showing.

In America the new book about Warren Buffett, The Snowball, tops the New York Times non-fiction list. Whoops, by Alan Greenspan, and Investing the Goldman Sachs Way, by Hank Paulson, are doing well. Only joking about those two. Mind you, on Amazon's UK list JK Galbraith's The Great Crash, 1929, first published 53 years ago, is back in the top 100.

Somebody will write a great book about this episode. Whether it endures as long as Galbraith's classic remains to be seen.

From The Sunday Times, October 19 2008