When J M Keynes used the term ‘madmen in authority’ he was referring to his contemporary equivalents of David Cameron and George Osborne. At the end of last year, though he talked about it incessantly, it was clear that Cameron had limited understanding of the need to rebalance the economy – see http://www.gordonpearson.co.uk/09/mr-cameron-doesn%e2%80%99t-understand/. The real business of making and distributing things for people to use and consume creates real jobs. But Cameron didn’t seem to understand the difference between that real economy and the speculative, bonus driven financial sector. He said he understood, but then always succoured up to his friends in the City.
His lack of understanding, or his duplicity, seems only surpassed by fellow Bullingdon intellectual and purveyor of the greatest budget shambles in living memory, Chancellor George Osborne.
The financial columns have recently suggested full state ownership of RBS was being discussed by senior ministers and treasury officials. It would cost around £5bn. But Osborne was against it. A rational objection was that it would mean taxpayers taking on full responsibility for the bank’s toxic debts, as opposed to the 82% responsibility they already have. But Osborne’s real reason was his dogmatic focus on cleaning RBS ready for sale back to the private sector, even though that won’t happen any time soon. Only Vince Cable has come out publicly in favour of nationalisation so as to boost lending to industry, especially innovative SMEs, in order to get the real economy moving again.
Since Thatcher, UK economic policy has been strictly conforming to an undergraduate understanding of the Austrian school, notably Hayek and Friedman, the ‘scribblers of a few years back’ as Keynes put it. Their neo-liberal economics generated a multitude of simplistic text book policy prescriptions. For instance, the then Transport Secretary, Philip Hammond awarding the £1.4bn Thameslink contract to Germany’s Siemens rather than Derby based Bombardier, causing the loss of 1400 jobs. It was done on the grounds of Hammond’s fervently expressed belief in ‘free trade and open markets’. As Defence Secretary he’s cut the army manpower by 20%, and is no doubt aching to get on with outsourcing the rest.
The same dogma leads Osborne to be in thrall to ‘the markets’ and therefore to the ratings agencies, Standard & Poor’s (S&P), Moody’s and Fitch. They’re the people who declared, among much else, Enron to be safe a few days before it went bust, who gave subprime mortgages a triple A rating which was a major cause of the financial crisis we still face, and who gave a similar clean bill of health to all manner of deliberately opaque financial “products” whose ingredients no one could know. Time and again they have been shown to be utterly incompetent or crooked, or both, and many times over the past few years have been shown to be not very clever, at least not very good at credit rating. But George Osborne still rates them. No matter that when S & P downgraded the US government, treasury yields actually fell to record lows rather than rising as a result of the supposed higher risk. If Osborne were to sanction £5bn expenditure on nationalising RBS, S & P might not like it and threaten to downgrade UK, and Osborne still quakes in his boots at the thought of losing the triple A.
For the same reason Osborne finds it impossible to contemplate putting money directly into innovation, in sustainable technology development and modernised efficient infrastructure. The ratings agencies might not like it, so better to keep the austerity clamp on tight even if it means throwing people out of work – no pain no gain.
A state owned bank focused on investing in the real economy to boost real jobs has been long discussed in the USA, home of the New Deal, where, despite the Tea Party and oddball Republican presidential candidates, policy options are still considered more pragmatically than in UK. Robert Skidelsky and Felix Martin made the case for a National Investment Bank (New York Review of Books, 30.3.11) to help maintain investment while at the same time cutting the deficit. They suggested a nationalised bank might achieve this while contributing to national policy objectives—such as the promotion of exports, the repair and development of infrastructure, and the efficient reduction of carbon emissions. The same might be achieved in UK with the 82% ownership of RBS – no real need for full nationalisation – requiring it to serve as a national investment bank. That change in role might restore some confidence in the economy – the key issue – by demonstrating that the Bullingdon intellectuals had, after all, some understanding of how things work.
But a national investment bank wouldn’t fit their free market, open access text book. For them quantitative easing (QE) remains the answer: money provided to the banks, to enable them to use their additional financial muscle to lend to businesses to create real jobs. The first round of QE had no discernible effect on the real economy. So a second round was implemented which was similarly ineffectual. So a third insanity confirming round was therefore implemented last month, an additional £50bn, bringing the total to an outrageous £375bn. All to no effect. Predictably. With the economy in recession, even innovative SMEs would try to avoid increasing their debt if they possibly could. Pouring more money in was, as Galbraith said, like trying to push the economy with a piece of string. Not until businesses see a brighter future ahead will they see benefit in borrowing more than is absolutely necessary. Blind persistence with QE fills no one with confidence.
Osborne ordered the banks to lend. They didn’t. So the Merlin agreement was constructed which set lending targets for banks. It was ignored. So the National Loan Guarantee Scheme was set up. It failed. So they devised the Funding for Lending scheme which will also certainly fail, because the only businesses who want to borrow are those who have no alternative. And on any rational analysis they will be recognised by banks as bad bets, unlikely to survive.
So if it hasn’t been lent to real businesses, where has all that £375bn gone to? The banks were pretty well all caught with their pants down when the crisis struck, most were insolvent and required massive external support. So first priority was to rebuild their own balance sheets. This has been an interminable process. As more progress has been made, the banks have found it feasible to own up to ever more of the junk and toxic debts they took on during the credit bubble. Hopefully that process will end sometime soon. In addition, considerable sums have had to be paid out in fines for crooked behaviour, such as mis-selling financial products and corruptly fixing markets. As well as those misuses of funding, there have also been a variety of hugely expensive trading cock-ups.
The remaining funds, not much in demand from real businesses till the economy picks up, are funnelled into the speculative investment banking activity. For all the talk of ‘ring-fencing’ retail from investment banking, nothing has been, or will be, done. Ring-fencing is a euphemism for doing nothing. Complete separation of investment from retail banking is the only way control could be regained. The investment banking arms engage in all sorts of skulduggery, betting on the opaque swaps and derivatives which caused the problem in the first place, but which are still available, largely unregulated, and promising quicker and higher returns than lending to any real economy widget maker or distributor.
Moreover the vast bulk of investment bank trading is now automated, carried out by computers and computer programmes without any interference by an actual human being. Around 75% of trades on the London stock exchange are conducted by ultra-fast systems of the kind which landed Knight Capital Group in trouble as reported by the Financial Times on 3rd August: ‘a $440m pre-tax loss from erroneous trading positions triggered by a software glitch that led to huge price swings in dozens of stocks.’ The FT went on to note that the ‘trading glitch highlights the dangers associated with high speed computerised trading, which has transformed the equity market in recent years and was pinpointed as a substantial factor in the May 2010 “flash crash”.’
Elsewhere, Georgetown Professor James Angel was quoted saying we ‘are all still vulnerable to all kinds of glitches, no matter what changes and precautions we make, there will always be an unanticipated scenario.’ He recalled an old bumper sticker which read: ‘To err is human, but to really foul up requires a computer’. Some commentators have asserted that ultra-fast trading will in the end ‘blow up Wall Street’. And London won’t be far behind.
Not only is high speed automated trading inherently unstable, but if ever business confidence returns and there is real demand for credit to grow, automated trading will continue to suck resources away from the real economy into speculative short term investments. It is not just socially useless, but hugely damaging. Moreover, it has destroyed the nature of shareholding which used to be on the basis of long term interest, but is now down to an average holding period of a few months and in many cases a matter of minutes or even seconds.
This all looks a bit of a mess. Ultra-fast automated trading threatening to blow up Wall St and the City of London as well as sucking investment out of the real economy. The failure of quantitative easing to do more than rescue banks from the disaster they themselves created. The continued ill-founded faith in ‘the market’ with the only apparent protection being through the demonstrably incompetent and careless ratings agencies. Nothing that the Bullingdon intellectuals have done so far gives any grounds for confidence. Their economic thinking is stuck in an era that is long past.
But there are some upsides. Enough of RBS is already in public ownership to convert it into an effective vehicle for government investment policy and practice. Retail and investment banking could be separated – anything short of complete separation will not prevent funds leaking from one activity to the other when one activity is in dire need of support. RBS could be used as a model for separation, with the investment activity disposed of separately.
Ratings agencies could be regulated so that false rating became a punishable offence. Their responsibilities could be treated as audit responsibilities should be treated.
The means of constraining the speculative financial sector, and in particular ultra-fast trading, has already been recognised with the suggestion of a financial transactions tax. It has only previously been discussed as a general tax on all transactions, but it could be made more discriminating. Firstly, tax could be levied on automated transactions. That would have the dual effect of slowing such transactions and making them less profitable. Secondly it could be levied on all transactions on synthetic opaque ‘products’ such as swaps and derivatives, again reducing their attractions. The proceeds from such arrangements could then be funnelled through the RBS national investment bank to energise the real economy.
If only our madmen in authority would throw away their free trade and open access text book and think critically about what might actually work!