Read John Redwood's summary of the Spear's Talk he gave at the Henley Literary Festival on Sunday, October 4 “For the private sector to be too much in debt may be careless. For the public sector to be too much in debt may be inconvenient. For the banking sector to be too much in debt might be worrying. For all three to be too much in debt at the same time is dangerous.”
FOR THE PRIVATE sector to be too much in debt may be careless. For the public sector to be too much in debt may be inconvenient. For the banking sector to be too much in debt might be worrying. For all three to be too much in debt at the same time is dangerous.
That is the position of the UK today. The boom phase encouraged excess debt in the private sector. Now individuals are busily repaying credit card debts, mortgage advances are well down on peak levels, companies are being forced to repay debt out of cash flow and asset sales or raise more money from shareholders. The private sector has been told in no uncertain terms to spend less and pay back more. The message is reinforced by high interest rates on most private borrowing, by scarce credit, and tough banks.
The government also used the boom to expand its borrowing, particularly off balance sheet. It set up lots of expensive Public Private Finance Initiatives, Public Private Partnerships and other routes to disguise public borrowing. It expanded its workforce and raised public sector salaries substantially, greatly increasing the public sector pensions deficits, and the costs of future unfunded pensions. Since the Credit Crunch it has expanded its conventional borrowing massively.
The banks,encouraged by their Regulators who allowed bank balance sheets to balloon, expanded their lending and then multiplied its effects through a large number of new complex financial instruments.
As a result we have a country weighed down by huge debts. The challenge for the next government is to help all sectors chart a course out of excess debt.
The private sector will adjust its own demands. There is already evidence of people doing just that, with credit card and mortgage lending falling. This process will unfortunately be speeded by the increases in unemployment that are happening, and by the interest rate rises to come.
THE BANKING SECTOR can also cut its leverage . The government owner of two major banks sbould be tougher in demanding cost reductions, asset sales and other mechanisms to get these banks into a stronger shape more quickly without recourse to public subsidy. The UK economy will not work well until the banks work well. RBS and Lloyds have been treated too generously, delaying the necessary cost adjustments and business improvements they need to make.
Which leaves the government sector. The three largest political parties all now agree that government needs to cut its spending. All agree that government can be more efficient and should strive to do more for less. Each party has identified a few items which they would like to see cut out of budgets altogether. That is a start.
The problem is the magnitude of the tasks. If markets are to remain optimistic there needs to be a clear course for cutting these excessive borrowings. A strong economic recovery would help curb all three deficits, swelling personal incomes, adding to company profit and cashflow, cutting the numbers unemployed and helping banks win profitable business.
This can only happen if there is world confidence in the economic policies being pursued. The treble deficit strategy is a high risk one. If these three deficits are not visibly coming down soon, it will mean higher interest rates and more difficulty for the UK to borrow money, which will be bad for the recovery as well as for the main borrowers. Something will be squeezed. At the moment it is the non bank private sector.
You cannot solve a crisis brought on by borrowing too much, by borrowing more. You cannot solve a banking crisis by simply transferring all the losses and dodgy debts to the taxpayer. You cannot sustain a recovery on excess public spending and borrowing.
The problem now is crowding out. The government is putting everything through the public sector, starving the private sector of the cash and credit it needs to get moving again. The main risk is that markets will lose confidence in government borrowing and in the currency at some point, devaluing the pound more, forcing higher interest rates and more cuts.
The government has to help the country tackle the treble deficits – past excess credit in the private sector, present and future excess borrowing in the public sector, and broken and over extended banks. You cannot have a sustainable recovery until the banks are mended and able to advance money to the private sector again in sensible quantities at affordable rates.
SO WHAT DOES the government need to do?
1. End the requirement on the banks to make such a large increase in their holdings of government debt. Higher bank liquidity should wait until the banks have worked out more of their bad debts and have strengthened their capital more through retained profits, asset sales and share issues.
2. End quantitative easing. The Bank's strategy is punishing the pound and pushing up asset and commodity prices very early in the cycle.
3. Implement a first round of sensible reductions in spending. At the very least it should end new pay awards to the public sector,reform welfare to encourage more back to work, and put on a staff freeze on all non front line posts.
4. Bring forward asset sales, and accelerate the transfer of banks back to the private sector, splitting up the monoliths.
5. End the idea of government insurance for the bad debts of the banks and make them find private sector solutions to those problems.The authorities would continue to act as lender of last resort and to stand behind the deposit guarantee scheme.
This is likely to include the weaker banks raising more capital from markets and selling more assets as a matter of urgency.
The present strategy appears to be more political than economic. It is based on spending large sums in the public sector, ensuring the money can be raised by a combination of making the banks lend to the government and through printing the cash. This I assume is designed to last until the election. The government now acknowledges cuts will be needed in due course to help correct the deficit, but wants us to believe the spending has to go on to bring about recovery.
The truth is there can be no sustained recovery unless markets and lenders see the deficit is being brought under control. No government can go on printing so much and demanding so much lending from the banks . The result today is not a decent recovery, but a private sector finding life much tougher than private sectors elsewhere already into recovery.
The private sector is waiting for reality and waiting nervously to know how more bills it will be expected to take on from the public sector. Present policy is just for an election, not for a sustained recovery to bring jobs and prosperity.
Read more about the crisis at www.johnredwood.com