Some Contrarian Ideas

Liam Halligan has a bit of an iconoclastic piece in the Telegraph today. In it he takes on fiscal stimulus and regulatory reform. I find myself agreeing with some of his points and on the fence with regard to some others.

Quantitative Easing

This column has long-argued the Western world’s policy reaction to “sub-prime” has been wrong. In my view, the grotesque fiscal bail-outs and the money printing, the ongoing assumption financial regulation could be tweaked rather than reformed wholesale, have made our collective predicament much worse.The consensus view, far from grappling with the technical and political difficulties of implementing the required policy response, has failed even to admit the extent of the problem. Yet such an admission is a prerequisite, the first step in fact, of doing what needs to be done.

For almost two years now, our leaders have been in denial, burying the details and delaying the really tough decisions. In recent weeks, though, something has changed.

For the first time since the credit crunch hit the headlines in August 2007, reality is punching through. Powerful people are breaking ranks and saying what needs to be said. Pretty soon we may even begin tackling the root causes of this debacle by facing down the vested interests and making the changes necessary to rescue the Western world from years of economic stagnation.

Earlier this month, Angela Merkel, the redoubtable German Chancellor, took a stand and appealed for “a return to policies of reason” – calling time on “quantitative easing”, the deeply misguided policy that has seen Western central banks double the size of their balance sheets to buy government debt.

QE was always a ruse to recapitalise insolvent banks by the back door, so their powerful executives could avoid admitting previous mistakes. Yet it has shattered the world’s faith in the West’s policy-making competence. It has destroyed any authority we had to tell economies elsewhere what to do.

QE will result in high inflation – in turn, destroying investment and jobs. And it will mean that, for years to come, Western taxpayers pay higher interest charges to service our government’s debts.

Here I find myself in agreement. I would quibble that the need for stabilisation of the system at the onset required unconventional steps but now that stability appears to have been reestablished it is indeed time to back off and assess our direction.

I realize that there is a continuing debate as to whether inflation or deflation is the bigger threat. I’ve read many of the opinions on either side of the argument and have yet to be convinced that inflation is not going to be the scourge that revisits us. While it might not now be a threat, that reality will only continue so long as the Fed perfectly times it’s change in policy stance and perfectly engineers a reduction in the money supply. To suppose that is going to happen is a case of hope triumphing over experience.

We have a central bank that has lost a great deal of trust among the political class as well as a piece of its independence. It has shown a reticence over the past decade to tackle difficult problems with agressive monetary action and there is little reason to suspect that it will act boldly when faced with the need to tighten. Even if it did begin to behave atypically, it is likely to run into a storm of protest which I doubt it has the will to resist. In the end inflation and a pretty severe dose of it is probably our fate.


King also stated “it is not sensible to allow large banks to combine high street retail banking with risky investment banking or funding strategies, and then provide an implicit state guarantee”.

These words echoed around the world. The Governor is calling for a re-instatement of the “Glass-Steagall” firewall – the removal of which allowed investment banks to merge with commercial banks. That meant taxpayer-backed deposits could be used by bonus-fuelled traders to make high-risk bets – in the knowledge the state would have to fund a bail-out given that ordinary voters deposits were involved.

By calling for a new “Glass-Steagall”, King is taking on Wall Street and the City – among the world’s most powerful vested interests.

Yet, politicians need to realise it’s precisely because this safeguard was removed, and the “universal banks” became so big, that what started as a banking crisis has become a fiscal crisis – a crisis so severe that some of the world’s leading nations could default and, at the very least, several generations of Western taxpayers will be saddled with the bill.

Here I find myself in complete agreement. There needs to be a great debate about once separating investment and commercial banking. The combination can by the evidence to date judged to be a failure. The institutions that were spawned by the elimination of the divide have grown too large and complex. They are both too big to fail and too big to manage.

Much of the debate in the U.S. has centered around making banks smaller. Reinstituting the distinction between the two types of banking would largely eliminate that need. Yes, you would still be left with very large commercial banks but the nature of their activities would entail much less risk and the tightly coupled systemic relationships would be relaxed. In effect, failure of one or more of them would be a more remote possibility and much less cataclysmic if it did occur.

At the same time, investment banking should be put back where it properly belongs. In smaller, preferably employee owned institutions that are free to innovate and take risk certain in the knowledge that failure would indeed mean failure. Though the government might be required to step in to avert emergencies, preservation of the franchise would not be an outcome.

Public Employees

Some state employees work hard – and we’re lucky to have them. But, in general, public-sector workers enjoy shorter hours, longer holidays, better job security and higher wages than their private-sector counterparts.

Yet 90pc of public-sector workers also have gold-plated final-salary pensions, compared to only 10pc in the private sector. They retire earlier too.

Our ageing society means most of us will reach for our slippers later and on lower pensions than previously thought. But state workers remain immune to economic reality – at everyone else’s expense.

The costs of this injustice are vast. Between 2001 and 2008, our public sector pension liability officially grew 110pc to £794bn. A new Policy Exchange report by Neil Record puts the true figure at a staggering £1,104bn.

This massive debt doesn’t appear on the Government’s balance sheet. Yet each year taxpayers spend more on public sector pensions than defence. By 2040, the annual bill will approach what we spend on the NHS.

Though this is written from a distinctly British standpoint,the thesis applies equally to the U.S. If the country emerges from the current recession with a chronically high unemployment rate, I have the feeling that the compensation and fringe benefits enjoyed by public sector employees could emerge as a contetious issue. State and local government employees in many states have been called upon to bear some of the burden of declining revenues. I think that the general populace recoginizes this while at the same time noting that the federal government has shown no propensity to either restrain its growth or request any sacrifice from its employees.

Many private sector workers have seen their self-directed retirement funds devestated by the recession and loss of asset values. A dynamic of government workers slipping comfortably into retirement while private sector employees find that goal deferred or possibly unattainable would not be tenable particularly if more tax dollars are required to make good on public sector pension promises.

An aside, here, I think that as more 50 year old and up are required by circumstances to remain in the workforce, the issue of age discrimination is going to explode. Several articles have recently danced around the subject but I feel that this has the potential to become a serious inter-generational issue.


Last week, leaders of four of the world’s largest economies – Brazil, Russia, India and China – met in Yekaterinburg, Russia. Known as the BRICs, these vibrant nations now account for almost 20pc of global GDP – the same as the United States.

Even this startling figure understates the importance of the BRICs, and the emerging markets (EMs) more generally. Together, they now drive 42pc of global GDP – and rising. That outstrips the US and EU combined.

Over the next few years, as the Western world stagnates, the EMs – with their low debts and highly productive workforces – will keep growing. Global investors largely agree. That’s one reason the world’s top 10 performing share indices so far in 2009 are all EMs.

Crucially, EMs now boast two-thirds of the world’s foreign exchange reserves. The BRICs control the lion’s share of that haul.

For the most part, the Western media has dismissed this first BRIC summit as “unimportant”. That’s partly because the G7 nations weren’t invited. The reality is the BRICs’ emergence on the world stage is transforming global commerce – and politics too.

These countries are crucial Western creditors. Insolvency looms, unless they keep funding our spiralling government debts. Western leaders need to grow up and realise the world has changed. If we don’t accept the emerging giants at the top table, they’ll create their own – resulting in a less prosperous, more dangerous world.

Here is probably where I disagree the most. I don’t discount the importance of the BRICs or the EMs nor do I believe that their growth is going to continue on a steep upward curve. I simply don’t think that growth can occur without healthy economies in the developed world. Absent the U.S. and some other major economies consuming the production of these countries their future is much less certain than Mr. Halligan asserts.

Yes, they do hold enormous foreign exchange reserves but those holdings make them as much captive as captor. New relationships among currencies will no doubt develop over time but it is going take years if not decades for that to materialize. In the meantime, the saber rattling on the part of the Chinese and Russians serves no useful purpose and might well work to their disadvantage. Even wounded dragons can still breathe fire.

Well this turned into quite a discourse. There are a lot of big ideas that Mr. Halligan touches upon. I think that he’s right in his assertion that the Western governments have essentially been trying to reestablish the status quo ante rather than going at the roots of some fairly serious problems that call out for fundamental reform. In not doing so, they set the stage for a larger disaster or the metamorphasis of Western democracies into something that we might not find quite so pleasant.

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