The past week has seen the inevitable short term rally in the pound, with it back up to $1.48 as I write. Regardless of short term market moves the UK economy seems to be moving dangerously towards the economic left, with government suddenly being the solution to market failure. When times are good every ones a Capitalist, but when harder times are felt, everyone suddenly finds that inner Marx. State spending is increasing with greater swathes of the UK economy being incorporated into the state. It's getting nearly as bad as the former Soviet satellite countries. There have been suggestions of a peoples bank. Whats the point? The Government already owns most of the private sector banks. Suggestions of a 3-day week have been mentioned, as though we should keep people employed in sectors where there is a lack of work to do. Strikes are back, marking the renewal of class antagonisms. The IMF has warned that the UK will face the worst recession since the Great Depression, with contraction the largest of the developed nations. British manufacturing is declining at a worrying rate, with the balance of payments going from bad to terrible. Even with our imports shrinking our exports are declining at a quicker pace, making the deficits larger. The Governments budget deficit for this year is already around £100bn and lord knows what it will be when its all added up at the end of the financial year. Still the Halifax housing stats were on up this month so we all best buy a house before the next housing boom, as though they come around every other year.
The UK seems like one big sinking ship at the moment. In a previous post I mentioned if we begin drinking vodka and smoking cigars you know we really are in trouble. Well we are well and truly heading that way, so get worried. The markets are getting the jitters with these perilous policies, with gilt strikes becoming common discussion. The bond market is one big bubble, and like any bubble will find a pin and burst. Whether the yields on bonds have to rise in order to attract buyers or as the government becomes ever more desperate and broke just decides to print up the money remains to be seen. Either way, we haven't even got started into this credit crunch. The interest on the current government debt is already a great burden with low treasury rates, but imagine the costs with double digit interest rates.
The printing of money is mentioned on the news bulletins, as though this was a sound economic theory, one in which will help us out of this mess. A belief that we can print our way to prosperity. On that account Zimbabwe must currently be the most prosperous country on the planet, even if they are slowly abandoning their currency. 'Economists' are defending these actions with statements that the central banks don't like to refer to it as printing money. Well what else is it?
A key concept in economics is unintended consequences, or secondary effects. With all the news of government bailouts it must seem like free money to people. I'm sure there are some deluded individuals who actually think the government keeps a nice pot of money that it can spend when it needs. In reality this isn't the governments money, this our future earnings, our money, our children's future. Its not government bailouts, its public bailouts. When the government spends or increases its debt, it in turn takes capital from the private sector. It crowds out the private sector by consuming scarce capital for bonds, instead of this capital being used for productive investment in the private sector. The more the government borrows, the more of a burden it is on the private sector and the more it crowds out free markets. In other words we get less bangs for our bucks, which causes further stagnation as inefficient government expands along with keeping broken business models afloat at the expense of good business. There's also the issue whereby more of our government debt is being bought by foreigners, as we have little internal savings. Interest payments rather than remaining in our country get sucked out, meaning less surplus capital available for ourselves. It really does worry me how low our savings as a nation have been in recent times, and the lack of productive investments we make with it (in recent years whatever capital we had got put into housing - not a wealth producing industry).
Well at least the Bankers are still getting their bonus
This is to be expected, in my opinion. There's no incentive to not give out bonuses, as the government has ruined the markets various pricing mechanisms. What surprised me was an article written by Robert Preston, defending these recent bonus announcements. Here are some quotes from the article in question.
"So the fear of the bank's board is that if it were to pay no bonuses, tens of thousands of its employees would be demotivated and all its best bankers would quit to go to rivals."
Well this whole banking bailout saga is an immoral and a tragic reflection on the state of British society, but I will accept the current state of affairs for what they are for the sake of this article. The first statement regarding attrition of staff, well this is what businesses do when they are loosing money - they put pay on hold and try and bring up the natural attrition rate, thus avoiding expenses such as redundancy. When I worked for EDS, a large US IT Services Company, they employed this policy as they were working on wafer thin profit margins, so had to reduce their headcount. And guess what? The best staff left as they went to the market to search for other work. So let these 'financial wizards' leave, the same ones who helped cause the current rot. What banking rivals are taking on staff anyway? Financial engineering is going to be in decline for sometime, indeed it needs to shrink as it expanded disproportionately compared with the economy. I doubt many other financial firms will be recruiting.
"But we shouldn't forget that RBS is a complicated global business with more than £2000bn of assets."
Complicated? What business isn't these days. Whats complicated about what RBS has to do at the moment? It has to stop lending, increase retail deposits and sell off what it can get for these '£2000bn' of 'assets'. Of course we should read, were worth '£2000bn' and liabilities for the above.
"It would be in our interest, presumably, to sell our 70% stake back to the private sector for a profit one day - and that would be impossible unless RBS were perceived to be a commercial success."
It's that mention of profit again. Forget about profit, lets just try and get half the taxpayers money back and I would be happy. Profit is already near impossible unless the UK decides to become the next China. A culture change that takes generations.
"That leaves more than 176,000 staff across the world who've worked hard and generated valuable profits."
For one they should be happy they have their jobs. And who doesn't intend to go to work and do a good job or not work hard? No one gets up and says to themselves "You know what, I'm going to make sure I really do a bad job today and see how counterproductive I can be". We all work hard, but it doesn't mean we should get a bonus. A bonus is all about giving people an extra incentive to meet company targets. If the company makes a loss, then the company goes bust eventually. So staff can't get bonuses if the company can't make a profit to their shareholders. RBS should be bust, so it should be grateful it is still around.
It's damaging enough that the real productive economy is to be burdened with these huge bank bailouts, but giving bonuses is just rubbing salt in the wounds and sowing the seeds for further public discontent. Banking is a sideshow, a middle man, an intermediary, whatever you want to call it. It's job is to direct capital to the areas of the economy that needs it, therefore assisting the tuning of the markets pricing mechanism and directing productive investments. With this in place, the real economy can do its job and provide goods and services for us all generating wealth. Paying traders millions of pounds in bonuses to buy low and sell high is not how it's supposed to work. In a free market with sound money, it wouldn't work like that, but it's too late for that now. We are in a hole and need to stop digging.
Alternative to saving the banks
The question is what are the alternatives within the current system? What would happen if we let the banks fail? This is the other option that I have been suggesting and the answer is a lot of short term pain. First you have the question of what happens to savers money, how would the banks pay back the savers? The government cover up to £50,000 so a great deal of savers would be covered by this, however the value of the countries savings is another matter. In short the government would have to cover a large amount, but no different to say the banks liabilities they have decided to cover recently. Savers should always be covered first. Of course the reality is, the banks don't have your savings. If only a small fraction of savers went to take out their money, the banks actually wouldn't be able to pay. Like in any fractional reserve system, once the credit contraction process kicks in, its inevitable that the banks can't pay out so look for government and central bank support, or further lines of credit. Its the elasticity of our current monetary system. Just as it expands very rapidly during the inflationary boom, it can contract just as violently during the bust. People also can't pay back loans, which is destroying the real savings people have. This is being replaced by all these bank bailouts, robbing Peter to pay Paul, essentially one big fraud. If the banks did default on peoples savings like they did throughout history, maybe people would start to question our current system. Maybe the alternatives out there could begin to be seriously discussed and a more fair and stable system could take its place.
When the government decided to prop up the banking sector, beginning with the collapse of Northern Rock this immediately began distorting the market. Once the government guaranteed all Northern Rock deposits this gave the bank a monopolistic competitive advantage over the other banks. So the public began taking their money out of the other British banks, like RBS, HBOS etc and putting it into Northern Rock. With a quiet run on these other banks, they had to go to the government to get assistance, in which the government had already helped Northern Rock so why not the other banks. Therefore we find ourselves in a position where the government, or us the taxpayer has taken on the risk of all the banks junk assets, all through the original bailout. This is in turn has sent the signal out to external investors, who we have become incredibly reliant on in recent years, that the UK is insolvent.
If we did let the banks fail wouldn't this ruin the creditability of London as a 'financial center of the World'? Of course it would, but what do you think the world thinks at the moment? All the bailouts have done is bought time. It's not fixed anything. It draws out this mess, inflicting further costs on the real economy, as other economic sectors earnings are used just to prop up the insolvent banking system. In case you haven't noticed, its not getting any better, in fact we are just starting the defaults that are about to occur here in the UK. And there is a whole lot of bad debt out there.
A classic historic example of letting the banks fail and not fail is Japan. Before the great eighties bull run Japan had a serve recession, where the government let the market take control. Banks went bust, huge amounts of liquidation ensued and at the time it looked as if the economy was going to collapse. This cleared out all the excesses, all the bad business models and set the economy on a sound footing. The subsequent years saw one of the greatest bull markets in history. Japan during the eighties was turbo charged, exporting huge amounts of goods and ideas, becoming a technological and business process leader. In films such as Back to the Future II, the future was portrayed as Americans working for Japanese firms, as their dominance looked inevitable. Then the 89'/90' bust set in. Rather than letting the market clear the excesses, the government decided to prop everything up. It began government programs, spending huge amounts of money, crowding out private investment. The hallmark of huge government debt is still there in Japan today. House prices and stock prices are still down over half their price than two decades earlier. Japanese business stagnated during these years, known as the lost decade (however as time has passed its now become the lost two decades). The UK is now preventing the liquidation, propping up weak businesses and creating artificial interest rates thus preventing the market realignment of capital goods to consumer goods.
History is repeating itself. It always does. Just like all recent economic crises, laissez faire, free market economics will take the blame, as we enter the Blame Game. These socialist polices, as though the market is always inherently wrong, will again take hold. I'm not a doomer or a prophet of doom that thinks humanity is heading on a course of destruction. I do however pay attention to economics and history and understand what happens when nations embark on polices like the ones we are seeing now. People are still clinging to the past prosperity they had, believing that this crisis will turn around at the end of the year and we can enjoy another decade of imminent wealth that the baby boomers believe is their right. There is no free lunch. We will have to pay for the previous years of wasteful consumption for decades to come. I was bearish before the bailouts and interventions began, but now I can see clearly that its going to get a whole lot worse. How bad depends on if people wake up to what is really happening. In my Blame Game post back in June before all these bailouts happened I suggested we would embark towards stagnation. The final paragraph of that post seems to fit more and more as time goes on.
"The key to the success of our nation will depend on the next 5-10 years. If we play the blame game I feel our economy and many other western economies will become stagnant for a longer period then the usual length of an economic cycle. If however we all accept part of the stupidity that has gone on and decide to work, invest, open our minds and produce creative goods and ideas, we will see a newer improved nation. In my opinion however, our mind set has changed drastically over the past generation and old habits die hard - stagnation for a considerable time seems more likely as time goes on."
Blame Game
“Government cannot make man richer, but it can make him poorer”
Ludwig von Mises
“Manufacturing and commercial monopolies owe their origin not to a tendency imminent in a capitalist economy but to governmental interventionist policy directed against free trade and laissez faire.”
Ludwig von Mises
The UK seems like one big sinking ship at the moment. In a previous post I mentioned if we begin drinking vodka and smoking cigars you know we really are in trouble. Well we are well and truly heading that way, so get worried. The markets are getting the jitters with these perilous policies, with gilt strikes becoming common discussion. The bond market is one big bubble, and like any bubble will find a pin and burst. Whether the yields on bonds have to rise in order to attract buyers or as the government becomes ever more desperate and broke just decides to print up the money remains to be seen. Either way, we haven't even got started into this credit crunch. The interest on the current government debt is already a great burden with low treasury rates, but imagine the costs with double digit interest rates.
The printing of money is mentioned on the news bulletins, as though this was a sound economic theory, one in which will help us out of this mess. A belief that we can print our way to prosperity. On that account Zimbabwe must currently be the most prosperous country on the planet, even if they are slowly abandoning their currency. 'Economists' are defending these actions with statements that the central banks don't like to refer to it as printing money. Well what else is it?
A key concept in economics is unintended consequences, or secondary effects. With all the news of government bailouts it must seem like free money to people. I'm sure there are some deluded individuals who actually think the government keeps a nice pot of money that it can spend when it needs. In reality this isn't the governments money, this our future earnings, our money, our children's future. Its not government bailouts, its public bailouts. When the government spends or increases its debt, it in turn takes capital from the private sector. It crowds out the private sector by consuming scarce capital for bonds, instead of this capital being used for productive investment in the private sector. The more the government borrows, the more of a burden it is on the private sector and the more it crowds out free markets. In other words we get less bangs for our bucks, which causes further stagnation as inefficient government expands along with keeping broken business models afloat at the expense of good business. There's also the issue whereby more of our government debt is being bought by foreigners, as we have little internal savings. Interest payments rather than remaining in our country get sucked out, meaning less surplus capital available for ourselves. It really does worry me how low our savings as a nation have been in recent times, and the lack of productive investments we make with it (in recent years whatever capital we had got put into housing - not a wealth producing industry).
Well at least the Bankers are still getting their bonus
This is to be expected, in my opinion. There's no incentive to not give out bonuses, as the government has ruined the markets various pricing mechanisms. What surprised me was an article written by Robert Preston, defending these recent bonus announcements. Here are some quotes from the article in question.
"So the fear of the bank's board is that if it were to pay no bonuses, tens of thousands of its employees would be demotivated and all its best bankers would quit to go to rivals."
Well this whole banking bailout saga is an immoral and a tragic reflection on the state of British society, but I will accept the current state of affairs for what they are for the sake of this article. The first statement regarding attrition of staff, well this is what businesses do when they are loosing money - they put pay on hold and try and bring up the natural attrition rate, thus avoiding expenses such as redundancy. When I worked for EDS, a large US IT Services Company, they employed this policy as they were working on wafer thin profit margins, so had to reduce their headcount. And guess what? The best staff left as they went to the market to search for other work. So let these 'financial wizards' leave, the same ones who helped cause the current rot. What banking rivals are taking on staff anyway? Financial engineering is going to be in decline for sometime, indeed it needs to shrink as it expanded disproportionately compared with the economy. I doubt many other financial firms will be recruiting.
"But we shouldn't forget that RBS is a complicated global business with more than £2000bn of assets."
Complicated? What business isn't these days. Whats complicated about what RBS has to do at the moment? It has to stop lending, increase retail deposits and sell off what it can get for these '£2000bn' of 'assets'. Of course we should read, were worth '£2000bn' and liabilities for the above.
"It would be in our interest, presumably, to sell our 70% stake back to the private sector for a profit one day - and that would be impossible unless RBS were perceived to be a commercial success."
It's that mention of profit again. Forget about profit, lets just try and get half the taxpayers money back and I would be happy. Profit is already near impossible unless the UK decides to become the next China. A culture change that takes generations.
"That leaves more than 176,000 staff across the world who've worked hard and generated valuable profits."
For one they should be happy they have their jobs. And who doesn't intend to go to work and do a good job or not work hard? No one gets up and says to themselves "You know what, I'm going to make sure I really do a bad job today and see how counterproductive I can be". We all work hard, but it doesn't mean we should get a bonus. A bonus is all about giving people an extra incentive to meet company targets. If the company makes a loss, then the company goes bust eventually. So staff can't get bonuses if the company can't make a profit to their shareholders. RBS should be bust, so it should be grateful it is still around.
It's damaging enough that the real productive economy is to be burdened with these huge bank bailouts, but giving bonuses is just rubbing salt in the wounds and sowing the seeds for further public discontent. Banking is a sideshow, a middle man, an intermediary, whatever you want to call it. It's job is to direct capital to the areas of the economy that needs it, therefore assisting the tuning of the markets pricing mechanism and directing productive investments. With this in place, the real economy can do its job and provide goods and services for us all generating wealth. Paying traders millions of pounds in bonuses to buy low and sell high is not how it's supposed to work. In a free market with sound money, it wouldn't work like that, but it's too late for that now. We are in a hole and need to stop digging.
Alternative to saving the banks
The question is what are the alternatives within the current system? What would happen if we let the banks fail? This is the other option that I have been suggesting and the answer is a lot of short term pain. First you have the question of what happens to savers money, how would the banks pay back the savers? The government cover up to £50,000 so a great deal of savers would be covered by this, however the value of the countries savings is another matter. In short the government would have to cover a large amount, but no different to say the banks liabilities they have decided to cover recently. Savers should always be covered first. Of course the reality is, the banks don't have your savings. If only a small fraction of savers went to take out their money, the banks actually wouldn't be able to pay. Like in any fractional reserve system, once the credit contraction process kicks in, its inevitable that the banks can't pay out so look for government and central bank support, or further lines of credit. Its the elasticity of our current monetary system. Just as it expands very rapidly during the inflationary boom, it can contract just as violently during the bust. People also can't pay back loans, which is destroying the real savings people have. This is being replaced by all these bank bailouts, robbing Peter to pay Paul, essentially one big fraud. If the banks did default on peoples savings like they did throughout history, maybe people would start to question our current system. Maybe the alternatives out there could begin to be seriously discussed and a more fair and stable system could take its place.
When the government decided to prop up the banking sector, beginning with the collapse of Northern Rock this immediately began distorting the market. Once the government guaranteed all Northern Rock deposits this gave the bank a monopolistic competitive advantage over the other banks. So the public began taking their money out of the other British banks, like RBS, HBOS etc and putting it into Northern Rock. With a quiet run on these other banks, they had to go to the government to get assistance, in which the government had already helped Northern Rock so why not the other banks. Therefore we find ourselves in a position where the government, or us the taxpayer has taken on the risk of all the banks junk assets, all through the original bailout. This is in turn has sent the signal out to external investors, who we have become incredibly reliant on in recent years, that the UK is insolvent.
If we did let the banks fail wouldn't this ruin the creditability of London as a 'financial center of the World'? Of course it would, but what do you think the world thinks at the moment? All the bailouts have done is bought time. It's not fixed anything. It draws out this mess, inflicting further costs on the real economy, as other economic sectors earnings are used just to prop up the insolvent banking system. In case you haven't noticed, its not getting any better, in fact we are just starting the defaults that are about to occur here in the UK. And there is a whole lot of bad debt out there.
A classic historic example of letting the banks fail and not fail is Japan. Before the great eighties bull run Japan had a serve recession, where the government let the market take control. Banks went bust, huge amounts of liquidation ensued and at the time it looked as if the economy was going to collapse. This cleared out all the excesses, all the bad business models and set the economy on a sound footing. The subsequent years saw one of the greatest bull markets in history. Japan during the eighties was turbo charged, exporting huge amounts of goods and ideas, becoming a technological and business process leader. In films such as Back to the Future II, the future was portrayed as Americans working for Japanese firms, as their dominance looked inevitable. Then the 89'/90' bust set in. Rather than letting the market clear the excesses, the government decided to prop everything up. It began government programs, spending huge amounts of money, crowding out private investment. The hallmark of huge government debt is still there in Japan today. House prices and stock prices are still down over half their price than two decades earlier. Japanese business stagnated during these years, known as the lost decade (however as time has passed its now become the lost two decades). The UK is now preventing the liquidation, propping up weak businesses and creating artificial interest rates thus preventing the market realignment of capital goods to consumer goods.
History is repeating itself. It always does. Just like all recent economic crises, laissez faire, free market economics will take the blame, as we enter the Blame Game. These socialist polices, as though the market is always inherently wrong, will again take hold. I'm not a doomer or a prophet of doom that thinks humanity is heading on a course of destruction. I do however pay attention to economics and history and understand what happens when nations embark on polices like the ones we are seeing now. People are still clinging to the past prosperity they had, believing that this crisis will turn around at the end of the year and we can enjoy another decade of imminent wealth that the baby boomers believe is their right. There is no free lunch. We will have to pay for the previous years of wasteful consumption for decades to come. I was bearish before the bailouts and interventions began, but now I can see clearly that its going to get a whole lot worse. How bad depends on if people wake up to what is really happening. In my Blame Game post back in June before all these bailouts happened I suggested we would embark towards stagnation. The final paragraph of that post seems to fit more and more as time goes on.
"The key to the success of our nation will depend on the next 5-10 years. If we play the blame game I feel our economy and many other western economies will become stagnant for a longer period then the usual length of an economic cycle. If however we all accept part of the stupidity that has gone on and decide to work, invest, open our minds and produce creative goods and ideas, we will see a newer improved nation. In my opinion however, our mind set has changed drastically over the past generation and old habits die hard - stagnation for a considerable time seems more likely as time goes on."
Blame Game
“Government cannot make man richer, but it can make him poorer”
Ludwig von Mises
“Manufacturing and commercial monopolies owe their origin not to a tendency imminent in a capitalist economy but to governmental interventionist policy directed against free trade and laissez faire.”
Ludwig von Mises
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