Andreas Whittam Smith: Amid the gloom and doom, I've a small piece of advice to offer

What should savers do now that inflation is dropping like a stone? Buy government bonds

Share
Related Topics

I can see what is going in the economy, both here and elsewhere. A dangerous downward spiral has taken hold. But it is a very tough question how to stop it. As you read on, you may find it hard to believe that I consider myself one of nature's optimists. In a Colonel Blimp-like manner, I tend to say, "Brace up". Every problem has a solution; you just have to find it.

Yet this economic crisis concerns me deeply. I can see answers to the smaller questions. Some 15 months ago when the difficulty was what to do about Northern Rock, I wrote here: it's bust, quickly nationalise it. Ask me how the regulation of financial institutions might be much better done and I, like countless other people, can make suggestions.

What should savers do now that inflation is dropping like a stone? Buy government bonds. I took my own advice some weeks ago and the result is so far so good. But I should be embarrassed were I to bump into the Chancellor and he asked me what should be done. I would probably cough and splutter and say that he might have to do something exceedingly unusual and perilous.

I am not alone in uncertainty, as the reaction to yesterday's further cut in interest rates by the Bank of England demonstrated. Here we have the Bank reducing Bank Rate by half a point to 1.5 per cent, the lowest level since the Bank was founded over 300 years ago. Even so, economists scratch their heads and wonder whether it will do any good.

Turn to the Bank of England's explanation of its decision and remember that this crisis began in August 2007. In the 17 months that have passed since then, central banks and governments around the world have been doing all they can to bring it to an end. They have even nationalised half their banks – or, as good as done so. And yet this is the result.

"The world economy," states the Bank, "appears to be undergoing an unusually sharp and synchronised downturn." In other words, what governments and central banks have done so far has been useless. "In the United Kingdom," the statement goes on, "business surveys suggest that the pace of contraction in activity increased during the fourth quarter of 2008 and that output is likely to continue to fall sharply during the first part of this year." It's getting worse, then. "The availability of credit to both households and businesses has tightened further." Which is to say that the sharp cuts in interest rates, the recapitalisation of the banks, the lectures from the Chancellor and the Prime Minister have achieved absolutely nothing.

There are in fact two downward spirals, the first having caused the second. The former is the relentless unwinding of over-borrowing by financial institutions and consumers alike. Only now do outsiders learn to what extreme levels did hedge funds and others take their ratios of borrowing to capital. It was quite common to buy securities with £30 of borrowed funds for every pound of capital. In some case the ratio reached 100 to 1. These professional financiers were even more reckless than home-buyers, who themselves were able to raise 100 per cent mortgages that exceeded their ability to repay except on the most optimistic scenarios.

This great unwinding is still going on. It has a double whammy effect. As heavy borrowers are forced to sell, they depress the values of similar assets and at the same time, unless they have got huge reserves tucked away, they land their banks with heavy losses. This is one reason why the banks are reluctant to make many new lending commitments; they have to get shot of their dud loans first.

You see the results of this process in housing markets on both side of the Atlantic. Prices are still falling with no evidence of any kind of rebound. In commercial property, the story is the same. In stock markets, every time there is a rally, the forced sellers take their opportunity and prices fall back again. This is exactly what has happened in the past few days – the market stronger last week but down again yesterday and the day before.

This is in turn why the Madoff scandal is so damaging. It creates an extra layer of panic. Bernard Madoff, a quiet force on Wall Street for decades, was arrested and charged before Christmas with allegedly running a $50 billion "Ponzi scheme" under which existing investors' returns were stolen from new investors' funds. This debacle is forcing withdrawals elsewhere, which gives an extra twist to the downward cycle.

While we can turn our backs on this doomsday machine in the financial markets, we are all involved in the second spiral. For whenever we cautiously and properly reduce our own outlays in response to the darkening prospects, the famous "preparing for the rainy day", we depress economic activity by an infinitesimal amount that, multiplied across the whole population, gives a further downward push to the economy.

Here is an example. On Wednesday, for instance, a pizza chain and a high street bakery both said how well they were doing while on the very same day, Thorntons, the high-class chocolate maker and retailer, said that it was struggling. If Thorntons has to reduce its staff, you could say that it will have been the thrifty customers of the pizza chain and the high-street bakery that will have done the deed despite their honorable intentions.

Why, though, should we face these dangers now on a scale unequalled since the 1930s? It has not been like this in our lifetimes. In response I would say that overtrading in the banking and financial markets reached an unprecedented level. That the inevitable unwinding has sucked credit out of the economy as never before with a consequent collapse of activity and that consumers, having been well alerted to the dangers ahead, are cutting out what they would now see as unnecessary spending.

As to the question the Chancellor might ask, I remember that I am due to attend a reception at 11 Downing Street later this month, so I may be put to the test. I would argue, first of all, that the attention being given to encouraging the banks to increase their lending is misplaced. The problem is surely unwilling borrowers rather than unwilling lenders. There are plenty of creditworthy customers of banks, whether companies or private people, but they don't want to take on fresh borrowing at this time. Companies will have less need of working capital as activity declines and there is less requirement for long-term borrowing as expansion is postponed. Ditto private customers in their new, frugal mood.

That leaves only the exceedingly unusual and perilous course of printing money. I am glad the Treasury is studying how this might best be done. But it may be that the risks of suddenly stimulating hyperinflation are too great. In which case, it would be best to admit that the recession will just have to take its course, long and bitter experience though that would be.

a.whittamsmith@independent.co.uk

React Now

  • Get to the point
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
iJobs Job Widget
iJobs General

Ashdown Group: Front-End UI Application Developer

£30000 - £40000 per annum + Benefits: Ashdown Group: Front-End UI Application ...

Recruitment Genius: Digital Account Executive

£18000 - £26000 per annum: Recruitment Genius: They work with major vehicle ma...

Recruitment Genius: Service Engineers - Doncaster / Hull

£27000 per annum: Recruitment Genius: Domestic Service Only Engineers are requ...

Recruitment Genius: Employability / Recruitment Adviser

£23600 - £27500 per annum: Recruitment Genius: The Employability Service withi...

Day In a Page

Read Next
 

South Africa's race problem is less between black and white than between poor blacks and immigrants from sub-Saharan Africa

John Carlin
Queen Elizabeth II with members of the Order of Merit  

Either the Queen thinks that only one in 24 Britons are women, or her Order of Merit is appallingly backward

Janet Street-Porter
Where the spooks get their coffee fix: The busiest Starbucks in the US is also the most secretive

The secret CIA Starbucks

The coffee shop is deep inside the agency's forested Virginia compound
Revealed: How the Establishment closed ranks over fallout from Loch Ness Monster 'sighting'

How the Establishment closed ranks over fallout from Nessie 'sighting'

The Natural History Museum's chief scientist was dismissed for declaring he had found the monster
One million Britons using food banks, according to Trussell Trust

One million Britons using food banks

Huge surge in number of families dependent on emergency food aid
Excavation at Italian cafe to fix rising damp unearths 2,500 years of history in 3,000 amazing objects

2,500 years of history in 3,000 amazing objects

Excavation at Italian cafe to fix rising damp unearths trove
The Hubble Space Telescope's amazing journey, 25 years on

The Hubble Space Telescope's amazing journey 25 years on

The space telescope was seen as a costly flop on its first release
Did Conservative peer Lord Ashcroft quit the House of Lords to become a non-dom?

Did Lord Ashcroft quit the House of Lords to become a non-dom?

A document seen by The Independent shows that a week after he resigned from the Lords he sold 350,000 shares in an American company - netting him $11.2m
Apple's ethnic emojis are being used to make racist comments on social media

Ethnic emojis used in racist comments

They were intended to promote harmony, but have achieved the opposite
Sir Kenneth Branagh interview: 'My bones are in the theatre'

Sir Kenneth Branagh: 'My bones are in the theatre'

The actor-turned-director’s new company will stage five plays from October – including works by Shakespeare and John Osborne
The sloth is now the face (and furry body) of three big advertising campaigns

The sloth is the face of three ad campaigns

Priya Elan discovers why slow and sleepy wins the race for brands in need of a new image
How to run a restaurant: As two newbies discovered, there's more to it than good food

How to run a restaurant

As two newbies discovered, there's more to it than good food
Record Store Day: Remembering an era when buying and selling discs were labours of love

Record Store Day: The vinyl countdown

For Lois Pryce, working in a record shop was a dream job - until the bean counters ruined it
Usher, Mary J Blige and Will.i.am to give free concert as part of the Global Poverty Project

Mary J Blige and Will.i.am to give free concert

The concert in Washington is part of the Global Citizen project, which aims to encourage young people to donate to charity
10 best tote bags

Accessorise with a stylish shopper this spring: 10 best tote bags

We find carriers with room for all your essentials (and a bit more)
Paul Scholes column: I hear Manchester City are closing on Pep Guardiola for next summer – but I'd also love to see Jürgen Klopp managing in England

Paul Scholes column

I hear Manchester City are closing on Pep Guardiola for next summer – but I'd also love to see Jürgen Klopp managing in England
Jessica Ennis-Hill: 'I just want to give it my best shot'

Jessica Ennis-Hill: 'I just want to give it my best shot'

The heptathlete has gone from the toast of the nation to being a sleep-deprived mum - but she’s ready to compete again. She just doesn't know how well she'll do...