When there is no consensus among the experts, it is hard to know whether the appropriate response is intellectual excitement, or foreboding. Last week I had two conversations, one with a broker, the other with an MP. They might have taken place in different worlds.
The stockbroker was hopeful. He thought that the markets would continue to recover, for three reasons. First, there would be fewer distressed sales. It is easy to turn shares into cash. In recent months, mini-rallies had been aborted because shareholders had been forced to sell to placate their banks. That phase was now largely over. Second, there was a great deal of cash around, looking for a home. A lot of rich investors had been waiting until the market was off the bottom: they were unlikely to wait much longer.
Third, a fair few brokers were feeling embarrassed. They had missed the recent twenty per cent rise; they did not want to miss the next one. Even if the Thundering Herd is extinct, the herd instinct is always very powerful in the City. My stockbroker friend had only one serious worry. A Tory, he was afraid that the recovery might come in time for Gordon Brown. As for the latest instalment of quantitative easing, the stockbroker thought it not only unnecessary, but incomprehensible.
The Tory MP was less interested in macro-economics. As far as he was concerned, the recession was alive, well, and manifesting itself throughout his constituency. He had high streets with two shops in five empty. His mail was full of hardship cases. He said that an average day's post seemed to consist exclusively of letters from struggling businessmen and from the employees whom they were sacking. He could see no sign of recovery. It may be that in London, pricey restaurants were still full of rich foreigners and their friends. But that told us nothing about the other 99.99 per cent of the population. Recovery in time to save Gordon Brown? He was worried whether it would come in time to save David Cameron in 2014.
That raises a point of equal relevance to politicians and economists. How quickly will a market-led recovery spread outwards from the indices and the rich who benefit from them into the normal world in which most people do their getting and spending? No economic model can give a confident answer to that question, for one good reason. Underlying it is an even more important question, and as fascinating a paradox as has ever troubled the economists and the markets.
Everyone agrees on one point. This crisis was caused because credit exploded out of control, permitting grossly excessive borrowing by governments and individuals. With some admirable exceptions, such as HSBC, the banks were caught up in the frenzy. Old-fashioned prudential banking was disregarded, in favour of Wernher von Braun's approach, at least in the Tom Lehrer version. "Once the rockets are up, who cares where they come down? That's not my department, says Werhner von Braun."
Much of the public has now concluded that the problem was caused by bankers' greed, as exemplified by their bonuses. But that is only a small part of the picture. On both sides of the Atlantic, politicians were to blame. In Britain, there was a reckless increase in state spending. In the US, Congress passed laws to prevent mortgage-lenders from enquiring into their customers' circumstances. In some cases, this was idealism: a desire to help poor folks escape from the trailer-park and buy their own place. In others, it was cynicism: using the banks to bribe their constituents. If they had not been earning bonuses for selling the mortgages, the bankers might have done more to complain.
Now, solutions are more important than complaints. If excessive credit caused the problem, the answer would appear to be simple: a curb on lending, with the aim of reducing the debt burden and increasing the savings ratio. In the case of the Government, the curbs would take the form of fiscal austerity: spending cuts and higher taxes. But none of that is as easy as it sounds. All modern economies depend on credit: on people's willingness to turn future income into current expenditure. If that ceased to happen, there would be a collapse in domestic demand, leading to still higher unemployment and declining tax revenues – in effect, what is already happening.
Government expenditure creates similar difficulties. The British Government is spending far, far too much. We face the highest budget deficit that any advanced economy has suffered in peacetime. Unless drastic action is taken, the current level of public expenditure could lead to a sterling crisis, a gilt-buyers' strike, an appeal to an already overstretched IMF: a collapse in economic activity and confidence whose malign consequences would endure for years. Yet even wasteful state spending stimulates economic activity. It creates jobs and jobs create incomes, which finance domestic expenditure and tax payments.
So there is an inescapable question. How can we improve the savings ratio and reduce government spending without an economic implosion? This is one of the hardest questions which any peace-time government has ever had to answer. David Cameron will almost certainly have to do so, one reason why he is doomed to greatness. Success would make him a great Prime Minister, setting the highest standard for his successors over the rest of this century. Failure would leave him down there – with Gordon Brown.
Given the scale of the task, it is easier to side with my MP friend – and with the Bank of England – than with my stockbroking one. Caution would appear to be the order of the day, and the Bank's willingness to inject so much extra cash indicates that it does not endorse the markets' optimism. It may seem to be another paradox, but in deciding on quantitative easing, Mervyn King and his team are also adopting a monetarist approach. The monetarists have always argued that the Great Depression was deepened and lengthened by an excessively tight monetary policy. So as the British economy is now suffering from monetary contraction, and especially from a sharp fall in the velocity of circulation, it is necessary to print money.
That would appear to be the Governor's assessment. Although one or two Tories have grumbled that he is merely watering Gordon Brown's green shoots, nobody in the Labour party regards Mr King as an ally. Over his time in office, he has proved his political disinterestedness. Whether his assessment is right, wrong or somewhere in between, he made it on economic grounds, not political ones.
We cannot solve our problems by stasis; the Japanese have demonstrated that. Ultimately, the economy will have to grow its way back to health. But in the short and medium run, it will also have to cope with the consequences of past excess. How can that be reconciled? It is a bit like trying to cure a cancer patient, while also training him for next year's marathon. Alan Greenspan spoke of "irrational exuberance". Could he have been describing a British politician who wants to win the next election?Reuse content