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Tuesday, 11 October 2011

Dustbowl Britain: The New Depression

YES, it’s official: this could be worse than the Great Depression of the 1930s – men slumped on street corners and kids with bare feet.

Inflation, fascism and economic war in Europe. “This is the most serious financial crisis we’ve seen at least since the 1930s, if not ever,” says Sir Mervyn King, governor of the Bank of England.

Now, I may be missing something, but isn’t this just the kind of alarmist headline-grabbing remark that central bankers are supposed NOT to make in case it spooks the markets? It’s people like me who are usually criticised for resorting to sensational forecasts about Great Depressions and the like. The commentariat is being done out of a job by the godfather of prudence. Whatever happened to “Keep Calm And Carry On”?

The Prime Minister, David Cameron, is said to be livid. Only 24 hours before King forecast the end of civilisation as we know it, Cameron had told the country to “bring on the can-do optimism”. Well, not in the Bank of England, clearly.

It’s hard not to read this as an implicit condemnation of government economic policy. At the very least, the PM and his Chancellor look as out of touch as the Labour PM, Jim Callaghan, when he said “crisis, what crisis”, just as the International Monetary Fund was about to take over the reins of the British economy in 1976.

So what has spooked Mervyn? Well, it’s the Greeks isn’t it, stupid? Actually, it isn’t the Greek default – it’s us. Mervyn’s panic attack coincided with the news that ratings agency Moody’s had downgraded the status of a raft of British banks just as inter-bank lending was seizing up.

Essentially, Moody’s is warning people with money in banks including Royal Bank of Scotland, Santander, Lloyds and so on that they might not get it all back. Why? Because the banks are becoming stressed again, just like 2008, and there is no chance that this time the Government will have the will or the means to bail them out. There’s very little public money left and the economy is slowing to a halt, which will make it hard for the Government to pay its own debts, let alone that of the banks.

The bailout of the UK banks in 2008-09 required £1.3 trillion, according to Mervyn King’s own figures. And what did we get for putting up all that money? Well, Stephen Hester of RBS got £11 million last year. Bank bonuses accounted for another £13 billion. The rest disappeared into the bowels of our rapacious financial institutions.

So what now? Well, if there isn’t any public money, let’s just print some. The last round of quantitative easing – creating more money – placed £200bn in the banks’ accounts in 2009.

What happens is this: the Bank of England electronically creates money, which it uses to buy bonds from the banks. This injects funds directly into the banks’ balance sheets, wiping out their losses and “restoring the health of the financial system”. The money is supposed then to be loaned to small businesses and people wanting mortgages, thus boosting economic growth.

Except that this didn’t happen. The banks hoarded it instead and paid themselves huge bonuses. All QE1 really succeeded in doing was increase inflation to 5%, which is generally what happens when governments print money. This has eroded people’s savings, pensions and salaries, meaning that they haven’t been buying much in the shops. Which in turn is why the economy is sliding back into recession. Britain has one of the lowest growth rates in the OECD and has one of the highest fiscal deficits. Stick that in your budget, Mr Osborne.

So why on earth is the governor printing another £75bn of QE? It looks like the economic equivalent of blood-letting: a pointless medical procedure that only weakens the patient. This is the great unanswered question of the age: why are policy-makers unable to see any solution to economic crisis that doesn’t involve stuffing the mouths of bankers with gold?

When historians look back at this period they will criticise governments for inactivity, short-termism and denial. But they will condemn them utterly for throwing oceans of public money at the very people who caused the crisis and were least to be relied upon to resolve it.

Instead of handing money to banks, in the vain hope that it will boost economic activity, why doesn’t the government hand it to poor people?

I’m not joking. At least lower-income groups can be relied upon to spend the cash in the high streets – in shops like Tesco, which has just announced its worst sales figures for 20 years. Give them VAT rebates, interest-free loans, tax “holidays”, elderly care grants, home improvement loans – anything to get money into the system.

Giving liquidity to people who don’t have it is the surest possible way of boosting economic activity. QE is like trying to get the car started by giving money to oil sheiks in Saudi Arabia.

Of course, the bankers would respond that, yes it’s all very well giving money to people other than us. But if you don’t hand over your cash, we’ll just go bust like Lehman Brothers, and that will cause a global financial and economic collapse. Ha ha.

And of course, they’re right – they are too big to fail. If, say, RBS went under, the shockwaves would be so great that bank lending would halt overnight. This means that companies which depend on short-term loans from banks to manage their accounts would go under too. International trade would freeze because there would be no credit for exporters.

There would also be a run on the banks, as happened in October 2008, when people and businesses withdrew their cash from banks like Northern Rock and HBOS because they didn’t believe their funds were safe. In 2008, according to the then chancellor, Alistair Darling, Britain was 24 hours away from the ATMs closing and people being denied even cash withdrawals.

Could we really be going back to all that? Well, yes – the Belgian-French bank, Dexia, has just gone bust for the second time in three years because people started withdrawing funds at an unsustainable rate and its share price collapsed. It could be the first of many, and governments cannot bail them all out.

Which means that if you are lucky enough to have more than £85,000 in any one bank – the limit of the deposits guaranteed by the government’s deposit insurance scheme – then you’d be well advised to get it out sooner rather than later.

I know that sounds alarmist,

inflammatory, but listen closely, and that’s what the Guv’nor is saying.

But there is an alternative. Instead of pouring more printed money into the banks, why not nationalise them completely? We already own RBS and most of Lloyds. The nationalised banks could be used to set up smaller, more responsible banks with a remit to lend to industry rather than speculate on derivatives and the commodities market, which is what they have been doing since 2009.

If the financial crisis really is as bad as King says it is, and we are about to drown in a hyperinflationary sovereign debt crisis, then the Government would be able to freeze asset deposited in the banks and conduct a kind of debt “triage”.

Those with more than £85,000 in deposits would be required to accept a proportionate reduction in the value of their deposits in order to stabilise the financial system and remove the debt burden on the state. This could be done by converting bank deposits into government bonds, redeemable at a later date. This is rather like QE in reverse. Needless to say, all bank bonuses would be scrapped, and bankers put on civil servants’ salaries.

There would be howls of anguish from the rich at their wealth being hijacked in this way. But they should be told that the alternatives are much worse: a run of bank failures, which means they would lose ALL their funds over £85,000. Bondholders would not just have a haircut – they would be decapitated by default or by hyperinflation.

There is still a great deal of wealth in Britain – £7 trillion in household assets alone, according to the Office for Budget Responsibility – but this is largely held by the very wealthy and “sterilised” in property and other assets. If we are facing the ultimate crash, the Government will have no choice but to commandeer these resources and use them constructively to manage the national finances. President Franklin D Roosevelt did something similar in 1933 when he ordered all the gold held by individuals to be deposited with the government.

I doubt if any politician has the cojones to put this kind of scheme forward right now – most of them are intellectually in hock to the City of London anyway. But what is not in doubt is that the Bank of England is already thinking the unthinkable.

Various schemes for crisis debt restructuring are surely already being run through the Bank of England’s computer models, and though they can’t admit it, this will inevitably involve some control of bank deposits and an orderly run down of debt. The Government will probably opt to raid pension funds first, because they are harder to move offshore. This is what the Argentine government did in 2001 when it defaulted.

What the Bank of England governor is warning of is a truly apocalyptic financial event. The Government has already seized large parts of the banking system and resorted to money printing. It may not be long before it breaks into people’s accounts directly. You have been warned.

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