Both QE and FLS are in a mess

George Osborne’s nanny state policy responses are failing our banks and perverting our markets. In the midst of the political rhetoric on welfare and debt, there is one economic policy that the chancellor has implemented which has a genuinely significant impact: Quantitative Easing (QE).

This has had a profound impact on the economy.

The normal way for the money to be supplied into the economy is for banks to provide loans. If ten £1k loans are made for every deposit of £1k, then £9k of new money has been put into circulation. The banks are liable for it if it isn’t paid back, so they have become expert at judging risk. The supply of money makes a good demonstration of the private sector achieving a public good, normally.

The problem is that lending is too slow. As a result there is a lack of new money going into the economy but people are continuing to repay the loans they previously took out. The net effect is less and less money in the economy. If money is the oil on the cogs, then without it, the machinery will grind to a halt.

As a policy response, we’ve had QE. The Bank of England is creating money on a grand scale. Under Quantitative Easing they have so far produced an extra £375billion. In this respect it is the largest nationalisation of private sector service since the 1945 Labour government. I wonder if George Osborne realises that.

For a long time the banks have been receiving contradictory instructions from government. They must lend more, but they must increase their capital reserves. It’s like telling a schoolboy to spend his pocket money then scolding him for not saving it.

As a result, innovative policies are not only proving expensive but also potentially counter-productive. The government driven Funding for Lending Scheme (FLS) aims to subsidise bank lending for small businesses.

It is bad economics. It has lowered the interest paid to savers, but achieved little increase to the loans given to small businesses. With the state competing with savers, the banks no longer need to attract deposits as they have cheaper source with government cash.

Ending Legal Aid will lower standards.

The government’s reputation for incompetence shows no signs of abating, as they mimic the management ethos of Mid Staffs hospital and apply it to the criminal defence service.

These are government proposals which are to be applied to solicitors’ firms providing advice in police stations and courts. They propose the removal of choice of solicitor from the service user, in order to create a greater economy of scale and drive down costs. But, by doing so they will remove the competition which drives up standards and establish a local monopoly, rarely the most effective model to promote efficiency.

Regional VAT, an idea for Ed Balls

When I was in Arizona, I kept getting overcharged in the shops. At least I thought I was, until I objected and was told that the extra 7% was the state sales tax. They weren’t including it on the price tickets, because Americans are weird. These days Arizona charges a whopping 9%, compared to Virginia at 5%, and New Hampshire at 0%. There is no strategy between these different rates. This is America. The states just does their own thing.

In the UK we pay 20%, and we call it “Value Added Tax”, because we’re not weird. Imposed centrally, we apply this tax at a uniform rate across the country, but if we wanted to, we could charge different rates in different regions, while continuing to collect it centrally.

There is serendipity to Labour’s economic policy. Mass house building is firstly intended to create demand in the economy, but by solving our chronic housing shortage, we reduce our private sector rents, and thereby counter poverty. It all seems so neat that, however, there is a flaw in this strategy.

Getting tough on late payment to SMEs

There was an interesting article in last week’s Economist about a speech made by Chuka Umunna to the Federation of Small Businesses, which began with the sleepy audience unengaged, but went on to inspire them to shout, “Hear hear!” I suspect this was following the announcement that Labour would crack down on big companies that deliberately hold out payments to small companies for months on end.

The Economic Case for more Social Housing

Rising house prices used to make cheery headlines in the papers. It was associated with economic success. We were all getting richer. If people can afford to pay more and more for houses, then the economy must be getting bigger and bigger. In truth, the rise in house prices had just as much to do with the easy availability of mortgages, which created an “effective demand”.

As a youngster, I remember how people’s excitement of buying their own council flat infected everyone else. Aspiration amongst the working population must be one of the most important factors to a thriving economy, and it was very much instilled in the east enders in the ‘80s. This is how Thatcher won.

Today we hear commentators speak of the “lack of animal spirits”, referring to an economy which is moribund. Few people are investing lavishly. Few new enterprises are born from a sketch on the back of a beer mat. There’s a general lack of excitement, of inspiration. A lack of moral.

The problem is that if we want to fix the problem of over-valued houses, then we would need to supply enough new homes to cause house prices to fall. However, deflation would stop developers buying land for fear of losses through falling prices. House price deflation would effect consumer spending. If people believe they are getting poorer in their assets they will avoid splashing out. How many politicians would choose policies that would have such an effect?

How ‘competitive tendering’ is ruining our economy

Year on year, every year, contractors and suppliers have to do their job for less money. These days it is written into the contract that savings will be made next year and the year after, so it is no longer just about suppliers believing they can save money now, it is also about faith in a future that will somehow, from somewhere, deliver savings.

So if I bid for a contract to clean a residential street, I must calculate the cost of the worker and the cost of his brush and pan, and then I must seek to reduce it. Next year I must reduce it more, and the year following, more still.

The previous Labour government were very much a part of encouraging this process, because the economy used to be so inefficient, and there is no doubt that we have a more competitive economy as a result. However, there are costs to the never ending pressure on suppliers.

Currency War and Debasement

When is inflation not called inflation? Answer, according to Mr Carney, when it’s dressed with the words, “Targeting Growth”. In fact it’s impossible to create growth through inflation in the long run.

In the short, you’ll get growth for one year, then the money is worth less, which wipes the growth out, so you have to generate more inflation to get another burst of growth, which is wiped out again.

The reason George Osborne doubled the money to attract Mark Carney to the Bank of England, was that he was desperate for someone from outside to invent a debt reduction policy which doesn’t look like Plan B.

The good news about inflation is that debt gets eroded. Government debt, the fixed-interest UK Gilts worth £1.15 trillion, get eroded pretty double-compound quick. If there was sufficient inflation, the debt would be eroded faster than Osborne’s failed policies are adding to it, and that’s saying something.

If the policy was moderate, using moderate inflation to reduce our debt, then maybe this wouldn’t be such a bad thing. But the problem is that they are being sneaky, shifty. They are calling it one thing but delivering another. Why the sleight of hand?

The bad news about inflation is that the policy maker can lose control very easily.

The other effect of debasing the currency is that Sterling falls against other countries on the foreign exchange proportionately, which should give our exports a boost and our imports some stiff competition. Although it doesn’t take long for prices to adjust accordingly and for the advantage to be removed again.

If everyone else around the world started trying to do the same trick, then chaos could potentially follow. If we try to outdo the Japanese, who try to outdo the Chinese, who try to outdo the Americans, who try to outdo us, then we’re engaged in a currency war.

If the Bank of England increased the inflation target from 2% to 4%, then we would be able to judge the success or failure of the policy against the target. But by “targeting growth”, there is no specific number for inflation, which means there is no accountability.