Saturday, 15 August 2009

Why Germany And France?

We could bore ourselves silly recalling Gordon Brown's fateful, progressively more desperate, words of how robust our economy was, how it we could out-run a recession, how we would handle one better than others and why we would recover first. The fact remains pretty much all the clap-trap he gave us was complete horse manure - and not the sort bought on MPs' expenses.

Rather than labour the point, let's just say he called just about every point in the credit crunch and recession wrong and that his understanding of economic matters was not as cerebrally enlightened as he led us all to believe. So much of all that leads to ask, well if he called it all so wrongly did he get the cure right? If not, have we spent all those £billions correctly or were they all wasted?

Two things this week brought this question into sharp focus. First, there are now doubts over whether Quantitative Easing (QE) is having the desired effect of getting us all spending with abundant credit again - as I blogged yesterday, there is now evidence that between banks missing lending targets and their hoarding of new money there is little stimulus reaching the likes of consumers and small businesses in terms of increased credit. Secondly, France and Germany have announced that they have, technically speaking, exited the recession. It must come as a hard blow to Brown's fallen economic ego that these two countries, who have typically led Europe in terms of their consistent economic sense and who fought him so hard on the issue of unlimited bail outs, have broken free of the grips of the financial chaos well ahead of Britain.

In fact, as France and Germany announced growth in their economies, Britain enjoyed a further significant decrease in its economy. So why did Gordon Brown call it so wrong and how little did he understand the pillars of sand upon which he had built what he thought was a robust economy?

Relative Cause and Effect

There is no doubt that the US and the UK had built much more unstable economies over the 10 years. The French and the Germans had struggled in relative terms over the same period, Germany particularly with the post-wall integration issues while France seemed to constantly wrestle with demons from within. We, meanwhile, enjoyed a bonanza pretty much built on thin air. Property prices began to rise on both sides of the Atlantic at alarming rates and many people dipped into their new found net worth by leveraging the equity increase in their mortgages - we effectively became our own banks. It caused a credit bonanza on an unprecedented scale as each new debt taken out was traded and traded again for incremental commissions each time and there seemed an unlimited supply of money.

What this illustrated for Britain was how important the finance sector is to us. Many assume that as it is contributes just 9% to our GDP it is not significant but the reality is that it was the pillar on which our whole system and people depended. As a society we saved negative amounts of what we earned and over the 10 year growth period our average household incomes had actually decreased in real terms - we were supplementing our incomes with our equity gains and that was purely finance driven and at the heart of which were our houses. As the world frenzy for cheap and unlimited money continued, the gamblers in the finance world thought they were cleverer than logic - they traded any old debt and in fact, there was no need to check the worth of an asset as while values rose if a repayer got into trouble they could just leverage more borrowing on each increase in asset value.

It was an upward spiral based on flawed thinking.

So when the bubble popped, US and Britain felt it hardest as we had been by far the most stupid. The other countries like France and Germany had stumbled and nearly lost banks but the reality was that their exposure to the whole 'scam' had been less due to their more conservative approach to simple things like mortgages, where in Germany around 60% deposit is required.

The cause and the effect of the credit crunch were much more exaggerated in the US and Britain.

Other Dependencies

Brown's frustration must have been that if there had been no credit crunch, then Britain was actually well set in terms of handling a recession - in theory. Germany, in particular, and France are the heart of the manufacturing engine in Europe. Their fortunes depend heavily on exports and so when the global economy dipped sharply, they were hit very badly. So much so that at the start of the year, while the British economy dropped 4.9%, the German economy dropped 6.7% and correspondingly, the fall in output was far greater too.

But any economist would tell you that as a recession ends, there is much sharper gains to be had as restocking occurs. Also, France and Germany quickly turned to within to stimulate demand and they introduced scrappage schemes immediately for their car industry that ensured that home sales never really dipped and so they weathered the storm more sensibly while Britain dithered.

Britain, meanwhile, more heavily dependent on the finance sector, saw a much slower recovery and this week we see that this recovery is merely banks recharging their batteries at the expense of taxpayers while the stimulus intended is absorbed by wounded balance sheets rather than getting money into the economy. It was really flawed thinking to believe that pumping so many billions into banks was going to mean an automatic resumption of the 'good times' but this has been the hallmark of the response to the whole crisis - wrong assumptions and undesired outcomes which seemed all too obvious from the amateur economists' armchairs and front bars.

Were The Bank Bails Out a Waste?

Individually, it is easy to identify that the knee jerk saving of Northern Rock was an unmitigated disaster and still is. For banks in general though, we had little choice but to act. However, the sheer quantity of money and immensity of the guarantees and loans required showed just how completely defunct our system had become purely because banks had strayed so far from the basic formula upon which all banks are founded - liquidity. It was as if the whole banking community had lost the ability to add up or to spot the obvious - the whole system had to collapse because it was trading on air not solids.

But getting back to how the countries tackled the issues they faced, Britain really did little more than Germany in terms of stimulation. We decreased VAT and this accounted for around a 1.6% of GDP stimulus while Germany pumped in around the same with around 2% next year while France was less bullish with just 0.7% of GDP. Our boost stops next year while Germany continues to recognise that it has to be a sustained boost.

In an odd quirk it is reckoned that the German and French social security systems helped consumers more than in the UK. As Britain sought to get glamour in loud shouts about how it was 'saving the world' and the PM was shuttling across the world on a fruitless journey for publicity, his continental counterparts just got on with the job logically and quietly. They became Brown's combatants at the G20 by forcing through toned down bank bail outs and wholesale squandering of money and they proved to be, annoyingly, right.

But here is the rub - as Britain pumped £billions in to save the banks, the Germans and French pumped some €5bn into the car scrappage scheme against the paltry £300m we have, of which, only £180,000 has been used to date. Meanwhile we have spent an estimated £1.5trillion bailing out the banks and this is the massive difference in approach in terms of % of GDP used.

Germany and France focused defined sums of money into specific key areas while protecting consumers well while Britain squandered £billions saving the necks of the very people who ruined us while umming and ahhing over whether to save any industries which would have provided direct stimulus to the economy and consumers.

It Was The Economy, Stupid

The problem stems back to Brown's belief that the British economy was in good stead and stable. It simply wasn't - it was built as a house of cards and every corner was a potential weak point as each depended on the unlimited supply of money which relied on no one questioning underpinning asset values, in simple terms. It was so obvious that it makes you scream but more gifted people than me seemed to think that all the great mathematicians of the past clearly had no idea how to add up - they knew best.

And they knew best because they were getting incredibly rich and the nation appeared better off. Indeed we seemed to be - every new gadget was bought voraciously, we bought second even third properties here and abroad, we holidayed more lavishly, we ate more at restaurants, became coffee and wine snobs foregoing staples like beer and tea and we shopped more avidly - like there was no tomorrow. And that was the formula - tomorrow never came. No matter that our wage packets were diminishing, there was always an endless supply of credit, loans, mortgages - all cheap at that and easily accessed thanks to the increased value in our homes. If the debt get on top of us, we simply took a little more money out of our 'banks' and postponed the whole thing.

Tomorrow was never going to arrive, was it?

Our economy had been bolstered alarmingly by all this to an extent that it could handle a recession, even higher interest rates but as long as property values rose, we were laughing. Nothing could stop that - except of course the money tap being turned off. The credit crunch was the 'Black Swan' in the system, according to apologists. The concept that a single, rogue and random event entered the system and proved to be the one thing that would bring it down. It wasn't a black swan at all, it was pure logic. The moment just one person questioned the value of underlying assets and then asked who was doing the due diligence and the whole thing imploded. It was simple accounting, adding up and logic - nothing more.

Sub-prime was just a manifestation of the whole banking flaw, it was not the cause.

Subsequently, we have the FSA squeezing out Independent Financial Advisers and making 30% of them leave the industry as they fingered bad guys but it was the clever people in the financial system who, unchecked, just traded anything for profit with no questions asked and became unfathomably wealthy in the process.

Britain's problem is that our over-reliance on that financial system to underpin our economy was our downfall and it is also the reason why it is taking far longer to recover. Unemployment has yet to peak and is already at 2.4m and the Fiscal Stimulus money will end next year - the pot is then empty. The danger is that if the German and French experience is a false dawn and they lurch into negativity again then the news is very bad for us. We need their recovery to drag us out of the mire too.

People who argue that our GDP is not dependent on finance as a contribution know little about how the economy works. The flow of money affects everything and so our economy became like a clogged engine, unable to operate without the financial lubricant. All that money came from the wrong sources and these are lessons we should have learnt, understood and applied new methods to avoid the problem in the future.

The problem is that in our blind, knee jerk haste to patch up a broken system, little thought was put into what caused it an so how to avoid it again because we had so little understanding of our own economy. Just take a quick glance at the renewed call for bonuses in banks here and the US and the soft regulatory response and you will see that little has been learnt and far less has changed.

We may yet recover, but we just have primed the system for the next fall.

No comments: