Market Indicators

It's a weird situation when on the one hand we are all starting to get very uppity about banks awarding their slim numbers of superstars obscene levels of bonus again after clocking up such massive losses and toxic debt and, on the other, we are talking of a second wave of the economic slump.

But that's how the financial system works. There is no doubt that banks took the brunt of the Credit Crunch effects and at least 6 high street names had to be rescued from bankruptcy while many have had to ring-fence toxic debt so that the taxpayers can take the liability off their hands to get on with the important business of paying a small percentage of their staff enormous money after culling many people from their customer-facing ranks who did not lose a penny in profit or bad debt. That's modern banking for you. It is also true, that as the financial system recovers, plenty of vast profits will be made out of thin air as the banks and institutions start playing their silly, high risk games again.

Meanwhile, back in the 'real' world, the slump continues. Quantitative Easing (QE) has been surprisingly extended by the Bank of England and its Governor, Mervyn King, has warned that Britain could suffer a 'debt deflation trap' which sounds about as appetising as trapped wind. There are also fears from other clever economists that Britain may suffer a 'lost decade' much as Japan did as we continue to try to revive our staggering economy. It is perhaps worth noting that Japan was one of the few developed nations to have used QE in recent years along with an extended period of 0% interest rates and their economy stagnated for a decade.

The members of our Monetary Policy Committee which meets to consider such matters and sets the Bank of England's interest rates amongst other things, are the pillars of the financial world. Hedge Fund managers, economists, bank board members we get them all. However, there seems a growing body of concern that the apparent green shoots of recovery are a mirage and that they are a false dawn of a wider recovery. There is opinion that we may well get three successive quarters of economic upturn indicating the technical end to the recession. But in the 1990s, Japan also experienced the same.

Such a recovery could be caused by short term effects only, such as more cars being bought due to the scrappage scheme or perhaps we get a restocking effect after destocking so temporarily boosting output. But there are concerns that the second half of 2010 could be more difficult than the period we are now in and so it brings into sharp focus the gravy train in the banking industry - as always the banks pay on short term gains and do not consider the long term, and there is a real danger that they will pay for merely an economic bounce that was inevitable rather than a long term revival of the system. It's like a salesman getting paid for sales which come in on their own every month and so not having to make a single call to get new ones.

Some of the reasoning behind the gloomy outlook revolves around things like VAT. The temporary farce of lower VAT will have ended next year and indeed the Conservatives, who are looking increasingly likely to be in power after next May, are planning a hike to potentially 20% which is equally stupid, if not more so, as it a form of tax which disproportionately hits poorer people.

But, in my opinion, it will be the tax burden in general, the increase in the jobless, and so the drain on the Welfare State, and the cuts in spending on Public Services - none of which have really bitten us hard yet - that will slow the economy more emphatically. As the state magnet is set to 'high' to remove more tax money from our pockets, the unemployment figures should have peaked at over 3m in the UK by the end of 2010 and so the burden on the State will be huge in terms of benefits, plus the number of people able to pay tax will have been reduced. All in all, it could be a 'Perfect Storm' to depress spending generally and while the banks whoop it up right now, they too will feel some of that pressure so paying bonuses right now for anything is seriously misguided if inappropriate anyway.

Sants in His Pants

If you want a giggle on bank bonuses, listen to the BBC interview with Hector Sants, CEO of the FSA, who tries to make out that he knows what he is talking about when it comes to regulation of bank bonuses. He says the question of bonuses is, in fact 3 questions. 1) Are banks disproportionately skewing rewards for more high risk transactions, 2) are banks paying too much of their profits to too few people and 3) are the size of the individual bonuses too much? He is right on one thing - that is 3 questions. The answers have always been 'YES' to all 3 - so it is a case of 'No sh*t, Sherlock' as that is exactly what happened before and is happening again.

He looked very excited as he thought the FSA could intervene in answer to the first two questions but question 3 was one for the banks themselves and the public to resolve. I am sorry, I don't get that.

You see, the FSA is on the one hand destroying the whole Independent Financial Services industry by imposing incredible regulation on the army of small businesses that give independent investment advice to small businesses and consumers, reducing commissions and restricting what they can and cannot say without immense bureaucracy. In the last year, it is estimated that 30% of small mortgage brokers and IFAs have either left the industry or gone broke. Meanwhile, accountants and lawyers who get involved in the giving of such advice for fees and are not regulated by the FSA so do not have to tell people, for example, that taxation has changed after a Will has been written, are protected from the consequences of their lack of or bad advice, yet are paid for it - and the fee size is unregulated. It is also pushing more of the financial advice back towards those institutions who have a vested interest in selling only their own products, like banks, building societies or insurance companies. Pretty soon, only large mortgage brokers and firms who focus on the corporate market will be left.

The army of local, independent financial advisers who are more ethical than ever, will soon be destroyed because the FSA has ruled exactly how little they should earn. Then we get Hector Sants saying the exact opposite for the bunch of former colleagues he worked with in the City.

That is why we should not pay him the £1m per year salary and bonus that he earned even though he sat by and watched the biggest financial disaster since the Great Depression. He does nothing to curb it as he is one of them. It is one rule for one industry that is public facing and one rule for the other that lives in its own dreamworld of high finance and it is the crux of the reason why banks and their bonus culture will not change.

It is because there is an in-built belief that small people are not important and there should be no curb on the fabulously wealthy, as 'wealth creation' is seen as good while servicing the public is second rate - it is a sentiment shared at the highest level in Government by former PM, Tony Blair, and current Business Secretary, Peter Mandelson. That is why, when banks fail they chop staff at the public end of their businesses while keeping the high-flying traders in place to get more bonuses.

Until we change that culture fundamentally, we will never rid ourselves of the problem in the world of finance. That will mean changing all the past bankers on Monetary Committees, Boards and Regulators as they are all part of the problem - they are not of the 'real' world.

Mervyn's Day At The Casino

In The Bank of England's incredible 315 year history no Governor has ever tried it, not even in very bad times before. Today Mervyn King will become the first man in British banking history to use the Fiscal Policy known as Quantitative Easing - for those of us who have not swallowed the Economics textbook it simply means to print more money.

Quantitative Easing (QE) - The Idiot's Guide

Imagine a pyramid made up of three layers of champagne glasses. QE is much like pouring in liquid into the glass at the top so that it overfills and cascades into the glasses below it which in turn fill and then overflow into the glasses at the lower level which also eventually fill and overflow. If you think of the top glass as the banks, the middle layer as business and the bottom layer of glasses as consumers, then what you see is pretty much the process of QE.

It's the idea that if you print a load more money, pour it into the banks, they will want to lend more to businesses who in turn offer us, the consumers, more credit.

Now the real dummies amongst us may point out that a great many transactions today do not use money and that therefore the process of printing more money will have far less relevance today than say in the period known as The Great Depression in the 1930s when the theory was honed.

All I can say is that the intelligent people who came up with this idea have pulled their heads out of the theory book, written all those years ago, and noticed that fact and have, of course, taken it into account. I think.

These intelligent people are the ones who have presided over the collapse of 5 major UK banks and pumped a great deal of money into the banking system already without any great effect but, keep quiet cynics, because now it's Mervyn King's turn - and he has kept a discrete distance from the fiasco to date, adding a few acidic words about policy every now and then. To a large extent, he has kept his credibility alive by doing so.

But today marks the start of his big gamble - one unprecedented in modern times. Let's all hope 'Big Merv' is right.

How Does It Work In Practice?

At midday today - as such is the pageantry of big banking business - an imaginary gong will go and the Bank will start to use its £75bn of new money it has printed to offer to buy £2bn of Government debt in the form of bonds from institutions.

It's some convenience to just go and print a load of new money and that's based on the concept of a 'Fractional Reserve'. This is vaguely about the notion that at any time The Bank of England has, say, £100bn in its coffers but it may print up to, say, £600bn of bank notes to go into circulation - remembering each bank note comes with a promise to pay the bearer the amount on the note its value should the bearer present it at The Bank. Fractional Reserve tells us that in practice no one ever does and certainly not at the same time - so we can print vastly more notes to go into circulation than their total promissory value held in the Bank's vaults. Quite how the Bank would pay these days as it no longer has any gold is another discussion entirely - but don't worry, our PM has thought of everything.

So the first of these bond auctions will start today and The Bank of England will be buying these £2bn batches of Government debt or Gilts. Two hours later, there will be a second stage when the institutions and banks will be allowed to participate in these reverse auctions - and similar activities will carry on twice weekly until all the new cash printed is consumed.

Gilt prices have risen sharply in the last few days as the financial system salivates at the prospect of more money being created out of thin air and being spent - it's just like a sucker walking into the East End with a wadge of new notes wanting to buy a car from Arthur Daley, there is not a chance in hell these Gilts will be a 'good deal'.

The top champagne glass is being filled starting today. The one snag in my analogy which is reflected in real life is that nobody knows how much the champagne glasses hold and so how long and how much money will it take to fill them all.

Deflation

This amazing gamble comes after The Bank has dropped interest rates to 0.5%, the lowest rate in history. This kind of Fiscal Stimulus goes into a new area known to some (i.e. me) as Fiscal Defibrillation - a series of very sharp and big jolts to the heart of the financial system to stimulate it into life. QE is the second major jolt, if you discount the meagre £1.3 trillion of bank bail outs, loans and guarantees on offer to the UK banking system. The disease that The Bank is trying to avoid is 'Deflation', the banking equivalent of 'MRSA' which is what the injured financial system may catch after its major surgery and tries to recover.

Thankfully, the financial system is not being treated by the NHS but by clever people like Mervyn King, Alistair Darling, Gordon Brown, Yvette Cooper and a host of really brainy, intellectual and incredibly greedy bankers. So our economy is in fine hands, as it has been for the last 10 years.

Deflation is a bit of a killer disease itself - it's the concept that just as the financial system is recovering then prices to start to fall rapidly - just as in the fire sales we have been seeing in shops. Consumers, of course, those irrelevant carriers of wealth that rich people would like to have, like lower prices - but we are not the important ones here. If bankers cannot make huge profits, where is the fun of loaning us money?

The perverse logic of deflation is that textbooks say that we, the evil consumer, will delay spending the cash given to us via our champagne glasses, in anticipation of yet lower prices - the concept that I will not go to the East End and buy that car off the nice man in the sheepskin coat and trilby this week as he will have a lower price next week. This of course has the effect of increasing the effect of the downturn.

When A Science Is Not Exact

The financial process of treatment and recovery is sadly not an exact science as we have seen so far from the vast bank bail outs across the globe, estimated at around $5 trillion and rising. Mervyn King grimly warns that he does not have any idea how long he has to keep printing money and how much will be needed to get us to spend again. All he knows, or should I say, thinks, is that eventually it will work.

That's why no one has ever tried it before. I don't know about you, but that really fills me with confidence.