Does the government need to change the question?

I had planned to write a review of the conference season for today’s piece but perhaps the only thing worthy of note that’s not already been endlessly commented on is that the Lib Dems were much more disciplined this year; they didn’t fall out or whinge excessively about losing the AV vote – they’re learning how to act as a party of government.

Instead, the most noteworthy events of the last three weeks have come from the Bank of England, firstly restarting its quantitative easing programme and then with the Bank’s Governor, Mervyn King, making an unusual tour of the TV studios, including making the claim that

[this] is the most serious financial crisis we’ve seen at least since the 1930s, if not ever.

As Governors of the Bank of England are not know for their hyperbole, this is a quite extraordinary claim and could do with some more examination. What does he know that we don’t and what’s going on?

The reference to the 1930s is an instructive one. That too was a global crisis which started in America, brought about by lax regulation and lending standards, followed by a panic, crash and credit crunch. One other parallel, not much stated but relevant is the bursting of the Japanese Asset Price Bubble, not just what happened then but what happened next.

The Japanese refer to the 1990s as The Lost Decade due to the virtual non-growth of the economy – particularly noticeable to them after the rampant growth in the post-WWII recovery. In fact, it wasn’t lost at all; they just weren’t looking in the right place. The Japanese spent the growth of the 1990s a decade earlier when they borrowed, speculated and spent massively. Likewise, the excess growth of the Roaring Twenties was funded by spending future income before it had been earned. So it has been again. As an aside, both America in the 1930s and Japan from the 1990s onward tried massive Keynesian stimuluses, neither of which restored sustainable growth.

The problem for the government is at the nexus where politics and economics meet: expectations. The public have come to expect renewed growth using current income as a baseline, and have had that expectation reinforced by the media and politicians anxious to restore Business As Usual. However, if that initial baseline was unsustainable based on what the country was producing rather than consuming, that implies that growth is nigh-on impossible without further artificial boosts until the real economy has caught up. Politically, that is a problem for the government if the debate remains where it is now.

Perhaps fortunately for it, the Bank of England is doing what it can to shift that baseline. It’s been criticised by some for taking its eye off the inflation target – something which of itself, the extra £75bn it plans to drop into the economy is unlikely to help. In fact, I wouldn’t be at all surprised if it is deliberately stoking moderate inflation, partly to push real interest rates even lower and partly to reduce living standards to something closer to sustainability. It just can’t that.

So far, so domestic. There is, however, an almighty heap of economic cumulonimbus to the south-east. If Mervyn King really is serious about this being a bigger crisis than the Great Depression, the South Sea Bubble and everything else, then he not only expects Greece to default but for the ripples from that to have major destabilising effects. As with the first round of the crisis, the risk is of a collapse of confidence as institutions work out who’s been left holding the bad debt.

All of which makes the prospect of an imminent return to the perceived normalcy remote. Yet that very prospect is dangled by politicians and talked up by the media. If it cannot change the question, the government is in danger of getting into a game it cannot win, with the only consolation being that the opposition seems ever keener to play it. As Italy and Spain see their credit ratings downgraded again, the right game is relative, not absolute.

David Herdson

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