Wednesday, November 26, 2008

Thoughts on the Credit Crunch #1

History repeats itself, first as tragedy, then as farce. Harpo Marx
We're all Marxist Brothers now, and we should look back to the late 1920s and 1930s as we navigate these uncertain times.

On Monday Alastair Darling made his pre-Budget announcement of measures to deal with the credit crunch. Key headliners was his cut in VAT from 17.5% to 15% and expansion of Govt debt to some £1/2 trillion to provide an economic stimulus. The Tories reverted to type, calling for tax cuts and, in effect, spending cuts as it warned against growing Govt debt. Osborne also called on the Govt to sort out the banking crisis by making the banks lend to consumers and businesses again - a bit rich coming from the party of city deregulation for the last three decades.

However, Osborne did have a point about the banks. The bankers are behaving like truculent teenagers. First they threaten mass suicide if they don't get what they want, and now they've locked themselves into their bedrooms and are refusing to come out and join in the family meal. The Guv'nor of the Bank of England, Mervin King, sounded like an exasperated parent when uttering his threat that the banks might be forced to start lending again. Yet King's quiet candour is a warning that the Govt's bailout is far from resolving the banking crisis. This is deeply troubling, especially since the British response has been the template for others facing similar problems elsewhere. If the bailout fails, then all bets are off.

Tax cuts, while welcome, do seem to be somewhat irrelevant for the following reasons. The credit crunch is a result of systemic failure, with loss of consumer confidence a by product rather than a cause of the crisis. Also, the fact that heavy in-store discounting of 20-30% has not boosted consumer spending does rather question the effect that a 2.5% reduction in VAT will have on high street spending. Furthermore, set alongside the collapse in the value of Sterling, which will mean that the price of imported goods will more than wipe out the VAT cut, this VAT cut will probably be of even more limited long term value. A nice news story in the run up to Christmas, but this recession is for longer than Xmas.

However, Darling was correct in pointing out that the Tories response - tax and spending cuts - was reminiscent of their policy during the 1980s recession. However, what he missed was that Thatcher used, and even prolonged, that recession for a social engineering and political restructuring project that aimed to permanently weaken the Labour movement and emasculate the Labour Party. This recession will be different because it is centred in those sectors - financial services, etc - that arose from the ashes of the early 1980s. While the slump of the 1930s and the recession of the 1980s were centred in the industrial heartlands of Old Labour, the chill winds of this recession will be felt throughout the land and will probably be more egalitarian in its promiscuity than its predecessors.

Labour should, however, be careful to look back into its own history as it confronts this crisis. It was the Labour Party's hidebound adherence to economic orthodoxy that sidelined it during the turbulent 1930s. The danger is that Labour repeats its mistakes by again resorting to orthodox measures in an unorthodox crisis. The first thing to recognise is that the credit crunch is on a par with the financial crisis of 1929, indeed it might surpass it in terms of its immediate impact and long term scope.

There are other disturbing parallels with the 1930s. Then all the bigger players were sidelined by events. America retreated further into an impoverished isolationism, British retrenchment reduced further its dwindling international standing, and German collapse and Italian adventurism destabilised Europe. The rise of authoritarian and expansionist regimes in Europe and the far east were one response to the world crisis. Today, the US is involved in two deeply unpopular foreign wars, and its own financial crisis will inevitably lead to a degree of foreign disengagement. Meanwhile, relations with Russia have steadily deteriorated whilst the resurgent Russian establishment looks to restore both pride and hegemony along its European borders. Events in Georgia have inevitably made Russia's neighbours wary, especially in the Baltic states where sizable Russian populations live. Russia is also throwing its energy fuelled weight around, looking to 'leverage' its energy resources in its foreign policy. There is little reason to doubt that Russia will not use America's distraction to its own advantage.

While none of this necessarily implies a repeat of the political and diplomatic tensions of the 1930s, we should be cautious of the possibility that an incident along the borders of the Balitc states quickly spirals out of control. A feasible scenario is that in such a situation Russia might attempt to use its gas resources as a blunt bargaining weapon with its EU neighbours. It's to forestall this possibility the the EU is now attempting to build a 'southern' gas pipeline beyond Russia's borders, but this project will not complete for some years yet.

In such a situation Britain would be incredibly vulnerable. The security of our energy supplies is more perilous now than it's ever been. Once self sufficient in energy, we are increasingly dependent on foreign supplies. We have around only two weeks gas supply in reserve for example. Even a particularly long or arduous cold snap would bring us to the brink of an energy crisis. If Russia choose to turn off the gas, we would not be well placed to respond and would quickly be confronted by power cuts, cold homes and public disquiet.

Here though is an opportunity for the Govt to address several issues at once - economic stimulus, energy security and global warming. It would require the Govt to undertake unorthodox measures and would run counter to their deregulatory tendencies.

The Govt should announce a war on fuel poverty and global warming and launch a publicly funded campaigns for fuel efficiency and energy renewables. The first thing it could do is engage unemployed quantity surveyors in a massive energy efficiency survey of Britain's entire housing stock. Every house found to be wanting in loft insulation, for example, would be insulated forthwith, regardless of income. This would be a mandatory scheme and would provide an immediate payback in terms of energy savings on an individual and national level.

The next aspect of the campaign would be a massive investment in wind and wave technology. The stimulus of Govt investment would kick start the renewables sector in the UK, providing us with an opportunity of gaining a technological and manufacturing lead in this vital sector. I would personally argue that national emergency should override the planning process and nimbyism, with wind farms popping up all over the place, on and offshore. The economic stimulus of such a package might be sufficient to keep Port Talbot operational for example, particularly if the Govt specifically favoured UK like-for-like suppliers (on ecological as well as economic grounds).

Finally, the Govt should embark upon plans to increase the UK's gas stocks, so that we have more security regarding our energy supplies.

Within 5 years we might be in a situation when the economic travails are over and we have something positive to show for it if the Govt adopted such a policy. While we won't have achieved economic self sufficiency, we will have helped those in need heat their homes more economically, reduced our reliance upon non-renewables and gained a technological and manufacturing lead in a vital new industry.