11th September 2011

Death by Dogma? The Great Borrowing

Spare me from zealots of any kind – religious, political and even economic. Now please don’t think that I can’t appreciate concentrated enthusiasm, but blind dogma is (to abuse a phrase) “the last refuge of a coward”. With this in mind, I find myself considering the arguments of the proponents of differing economic policies. This has been wonderfully focussed in an excellent debate recently on the BBC, held at the London School of Economics between the baying parties from the economic polar opposites of the Austrian economist and philosopher Frederick von Hayek (best known for his defence of classical liberalism and free-market capitalism against socialist and collectivist thought), and John Maynard Keynes the eminent British economist, who greatly refined earlier work on the causes of business cycles, and advocated the use of fiscal and monetary measures to mitigate the adverse effects of economic recessions and depressions.

The work of these great men and their views and opinions seem to be at the very heart of the current economic debate, not just for the UK but also for the USA and, come to that, the ramifications for the rest of the globe. Hayek’s disciples preach the themes of prudent financial control and discipline, and that at times such as these deficits must be reduced by cost cutting and suitable application of taxes to bring the books back into balance.

JMK on the other hand has always been quoted to support the arguments for remedial and interventionist actions to be taken to mitigate against the worst parts of the economic downturns.

Currently the UK government thinking is closer to the Hayek camp, but with all the other mounting issues around the globe, other voices are clamouring with greater decibels than before. The logic of trying to restore financial disciplines is of course laudable – the question is how we get to that position? Cut to rebalance and recover or invest to recover?

The argument has been that if you keep cutting in times of weakness, then you are stunting the chances of recovery and increasing the pain of the weakest affected. However, with most of the Western nations so heavily indebted how can they afford - or even justify - further investment by borrowing?

Now a good dose of 1970’s flared trousers and inflation would certainly help, but that seems not to be a too likely prospect for the time being.

So maybe there is another way to be considered. Last week I mentioned the concept of the next few years being the seen as “The Great Contraction”; maybe, though, it could be something completely different?

Given that US Treasury yields are now at their lowest for 60 years (last week the yield on the US Treasury 10 year was 1.98%), governments in theory could borrow money at extremely low rates for longer periods of time and deploy that money to allow them to generate a higher rate of return than 1.98%. Effectively use cheap money to develop future wealth, as suggested by Martin Wolf in the FT this week.

The concept may be attractive but the risk lies in what the new borrowings are used for and whether you can actually trust the governments to invest them wisely and not just fritter them away on short term populist political panaceas. This would also not remove the need for suitable curbs on spending, but would ameliorate the economic pressure on the weakest and fuel some further growth - enough to improve the economy to afford and eventually repay the debt and have the excessive imbalances in government spending to be addressed over time.

To accompany this there would still be tax reforms, especially to encourage investment across the economy from empowering and enthusing the entrepreneurs, to encouraging the larger corporations to invest for the future. So from “The Great Contraction” maybe we could see “The Great Borrowing”?

The Bank of England Committee is quite likely to be looking at issues in the form of the opaque title of Quantitative Easing. We have already had �£200bn of it and its impact is certainly far from clear. If we are to have more, then this time let’s have it properly targeted as investment money; so where could it - or should it - be directed?

Maybe housing by taking bad housing portfolios out of the banks, or maybe direct support for housing builds and financing, or alternatively significantly increasing smaller business entrepreneurial development and technology funds in the form of a far larger government private equity structure than is currently being proposed. Add to that the removal of some regressive taxes and we find that there are still some levers worth pulling – but it may take some imagination.  This route though would be more problematic as it would require direct government money, not asset buying from the Bank of England via Quantitative Easing.

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