Wednesday, January 21, 2009

Not even the end of the beginning

It is natural at the beginning of a new year to think about the future. After a well-nigh disastrous economic performance in 2008, it is also tempting to believe that things will improve in 2009. Yet there is now plenty of evidence that we are now entering completely new economic conditions and that these conditions may prevail for several years to come.

Over the past two months, economic activity has fallen off a cliff. Advertising revenues at Britain's Channel 5 have fallen 30% in January alone. International trade is diminishing at a rate that has never been seen outside of war and plague: Container shipping prices from Asia to Europe have collapsed an average of 42% and in some cases the rates have even fallen to zero. These key trends are not being changed in any way by the actions of governments.

Investors in almost every single asset class are nursing substantial losses and the focus is on capital preservation and reconstruction: there is simply not the money to put into investments even if investment managers were willing to commit, which in the short run environment of dramatic deflation and zero interest rates, they are clearly not willing to do. Linked with this is that the clear failure of government bank rescue programmes will require massive and dramatic restructuring of all credit providers, which is a process that as Paul Myners says, could take as much as a decade. The intended and unintended consequences will be dramatic and could be highly destabilising.

This institutional restructuring is causing governments, especially the UK ,to take on very large new debt commitments. Governments are taking on a variety of different measures to attempt to compensate for what is widely perceived as a failure of the market. However the practical result is very likely to be the complete crowding out of private sector access to capital. This could lead to further falls in asset prices and a continuing deflationary spiral.

Thus it is that the government is now seeking a "quantitative easing"- that is to say that it is asking the Bank of England to print money. The intended consequence of this is a level of inflation that will diminish the total size of debt to a manageable level.

This is likely to be a catastrophic policy. The fact is by totally abandoning any reference to the free market in their bank rescues, the British government is exposing the tax payer to huge losses. Let us take the example of RBS, whose balance sheet has unquantifiable exposures in a wide variety of global currencies and financial instruments. The Royal Bank is likely to announce losses of £7-£8 billion for 2008 and its total losses will be substantially higher overall. The UK tax payer is now being told to underwrite the entire estimated £1.8 trillion of RBS liabilities and thus take in full all the potential losses on this portfolio. Yet the government seems to have no plans for disposals. The auctioning of the portfolio is not even being discussed. To put this number in context, it is nearly twice the entire British GDP.

The fact is that Labour are behaving as if the nationalisation will be permanent, with no plan as to how to restructure- beyond creating high inflation- the British economy could be massively damaged. My parents have been prudent all their lives and now the government will destroy what little savings they have put by for their retirement. I can only recommend them to buy gold bricks at the moment, even though they give no interest- but then, thanks to the government, nothing else is either.

Destroying the value of money is a criminal policy. For this reason alone Gordon Brown's government has run its course.

I now recognise the scale of what we are seeing, and can feel no optimism in the face of such instability and such pernicious policy making. This is now seems not even close to the end of the crisis, it is not even the end of the beginning.

And there is no telling what the global economic and political consequences will be. As for the United Kingdom: I am genuinely afraid. Our ramshackle constitution, unaccountable administration and loose public finances were already significant problems. Now I fear that they will be tested to destruction.