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Home > Opinion > Philip Coggan

By Philip Coggan | Published May 21, 2012

Frustration grows at lack of near-term action

St Augustine’s famous prayer was “Lord, give me chastity but not yet”.

One way of viewing the current political and economic situation is a whole series of similar paradoxes – of behaviour that we might like to see in the long term, but could be counter-productive in the near future.

An obvious area is bank regulation. The collapse of the financial sector in 2007 and 2008 created a determination among regulators that taxpayers should not pay the price for future risky behaviour by banks. As a result, banks have been asked to raise more capital. The problem is that governments also want banks to keep lending, especially to the small and medium-sized corporate sector. Those two objectives are very hard to square.

As a result, banks have been asked to raise more capital

Philip Coggan

The regulators attempted to get around this problem by adopting a St Augustine-style solution – under the Basle rules, higher capital ratios would not be demanded until 2019. But faced with pressure from the markets, banks have moved much sooner. And, given the difficulty involved in raising private capital, banks have chosen to shrink their balance sheet (by selling assets) as their chosen route. This makes a credit crunch more likely.

The second area relates to market attitudes towards austerity. Investors seem to want governments to move towards balanced budgets in the long term. But in the short term, austerity seems to drive economies into recession, alienating electorates in the process. In short, the markets want a balanced budget, but not yet. This creates a real problem for governments which are really aiming to keep their bond yields low.

But it is far from clear what the right macroeconomic approach will be to achieve this. In Spain, for example, the markets seem to recognise that an overly Draconian policy would be counterproductive, but that hasn’t stopped investors from worrying about the health of the banking sector. Ten-year Spanish yields are back roughly 6 per cent.

The third dilemma should be all too familiar to financial advisers. Central banks are deliberately holding real rates at a negative level, for example, below the rate of inflation. It seems unlikely that this will change any time soon. Government bond yields are also negative in real terms. So the clear message is: don’t save.

At the same time, the whole direction of the pension industry has been to shift responsibility down to the individual worker, via the switch from defined benefit to defined contribution plans. But the lower the level of real interest rates, the more the worker needs to save for a pension. Not only do his savings have to work harder to get a given pension pot, the worker needs a bigger pension pot to generate his desired income. Rationally, workers should save more, not less.

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