There was little or no improvement in the FTSE 100 index during 2014, although that should have been no surprise to investors. This index is more of a world index, than one reflecting the UK economy, and one moreover with a strong tilt towards commodities. Today the FTSE 250 gives a better portrayal of British business but, after a couple of good years, that also faltered last year.
Simple questions, complex answers
Investors were obsessed with two questions throughout 2014. First, when would the Federal Reserve (Fed) stop quantitative easing (QE), and how would this affect markets? And second, was growth in emerging markets really slowing, and could a return to growth in developed markets compensate?
Central banks have more policy options than QE so, although the Fed has declared an end to it, this is unlikely to have a major effect on the S&P 500, at least in the short term. There may be greater volatility, as markets adjust to less liquidity in the system, but it has been US government policy, at least since quite early in Alan Greenspan’s rule at the Fed, to keep stock markets high and buoyant.
And other central banks seem keen to follow the example of the Fed. The Bank of Japan surprised markets with its aggressive use of QE as part of ‘Abenomics’, as it attempts to wrest the nation out of its 20-year deflationary spiral. The ECB has also announced a desire to enter into QE, through the acquisition of EU banking assets and even some buying of EU government bonds.
Markets responded positively, but the German Constitutional Court may well object. The ECB is rightly concerned that the eurozone is teetering on the edge of Japanese-style deflation, with governments deaf to its pleas for supply-side reforms. This year will not only witness very weak European activity, but the reality that the Bric story is now in disarray, with only India still promising some economic gains under a new government.
The great debate
The British populace might well believe that, after the rigours of this government, the public accounts are in better – or even in good – shape. Sadly they are wrong, although the coalition might plead that other governments have done no better. Standard Life recently published a study on governmental borrowing, based on the assumption that economic growth continues to disappoint. Their conclusions are grim, “In this paper we have tried to underline the severity of the public debt challenge facing the developed world. There are some important lessons to take from this exercise.
First, public financial positions are precarious at present and vulnerable to deviations from currently benign medium-term economic forecasts.
Second, if policymakers do not take aggressive action to raise near-term and long-term nominal growth, as well as enhance their long-term consolidation plans, more painful and damaging policies might be required to deal with excessive public debt burdens. While the current economic environment is challenging, the clock is ticking on the next global downturn. Policymakers should act with the utmost haste.”
Haste is the one thing that policymakers seem to lack. It is now some seven to eight years since the crisis broke, and the banks are neither reformed nor made safer, while the actions needed to restore economic growth continue to generate debate and policy paralysis.
The ECB banking report failed to consider the effects of deflation, despite the level of government debt in such balance sheets. Debts can only be repaid through economic growth, and only such growth can drive the productivity increases that produce personal prosperity.
Financial probity and economic prosperity
Andrew Mellon was US secretary of the Treasury, when the banking crisis developed in 1929, and had hated the growth of a prosperous but consumer debt-financed America. His reactions broke the US financial system, and that of the world with it. His successors learned that lesson and when, during the late 1940s/1950s, American competitiveness and dollar strength was set to destroy European industrial and agricultural recovery, the Marshall Aid plan gave all European governments the money and raw materials they needed to put their labour forces back to work.
It may have helped the US administration of that time that Keynes had argued at the Bretton Woods conference (designed to avoid a recurrence of the ‘beggar-my-neighbour’ policies of the inter-year years) that ‘permanent creditor’ nations were as dangerous to financial stability as ‘permanent debtors’. By 1959 the ‘dollar shortage’ had ceased to be a problem, and now it is German competitiveness and efficiency that is threatening European prosperity.
Given Germany’s financial history of the 20th century, it is easily understood that Germans would prefer to have no borrowing at all, and the eurozone likewise. But economic growth requires borrowing and lending, and spending money on the future. The sleekness of a top range BMW or Mercedes belies the shoddiness of German infrastructure, or its comparison with German-speaking Switzerland.
Squaring the circle
Europe and America both require a sustained and comprehensive programme of spending on roads, transport, railways and education. These are needed to replace much of which exists – and is crumbling – but also to extend accessibility to those countries of eastern Europe that were liberated only a few short years ago. They are also needed as a long-term boost to unemployment and wages – putting to work the workless generation of today, teaching them the disciplines of work but also the skills of tomorrow.
These should not be publicly financed, for the world is awash with savings desperate for exactly the long term, modest but certain returns that ought to be available from properly constructed government investments. What they do need, however, is a rediscovery of the talents of merchant bankers, who helped previous British governments identify the merits of privatisation and public finance initiatives.
Keeping the populists at bay
The EU was founded on the promise of prosperity and this is currently being denied. The median household income in the UK, and adjusted for inflation, peaked in 2007, and has yet to return to that level. Family incomes in the major eurozone members have done a little better than this but Ireland and the ‘Club Med’ countries worse.
The all-too-familiar consequences of economic stagnation and frustration are a turning away from liberal values of tolerance and a commitment to open democratic society, in favour of xenophobic populism and closed economic systems. This was the story of the 1930s. Unsurprisingly extremist parties of the left and right are appearing both in national parliaments as well as that of the EU itself.
And German politicians and financiers must remember other parts of their financial history.
In 1953 the London Debt Conference took up the matter of Germany’s unpaid debts – government, state, local and even private debt. Much of it was written off because, as historian Timothy Guinane summarised, “Most observers had in mind the long years of what they viewed as Germany’s irresponsible treatment of foreign debts and property owned by foreigners.
“Nonetheless the entire agreement was crafted on the premise that Germany’s actual payments could not be so high as to endanger the short-term welfare of her people. Reducing German consumption was not an acceptable way to ensure repayment of the debts.”
