Dec 15 2008
Why does Britain blame America for the current economic recession?
Perhaps this should have been titled; Is America solely to blame?
Gordon, there cannot be continuous ‘boom’ without ‘bust’. Anything that expands quickly will be overstretched, and will snap back to a more acceptable equilibrium.
That said, the Sub Prime market in the USA is generally blamed for the World recession by the British government, media and public. The real truth is that it was not so much the debt itself, but the way it had been constantly re-packaged and sold on amongst different banks that has led to problems. In the end, noone knew how much bad debt they were actually holding. This meant that banks figures were innaccurate, and they all felt they were better off than they really were. This was a clear failing of the Financial Services Authority (a QUANGO which took over responsibility for regulating and moderating the banks from the Bank of England, when the BofE was made responsible for interest rates). Putting the FSA in charge was Gordon Browns decision.
Additionally, suspicions should have been raised over the Enron/Anderson affair in the USA. Anderson were the biggest auditors in the US, and fiddled the accounts of Enron for it’s chiefs. If Anderson were willing to do this for one high profile customer, they would no doubt have been willing to do so for others. This would mean that the US major stocks could well be overpriced on Wall Street. Why were Anderson having to do this during economic growth, is a question that was not asked, and probably implied that the US economy was not as strong as thought. This is borne out by the massive collapse across the big companies of the US.
However, there is a lot more to the UKs financial system and failure than the USA, its banks and their ‘toxic’ debt. Domestically, 2 important signs were missed; spending on credit cards was larger than by cash for the first time in history 3 years ago, and domestic debt reached 4 times the GDP of the nation. This meant that the growth in industry was not being paid for by money, but by debt, that would need to be paid. The growth for the last 5 years was ‘on the never never’.
The government also hamstrung itself and the Bank of England, by making the BofE responsible for setting interest rates. This meant that the BofE had to focus on fighting inflation, whilst the housing boom spiralled out of control. As I stated at the being of this piece, nothing can expand rapidly forever. Now that housing represents its real value, most mortgage holders owe more money than their house is worth. After 20 years of paying, they may still not have got their moneys worth. Also, and because of the credit card condition mentioned above, controlling the flow of cash (ie the amount of genuine currency in circulation) no longer has the impact it used to. This was all predictable, yet Gordon missed them.
As house prices exceeded the value of the property, some UK banks were offering mortgages of 125% the market price. Even if house prices had stayed constant, this would be toxic debt. It was a stupid step, but the banks were falling over themselves to fight for our debt. This has nothing to do with the USA, and should have been stopped. Gordon did nothing.
Inflation has spiralled out of control, peaked and is now collapsing towards deflation. Keeping interest rates low for business, and causing the housing boom, has proven a pointless activity.
The rise in oil prices pushed inflation out of the BofEs control. Everyones fuel costs (private and business) rocketed. Now oil prices have fallen back massively (virtually a quarter their peak price), but Gordon has made Britain so unattractive to investors, that our currency has collapsed against the dollar and euro. As oil is priced in dollars, every country is now getting proportionately cheaper oil than we are. Gordon claimed we were better placed than other economies to weather the recession, and has refused to support the pound, or more likely - he doesn’t have the funds to support the pound, he gave it all to the banks. Unfortunately, only the Cabinet believe we are in better shape than others, or are just in denial. The World Bank, IMF and speculators worldwide, all of them disagree with Gordon.
As such, we are at a disadvantage to the USA and Eurozone, who are paying less for fuel, which will benefit their businesses.
Gordon Brown earnt the image of being frugal at the beginning of Tony Blairs government, by exercising cut backs and economising in government departments. He promised that the savings would be used to help regenerate the country. Manchester was promised an extension to its Metrolink service by Transport Minister Stephen Byers, who resigned in shame. He was replaced by Alistair Darling, who re-iterated the proposal twice, before running out of money and cancelling the whole plan. This week, Manchester voted no to a referendum offering us the same improvements Manchester had been promised, but this time by having a congestion charge area 10 times larger than Londons! All the money Gordon saved, he squandered, and it never went where it should have. Now, government wastage is just as bad as it was under the Tories. If things were so good, why did this money just drip away, shoring up other spending? Because, they were false economies in the first place.
Wake up Britain, stop blaming America and look far closer to home. Whilst a socialist myself, I must say that Vince Cable of the LibDems seems to be the only financial mind in the Houses of Parliament who understands our present predicament, and has sound proposals for the future. As a lifelong Labour voter, this scares me.
You seem to have a pretty good handle on economics. What happens when central banks cut their interest rates to 0 and why is it that the interest rates even exist in the first place if this is an option?
Hi skwguitar
Interest rates affect several diiferent issues, and come in different forms.
The simplest, and one that we are all most familiar with, is your banks interets rate. You will have noticed that they have a rate for lending to you, and a different one for if you have savings.
The lending rate is the way the banks earn a profit on the money they lend. This is usually slightly above the central bank rate, because the banks assume that some customers will default, and the money will be lost. The good payers subsidise this. As with all goods/services/products, banks compete with each other for our business, so rates will vary slightly, as will the terms and conditions of any loan.
With central bank interest rates, there is usually just one rate. Each country has a central bank, and that institute guarantees the currency. Eg. with Britain, the notes (£5,10,20,50) all still bear the statement that ‘the bearer is entitled to..’ This guarantees the legal tender. This is all backed up by what sed to be called the ‘Gold Reserve’, though nowadays it is not just big lumps of gold, there are also large sums of foreign currency. You may remember that a few years ago, when Chancellor of the Exchequer, Gordon Brown sold a large amount of our gold reserves off, and purchased Euros. You may also have heard on the news reports about ‘interbank lending’, and the fact that the banks aren’t lending each other money. The central bank is also the government and banks bank.
Reducing the base rate to almost 0% means that it is easier, and less risky to the banks, for the banks to borrow money and to start spreading that money across the country. If they lend to businesses at 4%, most businesses would be able to pay that back, and the bank would make nearly 4% profit. If the central rate was 4%, and the banks lent at 8%, more businesses would default because of the interest charges.
If banks pass the reduction on to the customers, then it becomes easier for people to repay their debts, reducing the level of defaulters, reducing losses for the banks.
There is another side to the coin, however, which affects those people who are fortunate enough to have savings. These individuals will gain nothing by having savings in bank accounts. In a recession, this can actually make these people look for other places to put their money; stocks and shares, government bonds, gold, silver, etc. Alternatively, they may actually spend the money on house improvements, new car, etc which helps businesses stay in business.
Unfortunately, such low rates can not be sustained forever. The effects are good during a recession, and can act as a ‘financial stimulus’ to the economy. However, in the long term, banks would cease to function; no profit margin if no interest rates. This would mean no lending, which almost all businesses need to help with start up costs for new business, or for investment for expansion or replacing machinery. There would be no mortgages, so the housing market would cease being a market. Capitalism needs money to move about to work.
When thinking of a countrys finances, or even the global economy, it can be helpful to think of it as a very complicated equation with lots of things on one side, and lots on the other, with an = in the middle. If both sides balance, an economy is stable but not growing. If the left is bigger, an economy grows, and vice versa. One of the numbers on one side is interest rates, along with total currency in circulation, speed of that circulation, government investment, and many, many more things. By altering any of these things, the balance gets tipped.
It can be a very difficult subject, with many strange terms and phrases, and I have simplified things greatly, but hope that this has helped answer your question.
If I can help any other, or if you agree/disagree with me, then please feel free to further comment. Thank you for your complimentary comments.
Thank you so much for your in depth and detailed response! That actually squared all of the questions I had.
Cheers!