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Riots in the Streets?

Riots in the StreetsIn 'UK - Time for Change?' last December, we cogitated on the background to the financial woes ravaging the UK.

We postulated the origins of the problem lay in the milking of consumers by businesses with short term horizons and that it was fuelled by a credit binge that had abandoned the notion of affordability.

We argued the whole credit system was a tissue of lies and a delusion in which we are constrained and milked by business and bankers - just as an ant strokes and milks an aphid for its sweet honeydew. And all with the blessing (and tacit support) of Government.

We said it was a curious state of affairs that loans had been deliberately made to people who could not afford to repay them, then those loans were sliced, diced and repackaged together with loans made to more reliable payers, and offered as 'irresistible' investment opportunities that subsequently fractured and fell apart when it became clear that most of the underlying investments were worthless.

The great Emperor of Credit became seen as naked.

Worse - for some weeks, the world's financial system teetered on the brink of collapse, as people's confidence in the ability of banks to return customers own deposits to them threatened to evaporate and vanish into thin air - just as the credit that had been so eagerly thrust into their hands was also evaporating.

The immediacy of that danger now seems to have passed (we think temporarily), and attention is starting to focus on dealing with the slice and dice mix of toxic assets 'to restore confidence in the interbank lending market' as Mr Darling puts it.

In effect this means that, broadly, banks have an idea of the extent of their own problem, and based on that, they don't believe other banks with bad slice and dice investments have enough cash to meet their liabilities, so they won't lend to each other for fear of not getting their loan repaid.

Would you?

The Government says we need to fix this. We're not so sure, but assuming for a moment it is the best way to solve it, how is it going to be fixed?

Well, the first thing Government tried was persuade the Bank of England to cut interest rates. The aim was to make borrowing cheaper, and credit even more widespread, and get people spending again. But that patently didn't work; neither the banks nor the people were taken in by it.

What it did do was upset all those who had been prudent rather than profligate, those who had saved, and who relied on the interest from their savings to support their bills or retirement. That income suddenly evaporated as UK interest rates dropped to 1% and threaten to go even lower.

So for its most recent 'fix' the Government said it was going to use a taxpayer-backed scheme to "insure banks' riskiest assets against further losses".

They hope this will clean up banks' balance-sheets and to encourage them to lend more freely.

The logic here is that banks should be able to separate out their bad 'investments' and put them in a Government backed 'bad bank' (though as one wag asked us, why should we create another bad bank when we have so many already?).

This would leave the nice trustworthy banks back in their former position with no worryingly bad debts, and it will "restore confidence to the banking sector." (For which read it will make us believe the banks have enough to give us our money back - when in reality they don't)

The Royal Bank of Scotland (RBS) was the first bank to sign up to the scheme. It will put £325bn of toxic assets into the scheme. Lloyds has said it would also take part in the programme.

To put this into perspective, here in the UK, £325bn is £32,500,000,000. (In the US you should add another zero because their billion is 1,000 million whilst ours is 100 million)

There are about 61 million people in the UK at present, so the money that has just been given to RBS is the equivalent of £532 for every man woman and child in the UK.

And that's just for the bad loans at RBS.

Banks that sign up to the scheme will bear just 10% of the losses on these assets, with the government (that's you, me, and several future generations of taxpayers) shouldering the remaining losses. Participating banks will also have to "enter into legally binding agreements to increase the amount of lending they provide to homeowners and businesses".

The Government does seem desperate to get its credit junkies back on the spending wheel, doesn't it?

It is thought that in the longer term, taxpayers may become liable for around £500bn worth of bad loans and investments (That's getting on for a thousand pounds a head).

So according to the Government, the answer is to get lending going again, to generate more easy credit - meaning that future taxpayers will shoulder the burden of repaying the loans of both the profligacy of former borrowers and the greedy incompetent bankers and investment experts who formerly proclaimed themselves to be the 'Masters of the Universe'

We don't understand why there are no riots in the streets of the UK.

But actually, it's worse.

Because next on the list of Government's tools to con people back onto the credit driven treadmill of unsustainable growth that caused the problem in the first place, is the delightfully named 'quantative easing' announced today.

This actually means they are going to print literally billions - hundreds of millions - of pounds of money they don't have and launder it through buying (and effectively writing off) their own debt, or by buying corporate bonds.

With this process they hope to increase the supply of money in the economy.

The in-principle decision to do this was unanimously agreed by the Bank of England's nine-member Monetary Policy Committee at their February meeting.

So they've been warming up the printing presses, and by now they might even have had the first few hundred million printed.

The next step is for Mr King at the Bank of England to ask the Chancellor if they can use what they will call the 'Asset Purchase Facility' to buy a range of securities on the Bank's own account, using the money they've created for themselves. They will get a "Yes"

The next thing they have to decide (probably this month) is 'How much?'

Large scale central bank purchases of government debt will make people very nervous, but it may be unavoidable - because they won't be able to buy enough corporate debt on the scale they need (probably in the region of £50 billion), because to do so would soak up and swamp the whole of the corporate debt market, so it's likely that a lot of gilts (Government debt) will have to be bought.

Gordon Brown and Co. will say this is not 'printing money' - they'll say they're getting it from a pal who is printing the money for them, so they're not printing it for themselves, but we're with the economists who will say "Yes it is".

You might hear it spoken of as "monetizing the government debt" and we argue its not dissimilar to the process taking place in Zimbabwe except that the UK Government isn't being forced to buy them because there is no other option (which is the case in Zimbabwe)

In effect, this is the same as the chap next door who is deeply in debt forging money to pay off his creditors - except that Governments can't be prosecuted for forgery when they print extra money for themselves.

They will print the money because the Bank of England has exhausted the use of interest rates which are their normal tool to control the supply of credit.

The Bank of England doesn't normally worry about how much money banks have in their accounts, or lend out to customers. They simply set the base rate and hope, (because they know when money is cheap to borrow it will mean more lending by banks, and higher interest rates means less borrowing, less credit, and less spending).

But when interest rates are at or close to zero, it all changes. You can't make money any cheaper to borrow, so the Bank of England has to target the amount of cash more directly by controlling, (or attempting to control) the amount of cash the commercial banks have in their accounts with the central bank.

So that's OK isn't it? If we can just print some more money and get ourselves out of the hole. What's the worry?

Well, the answer depends on who you are - or, more particularly, whether you have savings or whether you are in debt.

It's because printing money will trigger inflation (we mean real RPI inflation, not New Labour's 'seasonally adjusted' HCPI inflation) to extremely unpleasant levels. By the autumn or next spring, we will see inflation move from its presently unheard of low level to quite possibly 8, 9 or 10%, perhaps even more.

That's because printing money is more or less the same as devaluing the economy. There's more money about, but there's been no real growth in output, or increase in natural resources to fund it (eg no new oil strike in the UK), so each pound is worth less (by however much you have printed extra)

Now - if you have inflation - even if it is only at 5% - the value of your capital will halve every ten years (5% a year over 10 years is 50% over the period). So £1,000 ten years on has the buying power of only £500.


If you are in debt, the depth of your indebtedness also halves every ten years. (If you owe £1,000 and inflation is 5%, then in ten years time, the real value of your debt is only £500)

So once again the responsible person, the cautious, the saver, is being sacrificed to pay off the debts of those that spent like there was no tomorrow.

The underlying problem at the bottom of this is that there are now so many people in the UK who are, and have become accustomed to, maintaining their consumerism lifestyle on credit, that to do any different would push them into financial 'cold turkey' and cause social unrest.

But underpinning that problem is the one of consumerism, because the whole of this financial debacle is predicated on illusory, unsustainable growth.

It's the growth that Government creates when it prints money that it has no extra natural resources or productive output to cover each year, and the same growth that is funded by credit that is magicked out of thin air by banks that lend the same £1,000 to ten or more different people - all at the same time.

If you stop and think about it, this is quite terrifying. There is (or at least has been) no sensible limit on how much credit a bank will grant. They simply conjured money to lend to you out of thin air. It's called 'Fractional Reserve Banking' and it means you create credit to lend out at a multiple of at least six and probably ten or more times the deposits you have in 'reserve'. In other words, when someone deposits an extra thousand pounds into their account, the bank can, and will, increase it's lending to others by say £10,000.

The opposite - the one most people think is happening - is Full Reserve Banking, where the banks lending is limited to the amount they take in deposits.

The logic of this is that if everyone asked for their money back at the same time, they would - in the Fractional Reserve case above - quite possibly only get back one tenth of what they paid in.

That's why a 'run' on an individual bank has to be stopped at all costs. If the contagion spreads, the whole system will collapse. This is actually a bigger problem than the sub prime one if this particular genie ever gets out of its bottle.

But in the meantime, if banks can be persuaded to keep on lending, and so long as you go and spend what they lend you, the banks and the Government (and business) are happy.

They say 'Growth' had been achieved.

Your spending paid someone else's wages as their spending paid yet someone else's.

But sadly this growth is an illusion, the wages it pays are an illusion, and the jobs it creates are an illusion.

One of our readers put it very simply. "When I moved into my house, that door was worth about £68 relative to what I had to pay for the house. Today its worth about £320 relative to the value of the house.

But in reality, it isn't.

It's worth the cost of the raw material to make it, the man's time to machine it, the material and man's time to paint it and the cost of the handle and hinges.

The £320 is a perceived value, an illusion.

Those cars that are piling up on the airfields and in car parks are not real cars to be paid for with real money, they are illusory cars that no one has money for."

Quite so.

There are only two ways out of this - well actually, really there is only one way in the long term, but we won't go that way voluntarily.

The weak way, the way the Government are going, is to get us all to believe this has been a nightmare, but we have woken up in warm, comfortable, safe hands, and the sooner we get back to normality and spending again to make the door worth £320 again, the better.

The other way, the real way, is to recognise the illusion and shrink the economy to real values where the door is closer to £68 and banking works on the Full Reserve basis.

Instead of Keynsianism - borrowing and spending our way out of debt - we need a period of Micawberism where we spend less than we earn, where growth is much slower but real, and where inflation is not used to produce the illusion of growth that in the end, leads nowhere except to a bigger problem that we have now. We need more businesses with a long term horizon that work from a sound cash balance, not illusory, unsustainable borrowing.

Think of the UK's economy as something like 25 million households which at the height of the credit boom had collectively borrowed a net £130 billion to meet their consumerist spending habits. But since last autumn, they have dramatically tightened their belt (or more particularly had it tightened for them), because household borrowing has fallen from around £10bn a month to £2bn a month. But the credit junkies fixed that problem by using cash withdrawals and realisations.

In the run up to Christmas £80bn was spent this way. That can't go on of course. The family silver and the shares and bonds in each of those 25 million households will run out at some point, and if the credit market isn't fixed by then, there will be a substantial drop in spending.

Economists estimate that about £30bn a year will be available for credit in the future, and that will mean an 11% drop in consumption from 2007 levels. And because domestic consumption has been allowed to grow to 62% of GDP, that drop in consumption will shrink the national economy by about 7%

That's how big the credit bubble still is, even after all our future taxation has gone in bailouts. If Micawberism is thrust upon people the resultant cold turkey will quite possibly destabilise the whole of the political system in the UK, and in some ways, we can't help thinking a once and for all clearout of the rotten financial and political systems would be a good thing.

But that's not the way we will go if Government gets its way; so the trouble itself isn't going away.

Like an illness, we're only trying to suppress the symptoms. The pain of the treatment when it eventually comes - and come it will - will be more severe than anything we have known before.

Then there will be rioting in the streets.

Dated:  5 March 2009


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