W(h)ither The Economy?
We can all understand the Government’s insistence about the need to have a balanced budget. Most of us have experienced what it is like when we have no more cash in our pockets and our credit cards have reached their limit. Many of us have felt the uncertainty of whether we shall have enough money even when the next salary or pension payment has been made. We all understand that nations need to balance their budgets in the long run.
What many of us find less easy to understand is the Government’s apparent reticence to address the situation today. We are accustomed to the idea that, when something is wrong, the Government steps in and eases the stress for those in need. But that does not appear to be on their agenda. Perhaps they are waiting for electoral reasons?
It has fallen therefore to the Bank of England to protect the weak. That is in particular the weak that have big mortgages.
Those who are dependent upon the income from money invested in government stocks, annuities or savings accounts, be they weak or strong, are not likely to be helped by the Government or the Bank of England for years to come. The Bank of England is seeking to avoid a collapse in the housing market, which would in turn risk creating a new banking crisis. In trying to avoid the complete destruction of confidence in the economy, they are willing to tolerate the harsh treatment of those who were cautious with their money.
For this approach to be successful however the economy still needs to expand, even if that should be at a slow rate. If it does not, the problem of indebtedness will deteriorate.
In an attempt to avert this risk of a collapsing economy, in March the Bank of England announced an extension to its “QE” project. This has some merits: it helps to finance the enormous national borrowing requirement; it helps keep our banks solvent; and it keeps longer term interest rates at historically low levels, which allows the debts of households and companies to be re-financed with a lower repayment cost.
Unfortunately the downside of this policy is that lending becomes less profitable, and so more risky, for the high street banks. Therefore there is considerable risk that this intended stimulus does not in fact have the desired effect of stimulating the economy. It could be argued that “QE” seems better designed for staving off bankruptcies than boosting the economy.
Some changes to Government policy are required. The current concerns about the inequalities of life in the UK may help guide one’s thinking as to how these changes might be made without disrupting the current “austere” policy stance.
The primary objective would be to get more money into the hands of those taxpayers for whom it would make the greatest positive difference, without undermining the Government’s determination to reduce the budget deficit. This is because these people are most likely to spend it.
To do this would require the creation of more jobs and a shift in the overall burden of taxation from lower earners to those with higher incomes, but without reducing the scope for higher earners to spend their income .
Bringing forward to this year the increase of personal allowances to £10,000 would cost £9billion according to the Centre for Policy Studies (CPS). This could be financed in large part by restricting relief on pension contributions to the basic rate of tax, which currently costs £7 billion (CPS).
Such a shift would allow the lowest earners to take home more of their pay, while putting an end to the situation which allows the highest earners to receive a large hand-out from their fellow taxpayers.
Not only would this be fairer, but it would also be rational. Policymakers would strengthen the financial position of those whose spending and interest payments are most at risk during this difficult period, without upsetting the budgetary balance.
Direct action to stimulate the growth of employment should also be taken, but without changes to the Treasury’s medium term plan to cut the rate of corporation tax. Instead the Treasury and the Bank of England should set an additional course for the usage of “QE”.
“QE” should be used to fund some “trusts” which would hold valuable social assets, such as infrastructure or housing. Such trusts might acquire housing which is at risk of repossession without causing the eviction of the occupiers, thus protecting both the occupier and the bank. These “trusts” might also fund the development of new social housing or other infrastructure.
Such “QE” would act both as a safety net to weak parts of the economy, such as banks and employment, and would contribute to the development of stronger infrastructure for the long term. It could also be argued that, when mature, such trusts might also offer a stable source of reliable income for personal pensions.
Simon James is Founding Partner at Gore Browne Investment Management