onsdag 23 januari 2008

Recession is unavoidable

There is nothing that any government can do to avoid the coming recession. But taking the wrong measures in an attempt to avert it could make matters much worse, and that is seemingly what the US central bank is doing, with the Bank of England likely to follow suit.

The underlying problem is a credit-fuelled land price boom that had been going on for about ten years. This has had many interrelated effects. The first is that banks had an incentive to tempt people to borrow more than they could repay. The availability of ready credit pushed up the price of land, although this went unrecognised and was seen as a "housing" price boom and a good thing to boot. Banks then saw these bloated and rising land values, created by their own lending policies, as good security for more loans. They continued to lend even more, on the assumption that the inflated land values were real and would go on rising, seemingly indefinitely. Northern Rock, for instance, was advancing loans of up to 125% of the value of a property. A further factor that then came in was the buy-to-let fashion, when people were accepting rental returns which barely covered the mortgage repayments; they were relying on increasing land values to make their speculation pay. Another ingredient in this toxic stew was the Bank of England's policy of low interest rates to maintain consumer demand to meet targets for economic growth, as former Governor Eddie George admitted recently, again stoking up land values. The final straw was that existing owners were encouraged to borrow money against the inflated value of the land their homes were standing on, to pay for consumer sprees, resulting in balance of payments deficits in favour of producer countries, particularly China.

The entire edifice is a classic bubble, which the slightest disturbance was bound to burst. It happens to have been the collapse of Northern Rock and the US sub-prime lending market that tipped it, but it could just as well have been something else such as a sharp rise in fuel prices. Whatever a government does will cause pain to one or another group of people. Seemingly, the US and UK governments want to protect those who have borrowed or lent unwisely, at the expense of the prudent and thrifty, and of potential house purchasers, who have no interest in keeping housing at unaffordable levels. What kind of message does that give?

In this disaster scenario, what will happen next is inevitable. Land values will drop substantially. Recent purchasers will find themselves owing more than the value of the property they have as collateral - in negative equity. With the tightening of credit, general consumer demand will fall and unemployment will rise. Some people will be unable to repay their mortgages and the lenders will repossess. Some buy-to-let purchasers could be in trouble too, though cuts in interest rates will help them. Repossession will not, however, be a good option for lenders as the value of their collateral has now dropped, and some may choose to hold off for a while until things pick up.

Tax cuts and reductions in interest rates will, at best, delay the inevitable for a while, but will cause inflation. In effect, those who have saved will, in real terms, be made to pay some of the debt. And it will still not stop the recession from happening. It will be deep and, though I am guessing, the economy will not begin to pick up until around 2014.

As the economy slides into recession, the one beneficial thing a government could do would be to bring forward good - and not merely prestigious - infrastructure projects, paid for through judicious deficit budgeting; indeed, periods of recession are a good time to implement improvements in infrastructure, as there is some spare labour around to do the work. Many of the suburban railways south of London were electrified in the 1930s as part of a package of measures to alleviate the recession that was going on at that time. If, but only if, economic growth occurs due that investment, the deficit budgeting is not inflationary.

Looking beyond that: first, there is a need to question the whole concept of "growth" on which the present economic system is predicated. The economy cannot keep on growing. There are natural constraints. And what is it that we are trying to grow into? Second, these 18-year boom-slump cycles are not inevitable. They are, as is evident from current events, a consequence of the interaction between the land market and the banking system. The trough of a recession would be a perfect time to implement a programme for the replacement of existing taxes by land value taxation. This will promote recovery from the coming recession and prevent another, around the year 2025, in any country with a government wise enough to introduce it.

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