Does the fall in the pound presage a financial meltdown?

The British pound is now at its lowest effective (i.e. trade-weighted) level ever, according the Bank of England's 168 year index. There was a sharp initial fall after the referendum to leave the EU, and then a further fall over the last week after the prime minister's conference speeches pointed toward a quicker and harder exit than expected. Is this just a routine fluctuation that can be shrugged off, as bigger falls have been in the past, or does it portend something nasty? It is, of course, too early to tell.

The pound's fall has been seized on by supporters of Remain as the sole piece of substantive evidence to support their prediction that exit would make Britain worse off. Leavers are predictably unimpressed. Of course both sides seek to gather every scrap of evidence to justify the stand they took in the campaign, and this argument leaves us none the wiser. This blogger is not beyond such things, of course, but I do try to set a higher standard.

The first question posed by the depreciation is what was the pound doing so high before the referendum anyway. The country has a large current account deficit. In other words, as a nation we are spending more foreign currency in imports than we are getting in exports and investment income (or persuading foreigners to accept more sterling than they want to spend on British imports - it boils down to the same thing). In theory this suggests that the currency's real exchange rate is too high. This has been a persistent and to me perplexing phenomenon since the late 1990s. Demand for sterling has remained high, notwithstanding the deficit. Investment by foreigners in property and business assets (or Britons selling off overseas assets and repatriating the proceeds) has kept the pound afloat for 20 years - though at a much higher level before the financial crisis of 2007-09.

This is, literally, a confidence trick. Investors have had sufficient confidence in the British economy to think that their assets will grow in value in terms of their home currency, rather than ours. It is hard to pin down why for sure. Britain is an easy place for foreigners to do business - we don't have a xenophobic attitude to foreign investment, sometimes seen in countries as close as France. That encourages footloose capital in our direction. We have seen many takeovers of great British businesses (notably this year the chip designer ARM). Buoyant high-end property values have no doubt encouraged investors too, though it is hard to quantify.

Britain's membership of the EU is doubtless part of the charm of Britain, for business investors at least. They can set up operations here with ready access to European markets, free of tariff and non-tariff barriers. Leaving the EU, and its single market, must surely dent the country's attraction. But we don't know by how much. It won't change the ease with which foreigners can buy assets here. By itself it should not affect high-end property either.

There is, therefore, a clear case to keep calm. As sterling takes a fall, it makes British assets cheaper. This should be a compensation enough for British exit to the EU, though you might be wise to stay clear of some businesses, like motor manufacturing. A lower exchange rate should help rebalance the economy, reducing the current account deficit, and the country's dependence on foreign investment flows. This is all self-correcting. And if you are a true Brexiteer you will be confident that a more efficient, better balanced economy will eventually emerge from any transitional wobbles. That may be right - I always thought that the hair-shirt case for Brexit, as I called it, was intellectually their most persuasive argument (referencing a post I made in March which stands the test of time). Could EU membership have caused that current account gap, or allowed it to persist, leaving us with an unbalanced economy?

There is a problem, though. Capital markets are not rational. Nobody really understands how they work, and they are at least as influenced by a complex game of second-guessing short-term movements as they are by cool, calm assessment of long-term prospects. They are prone to bubbles: excessive periods of confidence followed by excessive pessimism.

You can see this by the way market observers talk about movements in prices being persistent trends, rather than asking what the right price is. This is at its most striking in the property market, where price movements are talked as "performance" rather than finding an appropriate level. A long view investor might say that the pound has simply found a new and more appropriate level. A short view investor might suggest that the pound has been performing badly, so that further falls are to be expected. In the former case you have would expect the fall to be limited, in the latter the fall becomes a self-reinforcing trend. And the difference comes down to a not entirely rational quality: confidence.

Confidence is not a nice, mathematically well-behaved quantity. It is prone to behaving in a very non-linear way. It can disappear suddenly. Confidence in Greek government bonds used to be nearly as rock-solid as German ones. And then it disappeared. Could confidence in the pound, and then other British financial investments, like government and corporate bonds, disappear just as quickly? Could the 20 year bubble burst? It doesn't have to be rational. If it does the wider consequences would be severe. Inflation could take off as the monetary floodgates are opened (by the government funding itself directly through the Bank of England); bank lending could simultaneously dry up causing a recession. Back to the 1970s in other words when, amongst other things, a massive rise in oil prices caused a rapid rebalancing. Is Brexit a similar shock? (even accepting, as with high oil prices in the 1970s, we end up in a better place).

It is hard to believe that things will turn out like this. There are some signs of vulnerability: property prices are high; the budget deficit remains high by historic standards, and so is the level of the national debt. There is little scope to restore financial markets by cutting interest rates. Gilt yields have been rising recently - suggesting that confidence in government finances is starting to fade. And yet the overall statistics do not suggest alarm - foreign exchange reserves, for example, look plentiful. But ultimately if the country has a current account deficit, and if foreign investors don't want to finance it, there will be defaults or inflation or both.

As the FT's Martin Wolf points out, a financial meltdown is not likely, but the risk of it has risen in the last week. The capital markets have given Britain an easy ride through its recent troubles, but that could change quickly. The government needs to be very careful about how it handles Brexit. Sovereignty in an interconnected world is always incomplete.

The post-Brexit phoney war on the economy

Two months after Britain's shock referendum result, and what has happened? Not a lot. Though you wouldn't think it from reading the running commentary. So was Project Fear the hoax that the Leave campaigners always said? Probably not.

The few days after the result seemed to fulfil Project Fear more quickly than even Remain campaigners suggested. The pound fell sharply and many stock indices tumbled too. There was much talk of this or that investment being stopped, or this or that institution or business being under threat. Remain supporters have kept up the pace of alarmist talk ever since, to judge by my Facebook feed.

But Brexit campaigners have a point when they poke fun at this. When it comes to cold, hard economic statistics it is very hard to see much, or any, adverse impact. The stock markets have fully recovered. Retail sales, employment and prices all looked pretty healthy in July. The government still finds it laughably easy to raise money on the bond markets; the Bank of England's currency reserves went up. Only that fall in the currency has persisted. And no doubt that reflects weaknesses in the economy before the vote - given the scale of the ongoing current account deficit. The various indicators that have taken a plunge represent sentiment rather than hard fact, and may have been contaminated by the sheer shock of it all, as might the gloomy reports from the Bank of England and the Institute for Fiscal Studies.

On only one thing can Brexiteers be disappointed. The remaining EU has sailed on just as smoothly as the UK, with the Euro strengthening significantly against the pound. This defies predictions of imminent panic and collapse gleefully made by (some) Brexit campaigners. No other country seems at all inclined to follow Britain's lead to the exit. Even as the emerging kerfuffle on Italian banks is as good evidence as you might ask for about problems with EU rules and democratic mandates.

There is, of course, one possible explanation for this insouciance: denial. Maybe people think that exit is so hard, and will have such obviously dire consequences, that it will never happen. Speculation about the invocation of Clause 50 for formal exit pushes it further and further into the future. If so it shows remarkably little insight amongst the market makers. Any process by which the referendum result is reversed will be very messy, and entail a lot of collateral damage.

Personally I think people are putting too much faith in the markets' ability to see trouble ahead. The signs that the 2008 crash was in the works were obvious more than a year beforehand, when the interbank markets froze. Strong enough, as I don't tire to point out, for me to move my pension portfolio from shares into index-linked gilts and cash. The more perceptive would have seen the trouble coming a year before even that, when US property prices started to slide, threatening the foundations of the whole financial edifice. And yet the markets did not reflect the mounting danger at all.

And at the other end of the scale, when it comes to the multitude of small decisions taken by consumers and businesses that drive the short term statistics, there is also a sort of built-in inertia. Short term decisions quickly overwhelm intangible longer term worries. People don't know what to do, so they carry on as normal.

There are two ways in which the Project Fear may yet turn out to be on the money. One is a slow decline that accumulates: slower growth turns to a shallow recession that persists. That would be perfectly consistent with current statistics. The other way would be like the 2008 crash: a delayed reaction leading to a sudden crash.  Both of these follow my metaphor of the economy being holed below the waterline in my post in the week after the result. The ship is in mortal danger despite no damage visible above water.

Why might trouble happen? It comes back to the basic weakness of the British economy (which, it must be said, EU membership was doing little to help) - a substantial trade and current account deficit. Britons as a whole are spending more than they are earning, and have been for many years. That has been OK because plenty of foreigners have been prepared to lend us money, or to invest in British businesses or property. Also British multinationals may be selling off foreign assets and bringing the proceeds home. Brexit is putting that investment flow at risk.

What happens if the country can't get enough currency to pay for imports? Demand for Sterling falls, and the currency sinks. That might attract investors (British assets look a bargain) or scare them (with the risk of further depreciation). Currency reserves, private and national, start to be drawn down. That will affect living standards. Then either the trade balance corrects (buy fewer imports and sell more exports), or things start getting nasty with a financial crisis as the stability of banks and the entire payments system comes into question - which is what happened in 2008, for different reasons. These changes tend not to happen smoothly.

The problem is that the financial system is very complex, with all sorts of buffers and hidden dependencies, which makes it non-linear. Responses are not proportionate to the changes to the system. Past performance is a poor guide to future dangers. There might be a lot of short-term factors stabilising things, but that could be undermining resilience. The country could be building up vulnerability to the next financial crisis, just as the Labour government of the naughties created vulnerability to the banking crisis of 2008.

Or perhaps the Brexiteers are right. The financial system will adapt to the new realities calmly and the British economy is fundamentally stronger than the pessimists say. The economy will sail serenely on and gather strength to boot.

The thing is that it is just too early to tell. It could be many months, or even years, before any crisis caused by Brexit emerges. I will be watching for signs of trouble. But, to be honest, I haven't seen them yet. It's all a phoney war.

 

Was the coalition’s austerity policy a colossal mistake?

Politics is dominated by historical myths, about which the different political camps disagree. Examining these myths critically is one way that societies can find reconciliation. While "austerity", the favoured shorthand for government cutbacks, is fast sinking as an issue in British politics, long since overtaken by Brexit, its mythology remains a defining issue. This mythology has right and left versions. I want to look at the mythology of the left.

Few in the Labour Party would disagree with Oxford Economist Simon Wren-Lewis in a recent article that austerity "will go down in history as probably the most costly macroeconomic policy mistake since the 1930s, causing a great deal of misery to many people’s lives." We in the Lib Dems are implicated in this criticism, as part of the coalition government of 2010-2015 that implemented austerity. It is exhibit B in the Labour case that the Lib Dems should cease to exist as a political party, and that all "progressives" should simply join their party (exhibit A being the tuition fees fiasco). So what are we to make of it?

Mr Wren-Lewis sets out this narrative very clearly in his article. He is an open Labour supporter, so his comments come with a political slant - but he is a proper economist and the case he makes is a substantial one.

This narrative runs something like this: in 2008-2009 Britain followed the world into a severe recession, brought about by a global banking crisis. This inevitably created a government deficit, of which he says: "We experienced record deficits in 2010 simply because the recession was unusually severe." The Labour government used fiscal stimulus to moderate the effects of the recession, but the Conservative-Liberal Democrat coalition that came to power in 2010 rejected this approach and focused obsessively (so the story goes) with reducing the deficit, using austerity policies - cutting government spending severely. He claims that this focus on austerity had no economic merit, and is best understood as a political exercise to reduce the size of government, with misery as its by-product.

Mr Wren-Lewis says that the government defended its policy with three arguments: that innovative monetary policy would provide the necessary stimulus; that improved business and consumer confidence would do the trick; and that financial markets would not finance the national debt unless action was taken. He demolishes each of these arguments, and I would not disagree with him, though there is an element of hindsight and the first two ideas came good in the end. As a result, he says, the British recovery was extremely slow, costing the average household £4,000 a year - coincidentally about the same as the Treasury's estimate of the costs of Brexit.

But Mr Wren-Lewis is being disingenuous. There was a fourth argument for austerity. And that was that most of the deficit in in 2010 was "structural" - in other words had a deeper cause the recession. If I remember correctly, the Office of Budget Responsibility estimated that about 8% or so of the 11% deficit was structural. In other words a lot of the pre-crash tax revenues were gone for good, and would require more than short term demand management to bring them back.There is plenty of scope for disagreement amongst professional economists here - but it does suggest an alternative narrative, to which I personally subscribe.

This narrative posits that the British economy was not in a stable position when recession struck. It had already been pumped up by excess fiscal stimulus; there was too much private sector debt; and there was an unhealthy dependence on international finance and, to a lesser degree, North Sea oil. The evidence for this is not just the precipitate nature of the crash - bigger in Britain than in other developed nations - but the large current account deficit before, during and after the crash, and the high level of Sterling beforehand, and its abrupt fall. It is true that the public deficit did not look outsized by international standards before the crash, but, as my macroeconomics lecturer pointed out at the time, the overall economic context had classic signs unsustainable fiscal stimulus. The crash was more than an ordinary business-cycle downturn, it was Britain's financial chickens coming home to roost.

So what does that mean? It means that fiscal stimulus as a response to the recession would have only a limited impact, and would not have restored the economy to its previous health, and in particular it would not have solved the government's deficit problem. Before long the additional demand generated would have led to inflation (in fact unlikely outside economics textbooks) or (much more likely) a worsening current account deficit, i.e. stimulating other countries' economies rather than ours. That put the British government in a bind. There was a case for stimulating demand through fiscal policy, and yet government expenditure had to be cut back towards something sustainable in the medium term. The government in fact plotted a middle way and, far from obsessively focusing on deficit reduction, moderated the cuts when the recovery proved slower than they expected. The trajectory of deficit reduction was close to that projected by the outgoing Labour government in 2010.

But many distinguished economists were and remain highly critical of the coalition's austerity policies. Labour supporters can quote any number of famous names. But you need to read what these distinguished people actually said, rather than the mood music they fed into. In fact they hedged their bets. They focused criticism on the lack of public investment, and not across the board austerity. Investment, in theory anyway, is a magic bullet in this context. It generates future productivity growth, so helps to put the economy on a more sustainable future path, while at the same time providing short-term demand. This is a perfectly valid criticism of the coalition record, shared by many Lib Dems who were part of the government. But it does not suggest that the majority of austerity policies were wrong in principle. Taxes and spending were badly out of line and something had to be done to return them to balance. All I can say in the government's defence is that public investment is much harder to do in practice than in theory - so often the money ends up in wasteful white elephant projects. But it would have relatively easy to allow the building of more council homes, for example.

Where I agree with Mr Wren-Lewis (though he does not explicitly say it) is that the macro-economic policy presented by Labour at the General Election in 2015, under Ed Balls and Ed Miliband, was much more sensible than the one presented for the Conservatives by George Osborne. Mr Osborne proposed a charge towards fiscal surplus that made little economic sense - and one year on it is being buried by his successor. The Labour strategy would have knocked some of the hard edges off austerity, while promoting a higher level of investment. The left is right to call to call it "austerity-lite", but wrong to suggest that this was a bad thing.

So criticism of austerity is warranted, but this does not amount to what the left wants it to do: to prove that cuts to government spending and benefits were unnecessary, and still less that they can be reversed. Extra spending will require higher taxes. Economists may feel that austerity policies are self-defeating in many instances, such as in some of the Eurozone adjustment programmes. But there is also growing recognition of a deeper weakness in many advanced economies, including Britain's, signified by the stagnation of productivity. That is limiting tax revenues and what governments can afford to do. That weakness should be the central topic of political debate.

 

 

Don’t panic, but look for signs that Britain’s finances are holed below the waterline

Last week, before Britain voted, I suggested that Britain's finances were vulnerable, and that a vote for Brexit would lead to a financial crisis. After Britain duly voted for Brexit, many commentators have suggested that just such a crisis is unfolding.  Is it?

My form on predicting such crises is mixed. I thought that Britain's failure to join the Euro in 2000 might lead to a crisis in due course, as international investors shunned Sterling. This was very wide of the mark.  But in 2007 I correctly foresaw that the apparent calm after the interbank markets froze could lead to a serious financial crisis, moving all my pension fund's assets to index-linked gilts and cash. Its value rose while most funds were badly battered in the crisis of 2008/09, facilitating my early retirement. So I need to take a deep breath and try to look at this objectively.

First, what do I mean by a financial crisis? There are two things to look out for. First is a collapse in asset prices that causes people who have borrowed to finance assets (which what people usually do for property) difficulties, which in turns affects banks and squeezes demand, causing job losses and recession. The second is one of governmental finance, whereby the government finds it hard to finance the national debt, forcing interest rates up, and a drive to austerity regardless of any need to stimulate demand. This is likely to be combined with pressure on the currency that makes it impossible for monetary policy to take up the slack. The 2008 crisis was of the first type, but the government managed to head off the second type. For the second type examples are Brazil currently, and Britain in the late 1970s and early 1980s.

Why did I say Britain was vulnerable? First, the country has a large current account deficit, running at about 7% of GDP, historically high. This suggests that the economy requires substantial amounts of foreign investment to keep going, at a time when uncertainty would put such investment off (both by foreigners and locals' overseas assets). Second the national debt is high, at over 80% of GDP, and there is still a fiscal deficit; though at 3% this is far from scary, there is not much margin for it to deteriorate into scary territory. Against this Britain's national financial management, led by the Treasury and the Bank of England, is world class, prepared (unlike the government for Brexit negotiations) and with an excellent track record. British banks are also in much better shape than in 2008, adding to overall resilience. International financial flows are very mysterious, and  it is hard to forecast safety or disaster.

The best thing to do from where I'm sitting, without high powered computer models, is to describe the danger signals, and keep a watchful eye. This means keeping an eye on some key statistics.

First there are share values.  The FTSE100 is a darling of journalists, because it is so accessible. It also tells us not very much, since many of its components are multinationals and not really British. Last Friday was not a good day for share markets, but nothing out of the ordinary either. Today is also bad, with the more representative FTSE 250 falling by 4.6% in three hours (the 100 fell by an unremarkable 1.3%). If these sorts of falls persist, then that could be a wider sign of poor business confidence, which will affect all important investment. But for an asset based crisis it is real estate that is much more important, and this moves at a more sedate pace. Too early to tell there.

Next, there is the pound Sterling. This is much more important. A weak pound will feed through to inflation, for example in petrol prices. This could put pressure on the Bank of England to raise interest rates, which would have all sorts of nasty knock-on effects. But I think that risk is overdone in market commentary - it is very 20th Century. These days employers do not feel the need to match price rises with wage rates, which puts a cap on general inflation. In the recent crisis the Bank was able to ignore rises in consumer prices without risk. But it will mean the public faces a squeeze, which will reduce domestic demand. A second issue with the pound is any effect it has on investment; a weak Sterling will reduce the attractiveness of gilts (government bonds) as a safe haven asset.

The pound had a bad day on Friday, though that was partly because markets were so confident of a Remain victory. But is has continued its fall this morning; if this trend persists there is serious trouble ahead. But there is no sign that the pound's troubles are affecting gilt prices; they have risen, as they are still regarded as a safe haven. If this continues the government stands a good chance of weathering the crisis. So far it is definitely a case of Don't Panic.

Looking further ahead, there are two statistics to keep an eye on. One, inevitably, is GDP. The stats here are wobbly and don't deserve the attention they get. But if growth slows or even goes into reverse, then the government will be under pressure either to extend austerity or to provide Keynesian stimulus, depending on its reading of the situation. The second, more relevant , statistic is tax collections. If this is under pressure then there is a risk of government finances spiralling out of control.

The first question is when the short term reaction to the vote overwhelms the country's financial system, causing emergency measures. Based on the gilt yields this looks highly unlikely, even in today's febrile conditions. The more important question is whether, having survived the immediate storm, the financial system is holed below the waterline, to use a nautical metaphor. When a ship is holed below the waterline, it sails serenely on, with only fairly minor signs of damage. But it is taking in water that may cause it to keel over later, if it does not make to safety in time. This was how the world financial system looked to me in 2007 - while many fund managers were saying that the crisis had passed. And the drying up of inward investment could make that metaphor appropriate to the British financial system now.

So my message is this. Don't panic, but look at for small but significant signs of longer term trouble.

Afterthought

What I probably should have emphasized is that I think it is gilt yields/prices that are the critical statistic to watch. If these stay low (yields) or high (prices) than it indicates that the government can readily borrow Sterling, which gives it the scope to manage the financial situation. If they go in the opposite direction, then it could be a sign of a more serious crisis.

 

Tax is the Budget gorilla

As a rule I hate clichés. I cringe whenever I hear about a "perfect storm". But I have a soft spot for the gorilla in the room, who is sometimes an elephant. The huge thing, obvious to everybody, but which it is impolite to talk about. In responding to Britain's annual (OK, twice yearly) Budget I'm looking at one of them.

Britain's Budgets are political theatre staged by the Chancellor of the Exchequer, as our senior finance minister is known, annually, or whenever there is new government. There is also an Autumn Statement, which amounts nearly to the same thing. The whole exercise is a process of heavily manipulated speculation in advance, followed by a tumble of instant reaction. All this shows how news is the enemy of information. By the time facts are known, contextualised and properly analysed the news media have long since moved on. People who try to be a bit more serious, like me, are torn. By joining the circus of speculation and premature response we get more readers and more reaction. But this is often at the cost of saying anything that is worth saying. My compromise is not to respond until after I have read the reactions the morning after.

The Budget process seems particularly farcical at the moment. The government is trying to set out its plans over a five year period, and in particular over the five years of a parliament, which in both cases means up to 2020 at the moment. This means they depend on five year projections of the economy. These projections are produced independently of the Treasury by the Office of Budget Responsibility (OBR). Without the smoothing hand of political manipulation, the five year outlook is highly volatile. Last Autumn the OBR "found" £27 billion; a mere six months later they had "lost" £56 billion. I can't offer much help about what is going on here, except to point out that economic forecasting is a dodgy business, and this sort of volatility simply shows the absence of manipulation. It is no basis upon which to carry out serious economic planning. And yet the government says that it is doing just that. Last Autumn it used the £27 billion windfall to relax its fiscal plans. This time it was forced to tighten up a little, plus deploy a few accounting tricks to pretend that it is on course to meet tis five year target to move the budget into surplus, even as interim targets fall by the wayside.

But nobody is convinced, and nobody cares. It is far too early to worry about 2020, with so many unknowns. The critical thing is the next year, and nobody disagrees much with the overall thrust of George Osborne's strategy. The muddle is particularly noticeable on the left. They are trying to capitalise on the fact that the government is missing its short-term austerity targets, while at the same time condemning austerity. Since 2010, the government has taken a pragmatic, Keynesian stance to fiscal policy, while pretending that it is being austere.  This means that the country's fiscal deficit and levels of public debt are higher than pretty much any other major developed economy apart from Japan, having started the crisis in a much stronger position. That this has still meant dramatic cuts to public spending shows just how out of control the government finances had become under the previous government, as it pursued the illusory goal of Scandinavian public spending backed by US taxes. The left are still in denial about this.

So what did Mr Osborne do? Not much. There were promised tax cuts on personal allowances and higher rate thresholds. He failed to increase tax on petrol, even after petrol prices have fallen so far. There were cuts to company taxes and capital gains. I don't approve of much of this, though many liberals do. But the impact will not be huge. He stepped up the ratchet on public spending, without being too specific, but pushing the hard decisions way into the future in the hope, no doubt, that the economy will come to the rescue. There were gimmicks and irrelevances aplenty, like a sugar tax, and pushing schools towards academy status, which I comment on in another post.

But here's the problem. Constraining, never mind cutting, public spending is getting harder. Benefit cuts are causing anguish that even Conservative MPs feel; the ambitious idea for Universal Credit could yet collapse amid its technical problems. The attempt to drive efficiency savings in the NHS through ratcheting up financial pressure annually, a policy that predates 2010, has now collapsed. Hopes that the NHS can achieve substantial savings through re-engineering are vanishing. The ugly behemoth is unmanageable, and the reforms made by the Coalition aren't helping. Outsourcing bits of it will not help. Meanwhile demand continues to rise. The government's bid to reform schools finance requires a lot of extra money to placate the losers if it is not going to run into big problems. Social care is in crisis. Attempts to curb the defence budget have collapsed.

Behind this can be spied a strategic problem. Or, rather, two. The first is a growing proportion of older people, with an added demand for public pensions, and health and social care support, while dropping out of the tax base. The second is that the benefits of a modern economy are increasingly going to the richest, leaving many behind without adequate savings, and putting pressure on the social security safety net. Rising property prices are exacerbating this, burdening many younger people with huge rents and no prospect of joining the property bonanza. I could add a number of further issues which suggest that the days of easy economic growth are over.

So demand for public services is rising, but the tax base is shrinking, or at least stagnating. There is a substantial current account deficit, which limits the scope for creative government finance (like "people's QE) we need lots of foreign currency to buy the all those foreign goods we depend on. There is really only one way out. Taxes will have to go up, and not just on the richest. That means the sacred trio of income tax, national insurance and VAT. But nobody talks about this. Not even the opposition parties.

And that is the gorilla.

Neither fish nor fowl, why I will oppose the economics motion at #ldconf

This weekend the Liberal Democrats meet for their Spring Conference. To most observers of the political scene, this is an irrelevance. But with the growing gap between Labour members and the general voting public,  and the Conservative Party riven by splits on Europe, who knows what opportunities might arrise for the party? I still care about it, anyway.

The party is rebuilding itself after the five year car crash of coalition government ended last year with it being reduced to near irrelevance in the House of Commons. And that followed five years of rather gentler decline after its peak year of 2005. The party conferences are an opportunity for members and leaders to decide what the revitalised party stands for.

One complaint after last year's meltdown was that the party was weak on economic policy, and so let others set the agenda. No doubt that motivated the submission of a motion on the economy as the first item of policy business on Saturday with just an hour's debate. Alas the motion plumbs the depths of awfulness.

I can't find a neat link to it, so I will reproduce it here in full below, so you can judge for yourself. But with its 10 whinges about the current situation, and 15 proposals, I'm not sure I would recommend a close read. It is mostly unobjectionable. It has some worthy ideas, and some airy aspirations. Item 11 od the 15 reads: "Addressing inequality through a renewed commitment across Government and society to analyse and address Beveridge’s Five Giants in modern society."

In some contexts a list of 15 rather disconnected policy ideas is not a bad idea for a policy motion - for example if the party was planning to negotiate a coalition programme from a position of strength. This is hardly the context now, and even then it fails. Just what would you do with a commitment to tackle the Five Giants in a coalition negotiation? Instead all such a long list of vague ideas serves is to offend people whose own hobby horses are left out of the 15, or are underrepresented, or given too low a prominence.

What the party actually needs from a debate on economics at this stage in the political cycle either of two things.

The first thing it could do is set out a very limited number of general themes, around which to hang more detailed policies. These need to display a bit of vision, and show  what the party is all about. I suggested a few last year: green growth, small is beautiful (or greater diversity and innovation, if you will), problem-solving public services and addressing inequalities and imbalances. It would not be hard to do better than that, and any debate would say something about the party's values and campaigning priorities. I can find no such clear general themes in the motion. Worse, I am rather shocked to see so few references to environmental sustainability in a party that used to pride itself on environmental consciousness - that alone is reason enough to vote the motion down.

The second thing it could do is develop a particular economic idea or solution to a specific economic problem. There are plenty of places where this needs to be done: investing for green growth; tackling the housing crisis; free but fair trade; taxing businesses. Or the role of fiscal policy in economic management, though the chances of getting a rational debate on that area in a left of centre political party are slim. This is actually where the heavy lifting needs to be done, and where the Lib Dems can make a substantive contribution to the wider political debate on economics.  The real world of democratic politics is evolutionary; revolutions fail. What is needed is a series of practical changes, each of which will works on its own merits, and which collectively will amount to radical change. The motion does point to some specifics, but each of its 15 proposals needs to be picked apart in a debate of its own. Instead we have a series of vague and useless commitments.

And as a result the motion is a complete waste of time. Much hope seems to be being placed on amendments. But unless these are allowed to replace the motion with an entirely new one, which would be an abuse of process, I can't see how it can either be turned into a general vision or a specific economic proposal. It is neither fish nor fowl.  The best thing to do with it is to throw it out and start again.

Conference re-asserts the Liberal Democrats’ continuing commitment to sound public finances, social justice, an open economy in an open society, and the principle of free markets whenever possible with intervention where necessary by an enabling state.

Conference notes:

a) The Liberal Democrats’ effective record in Government in stabilising the public finances and major contributions in the fields of apprenticeships, banking regulation, the British Business Bank, the Green Investment Bank and the promotion of innovation through the Catapult network.

b) The fragile nature of economic recovery following the 2008 crash, evidenced by interest rates which are historically low and continued Eurozone uncertainty.

c) The growth of house prices carrying the threat of a price bubble and subsequent crash.

d) The Chancellor’s unhelpful and arbitrary re-definition of the deficit, doubling the total by including capital spending, in his attempt to justify Tory spending cuts.

e) The medium-term risk to the UK economy posed by increasing and unsustainable private and household debt.

f) The threats to the UK economic prospects posed by Conservative approaches to UK membership of the European Union and immigration.

g) The International Monetary Fund’s advice to reduce debt through growth not cuts.

h) The UK economy’s over-dependence on London and the South-East.

i) The UK’s bad record in allowing the growth of an increasing number of young people with low levels of education, training and aspiration.

j) Growing inequalities in wealth and income, coupled with unfair and regressive action against the poorest people in the country, now exacerbated by the assault on welfare spending.

Conference calls for effective measures to support and grow the UK economy, including by many established Liberal Democrat policies:

1. Increased investment, both directly by Government financed by public borrowing, and stimulated by Government, particularly in affordable housing including social housing and infrastructure to support balanced growth throughout the UK.

2. Support for planning reform, institutional lending to small builders and action by local authorities for planned development, including assembling land for auction.

3. Further measures to improve and regulate banking services by promoting efficient lending, particularly to small and medium-sized enterprises, encouragement of challenger banks and increased personal accountability.

4. Strengthening takeover legislation to protect the country’s science base.

5. Reversing cuts in the development of green energy and promoting investment in green business initiatives.

6. Further development of the Government’s industrial strategy, promoting co-operation and supply chain development in key sectors for the long-term.

7. Re-balancing the economy towards manufacturing industry and regions, based on the coherent and substantial devolution of political and financial power.

8. Further reform of corporate governance to encourage ‘long-termism’ and to discipline executive pay, including an employee role in determining executive pay.

9. Renewed emphasis on vocational education and training, particularly through effective apprenticeships and especially higher-degree level and engineering and construction apprenticeships.

10. Coherent efforts across Government Departments to address the needs of young people who are excluded from the labour market and participation in wider society.

11. Addressing inequality through a renewed commitment across Government and society to analyse and address Beveridge’s Five Giants in modern society.

12. Investigating sustainable ways of funding universal services, including a cross-party, cross-society settlement on funding health and social care.

13. A new commitment to taxing unearned wealth, including Land Value Taxation.

14. Measures to dampen the growth of asset bubbles in opposition to Conservative approaches which tend to increase that growth.

15. Support for more diverse ownership models including worker ownership, social enterprise, mutuality and co-operation.

Economics essay 2: why global trade is going into reverse

Now for the second essay on economics that I wrote in 2008. The topic is trade, and it investigates the theory of trade between developed and developing nations. It turns out that standard trade theory, based on comparative advantage, works rather well here. But it contains a prediction that goes largely unremarked. Apart from Paul Samuelson (in 2004) I haven't seen anybody else raise the point. And yet it does much to explain what is going on in the world now, especially between Britain and China.

The theory of comparative advantage is part of what Americans call "Economics 101": basic first year economics. It explains how mutual trade can benefit economies even when one is manifestly more efficient than the other. But generally this wonderful piece of logic, made famous two centuries ago by David Ricardo, fails to advance much beyond Economics 101. Modern economists have not found ways of using it to make concrete predictions. Attempts to make the theory more specific, for example by relating it to availability of factors of production (like land, capital, etc.) have come to not much. Instead the idea is used to give a warm glow to the idea of trade being a Good Thing, and the basis of patronising comments to non-economists advocating protectionism, while economists get on with the day job without touching it.

That is a pity, because the theory repays more examination. Its central idea is that gains from trade are based on opportunity costs of the various products in an economy, or comparative advantage - that is how much of one product you have to forgo to produce a given quantity of another. The corollary is that where the differences in opportunity cost are minimal, the gains from trade are likewise minimal. As different economies converge, the less incentive there is to trade.

In fact trade does take place between similar economies, but it is driven by other factors, such as economies of scale, and is quite sensitive to transport costs. But the theory of comparative advantage does explain trade between developed and emerging economies rather well. These economies are self evidently very different from each other, and gains may be made between countries on opposite sides of the globe. But as emerging economies develop; they converge with developed economies. What happens then?

To explore this I created a simple mathematical model. I divided the economy into four sectors: agriculture, where productivity grows, but which is not traded; services, also not traded, but where no productivity changes happen; and two types of goods, high and low tech, which are tradable and where productivity changes at differing rates. I looked at three stages of development. The first, undeveloped stage has a huge and inefficient agriculture sector. In the second, intermediate, stage, low tech manufacturing has got going. In the final developed economy stage, productivity has advanced in all sectors apart from trade, but especially in high tech goods.

I then looked at how trade would work between the developed and undeveloped economy. There was no major impact, but the undeveloped economy would buy all its high tech goods from the developed one, in exchange for low tech goods.  The undeveloped economy's currency traded at well below purchasing power parity. Next I considered what would happen if the undeveloped economy moved to the intermediate stage. Now trade becomes much more important to both economies; once again the intermediate economy buys all its high tech goods from the developed one, in exchange for low tech goods. But the developed economy imports a high proportion of its low tech goods. Both sides gain substantially.

But what happens as the economies converge further? The trade disappears; the developing economy supplies an increasing proportion of its high tech needs, and exports fewer low tech goods, substituting productivity gains for gains from trade. The developed economy has to supply its own low tech goods again, and loses gains from trade. It is worse off.

All this models what has been happening between Britain and China quite well. Nothing much at first, but as China's agriculture became more efficient, and so its low tech manufacturing could grow, then trade ballooned, with gains to both sides. This took place in the 1990s and early 2000s. The price of manufactured goods in Britain dropped because of cheap imports, allowing other goods and services, and pay, to grow at a healthy 4% per annum or so, while keeping overall inflation at about 2%; the components of the inflation statistics became very revealing. A lot of the economic growth that took place in Britain in this period was surely driven by this, rather than advancing productivity.

But even in 2008 I could see that the party was coming to an end. Chinese costs were rising; they were moving increasingly into high tech areas. It has become harder for Britain to compete for high tech goods, but easier to repatriate lower tech manufacturing and services. This latter has been good for British jobs, but not for living standards, as what is being repatriated has lower productivity. Volumes of trade have fallen - though it is a complex affair so cause and effect are hard to prove.

Won't China be replaced by other countries? Japan started the trend after all, to be replaced by the "Asian Tigers" (South Korea, Taiwan, etc.), before China entered the picture. There are emerging economies that are taking up some of the slack - Vietnam and Bangladesh, perhaps. Africa has huge scale. But not only are many of these economies slow to transition to the intermediate stage, with a strong export manufacturing base, but the sheer scale of China changes things. The emerging economies are as likely to trade with China (and India, whose emergence takes a different but parallel path) as they are with the developed world. And perhaps low tech is becoming more high tech too - making it hard for the newly emerging economies to find enough of scale where they have a comparative advantage.

And this is yet another reason why developed economies appear to be stagnating, and why much of the growth that took place before the crash of 2008 was unsustainable. Trade has a reverse gear that is nothing to do with protectionism and ignorance of economic theory. Economic theory predicts it.

Why do governments follow austerity when orthodox economists advise against it?

It's by turns annoying and amusing: the way people on the left complain that orthodox economics has gone off the rails, and that we need fresh thinking to inform government policies. Apart from coming up with a lot of age-old tropes that economic models do not mimic real behaviour, or take account of information asymmetries, the main item of evidence is the persistance of austerity policies in the developed world.

But the main critics of austerity turn out to be.... orthodox economists. People like Joe Stiglitz, Paul Krugman and Martin Wolf. And newspapers struggle to find economists to make the case for the defence. The Financial Times often resorts to Niall Ferguson, who is a historian, not an economist, and no match for a Nobel laureate like Mr Krugman. The British Labour party is even roping in economics professors to bolster its economic credibility.

In fact there is a brand of orthodox pro-austerity economists. These are the old "supply-siders" from such institutions as the Chicago Business School, who developed a line of "neoclassical" economics, and rebelled against what was once the Keynesian orthodoxy. This branch of thinking grew out to the economic crisis of the 1970s, but proved utterly useless when the crisis of 2007/08 hit. Neoclassical economists pipe up here and there in America, but are mostly silent, their credibility shot-through. That leaves the field nearly unchallenged for the neo-Keynesians - at least far as the public debate in newspaper columns is concerned, in Britain, anyway.

Which leaves us with a mystery. Why are governments, from Europe to America (though not Japan, interestingly), ignoring the orthodox economists? Two explanations are usually offered by their critics. One is rank incompetence or wilful blindness. The other is a political agenda that austerity plays to, usually involving making the rich richer. Neither explanation stands up to close examination.

I am wary of accusations of incompetence, especially when made about clearly intelligent people, such as most politicians and technocrats involved in government finance. This is something I learnt as a history undergraduate (I studied both science and history in my original undergraduate incarnation, long before my study of economics as a mature student). Such accusations are bandied about freely down the ages, but never stand up to scrutiny. Mostly the wilful blindness comes from the people making the accusation, who cannot entertain the idea that there is a rival point of view to their own. Modern economic policy is no exception.

The political agenda is a bit more plausible. Perhaps governments are in hoc to big business interests and those of the wealthy? But if the last 150 years of history has taught us anything, it is that if poorer members of society are prospering, the rich will prosper also, and be left in peace. This is even more true of big corporate interests than anybody else. It is harder to make money in a stagnant economy. Those malign influences are there in politics, but their effects are altogether more subtle than doing down poor people to help line the pockets of the rich.

Sensing that these explanations don't work, many on the left build up an idea of "neoliberalism". This is a philosophy based on the old supply-side or neoclassical economics that may be waning in academic economics, but still holds a grip on the lesser mortals who staff finance ministries and banks, and other parts of the "elite". But this too is inadequate as an explanation. Certainly it is possible to identify a series of beliefs and biases amongst policymakers that equate to economic liberalism. But they do not explain austerity as a macroeconomic policy. And besides, we need to understand why the hold of these beliefs is so strong. Clearly some on the left think that an outdated economic orthodoxy is to blame. But surely such theoretical constructs cannot by themselves have such a grip on so many intelligent and practical minds?

Instead of a conflict between different types of theory, what is really going on is a conflict between theory and practice. The theoreticians may be gung-ho about fiscal and monetary stimulus, but the people who implement policy are acutely aware of the practical problems and risks. There are three particular practical issues about which the theoreticians are dismissive, but which weigh heavily on the practical types: economic efficiency; public investment; and financial markets.

First take economic efficiency. Pretty much everybody agrees that, ultimately, living standards depend on economic efficiency, or productivity. This piece of orthodoxy could be challenged, but that is not what most on the left mean (traditional Greens being the exception, along with liberal voices in the wilderness like mine) when they call for fresh thinking. They see slow economic growth as a sign of failure as much as any conservative does; and that ultimately is based on productivity. But economic efficiency is hard work politically. Both businesses and workers like to protect their patches with taxes, government agencies and regulations that keep the winds of change at bay. This is especially the case in Europe and Japan. And yet, in order to achieve long-term growth, these vested interested must be tackled, and reforms enacted. This has been shown in countless contexts in both developed and developing world. Mostly reforms have an economically liberal character - but only because this approach genuinely unlocks long-term efficiency.  Far-sighted politicians and officials want to use every possible chance to advance reforms. That includes the pressures created by economic hard times. Theoretical economists might suggest that boom years are the best time to push through reforms, or that reforms can be covered by macroeconomic leniency. Politicians know that the opposite is the case - it too difficult to muster the political imperative in easy times, or if short-term macroeconomic policies take the heat off.

Reform and austerity are not necessarily the same thing, but they almost always are.  This debate, of course, dominates discourse in the Euro zone, where economic hardship is concentrated in less efficient economies. Critics of austerity there offer no way forward for improved efficiency, beyond the hope that public infrastructure investment will deliver the growth they seek.

Which brings us to the difficulties of public investment. To theoretical economists this is the magic bullet. Public investment in infrastructure both yields gains to long-term efficiency, and a short term fiscal stimulus. The economists are exasperated that so few governments seem to follow their advice. And yet public investment is a graveyard of roads to nowhere and white elephants. When the imperative to  invest is political, the choice of project becomes political too. It is very hard to make sensible choices. China was much lauded for its infrastructure investment programme following the crash. This has now turned into a major headache, as so much of the money was wasted on empty cities and useless infrastructure. Something similar happened in Japan in the 1990s. Finance ministry officials are rightly wary.

And then there are the financial markets. If I've heard one economist here in Britain suggest that now is a fabulous time for the government to borrow, or even "print", money, I've heard it from a hundred. With so much demand for government bonds in the markets, and inflation looking mortally wounded, just what are you worrying about? But none of these economists work at the sharp end of government finance. If they did, such sanguinity would remind them of the sort of thinking that got the world's banks into the disaster in the first place: a reckless confidence that markets would behave in future as they do now.

Alas life is much more complicated than that. Grounds for confidence in the financial markets is stronger in some places than others. Japan has a massive export industry that sees to all its foreign currency needs, so that the state can borrow and even print the Yen with reasonable confidence. Which is what it has been doing, in prodigious quantities, for the last two decades, although to little apparent effect. The US is another country that can feel reasonably secure, even though its balance of trade is less benign than Japan's. The dollar is the world's de facto reserve currency. The United Kingdom, however, shares neither of these strengths. It needs to draw on overseas institutions and businesses, and its own private sector, in order to finance its significant current account and trade imbalances. This is not a problem that printing the Pound can help with. The state has been extraordinarily adept at handling this risk over the last few decades. But that is because of the conservatism that is currently attracting so much criticism.

To me the theoretical economists, the practical policymakers, and most of their leftist critics are all trapped by an orthodox way of looking at the world through economic aggregate statistics. This means that they are failing to take on the deeper problems that society faces: economic and environmental sustainability, alienation, and the gravitation of wealth to successful people and places. That has very little to do with the politics of austerity. People on the left who call for fresh thinking should be careful what they wish for.

 

The economy is for Labour what tuition fees is for the Lib Dems

If there is something that unites British Labour Party people, from rightist Blairites, to Brownites, through to the leftist Corbynistas, it is that the Labour government of 1997 to 2010 should not be held responsible for the financial crash of 2008/09, and the terrible state of government finances that followed. They are made indignant by Conservatives (and Liberal Democrats) who go on about how Labour is to blame for the financial mess the government left the country in in 2010, when the budget deficit had ballooned to over 10% of GDP. But the public finds the Tory line more convincing. And if Labour are to throw off this albatross, it will have to move on from its air of injured innocence.

There are two dimensions to this question. The first is a question of fact, or purports to be: how much responsibility did the Labour government actually have for what went wrong in the economy? The second is what is going on in people's heads when they think of Labour and the economy, and how the party might address it.

On the first question, Labour have quite a few sympathisers outside the party. And certainly the direct line of attack made by Tories is not all it seems. The Tory narrative is that Labour went on a spending splurge in the boom years, which then  proved completely unsustainable, leaving their successors  choice but to implement austerity policies. Defenders of Labour's record point out that there was no big government deficit before the crash. It was a relatively modest 2.5% or so in 2006 and 2007, and not regarded as irresponsible at the time. Nobody foresaw the financial turmoil, which originated in American sub-prime mortgage markets.

The Labour defence against this charge is mostly true. But not quite. Gordon Brown, as Chancellor (he became Prime Minister in 2008), claimed to operate government expenditure on a "golden rule" which meant no net borrowing over the economic cycle. But he had taken to moving the goalposts rather than applying the rule strictly. Had he followed his own rules as originally intended, there may not have been a deficit as the economy turned in 2007. But that only accounts for 2% of the problem. There was another 5% that came from somewhere else, allowing for a normal cyclical swing of 3%, and which cannot be blamed on Labour profligacy.

If you take a wider view, however, Labour's defence becomes more difficult. British government finances were worse affected than other major industrial countries, from France to the USA, and much worse than some, like Canada. There are broadly two reasons for this. The first is that Britain had a bigger financial crisis, because it had a bigger banking sector, especially in international banking, and so was more affected by its collapse. The second is that tax revenues fell unusually sharply in Britain. Both aspects have government fingerprints on them.

Take banking. Labour lauded the rise of the international banks, and celebrated Britain's "light-touch" regulation that helped bring this about. They gave RBS's Fred Goodwin a knighthood for no other reason than that he had expanded his bank, recklessly as it turned out - there were none of the usual good charitable works to point to as supporting a general aura of public-spiritedness, as is customary in such matters. Meanwhile, Britain's success as an international banking hub helped drive Sterling up and manufacturing exporters out of business. Mr Brown tried to wriggle out of responsibility by suggesting that he wasn't responsible for banking regulation under Britain's tripartite system of financial regulation (between the Treasury, the FSA and the Bank of England). This is pretty damning, because this system was of his own design, and it was clear that overall responsibility for making sure the system was working lay with the Treasury. It couldn't be anywhere else.

Then on taxes, Mr Brown engineered a switch from taxes on income, and Income Tax in particular, to an array of other taxes, like stamp duty, that turned out to be about milking financial bubbles. At the time, his reduction of the basic rate of income tax to 20% was lauded as a triumph. This proved a colossal misjudgement, as it has proved politically impossible to raise income taxes, even in supposed more left-leaning Scotland.

On top of this, a broader claim can be made. The world financial crisis was not some storm that happened somewhere else with unfortunate consequences for Britain. Britain was the world's leading international centre of finance; Britain's bankers were at the heart of it, Two of Britain's big banks, RBS and HBoS, collapsed, not helped a Britain's own reckless mortgage lending, which also affected smaller banks, like Northern Rock and Bradford & Bingley. These banks had all adopted highly risky business models, whose main assumption was that global banking markets would be stable. Sitting on top of one of the most prestigious finance ministries in the world, and trumpeting his own reputation as a financial manager, Mr Brown and his acolytes can't really escape the charge of incompetence for not appreciating these risks. And these risks were plan to some, including his Lib Dem shadow, Vince Cable, whose warnings were pooh-poohed.

Labourites are on stronger ground when they suggest that, once the crisis emerged, their government handled it well. It wasn't pretty (amongst innocent victims of the government's shoot-first approach were Icelandic banks and Britain's own Lloyd's bank), but largely stands up to scrutiny. Another argument is over whether the Tory/Lib Dem coalition that took power in 2010 was too tight with its austerity policies, compared to how Labour would have handled the same situation. Many independent commentators agree with at least the first part of that proposition, though I don't.

So, I don't think Labour were quite as innocent as they claim, even if much of the direct criticism is misplaced. But, in politics, such arguments actually count for little. A more important question is how the public perceives things. This is where Labour's real problem lies. What the public sees is a classic hubris to nemesis story, which is one of the oldest storylines in humanity, and takes some rebutting. Labour's problem is their boastfulness before the crisis. Labour appealed to voters because a Labour government meant "no more boom and bust", unlike with the Tories. And then one of the biggest busts in history happened.

And there is trust issue here. Labour's position is a bit like that of the Lib Dems over tuition fees. The Lib Dems vowed not to vote for an increase in student tuition fees before the election, and yet later that year they supported the trebling of fees. Many Lib Dems will give you a convincing intellectual explanation as to how this not nearly as bad as it sounds, and that anyway there was little they could do in coalition. But this cuts no ice with the public, because of the way the party presented their policies before the election.

Labour are onto an equally losing wicket if they try convincing the public that the economic crash of 2008/09 was not their responsibility. Ed Miliband, their leader at the last election, was quite right not to even try. Besides, the alternative argument that Labour were the hapless victim of world events hardly counters the public's perception of the post-Brown leadership (Mr Miliband and his successor Jeremy Corbyn) of being nice but ineffectual. The usual advice for when you are in a whole is to stop digging. The idea that if the party had come out fighting, public perception would be swayed, is pure nonsense.

The only way forward is for Labour to acknowledge their responsibility, and put forward hard economic policies that show they are capable of taking tough decisions if in power. And that means they have to stop banging on about austerity and get tough with some of their own supporters. For now, though, there is no chance of that.

2016 is nothing like 2008, but there’s trouble ahead for the world economy

In my New Year post I did not write much about finance, but made some rather throwaway comments that the economy could take a turn for the worse in 2016.  Having just read Martin Wolf's rather sanguine piece in the FT, I hadn't quite understood that my views were in line with conventional wisdom in the financial markets - and this not at all a position I like to be in. But pessimism is in, and reflected by lower share prices worldwide. This has filtered through to left wing commentators, like Will Hutton, who gleefully want to show that "austerity" or "neoliberalism" is leading to a repeat of the 2008 crash (though Mr Hutton is too good a writer to use those particular totems). This is definitely company I don't want to keep. Time to dig a bit deeper.

It helps to think back to what happened in the last turndown, the crash of 2008 - as this is foremost on people's minds. At the start of 2008 the banking system was in deep trouble, although on the surface things were quite calm, if gently sinking. "Holed below the waterline" was the description that I used at the time - alas I was not publicly blogging until three years later, or my reputation might have been made. Trust was breaking down because the banks were dealing a lot with each other, or off-balance sheet offshoots, rather than with the public or businesses. And things were starting to go wrong, beginning with US sub-prime mortgages. The huge tangle of interbank transactions and derivatives meant that nobody knew how the losses would play out or where - so everybody was tainted. Things kept superficially calm until quite late in 2008, when Lehman Brothers collapsed, threatening a chain reaction that would have brought much of the world's banking system to a screeching halt. Since the banking system is at the centre of everyday life in developed economies the result could have been catastrophic.

That catastrophe was largely avoided, but only because governments bailed banks out to keep the whole system afloat. Even then the damage to the non-banking economy was severe, and government finances, especially here in the UK, were ruined. What was so alarming about the whole episode was that a fairly routine downturn in the business cycle infected part of the US mortgage market, which then completely disproportionately went on threaten the whole system. Defenders of Britain's Labour government still can't believe it was anything to do with them - though in fact ten years of complacent economic management had left the country highly vulnerable to such a chain reaction.

Why are people worried now? Well one thing that helped the ameliorate the disaster in 2008 was that emerging markets, especially China, were less badly affected, and in China's case, government stimulus helped keep things afloat. Now that side of things is unravelling. The Chinese economy is slowing, and in the process it is undermining world markets for commodities such as oil, which presents the threat of widespread damage in the developing world. The Chinese situation arises partly because the country has hit an awkward point in the evolution of its development, and partly because their stimulus package after 2008 was largely wasted and bad debts are threatening its banking system. Indeed the whole soundness of China's growth strategy is coming into question (its second, state-directed phase , rather than Deng Xiaoping's original liberalisation from 1978).

This is serious, and no mistake. The role China has played in the world economy in the last quarter century is hard to exaggerate. What is happening there is much bigger than the US subprime crisis that was at the heart of the 2008 debacle. But it doesn't have the same destabilising features that caused such a fierce chain reaction - which were in plain view as 2008 started. China is not at the heart of a cat's cradle of complex derivatives sitting in off-balance sheet funds, with almost every international bank taking part. And the huge power of the Chinese state, and the depth of its financial reserves, means that the country's financial system will collapse slowly rather than suddenly. The western banking system is a much soberer thing than it was in 2008 too, even if many left wing commentators would have you believe that nothing has changed. For these reasons 2016 does not look like 2008. A meltdown, or near meltdown, does not look likely.

But there could be a slower moving form of trouble. Secular stagnation, the affliction of the world economy I referred to recently, is here to stay. Western economies will slow. Worse things may be in store in the developing world. Share prices may well fall badly - many markets have been overpriced for some time.

And in Britain? In my New Year post I suggested that 2016 might be the year the economy here started to turn sour. That comment wasn't based on any deep thinking. Britain is unusually dependent on the international economy, as is evident from persistent trade and current account deficits, and a value for Sterling that is hard to justify based on its "real" economy. So, with things going awry in the world economy, Britain might be vulnerable. The Pound could come under pressure; foreign investors could desert London's property market causing a chain reaction; or a downturn in the City's finance sector could do the same thing. On the other hand, capital flight from the developing world could benefit London in particular, allowing the country to weather the storm. Some left wing commentators have been trying to stoke alarm about the level of personal debt - but that doesn't stand up to close scrutiny. Neither should we pay much heed to Labour's economic adviser, David Blanchflower, who on the radio this morning suggested that Britain was less ready to deal with a crisis than in 2008, because interest rates were already rock bottom. That vastly inflates the effects of interest rate policy on crisis management. David Cameron's and George Osborne's luck could hold. I struggle to understand the alarmism on the political left - it will merely undermine its already shaky reputation for economic grasp.

it seems to me that 2016 will be the start of a good old-fashioned cyclical downturn for the world economy, with no more than the usual localised financial crises. Personally I think this will morph into a period of more prolonged secular stagnation that will put paid to economists' lazy assumption that 1-2% rates of growth are a law of nature.

And that should pose some very challenging questions for the art of economics. But that's a topic for another day. Meanwhile government bonds are a better bet than shares; cash is not a bad bet either; don't mortgage up to your eyeballs in property; and interest rates aren't going up.