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AMENDMENT OF THE LAW

Egypt, Pakistan and Hungary. My apologies to Bangladesh. It is sad that one must apologise to Bangladesh for being compared with the UK; there were times when it would have rather welcomed such a comparison. Running a tight ship is important. We have not done so and the prudent period of the early stage of the Government—when they committed themselves to following the spending plans they inherited from their Conservative predecessors—gradually eroded. At precisely the time they ought to have been starting to be more cautious, they became less cautious. They ought to have been repairing the roof while the sun was shining; instead, they were squandering the money coming into the Exchequer. The second feature that helped countries in those difficult times was that they had strong foreign exchange reserves. The Prime Minister squandered our gold reserves; had he known history, he would have realised that gold is one of the things that increases in value most during these cycles. The losses that he incurred by his decision to sell off the gold reserves exceed the losses of any of the Jerome Kerviels or Nick Leesons of the past, making him the biggest rogue trader of all time. The fact that our reserves are not as healthy, to the tune of many billions of dollars, is a sadness. Countries that had lower tax burdens did better in those circumstances than countries with high tax burdens. It is sad, too, that we have moved from having one of the lowest tax burdens in Europe to having one of the highest. We have overtaken Germany, not just because our burden has been going up but because other countries, prudently and sensibly in the good times, have been cutting their tax burden; we have not. The fourth feature that helped countries weather the storms was flexible labour and other markets. I am happy to say that we did liberalise our labour markets and reform our trade unions during the 1980s and 1990s. The Government inherited that and have retained a good part of it, which puts us in a better situation than we might otherwise be in. But they have been adding burdens to businesses and companies, regulating and collectivising, which means that we will be a bit less flexible than we might have been and a bit less well placed to deal with the possible dangers of coming years. We should also ask why the credit crunch is occurring: why are we facing the current difficulties in international banking and credit markets? It has been suggested that the crunch has been caused by a lemming-like move by banks and other financial institutions to invest in high-risk and imprudent investments. However, banks and financial institutions—some of them, at least—have always been prone to being imprudent. Some have always made bad investments, but those bad investments do not normally provoke a credit crunch. So what is different this time? It is a moot point whether imprudent investments, which have undoubtedly been made, have caused the crunch or whether the crunch revealed the imprudence. I drew an analogy in a recent debate: when the tide goes out, we see who was swimming naked, but the fact that some people forgot to wear their bathing trunks did not cause the tide to go out. Likewise, when the tide of credit ebbs, we discover who was making imprudent investments, but those imprudent investments might not have been what caused the credit crunch. The usual criticism of banks is that they will not take risks. I constantly meet businessmen who say, ““I’ve got a terrific idea and project, but the trouble with the banks is that they will not take a risk.”” As the banks are usually criticised for preferring safe investments to risky ones, why have they apparently moved towards investing in riskier assets in recent years? I suggest the answer is that interest rates have compelled or encouraged them to do so. We have been through a period of low interest rates in real terms. That is to do with the supply of savings relative to the available investment opportunities. The supply of savings comes above all from China, but it transfers itself across the world economy, and in order to bring about a balance between borrowing and lending and saving and investing, interest rates had to be held lower. That meant that people had to invest a large sum of money in lower yielding assets because there were not enough higher yielding assets—in less secure assets because there were not enough highly secure assets. They did so because that was all that was open to them—not because they suddenly became transfixed with the idea of taking high risks for low yields, but because there were not any high yields for low risks. If they had not done so, we would not have had a balance between supply and demand in savings and investment, and we would then have been in the classic situation of a Keynesian credit slump. Suddenly, the banks are now holding off from investing. Instead of everyone praising them, saying, ““Oh, good, they are being prudent; how wonderful,”” the central banks of the world are saying, ““For God’s sake, resume lending. We will flood the banking markets of the world with money—cheap, easy, readily available, often secured against rather dodgy assets—because we want you to start lending again.”” The problem has been aggravated by the fact that the banks thought they had security by lending against collateral. They took as collateral solid bricks and mortar: property. The banks and financial institutions of the world—including Northern Rock—invest in mortgages secured against physical assets. The trouble is that the value of physical assets is a financial issue, not a matter of physical bricks and mortar. For a while it all seemed wonderful. They took property as collateral. That encouraged more investment in property. That drove up the price of property. That seemed to validate their decision to take property as collateral. It was all hunky-dory until there was a feeling that the money created by that lending was flowing into other markets and inflation was beginning to rise. The central banks across the world began to raise interest rates again to choke off the prospect of inflation. Their doing so initially choked off inflation in the housing market in America—it is beginning to do the same in the UK. Suddenly, the collateral was worth a lot less; there have been sharp falls in property prices in America. The property bubble burst, and that had a synchronised effect. It was not the random effect whereby someone dealing with different businesses in different markets will find that some experience problems while others do well. Because the banking system as a whole was relying on property as its collateral, the banking system as a whole found itself in difficulty. The whole world financial system is hugely brittle; we are sitting on a knife edge. The financial institutions—the monetary authorities, led by the Federal Reserve and with our own central bank joining in—are trying to flood the system with money to start people lending and borrowing in order to prop up the value of collateral. They are dealing with a difficult problem and there is no guarantee that they will succeed—I think Keynes described it as like pushing on a string—but I hope that with enough cheap money they will. The difficulty lies in whether they can restart things without going to the other extreme and triggering greater inflation next time round.