The riots and the return to the big picture

Last week’s riots were shocking. The effect upon the many communities, families and individuals affected was undoubtedly profound. They have prompted plenty of soul searching and a wide range of diagnoses. If we are optimistic we should hope that they act as a catalyst for addressing problems of urban Britain that have been developing over many years.

The riots have not shown the political classes in a great light. There was the slow response from the Government – was this really a situation sufficiently serious to justify curtailing our vacations? There was the muddle over who has shaped policing strategy, leading to a potentially damaging war of words between the Government and senior police officers. And there is the extraordinary range of illiberal and disproportionate measures that David Cameron has seen fit to propose in response to the crisis. He seemed intent on manufacturing a full blown moral panic in order to take a worryingly authoritarian turn. Liberal Democrat MPs are clearly very uneasy at the way in which Mr Cameron has changed his tune from those far off days of compassionate Conservatism.

The riots have pushed just about everything else to the back of the news agenda for the last week. That is deeply unfortunate for at least two  reasons associated with this period of momentous – indeed unprecedented – economic turmoil.

First, if we cast our minds back to the period just before the riots broke out the news was dominated by the S&P downgrade of US government debt, ostensibly in the light of the political difficulties in negotiating the raising of the debt ceiling. That the two other major ratings agencies did not feel moved to alter their rating of the US debt – because their assessment methodologies differ – indicated to many that the move by S&P had political overtones. The fact that S&P is part owned by a billionaire with close associations with Bush Republicanism allowed conspiracy theorists further room for speculation and allegation.

The S&P downgrade opened a window on the inner workings of parts of the global financial system that rarely get much public scrutiny. The role of the ratings agencies in stoking the boom that ended in the Global Financial Crisis of 2008 is well known to those who follow such things closely. But it isn’t widely understood. And now a ratings agency appeared to be punishing governments for taking proactive steps to deal with a problem they themselves contributed to creating. So the US debt downgrade resulted in many people rightly questioning how the decisions of a small number of secretive and unaccountable individuals can be allowed to shape the fate of nations and millions of people. When attention then switched to the problems of the Eurozone countries – particularly Italy and Spain – the role of credit rating agencies again emerges as vital. A CRA downgrade because a country faces problems simply intensifies those problems and makes the job of sorting the country’s finances more difficult.

Politicians were exposed as being more concerned with keeping the CRAs happy than listening to the views of those that elected them. In itself that isn’t news, but it came as news to many.

These issues had risen to the surface and some pointed questions were being asked. Following hard on the heels of the News International hacking scandal it appeared to be another example of unwarranted corporate control over democratically elected politicians. But the riots pushed this off the agenda. I’m sure there are many in the financial community who are only too grateful.

Second, the riots distracted from the turmoil in the Eurozone. The members face some truly momentous decisions. The financial community is pushing for a solution involving the creation of Eurobonds or an increase in the size of the bailout fund of the order of at least 500%. Of course, it would. Those strategies would means that it had succeeded in passing pretty much all the risk associated with its irresponsible lending back on to governments. But there are huge problems with this. On the one hand, a bailout fund on this scale has the potential to undermine the fiscal position of even the strongest economies in the Eurozone. On the other hand, political opposition to Eurobonds seems insurmountable. There are strong rumblings from public opinion in countries like Germany and the Netherlands that tolerance for further bailouts is exhausted. As economic growth in northern Europe stalls opinion among a majority of voters seems to moving towards favouring the ejection of weaker members of Eurozone rather than trying to keep the Eurozone intact. Yesterday’s meeting between the French and German premiers did not really result in significant moves in any particular direction – apart from the move to align the countries’ corporation tax rates and reviving the idea of a Tobin tax.

Alongside the set piece debate on the riots at last Thursday’s session of the recalled Parliament, the Chancellor made a statement on the global economy. The statement contained a sensible, if limited, analysis of the situation we’re facing. It then went on to claim that the Government’s strategy of fiscal consolidation is responsible for the fact that the UK has not – yet – faced the full force of global turmoil. He claimed that:

The market for our government bonds has benefitted from the global flight to safety:

UK gilt yields have come down to around 2.5% – the lowest interest rates in over 100 years;

And earlier this week the UK’s Credit Default Swap spread, or the price of insuring against a sovereign default, was lower than Germany’s.

This is a huge vote of confidence in the credibility of British Government debt and a major source of stability for the British economy at a time of exceptional instability.

The programme of fiscal consolidation had:

… made Britain that safe haven in the sovereign debt storm.

Our market interest rates have fallen, while other countries’ have soared.

And the very same rating agency that downgraded the United States has taken Britain off the negative watch that we inherited and reaffirmed our AAA status.

In times of uncertainty politicians typically feel the need to give reassurance to their population. And of course it is natural for them to feel the urge to claim credit for the efficacy of their policy programmes. But is this interpretation of the situation credible?

It seems unlikely. The probability of a return to global recession is perceived to be increasing. The change in bond yields is less a vote of confidence in the policy of fiscal consolidation and more an indication of quite how bad the prospects are in other parts of the economy. It is “push” rather than “pull”. Also, it can be argued that the lacklustre performance of the British economic has simply not attracted much scrutiny when elsewhere in the global economy there is absolute chaos and carnage. It is likely to be only a matter of time before the British economy comes under rather closer scrutiny.

In a piece in yesterday’s Wall Street Journal, David Cottle made this very point. He provides an alternative perspective on the British situation:

… huge debt, low growth, ineffective monetary policy, entrenched inflation and, now, rampant civil disobedience. How safe is this place looking to you so far?

It’s not exactly Zurich on Good Friday, is it?

He concluded his piece with the observation:

HSBC … said sterling was probably the currency most at risk from another bout of market instability for, while the financial markets have been appropriately pricing in likely euro-zone bad news, there’s been a notably rosy tint about their view of the U.K.’s performance.

Said the bank on Tuesday, “The market has been overestimating the strength of the U.K. economy  ever since the beginning of the financial crisis.”

The risks facing the world economy are immense. It seems to me that the probability that events taking a disastrous turn for the worse are high. And western governments would seem to me to be lacking the political or economic levers to arrive at an effective preventative strategy rapidly enough. If things get out of hand in the financial markets again there is a limited amount they will be able to do.  To pretend that the UK would be immune is nonsensical. Indeed, with the country’s staggering levels of public and private debt and its continuing overdependence on the financial industry it could be catastrophic. We can already see, with today’s worse than expected unemployment figures, that the economic picture in the UK is deteriorating. That is going to start to be noticed by the people that matter sooner rather than later.

The riots are undoubtedly significant. But they have also been a distraction from the bigger picture.

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