Lessons from the Great Depression won’t help us now

By Iain Macwhirter
Iain Macwhirter on recovery.

IT'S NOT bad being a banker, really. All you have to do is borrow money at a low interest rate from the government and then lend it at a higher interest rate to businesses and mortgagees. Doesn't take a lot of genius to do that. Even I could make money out of it.

So, why does the government waste its breath squealing at the financiers to pass on interest rate reductions? If they're serious, why don't they just move in and take operational control of the banks - many of them are state-owned already, such as Northern Rock and Bradford & Bingley, or with a large state holding, like Royal Bank of Scotland. It's not as if banking requires any special skills. You could nationalise the lot and no-one would notice, except luxury car dealers and yacht builders.

But no, ministers would prefer to stand on the sidelines shouting and pointing fingers at the nasty bankers for refusing to lend. Well, the banksters deserve it, you cannot deny that. I was one of the first to denounce the practices that got us into this mess. Their predatory lending, extravagant greed, short-sightedness and plain stupidity have condemned them in the public eye for a generation. Everyone is talking about a return to the 1970s, with economic crisis and mass unemployment, but this time it's not the trade union barons who are in the dock of history, but bankers.

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However, like the trade unions, the banks aren't always wrong, and in one respect they are introducing an element of sanity into monetary policy as the government tries to turn the clock back to 2007. They are pointing out that this is a debt crisis and that taking on more debt isn't necessarily going to get us out of it. That we have to save for the future, and that means making it worthwhile for people to do so. The government seems to have been persuaded to adopt the opposite policy, of slashing interest rates and debasing the currency by "quantitative easing", or printing money. The idea - though they won't put it quite this way - is to ignite inflation so that people with savings are forced to spend it, or see its value evaporate.

Someone needs to say this right now as caution, and money, is thrown to the winds. The government and the Bank of England have gone from complacency to panic in a matter of weeks. Only last summer we were still being told that the economic fundamentals were sound and that the end was in sight; now it's just The End they see. Instead of the measured don't-frighten-the-horses quarter percent steps on interest rates, the Bank of England has taken to massive one and one-and-a-half point leaps which not only frighten the horses, they make the rest of the world bolt for the door. If the government were trying to engineer a sterling crisis, it couldn't do much better.

Now, it is true that deflation is not very nice. Prices fall and businesses go bust. But there is a logic to it. After all, the present crisis is almost entirely a result of an unsustainable consumer boom financed by debt. The British people owe £1.5 trillion in personal debt - considerably more than the nation's GDP. The number of people who spend more than they earn has risen to nearly 5.3 million, according to Legal General. Meanwhile, the government is on the way to a trillion-pound deficit. This means that, by next year, every household in Britain will carry £50,000 of public debt as well as an average of £60,000 in personal debt - that's a almost Icelandic total of £110,000. The government hope that rising prices will lower the value of these debts. But this is not just a temporary imbalance on peoples' domestic accounts we are talking about; it is a chronic and ingrained debt habit which must be broken if the economy is to be stabilised in future.

The inconvenient truth is that we simply have to save. The banks are trying to keep their deposit interest rates high to encourage people to save with them. This isn't out of philanthropy - they need the cash to rebuild their balance sheets. But they point out, fairly, that low interest rates penalise many older people who rely on their savings in retirement. We have yet to hear from silver surfers about the raid on their living standards, but the government might do well to reflect on the fact that there are now more people over 65 in Britain than there are under 16, and that older people are much more likely to vote than the under-34s.

The government hopes that low interest rates will get people buying houses again. But there is no guarantee that slashing rates and printing money will necessarily stabilise the housing market. Frankly, no-one is going to buy houses in a collapsing market, no matter how low interest rates go. In neither America nor Japan have low interest rates halted the collapse of unsustainable house prices. Indeed, the Japanese housing crash has lasted nearly 20 years. Anyway, the last thing we need is another house price bubble.

There's no mystery about what the government is trying to do. After the Black October crash, the government and the Bank of England got out their history books and started looking at what happened in the Great Depression. In September 1931, as unemployment reached three million, the national government slashed interest rates and abandoned the gold standard. The value of the pound fell by 25%, just as it has today. Interest rates fell from 6% to 2% - deja vu - and this led to a modest, export-led recovery. Unemployment fell marginally in 1935 as a recovery in the housing market, mainly in the south of England, boosted economic activity. The government is clearly trying to do the same today.

However, this isn't the 1930s. For one thing, there was a lot of spare capacity then in the economy, which is not the case today. We also had the Empire. Britain erected tariff walls against imports and used the colonies - yes, we still had them - to provide cheap food imports. The 1930s depression wasn't caused by consumer spending and debt, it was a classic crisis of ineffective demand.

Also: it didn't really work. Unemployment remained stubbornly high throughout the 1930s outside the south-east of England, and it was only rearmament, as the Second World War approached, that ended mass joblessness.

We are in a very different situation today. We cannot seek salvation in another unsustainable boom and we certainly cannot afford to go to war. We have to get out of this one ourselves. And I fear that the government is going in the wrong direction.

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