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  1. Wealth
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September 1, 2008

Gordon Fool

By Spear's

Gordon Brown has thrown his fiscal rules out of the window and mucked up the economy. How could he get it so badly wrong, asks Stephen Hill

In 1997, under the new Chancellor of the Exchequer, Gordon Brown, HM Treasury published two rules to counter the effects of the economic cycle. These rules were formulated by Ed Balls, Brown’s economic adviser, and by Gus O’Donnell as head of HMG’s Economic Service.

The first was the Golden Rule — only borrow to fund public investment over the cycle — and the second was the Sustainable Investment Rule — maintain public debt at a stable and prudent level, below 40 per cent of GDP.

The public finances, however, are now in a real mess. Public debt (the Public Sector Borrowing Requirement or PSBR) is at 38.3 per cent and rose to over 40 per cent at the end of July. Add in Northern Wreck and it’s already at 44.2 per cent. That’s before we add in the long-term liabilities of the Private Finance Initiative (PFI) and — don’t even mention it — the huge overhang of the unfunded public-sector pensions liabilities.

Tax receipts are falling, with no scope left for further taxation, as the PSBR heads towards an extrapolated £73 billion, implying a deficit of up to 6 per cent of GDP, twice the maximum level permitted by Maastricht under the EMU restrictions (to which the UK is a signatory). It is brown envelope time in Brussels, as the Eurocrats work out their fines to send to Whitehall. Whoever thought a British Parliament would vote to let foreigners fine us for not complying with rules not invented at Westminster?

The question is whether these rules are just plain wrong, or whether those operating the rules couldn’t read the signals and pulled the wrong levers. The rules appear reasonable as stated, albeit very incomplete, with just an artificial horizon to fly by.

So the crash investigation committee is turning its attention to the pilots on the flight deck. Pilot error abounds wherever you look: Gordon Brown thought that ‘investment’ meant creating 750,000 jobs in unproductive bureaucracy as the same number of jobs was lost in industry over a decade, but those unproductive jobs are paid for by the public purse, not the private, and their expense just goes on and on.

His handling of Northern Rock was ludicrous. Lloyds TSB offered a solution on day one, which he spurned, preferring to open the public purse, again. Then he and the Monetary Policy Committee — ‘We’re only watching inflation, guv’ — didn’t see the downturn coming. They miscalculated the cycle and then tried to make the cycle fit their own erroneous flight-path. It was as if they had just discovered they landed on the M4 instead of Heathrow 28 Right, and were in the wreckage trying to grab the black box first to reset it to hide their own incompetence. And the captain’s name was Prudence!

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The short economic cycle was first perceived by the French physician Dr. Clement Juglar in 1860, when he observed that the human birth-rate rose and fell with the economy over what he defined as an eight-year cycle, although his followers have argued for nine- and ten-year cycles. I prefer to think in terms of a nine-year cycle, before allowing for man-made and natural distortions of one or two years — such as Alan Greenspan’s running the US economy at a 1 per cent interest rate for two years longer than was appropriate.

Analysis of the short circle confirms the crisis points as 1825, 1836, 1847, 1857, 1866, 1873, 1882, 1890, 1900, 1907, 1913, 1920 and 1929. The Great Depression and World War II were man-made distortions that broke the pattern, which reasserted itself after the war, as we shall see.

Where Juglar spotted the short cycle, another econometrician saw the workings of the long cycle. Nikolai Kondratieff, born in 1882, studied the rise and fall of agricultural production in Russia and formulated the ‘Long Wave’, or 90-year cycle in which the cycle goes up for 45 years and then turns down for 45 years, give or take ten years for man-made and natural vagaries and distortions.

The important point is that both the short and long cycles exist, so the short cycle is not operating between parallel lines, as it were, but between bent lines with 45-year crisis points, so that the real crises occur when the two cycles both hit their low points. Kondratieff placed the crisis points as 1745, 1790, 1844 and 1890, which conveniently leads us to 1930, then 1974. The Soviets, with their five-year state plans that never hit their man-made targets, couldn’t stand it and Kondratieff was arrested and died in the Gulag, we know not when.

In 1992, I wrote a book called Lions Led by Donkeys: How to Make the Real Economy Work. In it, I wrote: ‘The cycles cannot be stopped by mankind, but it is possible to work knowingly within them.

‘For example, the banker who lends most or all of the finance required for a three-year [commercial] property development late in the cycle and after values have risen strongly may find the bank’s loan turns sour in the approaching downturn, as rentals decrease and the capital value of the project is exponentially reduced.

‘The politician who eases credit and taxation as the economy booms, seeking “a dash for growth”, will find that it merely magnifies the existing upturn and the negative effects of the inevitable downturn. If they do this just as the 90-year cycle is itself turning down, the results are likely to be near-catastrophic.’

This, or something like it, was what we all thought Gordon Brown had got the hang of — or so he would have had us believe. What fools we were to believe his rhetoric! Or was it that his words did not tally with his arithmetic? Consider the graph and table above, a Treasury favourite, taken from the Pink (formerly Red) Book for the 2008 Budget.

If we go back to the same chart in the 1992-1993 Red Book, we can produce our own summary table for Juglar’s short cycles for the last 36 years. It is no surprise that 36 divided by nine gives four cycles, as confirmed by the graph: 1973-1982; 1982-1991; 1991-2000; 2000-2009.

We are looking at the Treasury’s own statistics here, and none of us have any difficulty following the argument so far, nor the graph which works on the simple sum of adding nine, but then we don’t work in the Treasury. The mandarins at the Treasury will be fuming at the use of this graph in this argument: ‘Hey you, you can’t do that to us! That’s not the UK, it’s G7, and that includes Japan!’

But that is precisely why I have gone back to 1973. The UK is a world trader, importer and exporter and this graph spells out the cycles clearer than any other. Japan’s inclusion, in fact, is irrelevant, since for twenty years their annual percentage changes have been negligible, so the graph gives a good or better reading on the Anglosphere world’s cycles than any other. It passes the empirical test.

It could not have been more blindingly obvious from this graph that from 2005 onwards it was time to take the foot off the gas, stop looking in the rear-view mirror at how much dust Gordon Brown was blowing into the electorate’s face, look through the front windshield instead and hunker down for the next cold shower.

It was already clear that M4 — broad money in circulation — was going through the roof, past 10 per cent in 2005 and on to 13 per cent in 2006, but nobody was watching the gauge. When did you last hear mention of M4?

The problem with the Treasury is that they are always looking backwards at the last quarter’s tax revenues and the historic cumulative trends on receipts and expenditures, and never see the brick wall in front of them until it’s too late, when the inevitable sound of splintering wood and flying glass shatters our eardrums, and we find ourselves in another fine old Laurel and Hardy mess.

The Treasury boffins just pick themselves up as though nothing had happened — they’re used to it by now! — dust themselves down and get ready to do it all over again. ‘Wonderful thing, this capitalism,’ they all chortle. ‘It never ceases to surprise us!’

In the Pink Book’s graph you will notice the shaded area on the right. This is the Treasury’s forecast, based on OECD data, but their interpretation is just plain wishful thinking. It would be better called the Treasury’s snake-pit. They hope to exonerate themselves this autumn in the Blue Book on the national economy by reclassifying when the cycle started to try and prove that they were not wrong at all — or at least not yet!

We will watch this space, but nothing could be clearer than their own published data, reproduced above for all Spear’s WMS readers to see and ponder with disgust.

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