At the recent G8 and G20 summits, Barack Obama was preaching caution to a number of European countries (including the UK), about early cutbacks potentially triggering a double-dip recession. Economists at the IMF appear to share his views.
Whilst nobody seems to disagree about the need for sweeping cuts in public expenditure, timing is a contentious issue. Mervyn King, the Governor of the Bank of England, openly supports the current UK Government’s plans to make the cutbacks sooner rather than later.
The problem with any economic model is that there are so many variables which can influence the end result. Consequently nobody can predict the outcome with any certainty.
Cutting back public spending ultimately translates, to a great extent, in reducing the public wage bill. Inevitably resulting in cuts in the number of public employee jobs, wage levels and a resultant reduction in services. Also there will be effects on the private sector through the loss of government contracts and the knock-on impact of lower public spending.
A potentially bigger, unknown impact can be that on consumer and business confidence.
No government wants higher unemployment, there has been reports the Treasury is assuming private sector growth will create 2.5m jobs. These will be in the next five years compensating for jobs lost as a result of the spending squeeze.
If this is a realistic assumption, then the government must address the “credit crunch” – the desperate shortage in the availability of credit for cash-starved businesses. Businesses will not be able to expand and create jobs without sufficient cash flow – the vital, life-force of any business. Ironically, the demand for consumer credit traditionally tends to drop during economic uncertainty as a consequence of lack of confidence about job security.
It was because of the general failure, at a very high level of bank management, to follow the basic canons of lending that the banking industry failed the global economy. But the pendulum has swung too far the other way and there is now an overwhelming risk-averse culture amongst the High Street banks. Despite publicly claiming otherwise, the banks are still only supporting the strongest of businesses.
It is in the nature of banking to assess and take risks to then monitor and manage lending portfolios. This doesn’t mean throwing caution to the wind and “pawn-broking” – i.e. lending against the value of security (particularly against falsely inflated valuations of property). No it means, irrespective of the size of the borrower, accurately assessing the terms, risk and ability to service any borrowing and, only as a backstop, considering the value of any security taken.
The global economy is fragile. It is imperative those left in control of our destiny take steps to ensure the banking industry has the funds. As well as responsibly making them available to businesses looking to expand, provide employment and rebuild our economy.