I thought I could safely ignore the election for a few hours this evening. I voted days ago by post. And not much normally happens before the polls close at 10 pm.
But the past few hours has seen worrying economic tremors – as a raft of bad news from China and Europe, combined with skittishness over what will happen in Westminster tomorrow, drove a panic in the markets (with a trader’s error possibly fuelling the chaos [for more – see Felix Salmon]).
A 4 per cent drop in Chinese stocks started the downbeat mood, which carried over to Wall Street’s S&P 500 index, which was down 6 per cent to 1,065 – its sharpest correction in over a year, erasing its 2010 gains in one afternoon. The VIX index of market volatility spiked to its highest in a year.
“It’s really shocking,” said Jeff Palma, global strategist at UBS. “Stocks fell to minus nine on the year within seconds, that was a pretty shocking move. This is not your normal every day pull back, this is a pretty full-on collapse in risk appetite.”
As Alex pointed out earlier this week, bond markets will be open at 1 a.m. (in just four hours’ time) – at which they throw fuel onto the fire if they so choose:
Bond traders will be able to react in real time to results rolling in from key marginal seats, in other words: so as well as measuring how the night’s going through the traditional BBC swingometer, we’ll also be able to track progress through yields on three month short Sterling interest rate futures. Well, great.
All this reinforces how the UK – bereft of leadership throughout the campaign – has been sleep walking as a new economic reality (and a pretty disastrous one, at that) unfolds around it.
That’s why, over a week ago now, I called for the Chancellor (for now, at least) Alistair Darling to get off the campaign trail and get back behind his desk:
Election or no election, the UK simply cannot afford to sit on the sidelines while this crisis runs out of the control. Alistair Darling needs to stop giving speeches to activists in Scotland and get back to work at the Treasury.
Lord Adonis stopped campaigning as soon as Eyjafjallajökull erupted. Darling must do the same as the UK faces contagion from Eurozone turmoil.
Let’s hope he is at work now. Until a new PM has the ‘confidence of the House’ (and if results are close, that could take days to work out), he is 100% responsible for the British economy.
If necessary, he needs to haul in George Osborne and Vince Cable, and hammer out a consensus behind any short-term fire-fighting measures that might be necessary.
Once we have a new government – and assuming we have weathered any immediate post-election crisis – the team (of whatever political colour) will need to take an extremely active approach to economic policymaking.
Gordon Brown may have got the UK into this mess (he did), but there can be little doubt that the British government has played an important, and at times pivotal role, in trying to patch things back together again.
You just have to look at the absolute mess that the Germans and French have made of responding to the Greek crisis to see that this is a time when any half-way competent hand needs to be called onto the bridge.
I continue to believe that we’re seeing the latest stages of a crisis that stretches back until at least the late 1990s. This long financial crisis should force leaders to admit that they are part of an economic system that (i) they don’t understand; and (ii) seems to becoming more volatile, rather than less.
So how should the new PM and his Chancellor react? Here are three pointers – each of which cover the UK’s international economic policy (and its domestic policy, insofar as it is important to broader global financial stability).
First, the new government needs to balance the risks inherent in high levels of public and private debt.
We have heard a lot about the government’s deficit in this election, and quite a bit about its overall debt. But almost nothing has been said about colossal levels of private debt.
Private citizens owe much more than the government – most of it in the form of mortgages, secured against a residential property market that is significantly overvalued. (I wrote at length about the election and the housing crisis here.)
It’s no good trying to appease the global financial markets simply by cutting spending or raising taxes. Stall the recovery and unemployment will shoot up, while property prices will head down, threatening the banks again, and sending the tax take much lower.
No-one is going to be fooled into believing that the government can repay its debt, if we are hit by the twin nightmares of a double dip recession and housing market crash. That really would be game over.
So what can the government do?
There is so little room for manoeuvre that the unfortunate answer may be: nothing. However, I think the best strategy would be as follows:
- Take immediate and dramatic action to cut the structural deficit (I’d raise retirement age immediately, and then peg it to life expectancy – but any package of credible long-term tax or spend commitments would do).
- Avoid raising taxes or cutting spending by much in the short term, as the economy is still too fragile to take it (the government should probably make less of a song and dance about its caution here).
- Be explicit with the markets that interest rates will be kept low (propping up the housing market and boosting growth), even as the economy recovers – that the government’s main weapon against inflation will be its own spending. Think of this as a piece of reverse-Keynesianism.
- Take action to ensure that today’s secondary bubble in the housing market is not allowed to inflate further. Plans to cut stamp duty, for example, should definitely be put on hold. We don’t want housing prices to fall too fast, but neither should they be allowed to rise above today’s totally unsustainable levels.
Second, the government needs to get stuck into the Eurozone crisis, as I recommended in my post on Europe earlier this week, when I recommended that it should be:
…aiming for (in order of preference): (i) A strengthening of the Euro with greater sharing of economic sovereignty among Eurozone members (but with the UK left on one side); or (ii) An orderly removal of the weaker economies from the single currency.
Even on the Euro, the UK has some influence as an honest broker, given its position as an interested party, but not a full player. Cameron should adopt this role wholeheartedly – reminding British voters that the disorderly breakup of the single currency would be absolute disaster for the UK economy.
Third, we need to get the G20 back on track.
It briefly emerged as the forum for tackling the global economic crisis, but has now gone AWOL for, I suspect, a number of reasons:
- Obama is embroiled in a political system that cannot make foreign policy decisions.
- The Chinese are still bruised after Copenhagen.
- The Eurozone powers have utterly lost their nerve, and
- The Brits have left the field as the election approached.
Only the G20 has any hope of steering the global economy through what seem certain to be some exceptionally rocky times. If it is allowed to become a hopeless talking shop like the G8, then I think we are probably screwed.
Over the next year or so, the UK’s G20 policy will be its foreign policy. It’s essential that we have some radical new ideas to put on the table.
[Read the rest of our After the Vote series.]