The bubble has burst: it is futile to resist reality

 
Allister Heath
THERE are two ways that one can react to change. The first is to embrace it; the second is to resist it. Contrary to what is often believed, the second option doesn’t always fail – there is no such thing as historical determinism. Wars can often be avoided, for example, or populist tides resisted. What cannot be changed is reality: it is impossible to will away scarcity of resources or the laws of physics. If there is not enough stuff being produced by the economy, protesting against that fact or passing a law against it won’t help. The only answer is to find a way of making more of it.

Assessing yesterday’s news stories through this prism is, for once, not entirely depressing. One can see plenty of deluded resistance to change but also signs that at least some people realise the old global order needs to be replaced by something better. There were far more heads stuck in the sand six months ago, let alone two years ago. The intervention by central banks to provide more liquidity was partly a case of attempting to prop up the Euro Titanic – but it was also an admission that the situation is truly terrible, and that something dramatic needs to be done to prevent a new credit crunch.

I don’t want to give readers the wrong impression: yesterday’s move was probably necessary yet also deeply dangerous. As Marc Ostwald of Monument Securities points out, the implication that central banks appear to be willing to expand their balance sheets limitlessly means that they eventually risk becoming a central counterparty for the interbank market, which would mean a disastrous, terminal breakdown of the financial markets. Even worse, central banks are backed by governments – so them bailing out governments suggests a dangerously circular flow of funds which once again puts into question the viability of paper currencies. Yet the monetary authorities, for all their flaws, are far more aware of the gravity of the situation than they were three or four years ago. While equity markets bounced in their usual short-sighted fashion on yesterday’s news, the intervention should have been seen as a massive vote of no confidence in the politicians, an attempt by the Fed, the ECB and others to jolt them out of their stupor.

It remains to be seen whether this will work, of course: another big story, the ongoing attempts to reform the Eurozone, suggest that most European leaders still don’t get it. But at least the private sector now does: the world’s biggest multinationals are drawing up contingency plans to deal with the possibility of a euro break-up. The fact that such a scenario is openly being discussed is a major leap forward. And what of the disintegration of relations between the UK and Iran? After years of the despotic regime in Tehran running rings round the world, at least there is now a growing realisation that it is trying to obtain nuclear technology and must be stopped.

The strikes were the only major story that was entirely a case of people resisting unavoidable change caused by powerful economic forces. The bubble has burst; the economy is much smaller than everybody thought it was. That means that people need to readjust to a lower standard of living. The Institute for Fiscal Studies estimates male public sector workers are paid 4.3 per cent more per hour than their private counterparts, while female workers receive 10.5 per cent more, once education, age and length of service are taken into account. This cannot be sustained. The same is true of public sector pensions: even after the reforms, they will still be far more generous than what is on offer to most of the private sector. Many firms offer no pension provision at all.

The problem for George Osborne is that only one twentieth or so of his planned 5.3 per cent cuts in total spending by 2015-16 have already been achieved – and yet there are already mass protests. If the UK is not careful, much larger and faster cuts will eventually be imposed on it. Bank of England data reveals that quantitative easing and capital flight from the Eurozone have propped up the UK gilts market. The Bank entirely monetised the budget deficit in October, buying £16.9bn worth of UK government bonds with freshly issued money – more or less exactly equal to the £17.0bn in fresh gilts issued. We cannot go on printing our way out of the deficit – at some point, reality will reassert itself. It is a shame that the strikers couldn’t see it.

allister.heath@cityam.com
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