How we can ﬁght off a depression
Only wide-ranging action by the government can stave off a lost decade, tells one of the world’s top financial figures
Thousands of hunger marchers assemble in Trafalgar Square in 1932 during the Great Depression
The government must act to contain the recession and avoid a revival of nationalism, social unrest and protectionism, warns one of the financial world’s most authoritative figures.
Such a caveat is sounded by George Magnus (below), the senior economic adviser at UBS. Mr Magnus, 59, who was one of the few to foresee the financial crisis, says we should be braced for the recession to linger through 2009 and possibly into the following year.
He says: “My biggest concern is that governments won’t do enough or act in a timely enough way to contain the recession and that there won’t be major global response to what is an unusual global recession. If these concerns were to be realised, the prospects would be bleak and we might see a revival of nationalism, social unrest and protectionism.”
But the difference between a bad recession and a lost economic decade, he says, depends on policy.
So, what needs to be done? “The acid test now is the ability of the authorities to orchestrate a comprehensive assault on the central problem, namely the unravelling of the debt mountain that we built up over the last 10 years. This involves four key components:
“First, the banking system must not be allowed to implode. The Government’s plan, announced in October, which has thrust it into the ownership structure of RBS, Lloyds and HBOS, was a good one. But it is a work-in-progress, and there may be a case for additional capital to be injected into UK banks.
“Second, the banks have to be encouraged to keep their lending flowing to good companies and good mortgagees, but we should not want or expect banks to pick up the massive lending that was undertaken by nonbank financial entities in recent years and which is now collapsing.
“So the Government has to step up and widen its own direct lending, offer adequate guarantees on smaller-company loans and try and breathe some life into the moribund mortgage market.
“Third, the Government’s recent announcements on budgetary policy, centred on the cut in VAT, were right in spirit, wrong in substance. The VAT cut is lost in the tsunami of retail discounting.
“More must be done next year to use the Government’s authority over spending programmes for infrastructure and energy that leave long-lasting, positive effects on jobs and incomes.
“The Government is going to borrow an awful lot of money — but much is simply substituting for the private spending and borrowing now in hibernation, and the rest will have to be paid for eventually.
“It’s important that the government’s strategy is credible.
“Finally, now that the Bank of England has belatedly lowered interest rates to two per cent, we face the prospect of a decline to levels never seen since the Bank was created in 1694.
“If that happens, the Bank will almost certainly have to embark on a different sort of policy that involves printing money.
“This isn’t as ‘evil’ as is often made out, though this policy needs to be abandoned as soon as its objectives have been fulfilled. It is sensible and potentially powerful, in conjunction with the other three policies, to avert a much more serious economic slump.
“Even if we are very proactive, the economy could still flounder and remain unresponsive if the global economy remains in deep recession. It’s vital therefore to keep an eye on president-elect Obama’s probably bold economic plans for the US, since we seem to be getting no support of significance at this time from the eurozone countries in general and Germany, in particular, which is well able to afford a leadership role.”
Which sector will find it the hardest to recover? “My guess is that the financial services and housing sectors won’t recover fully for many years. They’ll be different, more tightly regulated, and the rocket scientists that were attracted into financial services will go back to making rockets, if you see what I mean.”
He acknowledges this will mean an increase in the importance of business services and manufacturing. “It seems very likely that green projects, alternative energy companies, resource-related companies, for example, will be favoured by the concerns we had anyway.” Mr Magnus, the author of The Age of Aging: How Demographics are Changing the Global Economy and our World, says the economy will not embark on a sustainable recovery until 2010/2011 at the earliest.
“There is a serious risk that the economy will resemble an ‘L’, stagnating for a decade, like Japan.
“I don’t think that’s the most likely outcome, but we had better ensure our elected representatives take appropriate action soon.
“Consumption by households will have to fall for a few quarters, and might not then recover very fast at all. Financial services and banking won’t be the same for many years.
“Easy money and the culture of debt have gone for the time being. And we will record anaemic economic growth over the next five years.
“Also, hidden from view, of course, is the rapid aging of our society, which will bring with it new economic and financial challenges.”
Mr Magnus has been senior economic adviser to UBS investment bank since 2004, following an eight-year stint as the bank’s chief economist.
Before this, he had been the chief international economist at pre-merger UBS from 1995 and the chief economist at SG Warburg from 1987. He has four children and lives in Highgate, North London.
“The Age of Aging” is published by John Wiley & Sons, 2008