Times: Worst of slump yet to come, says economist

Article Published in the Times, September 1st 2009. Photo by Jon Enoch.

Ann Pettifor predicted a painful end to the good times. Now she says that only radical action can prevent further gloom

Phil Thornton

Ann Pettifor is a member of a select club — the seers who saw it all coming. Now the economist, who predicted the credit crunch as far back as 2003, believes that the worst is yet to come unless there is radical reform of the financial system.

Six years ago she parodied the International Monetary Fund’s annual economic forecast with her own — The Real World Economic Outlook. Then, in 2006, her book The Coming First World Debt Crisis, warned that rich countries were heading for a debt crisis that would overshadow anything seen in the developing world. Both were ridiculed.

With the British and world economies languishing in the worst recession since the Great Depression and with once-mighty banks reliant on government life support, she could be forgiven for being a little smug. Not a bit of it: “No, being Cassandra is not something I wish for. I hate this role of being a gloomer and doomer, as I’m an optimist by nature. But I am very pessimistic now.”

She is dismayed that politicians have failed to seize the opportunity that the crisis has given them to embark on tough reform of the banking system. Stock markets have rebounded and house prices have stopped falling, but Ms Pettifor fears that politicians and households have started to relax prematurely.

“The economy is no longer in freefall and, as a result, there’s an enormous amount of complacency from politicians, in particular, about what will happen next. I believe politicians have given away the opportunity to restructure the banks and reconfigure the system.”

She likens Alistair Darling, the Chancellor of the Exchequer, to a high-wire artist. “He thinks that if he can just keep his eyes closed he will get to the other side. Yet underneath him is this vast debt that has not been cleared off the banks’ balance sheets. Many of the banks are still insolvent and this has not been addressed.”

Ms Pettifor, executive director of Advocacy International, which advises countries on debt management, made her name spearheading the Jubilee 2000 campaign to cancel the debts owed by the poorest countries. She believes that there are only three solutions to Britain’s woes: write off these debts as unpayable; convert the debt into equity; or use the benefits system to raise people’s incomes so that they can meet their debts.

She is baffled that the Government has used billions of pounds of public money to rescue the banks without insisting on any change in behaviour.

She highlights an admission by the Treasury that one company in three is paying interest rates more than nine percentage points above the base rate and is furious that banks such as Barclays feel able to offer bonuses reminiscent of the pre-crash boom. If the banks do not change their ways, she says, the Government must simply withdraw the insurance guarantees that have kept them alive.

Instead, public money should be used to bail out households and businesses threatened by bankruptcy. “The banks are not using the money productively, yet what we need is for the Government to spend more productively,” she says. “But now there is a consensus that governments should not spend any more in this crisis. That will tip us into a big depression.”

Ms Pettifor, who is a fellow at the New Economics Foundation, a left-leaning think-tank, believes that it is not too late for politicians, regulators and even bankers themselves to embrace reforms that will prevent another cycle of boom and bust. She believes that a culture of easy but expensive credit, which she blames for the accumulation of unaffordable debts over the last two decades, should be replaced with a model of “tight but cheap credit”.

“Orthodox economists talk about cheap money being the cause of the crash. But it was not cheap — subprime homeowners were paying 19 per cent interest. It was easy money that was the cause.” This, in turn, led to the massive inflation in property prices — house prices trebled between 1997 and 2007. “We over-borrowed against these inflated prices. The rollicking times were rollicking and now we are getting a bollocking.”

She was baffled by a recent letter to the Queen — from other leading UK economists — after she reputedly asked why nobody had seen the crisis coming. With a voice bordering on incredulity, she reads out a passage where the letter-writers say “inflation remained low and created no warning sign of an economy that was overheating”.

“What about asset price inflation? We repressed prices and wages but turned a blind eye to assets,” she says, adding that central bankers must monitor asset prices in the same way that they track high street costs.

But how do we achieve cheap but tight credit? In terms of tighter lending standards, it means an enhanced role for bank managers. “When I and my partner took out a mortgage in 1970s we had to see the bank manager, who went through our finances with a fine-tooth comb,” she recalls. “That’s all you need — more bank managers making an assessment of risk.”

Since she believes that high interest rates were a key cause of the crash, she says that low interest rates for loans are essential.

Her prescription for achieving cheap credit is more radical — nationalise the setting of the London Interbank Offered Rate (Libor), which tracks the rates at which the largest banks are borrowing money from each other and is used to set mortgage and business loan rates.

She says that government intervention to keep real rates at a level at which businesses can make a profit would help to stem the rise in insolvencies that, in turn, leads to people losing their jobs and their homes.

This taps into Ms Pettifor’s long-standing worry over the “financialisation” of the economy that has allowed banks to become the “masters, not the servants” of industry at the expense of genuine entrepreneurial activity.

Future lending should be directed towards sustainable home ownership and business activity, rather than speculation.

At times her model comes close to a form of Sharia, the Muslim financial code that forbids the earning of interest. Indeed, in her 2006 book, Ms Pettifor urged society to return to the traditional religious approaches to usury as a way of curbing the excesses of capital market speculation.

The final element of her vision is a “green new deal” to create economic growth and the jobs needed to fill the “crater” of lost employment and output caused by the crash.

Ms Pettifor would take a leaf out of the Bank of England’s book on quantitative easing but would direct new money to the Government to support green projects.

Private banks could lend to the Government at low interest rates for the same effect. “The fact is that when the Government spends, the private sector is the biggest beneficiary. If the Government announces a home insulation programme, it will be the construction industry that will do it,” Ms Pettifor says.

Her forecasts of a crash have been proved right, but will her latest warnings receive a better hearing? She admits that none of the three main political parties is likely to adopt her policy prescriptions. “There is a weakness in being too far ahead of the game.”

Originally published in The Times, September 1st, 2009.