The Financial Times reminds us today that 2015 has been a vintage year for the finance sector and lists twelve of the “choicest gifts” bestowed on the sector, including “the unexpected Conservative party election win… a win for the numerous hedge funds and financiers who donated to the campaign in the hope of pro-business policies”. Chancellor Osborne gifted the sector by calling “time on the era of heavy fines following financial scandals that had blighted the City’s reputation, such as the Libor and foreign-exchange rigging scandals”. Another “choice gift” was George Osborne’s decision to cut the bank levy.
Before euphoria engulfs the City, it might do to remind the sector that while Conservative governments may periodically enrich the already-rich by inflating the value of their assets, and bestow upon them the choicest gift of tax breaks – they have also regularly adopted policies “with terminal consequences” for British banks.
I’m reading Duncan Needham’s excellent book: UK Monetary Policy from Devaluation to Thatcher, 1967 – 1982 (Palgrave Studies in the History of Finance). Its difficult not to be struck by the parallels between the 1970 Conservative government of Edward Heath and his Chancellor, Anthony Barber and today’s Cameron government.
The book is about how flawed monetarist and ‘free’ market economic dogma – as dictated by both the IMF, Tim Congdon and others – influenced changes made to Credit rationing by the Bank of England, and led to the introduction of Competition and Credit Control (CCC). The result was that in 1971 rationing credit creation by Bank of England control was replaced by rationing by cost – in other words by higher expected market rates of interest.
Unfortunately for the Bank of England’s monetary theorists, neither the then Chancellor Anthony Barber nor his Prime Minister, Ted Heath, fully understood the implications of targeting the money supply and rationing credit by cost. Unfortunately too, the Conservative manifesto for the 1970 election had called for an ‘end to the tax nonsense…[that] disallowed the interest on many loans as a deduction from income for tax purposes’. John Nott (remember him?) insisted that tax relief for interest was a manifesto pledge and was therefore ‘inescapable’. So it was included in the 1972 Budget.
Needham: “This could hardly have come at a worse time for monetary policy. Just six months after predicating monetary control on the interest rate weapon, that weapon was blunted by making interest payments deductible against tax. For a basic rate taxpayer, the cost of servicing a loan was immediately reduced by 30%. For the highest rate taxpayers it was reduced by 90%. (My emphasis). This measure alone meant it would take much higher interest rates to control bank lending to the private-sector and therefore, M3. It also meant that, far from generating the investment boom the PM was looking for, the dash for growth would produce an asset and property boom that would crash in 1973 with terminal consequences for a number of British banks.”
British bankers cannot say they have not been warned.