The market collapse in 2007-8 was the result of poor monetary management in the US, the UK and parts of the EU in the last five years. The boom-bust approach created bloated banks which were then severely weakened by the shift to tight money. It is of little present importance whether you belong to the group who blames the bankers for being too greedy in growing their businesses beyond the prudent, or the group who blames the monetary authorities and regulators who encouraged the boom by low rates and easy money then helped bring on the bust by higher rates and demands for more capital. We are where we are.
Apportioning blame is part of the political process. Parties of the left will tend to blame the bankers more, and parties of the right or more favourable to the markets will tend to criticise the authorities more. The common ground between both groups will doubtless lead to some more banking regulation and some more monetary innovation, as all political parties in power will be keen to avoid blame being ascribed to governments. They will see legislating more as proof they are concerned and keen to prevent a recurrence.
There will be limits placed on how far they go in regulating by a growing understanding that big banks are global and need to be regulated by more than one jurisdiction. There is also a tangible nervousness about recovery, so more efforts will go into creating and fostering easy money than in more immediate further restrictions on banks. So far governments have concentrated on criticising banking bonuses. They claim they encouraged too much risk taking. Governments have been reluctant to try to ban bonuses in new laws, and have often acquiesced in new bonus arrangements in banks where they are the owners or have significant stakes.
The difficulty for demand in the world economy is that the main debtor countries where the banks are weakest will find it difficult to crank up their borrowing again as their banks remain overstretched and their Regulators keen for them to improve their capital ratios. We are living through a strange period where huge sums of money are being created in the US and the UK to make markets more liquid. Money is rushing into asset markets, driving up the prices of shares, bonds and commodities. That same money is not rushing into bank lending to consumers and companies. The banks remain weak, unwilling to increase loan books. Customers are keener on repaying debt, worried about the possible loss of jobs, concerned that one day interest rates will go up again, and thinking about possible increases in taxes. The banks have to lend the money back to governments with a large appetite for new debt.
In both the UK and the US there is now active discussion of the need to cut public sector spending, but still little sign of action to do so. Both governments hope that making statements about the need to curb the deficit by cuts in spending sometime will be reassuring enough. The UK administration is not keen to make cuts with an election pending, whilst the Obama administration is keen to press on with its increased spending plans for health, as its political priority.
The truth about both the US and the UK is they have to rein in spending, export more and repay debt. The private sector is having to do this already. If the public sector does not make the adjustments soon, long-term interest rates will be forced up and the private sector will be hit again. We have avoided UK equities for some time, and are taking profits on some US positions. We still prefer Asian equity, where the growth is better. Returns so far this year have been good, so why not put some more of the money into bonds, to cut the risks?