Who Might Run Industrial Policy?

It has been a while since I have last written a post, and the choice of subject matter for this post has proven to be a difficult decision. On the one hand, there is the ongoing tremors in the financial system, and on the other there are the global shifts, such as the unsubstantiated suggestion by China that they may allow the RMB to appreciate. Added to this, there is the ongoing ascent of the gold price, as investors and governments move into the asset of last resort, and the progressive decline in value of the $US. This from the Wall Street Times:

"The gold market is kind of surprising here," as it holds on to the psychologically important $1,100 level, said Ralph Preston, senior market analyst with Heritage West Financial.

Watching the dollar's next moves will be crucial, Preston said. "It's going to be interesting whether the dollar is developing a bottoming formation or if it is about to fall off a technical cliff."

I will leave such matters alone for this post, as they are being covered elsewhere. Instead I would like to focus on one of the widely utilised government stimuli; the cash for clunkers schemes. I am focusing on this subject, as the scheme has appeared to give a temporary reprieve in the downwards trajectory of many economies. My inspiration was an article in the Telegraph, in which Jeremy Warner analyses the impact of the stimulus on the UK economy.

The purpose of my post is to highlight the absolute foolishness of such government measures in relation to arguments for more government interventions in economies. A long while ago, in a discussion of GDP measures, I pointed out that Hurricane Katrina would have seen an uptick in US GDP. The destruction of infrastructure, housing and other assets would have led to increased activity in the economy, as business and government sought to replace the assets that were lost. In other words, the destruction of a hurricane would appear to be a positive boon for an economy. On such logic, bombing your own cities would be good for the economy.

As it is, we have seen a natural disaster replaced with a man made disaster. Each of the cars that has been scrapped early is an asset with a real value, and useful life. Just as a bridge being destroyed in a hurricane still has a useful potential lifespan, the same might be said of the cars that have been scrapped. Quite simply, the result is just the same.

In some ways it is an identical process to running a production line with a garbage compactor at the end of the production line. As each unit comes off the production line, the compactor simply crushes the item. The result of such a measure would be that the demand for the item might never be met, and the production line would be kept endlessly busy. Output would be maintained, GDP figures would be positive, and the economy would apparently be doing well as the result of this ongoing activity.

What I am discussing is not particularly original, and many other commentators have made similar observations. On this occasion, I am reiterating the point due to comments on my previous post. One of the regular commentators, writing under the name of Lord Keynes, made a robust defence of government intervention in the economy, proposing that governments develop industrial policy. What followed was a heated debate about the relative merits of government interventions, with both sides of the debate arguing their points vigorously.

In light of this debate, the purpose of this post is very simple. I have outlined the principles of a government policy, adopted in many countries, which is just a process of destroying useful assets - governments destroying something and suggesting that this is good for the economy. These governments include the same people in whom Lord Keynes appears to profess so much faith. These masters of our economic destiny actually think that premature destruction of assets is good for an economy. These are people who would count Hurricane Katrina as having had a positive impact upon an economy. Few would say such a thing directly (though I do recall that the Economist magazine came close to actually saying it), but they would see the positive GDP growth from the activity from Katrina as a 'good thing'.

My question is very simple. How can anyone have faith in these people? It is extraordinary that anyone might have faith in people with such bizarre beliefs. Really, can we trust these people with the widespread interventions in the economy, as proposed by Lord Keynes? The very same people who instigated the cash for clunkers policy would be the same people who would devise 'industrial policy'. Lord Keynes is not alone in having such faith in government interventions, and the worry is that those with his views are gaining ground. The advocates of ever more interventions, ever more shift of resource into government hands, are becoming ever more plentiful. That such beliefs are gaining ground is a real cause for worry.

UK Bank Bailout - Round 2 Begins?

The main post today is quite brief as I would like to catch up on some of the questions and comments from previous posts. I have been reading the news and it is ever more apparent that the bailouts of the banking system are really just not working. I had the following to say on the subject in June of 2008:

In particular, the problems with credit and the banks are going to reach their real crisis in about six to eight months time. The reason is that the fallout of the sub-prime fiasco is just the start. The next phase will be the consumer credit crisis and the SME crisis - and the results will be equally as dramatic, but with the added pain of hitting the banks when they are already suffering severely.

So what are these crises. The first is that consumer credit was already reaching breaking point, where many households were borrowing to repay borrowing. This was, in any event, unsustainable. Added to this factor, the story of inflation needs no more retelling. Finally, we have the spectre of rapid increases in unemployment, and it will be this development that will spark the second banking crisis. In particular the number of delinquent loans will start rising rapidly as unemployment increases, and accelerating concerns about the already weak balance sheets of the banks will see even greater tightening of credit conditions. Furthermore, unemployment will see even more mortgage defaults, and the banks will be trying to sell assets into a falling market. Quite simply, their losses are going to be staggering.

The second problem will come from the Small / Medium size businesses. As the economy turns down, think of the small traders - such as restaurants, who are already only marginally profitable. These will rapidly fail, in many cases leading to losses for the banks. Even the medium size companies, with a better financial base, are going to be negatively effected by the consumer downturn, and their failures will hurt the banks even more.

Remember that these problems are going to hit the balance sheets of banks when they are already tattered, and hit the reputation of the banks when their reputations are at a low.

I said all of this before the huge bailouts and nationalisations. The truth is that the government was always going to have to keep pouring money into the black hole of the banking system. I had the following to say in September, at the time the bailouts were being justified to 'get the banks lending to each other':

The reasons that the banks are not lending to each other is that they all know that they are all holding toxic debt. This is not just CDOs etc. but also fast deteriorating commercial debt, unsecured consumer debt, and old fashioned mortgage debt (held on devaluing assets with people with ever more insecure job prospects). Furthermore, the sources of liquidity from the East are drying up as confidence in the 'rich world' banking system is evaporating.

And finally, I had the following to say in October, having discussed lending into a falling market, and the attempts by government to push the banks to lend.

The government is talking about re-privatisation in about five years time, and suggesting that the nationalisations will not cost the taxpayer money in the long term. The idea that the government will be able to gain any return on the investment, in light of what I have discussed, is very remote indeed. Instead, as the finance of the nationalised banks continue to decline in parallel with the economy, the government will find itself having to provide more and more capital injections to keep the banks afloat. This will be never ending, as the risky lending that is the condition of the nationalisation will just produce ever more toxic debt.

I could go on quoting such commentary, but I hope that you get the picture. In the first quote I suggested that the second crisis would be in 'six to eight months time'. That was in June, and we are now at the point in time that I predicted that the second crisis would hit - and all the major news papers are highlighting that a new bailout is imminent (e.g. Times, Telegraph, Guardian). The Times says the following:

Under one option, a “bad bank” would be created to dispose of bad debts. The Treasury would take bad loans off the hands of troubled banks, perhaps swapping them for government bonds. The toxic assets, blamed for poisoning the financial system, would be parked in a state vehicle or “bad bank” that would manage them and attempt to dispose of them while “detoxifying” the main-stream banking system.

And from the Guardian:

Banks and building societies are being deterred from lending by the worsening economic outlook and the fall in house prices and other assets against which loans are secured.

Over the last month, we have articles reporting that the problems in mortgage repayment are spreading to 'prime' borrowers, reports of increasing insolvencies in the retail and service sectors... the articles in the links are just a random sample. I could go on, but the news is best expressed in the necessity of the Telegraph to publish an article on how to avoid repossession of your home.

All the while this is hitting the banks when they are already struggling with battered balance sheets, and it is going to get a lot worse yet....

This raises the question of how much the government can pour into this black hole, and takes us right back to the money printing scheme that is the last desperate attempt to stem the tide. With the government sitting on the boards of major banks, they will certainly be aware that the balance sheets of their 'investment' are, even as I write, falling off a second cliff. As I sit here typing I am listening to 'Ne andrò lontana', and it seems somehow appropriate background music for this post.

The trouble with the banks has only just started, and there is much more pain yet....

Note 1: I will try to address some of the many questions that I have been neglecting. I will work backwards from the most recent, and apologise that I will only be able to get so far....there have been a very large number of comments of late (my inbox is overflowing), many of which have (as ever) been extremely good.

I will start with the comments on my post on government or market responsibility for the crisis. I am unsurprised that, in the current climate, my post is causing some controversy. Unlike just about everyone, my post exonerates the market.

From anonymous there is the suggestion that, rather than bailing out the banks we should do the following:

'I'm sure there are science(physics) and humanitarian projects that could chew up several hundreds of billions of dollars without too much problem probably over the next 10 to 15 years but at least it will inject large amounts of cash into the world and people won't have to pretend to work to get government handouts but actually do some real work with real future benefits.'

Whilst agreeing that pouring money into the pit of the banking system is not the best use of the money that is being borrowed, my answer is quite simple. Do not borrow money when the problems you are experiencing are as a direct result of .....borrowing money. However the money is spent, it must be paid back, and that means a future contraction in growth. We can not spend the same money twice - if we spend it now, we will not have it in the future. Yes, it would be better to spend the money on something else, but the real answer is not to spend money you do not have. If you read the other sections of the blog, you will see why this is the case...

Jeremy (an increasingly regular commentator) makes the following comment:

'Isn't the best end-game for China to wait until the US stock-market bottoms and then buy all the best assets with their huge $ reserves?

They don't want the US to go bust, but they want it cheap and they might not want to buy dodgy motors from them but they'd probably be interested assets like Silicon Valley.

If China invested $1 trillion in US companies then there would be plenty of americans with enough money to buy chinese exports again and China would eventually end up owning the US lock, stock and barrel.

Just a thought. '

A very good thought. If China were to use the money to buy US assets, it would help buttress the $US for a while, but it would not help in solving their current domestic contraction. Furthermore, once the money was used, the US would still be left in a position of not having enough to sell, meaning that the $US would in any case fall. China would then be left with substantial losses on its assets - albeit at the benefit of increasing their economic power. The point of my post is that the problems lie with how they can ameliorate their collapsing export market, and that problem is short-medium term, and one which risks the very stability of China overall. They would also face a backlash (protectionism) if they started buying up the high-tech assets that you refer to in any significant quantity. However, as I said, a very good thought.

I have had an interesting question from anonymous, as follows:

The point about China's accumulation of Treasuries is that most of them stem from the last couple of years, so even if they were to be worthless soon, the Chinese have the process mechanisms of creating that wealth again quickly.
Also, how is it possible that China can seemingly subsidize its economy to gain such an advantage over the whole world when its economy is in fact still only a fraction of total worldwide output, i.e. how can a government with such comparable resources manage to create such a huge distortion? That seems very odd.
Furthermore, how far worse of would Western consumers be without cheap Chinese goods? As far as I know spending in America has gone down for consumer goods but massively increased for government-distorted things like health-care and housing.

I am afraid to say that the trade imbalances with China remain, even as the economies of the West are contracting. China makes many products for the budget end of the market, and are therefore relatively well placed to continue to export. In more cost conscious times......

The subsidy question: There are many forms of subsidy that China can use. One of the subsidies that I highlight is the subsidy implicit in their currency manipulation. In this case, the subsidy is collectivised over the whole economy. In keeping their currency low, they are effectively removing purchasing power from every individual in the country, and every business. It is actually an indirect taxation. This is quite difficult to explain in short but I will try. When a consumer walks into a shop in China to buy a pen, the artificial exchange rate will make the pen made in the US x% more expensive. The indirect taxation on purchasing is the difference between the price of the US made pen in the situation of a free floating currency and the actual price today with the fixed exchange rate (y). The person is 'y' poorer as a result of paying that indirect tax.

Although you suggest that China is only a small part of total world output, the size of the (so called) output of countries like the US and UK is overstated by huge amounts (I estimate at least 30% for the UK), as the output of such countries includes output that is resultant from debt. One of the major creditors for that debt is actually China. If the lending by China to the US was retained within China, for example used as it has been in the West for consumption, there would be a significant rise in the output of China, and a commensurate fall in output in the US. This is actually what is happening to US output - as the credit taps switch off, their 'output' is falling. I suggest a read of this post to explain it more clearly. This is not to include the critical consideration of relative strengths of currencies in the consideration of output. For example, UK 'output' has been falling both absolutely but also because of the weakening of the currency.

I will leave the answer there, though much more could be said...I think most of the detail is scattered through the blog.

Another anonymous poster asks the following:

"Our creditors, such as China and Saudi Arabia, are now turning off the supplies of credit, and are no longer buying the £GB to lend to us. Demand from this source will continue to evaporate..."

Could somebody briefly explain the mechanichs of this? How did they lend to us? By buying Government bonds?

The short answer is 'yes', they buy bonds, and a range of other forms of assets. A full analysis of the situation can be found here. A quote from this discussion is:

China’s low (controlled) interest rates imply that, since its reserve holding are believed to be held primarily in medium- and long-term industrial country treasury instruments and government agency bonds.

However, there are many other factors that need to be accounted for, such as 'round-tripping' (setting up a fictional Hong Kong entity for a mainland company), and the report details this better than I can in a short answer. However, you will note how opaque it all is....The tables at the end of the article are the most useful part (tables 7,8 and 10 if I remember correctly), and these will give you a detailed answer.

Another anonymous poster questions the idea that the market is a good thing, suggesting that government will always need to intervene:

As I see it, in a finite world and an exponentially increasing population, unfettered markets won't cut the mustard, unless of course you are prepared to throw millions of losers overboard.

If we look at China, it was a 'fettered' market before 'opening'. Millions of 'losers' were already 'overboard', and have been rescued by markets. As I have always emphasised, the world has overall become considerably richer overall since China opened, but the problem for the West is that, not only has the world become richer overall, but there is also an ongoing redistribution of the wealth towards the emerging markets.

A simplistic way of illustrating this can be seen in the car market. In the West there has been massive growth in the luxury brands of cars such as Mercedes. It became conventional wisdom that the best place to be in the car markets was the upmarket brands, which explains why Ford invested so heavily in European luxury brands. This is a perfect illustration of the imbalances that are now becoming evident. It is now, as the wealth of the world redistributes over more people, that we see the emergence of the Tata Nano, and the amazingly cheap Renault being sold into Central European markets.

There are more people with more wealth, but that wealth is divided over more individuals, making these cars a type that best serves the market. The luxury brands are looking increasingly vulnerable as the shift in distribution of wealth occurs. However, in the long term, as the wealth distribution runs its course, the demand for these luxury brands will return. The question to ask is where that demand might originate?

Lemming asks many questions and raises many points, as follows, so I will need to quote in full:

'I am persuaded by your view that government intervention is a distorting element which prevents the free markets from functioning 'properly' - and your idea that we need less, not more, banking regulation seems to be 180 degrees opposite to the view of every other economics commentator I have read, recently, by the way.

But I am still worried that there are other distorting factors which might render "the invisible hand" useless. One such is the way that money is issued: is the free market system meant to be stable regardless of how money is issued? In your post you suggest that growth and recession are both natural conditions for the economy, but I cited Eddie George speaking to the Treasury Select Committee in a comment a few days ago, stating that the BoE had pursued a policy of unsustainable lending rates in 2000/2001 to avoid "recession", as though that condition was to be avoided at all costs. Why? Is it because almost all money in circulation is temporary and therefore growth must be maintained otherwise the system collapses uncontrollably? Certainly a condition of recession is assumed by most economics commentators to be a huge problem. If our version of free market capitalism is set up to depend on perpetual growth, then in the real world of finite resources, it must fail eventually, and you have often given the example of a temporary bottleneck in the supply of oil limiting growth. Is continual growth a prerequisite of free market capitalism, and if so, does this example, alone, negate the validity of free market capitalism in principle?

(And how about the fact that interest rates are set 'manually' in our system of fractional reserve banking? It seems to be a very crude government intervention in itself, yet "the invisible hand" is supposed to be self-regulating and shouldn't need any external control to function.)

Another distorting factor must be the free markets operating on commodities whose availability and price do not vary by supply and demand. There is a frequent commentator on CiF called 'physiocrat' who continually refers to the problem of land in the economy and points to this website: www.landvaluetax.org. I suspect he is probably right. Surely a commodity such as land is a huge fly in the ointment of free market principles? '

The first point is that I am increasingly alone in defending the markets. To this I would highlight that I was in a very lonely (though apparently not completely alone), when predicting this crisis. It certainly seems that the mainstream are all becoming increasingly interventionist. This is in part because they look at the symptoms, not at the cause of the symptoms. They see that there has been lunacy in the banking system, and think that this lunacy is the result of a free market. However, they do not ask why it is that people were happy to place their money so blindly in a system that was simply not working. They do not ask why there was such a flood of capital in the first place. I could go on, but I do not want to repeat my post. They are quite simply not asking the right questions.

With regards to the question of stability and instability. Should economies be stable, and should the governor of the Bank of England be trying to manipulate the economy to avoid recession at all costs?

I will illustrate the need for instability from my experience in China. When I first arrived there was a boom in the manufacture of televisions to supply into the China market. There was massive growth as ordinary Chinese people tipped over the financial point where they could afford this item. That emerging demand saw the emergence of large numbers of manufacturers, all of whom responded to the market demand, and provided ever cheaper and better televisions. In the early stages, no doubt, many were making good money. However, as more and more companies entered the market, the market became flooded, and the bust then happened. All of the new entrants saw the potential for profit, but ended up destroying those profits through oversupply. The only answer was a rash of bankruptcy in order for the market to reach an equilibrium (in this case the over-supply was exacerbated by local governments jumping into the market with their own investment in production). At the end of this process considerably less businesses were left standing, but those businesses would be the strongest businesses, operating with the best products to meet the demands of the market.

Such an example shows how markets can boom then bust. In the process a lot of people purchased consumer durables, and future industrial giants started to rise. The bankruptcy of the other companies was a necessary part of that process, but would have led to a lot of people also losing money, as well as people losing their jobs. However, you are left with an industry where the output is actually geared to meeting demand, and the companies meeting that demand are the most efficient in their overall operations.

Lemmings' other questions largely pertain to the status of commodities within a free market. These are a critical element, as without commodities, the market can not expand. The trouble arises with many commodities is that, during times of growth, it often takes a while before new commodities come 'on stream'. As such, what often happens is that commodity supply lags growth, such that the growth in commodity supply comes on stream just as a spurt of growth comes to an end. If we think of the television example as a proxy for world markets, the cycle of that sudden growth and bust was over (I guess, but am not sure) about five years. If we think of this example, and imagined that component suppliers needed to build new factories to supply the components for the television (equivalent in this example to commodities), the extent of the boom would only become truly visible in about the second year of the boom. If we imagine that this fictional component required two years to build a factory, it would only come on stream as the boom is about to collapse, leaving the factory with excess capacity.

However, if the next boom is in hi-fi, and the components the factory makes are suitable for hi-fi, then the factory will benefit from the second boom. The trouble is that, whilst awaiting the second boom, they lose money. Commodities suffer from the same problems. The problem recently was that the dumping of so much labour into the world market so quickly just left the ability for commodity producers to keep up as an impossible task.

As for the question of land, the Economist gives a good example of where 'land' rights ensure that land is utilised well. I have not read the full report in the latest edition which is on rights in sea fishing (my print edition has not yet arrived) but, when you give rights to the sea to individuals/companies, they seek to preserve the value of those rights through better management of the fishery. The original report I read dates back a while, but can be found here. I am sure that the new report in the Economist will have similar examples.

Regarding Property Tax: I have read some of the property-tax arguments briefly, but do not have time to discuss these in depth on this occasion. However, I will quote something from the home page of the website Lemming pointed to as follows:

It would operate as an annual charge on the rental value of land, assuming that each site was in its optimum permitted use

I will leave you to work out why that might be problematic in this proposal, but the words 'who' and 'how' come to mind. I checked their FAQ, and looked briefly elsewhere, but found no answer.

I have a had a few comments from the curiously named B33ENN (?), who asks in one post:

If there is a Western economic collapse on the horizon, meaning China's export economy fails along with us, what effect would having a surplus supply of real and valuable raw materials have on China's internal economy? What effect would their fast-track education in modern technology have on their internal development?

At that point, would they really need or want anything from us at all? If they learn to produce everything for themselves, from low-tech to high-tech, what would they need to trade with us and our worthless currencies?

The question then becomes, is China really viewing itself as part of a world economy? Or is it exploiting the benefits while it can, all the while more interested in its own internal wealth and future, independent of the world?

China has a long history of supposedly being isolationist, but their moves towards the development of a blue water navy, the quest after commodity supplies around the world tells us a different story. China simply does not have the access to the materials they need to function as a modern economy. For example their major oil fields are close to exhaustion (I forget the name of the oilfield, but I am thinking of the one in which a revolutionary hero, 'Iron Man Wang', sprang from).

Perhaps an interesting perspective on the rise of China is the argument that China is just returning to its 'natural' status in the world. This is the argument found in 'The Great Divergence' by Kenneth Pomeranz. I think his argument is very poor in places, but would agree with the central principle that China does have a natural 'weight' in the world. He ignores that this weight has been achieved by the greatest and most enduring imperial expansion in history, and there is nothing to say that China will not seek to continue this pattern of growth and expansion. It is very easy to forget that China is an empire, and is therefore not as isolationist as perhaps is commonly perceived. The nature of China's growth may be simply towards economic expansion, but any idea of it taking an isolationist approach is very unlikely.

With regards to trading with us for our 'worthless' currencies, it is at this point, when our currencies are 'worthless' that we might be in a position to once again return to growth. At that time, we will all be much poorer, but will therefore be more competitive. In the most basic terms, our workers will be demanding less of a return for their labour, a return closer to that of an equivalent Chinese worker, allowing for us to sell our goods. However, as I have emphasised, we will also need to reform ourselves broadly in order to return to growth, and that is something detailed throughout the blog, and which I will not cover here.

Note 2: At this point, I have to offer my apologies, but I must call a halt. I have answered the questions in order, so I have not made any particular determination in which questions I would answer. I mention this, as there have been many other excellent questions and useful comments that I would like to respond to...Sorry for some rushed answers, and I hope that they are as clear as I would like them to be.

Bank Nationalisation - A Continuation of the Debt Economy Delusions

The dust is starting to settle on the first tranche of bank nationalisations, so I thought it might be worth considering what this will mean. First of all a quote from the Telegraph article (link above).

'Mr Brown was said to be "genuinely shocked" when he was told how much cash was needed to recapitalise RBS, which was ordered to accept up to £20 billion of investment, making the Government the majority shareholder.'

This is an interesting point, as it is an indication of how severe the problems are. However, my suspicion is that this is about the problems at this current stage of the crisis, not the problems that are going to emerge as the economy continues to contract. There is already talk of needing more money for the bailouts and, as more and more consumer credit, commercial debt and mortgage debt goes bad, there will be ever more need for additional financing. In other words, this is only the start.

The next quote from the same article is also very revealing:

'Banks will effectively be state-run, with Government-appointed board members put in place to ensure it once again begins lending to businesses and individual customers. Together with Northern Rock and Bradford & Bingley, the move will mean the Government effectively has four of the country's biggest lenders under its control.'

This really goes to the heart of the matter, as it is here that one of the greatest dangers lies. The question here is 'lend to whom, under what circumstances?' Aside from the long term risk of political decisions on lending (using the banks money to lend to failing 'key' industries etc.), there are more fundamental questions.

It is not entirely clear from anything that has been announced exactly what the direction of this lending might be. As such, I need to speculate on some examples. Let's start with lending into the individual consumer mortgage market. If this is the direction, then the lending will be directed at a market where the security for the loan is declining in value. In this situation, unless there is a considerable deposit required, the banks will be lending into a very high risk market. If it is consumer credit, then it is an attempt to prop up the service sector, and in doing so prolong the credit driven economy. Furthermore, if this is the intention, it is again lending into an increasingly risky market, as unemployment is now increasing very quickly, and that will mean ever more consumer debt defaults. If the lending is to businesses, once again, the risks are very significant, as the economy is entering into recession and that means an increase in commercial failures. Finally, if it aimed at inter-bank lending, it should not be forgotten that the reason for banks lending to one another is because the banks are worried that other banks are insolvent. The scale of these problems have already been revealed in the nationalisations.

Now the key question. Will this new lending be used in any significant way to build new productive assets, such as new manufacturing plants, or investment in new technologies and equipment for manufacturers? In other words, will the money be lent into wealth creation investments, or will it be used as a continuation of the debt money-go-round? Why is it that I suspect that very small percentages will be used for real wealth creation?

In short, banks are not lending not only because of hoarding of capital, but also due to the fact that there are very high risks in most forms of lending at this time. In other words, the government will be forcing the banks into behaviour which will, in the long term, just create more problems. I may be wrong about the lending into real wealth creation, but I do not think that this will be the case. The underlying idea in these nationalisations is to restore 'confidence', and by confidence the government really means to prop up the service based economy with new lines of credit.

The government is talking about re-privatisation in about five years time, and suggesting that the nationalisations will not cost the taxpayer money in the long term. The idea that the government will be able to gain any return on the investment, in light of what I have discussed, is very remote indeed. Instead, as the finance of the nationalised banks continue to decline in parallel with the economy, the government will find itself having to provide more and more capital injections to keep the banks afloat. This will be never ending, as the risky lending that is the condition of the nationalisation will just produce ever more toxic debt.

As if this were not bad enough, these nationalisations are creating a massive distortion in the banking market. In a recent article, Barclays (not one of the nationalised banks) has suggested that the nationalised banks will be hobbled by state intervention. This could not be more wrong. There is a precedent for what happens when there is an implicit state guarantee for a financial institution, and that is the example of Fannie Mae and Freddie Mac. The result of the implicit state guarantee meant that these institutions could raise money more cheaply than rivals, leading to their domination of the US mortgage market. This in turn left only high risk lending markets, untouched by the two mortgage giants (except that they bought into the risk through the 'backdoor'), for their rivals and is one of the explanations for the growth in sub-prime. In the case of bank nationalisation, the guarantee is not just implicit, but is explicit. What kind of distortions will emerge from this?

If both individuals and companies see the nationalised banks as a safer bet, it may well be that there will be a shift in deposits to these institutions, creating a chain reaction of crisis in institution that might otherwise have been healthy. It is possible to speculate that the Barclays spin on the crisis is designed to forestall such a reaction.

All of this is to leave aside the sorry history of nationalisations in general. I need not detail the long history of how nationalised industries end up as bloated corporate welfare institutions. Whilst there have been a smattering of successes, the majority of nationalised industries turn into long term drains on government finances. With the appalling state of the nationalised banks, combined with government use of the nationalised banks to achieve broader national economic aims, what chance do these banks have of ever achieving commercial success?

The most worrying aspect of this is that the idea is now spreading around the Western world. Euro zone countries and possibly the US (in a modified form?) are using the UK solution as a template for their own 'rescues' of the financial system. The idea that the rest of the Western world is following a solution like this is very disturbing. Yet again, it is a continuation of the delusions that have been driving the economic policies of the governments in the Western world. Yet again, more debt, more borrowing from the rest of the world, is seen as a solution. The idea that this is anything more than an attempt to reflate the debt based economy is the great delusion. However, the governments will point to the rise in stock markets as evidence of the success of their plans. Such a positive swing in sentiment will only be a pause, as economic reality will once again intrude on such misplaced optimism.

For regular readers, my analysis of this situation may come as no surprise. It is just a continuation of my argument is that the only real solution to the current crisis is long term structural reform that promotes real wealth creation for the economy. However, I have analysed the current crisis from a different perspective, which faces the reality of the changes that have taken place in the world economy, and this is why my analysis differs. Furthermore, I have posted many times suggesting that the US and UK economies are actually structurally bankrupt. These nationalisations have seen the government of the UK take on ever more liabilities, and this will stretch an already dangerous financial position ever faster towards the breaking point.

Perhaps the most shocking part of all of this is that the nationalisations seem to have very broad based support. The only explanation for this is an ongoing desire to stick our heads in the sand, and hope that the underlying economic problems will just to away. As I put in the title, just a continuation of the ongoing delusions.....

Note 1: I have had a comment from 'LordSidcup' (name from the Jeeves novels, I believe) asking a question as follows:

What better alternatives can YOU suggest that Gordon Brown should do in the short to medium term

My answer to this is simple. There is no short term solution. I once made a comparison with governments and King Canute trying to turn back the tides (Canute knew he could not actually do this). If I might stretch the analogy a little, this is like trying to build a wall of sand on the beach to turn back the tide. Just as King Canute knew that the tide could not be turned back, so do I. This is not 'defeatism' but recognition of the reality. Some number of posts ago, I made the comparison with a household on the threshold of bankruptcy, and how tempting it was to put off finally facing the reality with a last big loan. It is not changing the real problems that they have to face, that they do not make enough money to cover their debts and expenditure, and that they really just need to accept their real financial position. The new loan will just prolong the pain that bit longer, and leave them with ever greater problems.

I have proposed some solutions which will take a few years to really impact the system in any significant way, some of which can be found in the links at the top of the page. For the short term, there are some fast 'hits' that can be made, which may be able to help government finances. A long time ago, I started reviewing the comprehensive spending review, but only managed 1 of the 2 posts before events distracted me. One of the purposes was to look at where tax money actually goes, and to identify the most obvious areas of waste to be culled. However, in light of my not having done this, I can only suggest a look through the 'Taxpayers Alliance' website, which looks closely at waste. However, I must emphasise that these savings will do nothing to 'save' the economy in the short term, but are a good start for hastening recovery in the medium term.

The simple answer is that, one way or another, there is nothing that can turn back the tide, and governments should be concentrating on how they will manage a recovery and a return to the business of real wealth creation. I note that there was accusatory 'YOU' in the post, suggesting that it is easy to sit on the sidelines and criticise. I hope that, if you read my solutions, you will see that it is not for the lack of imagination that I offer no solution. I am not offering any soltuions because of an acceptance of the reality of the situation. The reality is -

Wealth is made - not borrowed money or something imagined into existence.

Keep this in mind, and the walls of sand being built on the beaches will be seen for what they are.