John Redwood

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READING EVENING POST

  We are paying a high price for careless economic management over the last six years. The large increase in taxing, spending and borrowing by the government is having an impact. So is Gordon Brown’s decision to switch inflation targets before the last election, moving from the Retail Price Index which everyone uses, to the Consumer Price Index which just happened to be going up less quickly.

  The result is we are paying much more interest on our borrowings than people in the Euro zone, in Japan, and  in Switzerland, and we are facing much higher inflation than all our main competitors. We have to accept that we will need to live with higher interest rates for longer, and we may have to put up with further interest rate rises.

  This is made worse by the general position of too much borrowing worldwide. We have just lived through an amazing ten years of very easy money throughout the world. There has been money available practically everywhere for everything. Interest rates have been incredibly low in Japan and Euroland, and were very low in the USA.

  The world now has a debt mountain, built up by clever  bankers and market traders on the back of the easy money. We see the first signs of stress from too much debt in the so-called sub prime mortgage market in the USA.

  Mortgage banks in the US lent more and more money to people to buy homes paying less and less attention to their ability to repay or to meet the interest payments when interest rates rose. Now rates have risen more of those borrowers are having to admit they cannot afford what they have taken on.

   Meanwhile, the mortgage banks had often sold the mortgages  on to other market players. These purchasers of poor quality mortgages themselves borrowed to buy the mortgages. Then other financial professionals  borrowed to buy the funds that had bought the mortgages!
   Now some of  the people with mortgages cannot pay the interest on their borrowings, it undermines not just the mortgage market but the big markets in financial funds as well. The whole system of mortgage holding funds, and funds holding funds, depends on each original mortgage holder paying the interest. That interest pays the interest on all the rest of the debts taken out by the people who have bought up the mortgages, and bought the funds owning the mortgages.

  Some think this is just a US problem, and just a mortgage market problem. Similar things have happened on this side of the Atlantic, and similar pyramids of credit have been built up around company borrowing and investment, as well as around mortgages. The main central Banks, the Fed, the Bank of England and the ECB, have a difficult call to make. If they carry on pushing interest rates up, they will undermine more of these debt structures, destroying a lot of wealth. If they do not keep rates high enough for long enough they will not squeeze inflation out.

  The UK is in one of the worst positions, as we have 4.4% inflation as measured by the retail Price Index, compared with the old Bank of England target of 2.5%. The Bank should avoid  overdoing the squeeze just because the present figures are poor, in view of  the precarious credit structure. The best way for the government to relieve the inflationary pressure would be to spend less in the public sector, and get better value for what it is spending.