NO WAY TO CURE THE HANGOVER

Christopher Fildes diagnoses a bad case

of debt, and says that the medicine prescribed is making matters worse

FIRST the binge, then the hangover, now the medicine — we have had too much of them all. It is as if the Prince Regent, when drawn by Gillray as a voluptuary in the hor- rors of digestion, had overdosed on Alka- Seltzer.

Around the British economy, the doctors cluster. The newish general practitioner tries to look confident. Recovery is on the way, he says, preparing a placebo to be labelled as a tonic. He has been saying this at intervals for some time. His predecessor, Doctor Major, used to explain that if it wasn't hurting, it wasn't working. Now he more cautiously says that there is a lot of it about.

The specialists dis- agree with them both, and with each other. Professor Walters says that when he was thrown out of the sickroom, all was well, so it must now be the doctors' fault. John Smith, the reassur- ing Scot supplied by cen- tral soap-opera casting to succeed Doctors Fin- lay and Cameron, says that the patient needs building up, which is true, but not much help. In her starched uniform, an old lady from the Shouldering our way past them, let us approach the bedside. Well, now, what seems to be the trouble? Aha, it is as we thought: debt.

:There is nothing (we doctors say) wrong with debt — not in itself. It contributes to a balanced diet. Taken in moderation, it can be a stimulant. Taken to excess, it gives a sensation of walking on air — but, like other stimulants, it has depressive conse- quences, ranging from severe headaches to debilitation and death. Never forget that at all stages of the cycle, its effects are cumu- lative.

Let us now riffle back through the case notes. Ah, yes, here is the patient four years ago, apparently robust, certainly buoyant, almost hyperactive. The medical man then in charge chose that year to give a fiscal injection of £4 billion, for which he has been much blamed. The stimulus that mattered, though, came not from tax but from debt, where £4 billion would scarcely account for a month's usage.

The habit was well established. The doc- tors became worried by some of the symp- toms, and tried the high interest rate treatment, in increasing strength. The patient seemed not to respond, and instead reached for more debt to keep going. The doctors issued repeat prescriptions. The reaction, when it came, was intense, and they cannot claim to have foreseen it They played their part in making it worse.

The turning point came two years ago. Debt was still piling up, inflation was rising, John Major as Chancellor was sticking to the 15 per cent base rates he inherited. From the financial markets came the signs of change. Property values cracked, house prices ceased to defy the law of gravity, and the banks ran into a rash of failures and bad debts.

The chairman of Barclays shook .)his head. Too many new businesses had failed to put down roots (he said, that summer) and now they had withered. His losses were worrying — big enough to suggest a sharp economic downturn, but we didn't want to talk ourselves into a recession, did we? In the months that followed, the banks' busi- ness, and business generally, fell off a cliff.

Until the last, the Treasury still forecast that there would be no recession. When it had plainly arrived, the Chancellor (by now Norman Lamont) was allowed to speculate that it would prove short and shallow. The Bank of England, by contrast, hoped that it would be short and sharp. That, said senior Bank men, was just what was needed — a cold-water cure for inflation. Was it better to go into recession with the bank, on pur- pose, or with the Trea- sury, by accident?

Professor Tim Cong- don diagnoses that the Treasury gets these things wrong because it does not pay enough attention to money. Its forecasters' most elaborate model of the economy can only be as good as the assumptions they build into it. On those assumptions they were not much worried (when the Bank was petrified) by the credit boom, and not worried enough when it burst. The Profes- sor would say that they are not worried enough even now.

The recession which fooled them was unfamiliar. Recessions used to start on the Tyne and work downwards. By the time they had reached the prosperous home counties, the worst would be over. This recession began in the home counties, in the service industries, in financial business- es and in new businesses. What they had in common was a dependence on debt.

Debt is the clue to this recession, and the best pointer to what happened all last year and what is happening now. Big companies had for much of the 1980s been able to finance their growth out of their (much improved) earnings. Small companies, and new ones most of all, financed themselves on bank debt. As the decade ended, com- panies started to overspend their income. The interest bills mounted up. Last year more than a third of the average company's takings went to pay the bank. Some found their debt running faster than they could. They were caught in the trap of compound interest, and few escaped.

Those that could ran for cash and cover. Companies put off their regular purchases, ran down their stock and staff, and took as long as they could about paying their bills. An odious type of back-office manager would sit on the invoices sent to his comp- any, and give excuses to its trading part- ners, instead of cheques. The normal flows of money began to dry up.

Big companies turned to the stock mar- ket to raise billions. Small companies had nowhere to turn. They were living on bor- rowed time and borrowed assets — their cars and equipment on lease, their bank loans secured on the directors' houses. They too often went to the wall, and the houses went for auction.

Running for cover was harder for people than it was for companies, but no less urgent. Nigel Lawson in his last week as Chancellor said that the British people had temporarily forgotten the habit of saving. It would have been truer to say that they had formed new habits of borrowing. Plastic credit made a convenient scapegoat, but five-sixths of personal borrowing is on mortgage. Borrowers chased house prices higher, and then borrowed more, until by the end of the decade the British people, for the first time ever, owed more cash than they held. Then the house price bub- ble burst. Houses are the biggest item in our personal wealth, which, after inflation, has shrunk by 14 per cent in two years. Vanishing wealth and high debts are a lethal combination. Let us hope that we never find out how many house-owners are, at this moment, insolvent. The average first-time buyer who came in at the top on an average-sized mortgage must be under water. If he can stay put and keep up the payments, he will make it to dry land, but he and his building society must both hold their breath. What he will not do now is splash out.

By this time, he is part of the lenders' problem. Even now, that is not understood.

Next month the Big Four banks will, for the second year running, struggle to show profits. The big five general insurance com- panies will come out even worse, with loss- es of more than £1 billion between them. Most of that money has been lost on insur- ing mortgages. Town & Country, the build- ing society which tried to insure itself, has had to be bundled away, and no one believes that it will be the last.

Leasing companies find that their clients, their income and their assets have all left the premises. Foreign banks which lent in London have retired hurt. Lloyd's must face unheard-of losses and radical change.

These are all financial middlemen, and we can be glad that most of them came into the cold spell with wool on their backs. (In the mid-1970s they froze to death in dozens.) Even so, a weakened financial sys- tem is a doubtful foundation for a strong recovery.

It was not, in the circumstances, clever of ministers to haul in the banks and the building societies and tell them to stop being beastly to their poor little customers. By now, though, the lenders' diminished capacity to lend has been matched by their customers' lack of scope or enthusiasm for borrowing. One way and another, there is not much money about. Monetarists (like Tim Congdon) argue that not much money means not much recovery.

Ministers, though, preferred to put their monetary policy out to contract in Europe.

The exchange rate, they were told on all sides, was the best indicator, and a stable pound would mean a stable policy. Stable, that is, not against such currencies as the yen or the dollar, but against the puissant peseta and the truly European mark.

'Great heavens! A dessert island!' Their simpler supporters believed in the golden scenario — joining the exchange rate mechanism would make sterling strong, so interest rates and mortgage rates and inflation could come down, in time to win the election. Their loftier supporters none loftier than Lord Rees-Mogg, the Sage of Hinton Blewitt — looked to far horizons. Outside the ERM, so the Sage taught us, there was no salvation.

So we joined, and the Sage at once said that we had gone in at too high an exchange rate. Now he tells us that the decision to join, both when we did it and how we did it, was wrong. Would we be better off if the exchange rate was low- ered? Ministers have glanced towards that exit, but it will not take them where they want to go — which is to cheaper money.

Their trouble is that the Germans are making the weather, and not to suit us but to suit them. Who expected them to do anything else? The two economies, though, are at opposite ends of their cycles. Dear- money policies to curb German inflation at the end of a long boom are not tailored for the British economy in a recession brought on by dear money and debt.

Norman Lamont is left to play Grand- mother's Footsteps with the Germans. He took his chances last year, getting interest

rates down 31/2 per cent in the mark's

moments of weakness, and in time more chances will follow. Just now, though, he is stuck with real interest rates (that is, aim- ing off for inflation) of 6 per cent, which would be high enough in good times, and in these times are worse than pointless.

He can console himself with the thought that other economies have had even gross- er binges on debt, and fouller hangovers.

He can envy the Americans, now treating theirs with the lowest interest rates for a quarter of a century. He can try treating ours with tax cuts, the economic equivalent of stroking the cat to make the dog feel better. Or he could brood on the Duke of Wellington's helpful advice: Sir, you are in a deuced awkward predicament, and you must get yourself out of it as best you can.

He is there because the doctors mistook this recession's cause and its cure. They did

not reckon with the cumulative power of

debt, first to stimulate and then to depress. They let things go too far, both ways. They kept on the dear-money treatment, at first because they were slow to see it at work, then because their new European medicine left them little choice. So the treatment became part of the trouble.

In the end, recessions cure themselves. Companies cannot run down their stocks for ever, new buyers find affordable hous- es, baby needs a new pair of shoes. One sign of the end is a flurry of business fail- ures. Companies which survived the reces- sion but used up their capital start to expand, over-trade, and go under. A doctor determined to look on the bright side could point to such symptoms now, but he would do better not to say so.