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Sunday 8 November 2009

There is nothing magic about this Keynesian fad

Last week, The Spectator said that ‘Keynesianism is not the answer’. Here, Tim Congdon says the government’s economic recovery strategy is a sham based on outmoded leftist thinking

Mr Brown’s bank recapitalisation exercise has been portrayed in the British media as a financial and political coup. The Financial Times has been particularly enthusiastic, describing it as ‘a global template’. Mr Brown’s admirers apparently believe that the British government’s programme is both intellectually original and a real-world success, and is therefore being copied in other leading nations.

The truth is very different. The government’s policy is not intellectually original, it will not be fully implemented in practice and, to the extent that it is implemented, it will be a disaster. Further, no other country is copying Brown’s plan or behaving as vindictively as Britain towards its financial system.

Admittedly, the Treasury has acted over the last month with a decisiveness that was sadly lacking in the Northern Rock affair. This may explain — although it does not excuse — the widespread readiness to applaud the plan as new and clever. The key elements have been widely reported. They include two types of money-raising, a requirement that banks issue preference shares to which the government would subscribe and a government offer to underwrite new equity issuance by the banks. An open threat was used to enforce the money-raising. If a particular bank did not issue the amount of capital suggested and agree in certain circumstances to sell much of it to the government, the Bank of England would stop lending to that bank and so force its nationalisation.

We live in a world of bounded rationality, in which more than 99 per cent of the population are as unfamiliar with modern corporate finance as they are with quantum mechanics. To news desks and political hacks, the idea of preference capital must have seemed a brilliant wheeze. Banks can remedy their shortage of risk capital not just by issuing ordinary equities, which receive ordinary dividends, but by issuing a special type of security. This security is really a bond, since it carries no votes and is repaid at par, but it is called ‘capital’ and receives preference dividends (i.e., dividends paid before any ordinary dividends are allowed and in that sense are preferred).

More articles from: Tim Congdon | this section

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