In previous pieces I have compared the current global political and economic situation to the 1930s, suggesting that neither economically nor politically is the current position so dire, but that there are important similarities. However a much closer comparison is to the 1970s – not to the U.S. 1970s, a relatively benign comparison that has frequently been made, but to the British 1970s, in which economic difficulties that were shocking in their unpleasantness combined with a dawning appreciation of the country’s enfeebled geo-political position. The institutions such as the merchant banks, the legal system, the bicameral Parliament and the benignly stratified society that had created British greatness still existed, but they no longer seemed effective in the new cruel world. In short: as a Brit who has become an American, I have seen this movie before.
The parallels to the British 1970s are disquieting. In that case a massive surge in money supply following the 1971 freeing of interest rates led to a huge real estate bubble and the collapse of innumerable “secondary banks” lending to the property sector. Even the mighty National Westminster Bank got in trouble, and the two entrepreneurial leaders in British finance, Jim Slater of Slater Walker and Oliver Jessel of Jessel Securities, were forced out of business. Meanwhile on the public finance side, moderately irresponsible governments under Harold Wilson (1964-70) and Edward Heath (1970-74) were followed by the hugely irresponsible and leftist second Harold Wilson government (1974-76) which ran the budget deficit up to 10% of GDP in the year to April 1976. Politically, the parallels with the current U.S. position are also striking; the Heath government came to office on a platform of public sector retrenchment, which it proceeded to abandon within two years, while Wilson’s second government was notable for its attempts to create state control of the British automobile and motorcycle industries.
There were also differences. Inflation in Britain peaked at 25% in 1975; so far we have not seen anything approaching this in the United States. (The Keynesian theory that inflation cannot happen while the economy is operating well below capacity is disproved by the British experience of the 1970s, as well as by many other examples including the early Weimar Republic.) Partly because of this, the British housing market suffered only a moderate downturn in the 1970s; by 1977 consumer prices had risen so far, with incomes reasonably close to following them, that nominal house prices that had appeared grossly excessive in 1973 had become much more affordable.
Conversely, the 1974-75 recession saw only a modest rise in UK unemployment, to around 6% compared with the current U.S. level of over 9%. The major rise in UK unemployment came with the overvalued pound and industrial shake-out of the early 1980s.
Thus the two crises are not precisely parallel. The British crash caused major inflation but relatively minor unemployment (initially) while the current U.S. recession has had a most unpleasant effect on employment, almost similar to the early 1980s in Britain, but has so far produced only limited inflation.
More interesting than their precise trajectories is the effect both crises had on their countries’ position in the world, both actual and perceived. The British trajectory of the 1970s and the aftermath is now well known, and shines an interesting light on possible developments for the United States today.
British power had already been declining for about a century before the 1970s. The Empire had been lost, with the last major holdings being given independence under Harold Macmillan in the early 1960s. The major British international investments had been liquidated in the Second World War, mostly at fire sale prices, and three decades of exchange controls had made many British companies insular and old-fashioned, unable to face a newly competitive world market.
Nevertheless, in 1970 the country retained certain strengths, economic and strategic. The City of London was almost entirely British-owned, and the merchant banks remained collectively the most important innovators in international finance, having devised the Eurobond market in the preceding decade. While the U.S. investment banks were an increasingly important force, they remained by capital smaller than the largest merchant banks, although their excessive leverage gave them larger balance sheets overall. In any case, most innovation remained concentrated among medium-sized houses, with the large U.K. clearing banks and their U.S. and Continental equivalents adopting innovations only after the markets for them had been established.
British innovation remained competitive on a world scale in many industries, although here there had already been some retreat since the heady days of the 1950s, when the De Havilland Comet had seemed likely to dominate the world jet aircraft market, for example. Nevertheless British pure science was still world-class and in terms of Nobel prizes the country was still a world leader. My college’s old brag “Trinity College, Cambridge has more Nobel Prizes than France” was still true back then.
The 1970s changed all that. British salaries and research budgets, in both academia and industry, became pathetically globally uncompetitive, resulting in the draining of the pool of available talent, and the country’s drop to the second or even third tier in scientific and technological innovation. The merchant banks and the rest of the financial sector were devastated by the combination of high inflation and punitive taxation, which wrecked their capital bases in comparison with their increasingly aggressive overseas rivals. (Worst affected were the jobbers (specialist market-makers), which were forbidden by Stock Exchange rules from incorporating, and so were taxed at insane individual tax rates of up to 98% on their income while their capital, being invested in financial assets, depreciated rapidly in real value.) By 1979 neither British technology nor British finance were truly competitive on the world stage.
Britain was of course immensely lucky from 1979 in that it got the vigorous and reformist Thatcher government. Many of the problems that had bedeviled the British economy for decades, like exchange controls, or for a century, like legally immune trades unions, were swept away by the new broom. In certain respects, the British economy of 1990 was far more competitive than it had been in 1970, while destructive anomalies such as 98% tax rates had been removed. However, when exposed to a “level playing field” the merchant banks proved wholly unable to compete with their now much larger transatlantic and continental cousins. The British technological capability of 1970 also proved to have been destroyed by the 1970s and by the grinding deflationary recession of 1980-82, and has never really recovered.
Internationally, Britain had not entirely been self-deluding when in 1970 it sought to play an independent geo-political role at the world’s top table. In the 1980s, Thatcher managed to retain Britain’s top-tier role by sheer force of personality, but in the event the Falklands invasion of 1982 proved an anomaly, and after Thatcher went in 1990 Britain became enmeshed in the petty squabbles of the EU bureaucracy and was no longer a major world player, or even an independent one.
Many of the problems that afflicted Britain in the 1970s affect the United States today. U.S. financial markets are increasingly losing pre-eminence to the major capital markets of Asia, with the Asian timezone leading the world in capital raising for new companies. The Government Accountability Office report released last week demonstrating that over the 2006-10 period Wall Street’s six largest bank proprietary trading desks lost money was a truly devastating commentary on how few clothes the Wall Street emperor actually has. Since the stock market was about flat over the same period (but paid fairly substantial dividends) it showed that the finest brains of Wall Street, with the best inside information on deal flows in the world and almost infinite capital at their disposal, could not quite manage to beat an index fund.
Similarly U.S. innovation, for the last century the world’s finest, is increasingly being lost to Asia. David Ricardo’s 1817 “comparative advantage” doctrine, that outsourcing low-skill operations to cheaper labor markets would maximize welfare all round, fails to consider the possibility that the cheap labor markets, by participating in the outsourced activity, could clamber up the value chain and eat the outsourcer’s breakfast. That appears to have happened in software with India, in solar panels with China and doubtless in other sectors we will discover in the years ahead. Meanwhile U.S. innovation is mostly confined to trivia like “social media,” in essence largely a mechanism for transferring consumers’ personal data into the hands of the Russian mafia. (It is interesting in this context that the Russians, apparently devastated by losing the Cold War, have not lost their supreme capability for general menace and bad-guy behavior, but merely privatized it.)
Geopolitically, the British decline of the 1970s may be paralleled by the U.S. experience today. Naturally, being a much larger and more powerful country, the U.S. is unlikely to undergo a castration experience similar to that of joining the EU. Nevertheless, its old pre-eminence has disappeared, and it is arguable whether to the average African, Asian or even Latin American experiencing the thrust of Chinese economic and political activity, the U.S. is today even primus inter pares. China has become a superpower, according to a recent Pew Foundation global survey; the question is whether the U.S. can remain one.
To get out of its current tailspin, it is increasingly apparent that the U.S. needs a Margaret Thatcher, preferably without her 19th century Whig fantasies of level playing fields. Looking at the potential Presidential field for 2012, it is hard to see one.
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(The Bear’s Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that the proportion of “sell” recommendations put out by Wall Street houses remains far below that of “buy” recommendations. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)