Time to Save, Not to Spend ?

The more I think about how Governments are responding to the recession, the more worried I become. The "Neo-Keynesian" response of the British, American, German and other major western Governments is based around the view that public money supporting the banks and increased public spending will maintain economic activity, keep people in jobs and re-ignite consumer confidence.

Backed by falling interest rates, the consumers will start spending and the economy will recover while large publicly-funded capital projects will keep industries such as construction and other parts of the manufacturing base going until the economy, as a whole, recovers.

The trouble is, not only is there plenty of historical evidence that this kind of large-scale spending doesn't work, the consequence of this spending or "qualitative easing" or the printing of more notes by central banks is resurgent inflation and interest rates down the line coupled by the need to service vast levels of Government debt keeping taxes high and credit difficult.

In addition, we got into this mess by building up a consumption and spending-based asset bubble and the solution merely perpetuates this. We keep spending because that's how we keep the economy going.

The problem is, the cure ends up being worse than the disease.

Let's start with where all this started - the banks. Banks need deposits as their main means of capitalisation and they also need, if successful, to be bringing and keeping more in than they let out in lending. It was irresponsible and reckless lending that got the banks into trouble in the first place and it was reckless consumer borrowing based on the mistaken perception of a perpetually-expanding property asset price bubble that unbalanced the whole economy.

The LAST thing we need is to re-start the cycle of borrowing, spending and consumption. The LAST thing we need is to build up more debt, both public and private. Cutting interest rates as a mechanism is a way to stimulate activity but it cannot become a mechanism for renewed inadequate debt management.

The real losers from falling interest rates are savers. Savings are now attracting rates very near zero so what's the point of saving, many will ask ? Better to spend the money.

That's a one-way ticket to disaster as banks need deposits to be maintained and strengthened. Far from being disincentivised, savers need to be actively and a savings culture needs to be re-created. There was a time when people regularly put away up to 10% of their income for the proverbial "rainy day" but the economic culture of the last 15 years, with low inflation and low interest rates and rising property prices, has been very different. There has been a huge shift from saving to spending predicated on the belief that rising property values will build up the capital and savings "pot". No point saving at 2% per year if the house is appreciating by 10%.

That's all over.

We need to re-incentivize savers and savings. One suggestion has been to abolish all tax on interest payments. This has a lot going for it and I would suggest to Vince Cable that this is a far more constructive and popular Liberal Democrat policy than wild talk about tax cuts. Removing tax on interest payments would boost returns on savings by anything from a quarter to a half and would mean individuals not having to look around for £3,600 to invest in a tax free ISA. Essentially ALL savings would be ISAs.

I believe this would do a lot to re-create a culture of saving and would be of more long-term significance than tax cuts.