Gordon Brown will almost certainly be the next prime minister. Unfortunately, we know next to nothing about what he has in store for us. If his track record is any guide, we should be worried, says James Ferguson
Gordon Brown is the self-styled prudent' chancellor. He likes us to think of him as cautious, rational and wise. But the fact is that outside of Labour's inner quorum, few people have any idea what the chancellor is really like, or what he plans for the country. Frankly, Brown's vision seems to always have been to make prime minister. That alone has been the goal which he now looks set to achieve.
So what can we expect from Brown the prime minister? So far, it's all very vague. In a recent speech, he promised a "new kind of politics". The challenge facing the government was to "create a strong society" to go with Britain's "strong economy". I'm not sure I know what this means but I'm equally unsure that Brown can take the country with him on any such journey.
He has little time for consensus building and sees himself as experienced, intelligent and generally superior to those around him, let alone the nation at large. These are hardly leadership qualities and Simon Jenkins, writing in The Times, agrees. Brown "has been a man ill at ease with himself who has neither the executive or presentational skills to be a well-rounded leader of a diverse nation".
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Regardless, it seems we are set to have him foisted upon us so perhaps the best way to get a better picture of Brown the prime minister is to look at his track record in the Treasury. As we are about to see, the picture painted is not a pretty one.
Brown's greatest triumph?
Things started very promisingly with Brown's first act to make the Bank of England independent and grant the Monetary Policy Committee (MPC) freedom to set interest rates as it saw fit. The press loved it and in many respects Brown has been living off the positive fallout ever since.
But, as always with Brown, there was small print. The MPC's decision wasn't entirely free they had to keep inflation within a narrow band. Fair enough, you might think. But as soon as inflation got too high and interest-rate rises threatened, the chancellor arbitrarily switched the measure used from the Retail Price Index (today at 4.5%), which had got us through 50 years without a hitch, to the much lower Consumer Price Index (now at 2.8%).
Meanwhile, the Office of National Statistics (ONS) has allowed itself to be bullied into using all sorts of tricks to deliberately lower the reported rate of inflation. There's hedonics', where if a product is assumed to be better quality (like a computer having more memory) then its price rise is actually recorded as a price drop. Worse is substitution', where an increase in the price of chicken is ignored if beef prices stay flat, because households are assumed to have substituted beef for chicken. Yet even with these efforts, CPI is now way above the Bank's 2% target.
Is there any difference between a political chancellor setting rates so low that while they stimulate consumption, they also let inflation into the system; and a so-called independent MPC which is instructed to slavishly follow a measure of inflation that is itself manipulated by their political masters until exactly the same thing happens? Very little, I'd say. But such cynical manipulation was always going to end in tears. Now inflation is out of the bag. The numbers we see are underestimates, yet even so, in the past whenever RPI was at current levels (blue line on the chart above) UK base rates were usually nearer 8% (red line), not 5.5% as they are today. Not only that but whenever rates have been behind the inflationary curve like this, it has inevitably led to a vicious circle of faster price rises and catch-up rates as we're starting to see.
"Chancellor mugs pensioner"
However, Brown's most damaging decision was his tax raid on dividends going into private pension schemes. This foolhardy decision made, we now know, in the full knowledge of the damage it would wreak seems to reflect a cynical belief in the intellectual inferiority of others. Why else destroy a pension system that was the envy of Europe, and for so little gain (maybe 1% of total annual tax revenue) unless you honestly thought no one would notice? "Pensions are complicated, boring and a long way off," Brown must have thought, "so no one will care." The humiliating thing is that for quite a few years, he was right.
Less well known is his responsibility for the pensions regulator's mis-handling of pensions funding rules. This ill-thought-out rule change has been nearly as disastrous as the tax raid. The regulator was told to judge a pension fund as underfunded if too many of its assets were in equities (an asset class long known to outperform bonds on any medium to long-term time-frame). This forced the pensions industry to sell equity holdings and buy government bonds en masse.
By early 2006, buying by pension funds had pushed long-dated gilt yields to 50-year lows of below 4% for most maturities. With yields now well above 5% these have proved painfully loss-making trades (as yields rise, bond prices fall). With inflation threatening, it is feasible that those yields will be the lowest available for years to come. Meanwhile, equities have risen across the board, while many of the companies whose shares the pension funds were forced to sell, have been taken over at lavish premiums. Many FTSE 100 companies' shares still yield more than gilts do. But can pension funds switch back? No not unless they are fully funded through their bond holdings.
The truth behind Brown's miracle
As his manipulation of inflation data and downplaying of the pensions scandal shows, Brown's economic record has relied on spin as much as his leader's ever has. Even the Daily Mail recently referred to "a decade of steady economic growth, thanks to Gordon Brown's mostly shrewd management". Yet an OECD report shows UK growth averaged 2.7% between 1997 and 2006. Sure, it's higher than the 2.1% eurozone average, but below that of any other English-speaking country. Much domestic growth and job creation was paid for with taxes, boosting the size of the state sector. This confounded conservative forecasters, who were looking at the more stagnant private sector.
But the real driver of Brown's economic miracle' is the rise of global trade and the longest US economic boom in living memory something he can hardly take credit for. Tony Blair reckons Brown "has steered our economy from one of boom and bust to one of the best in the world". But it's much more likely that the boom is merely an extended one and the next bust will prove that. Already business leaders are worried. "We worry about inflation, interest rates and government spending," said Sir Martin Sorrell, head of WPP. "We'll have to pay the price sometime," he told Liam Halligan in The Sunday Telegraph.
The Ernst & Young Item Club reckons Britain now faces "inevitable" tax rises. That's a sobering thought, given that Tax Freedom Day which calculates when the typical person stops working to pay their taxes and starts earning money for themselves has already crept forward five days to 1 June under Brown's tenure. Theoretically, tax revenue as a proportion of GDP should fall when times are good and the government surplus should rise as the country saves for a rainy day. But in fact, public sector net debt as a percentage of GDP is now 37.4% and has risen steadily for the past five years. Brown has squandered the benefits of an extended up-cycle by adding to, rather than paying off debt.
The man behind the property bubble
Unfortunately, the rest of the nation has followed his example. Household debt is now in excess of £1,300bn, compared with financial assets of £660bn at the end of 2005. The chancellor has been as guilty as anyone of downplaying this imbalance and claiming that house prices adequately close the gap but then Brown has always been happy to encourage the illusion of wealth creation through house-price growth. His manipulation of inflation data kept the MPC from raising rates. The Treasury also misrepresented the extent of the affordability problem by using the interest-only mortgage rate, rather than the repayment burden, in their arguments. Lastly, by savaging pensions and discouraging savings and investment, he forced households to bet all their finances on bricks and mortar.
Yes, this boosted consumption, indirectly through the wealth effect (you feel richer when your house price inflates) and directly through mortgage equity withdrawal (borrowing money against that inflated value), but at what cost? The average first-time buyer is now in their mid-30s, rather than mid-20s. A generation of debt-laden graduates and young professionals have either been forced off the property ladder or have had to forego other savings, like pensions and insurance, to get on. Worse, home ownership now requires mortgages of five, six, even seven times gross incomes. If there is a crash and I believe one is now inevitable a whole generation will be repaying mortgage debts for most of their working lives.
So as consumers have piled all their money into property, where has Brown been pouring all our taxes? Largely into the bottomless pit that is the NHS. Spending on the NHS has basically doubled in real terms. And for what? It's still riddled with bad management, poor practice, a culture of inefficiency and now poor hygiene has crept into the mix. Sure, waiting times have dropped and as long as you don't have an accident requiring a local A&E, the service genuinely seems better than ten years ago just. But what a small gain for such a huge amount of money. And now Brown says he wants to target both schools and the NHS equally. After ten years of throwing money unrewardingly at the NHS and at the expense of education, it'll be interesting to see what he comes up with that's new.
Brown's one good decision
On one front, I'll concede Brown made the right decision Britain never joined the euro on his watch. As the architecture around the euro crumbles and bets are placed on which country will leave the currency first, his determination not to get steamrollered into joining will be seen as a blessing. At least if inflation gets out of control, we have the option of tackling it, rather than remaining at the mercy of the European Central Bank.
But other than this, has Brown been a prudent chancellor, responsible for a decade of stable prosperity? Not really. The truth is that much of the prosperity was bought for today at tomorrow's expense and the rest wasn't down to Brown at all. What should he have done? He shouldn't have taken the good times for granted and should have been working down government debt to levels that would allow the Treasury to finance social services and fiscal stimulation in any downturn ahead. He should have urged households to make the most of the good times by building on the best pensions system in Europe and by encouraging savings and investment in wealth-generating assets.
Instead, he helped destroy final-salary pension schemes and was a cheerleader for the biggest rise in household debts we have ever seen. We have what looks like a massive property bubble, which will cause years of hardship when it bursts. Worst of all, the spin which he insists is Tony Blair's legacy has embedded itself in the Treasury and even the inflation statistics, allowing rate-setting policy to get behind the game.
The best-case scenario may now be for rates to rise swiftly to 6% or even 7% (but the MPC will fear that would blow up the housing bubble). The worst case scenario is that the MPC abrogates responsibility and waits. Either way, history will judge Brown a reckless squanderer of a golden age. Long before that, however, the electorate will get to judge him. There will only be one agenda at the next election: "It's the economy, stupid."
How to Brown-proof your portfolio
If you had to sum up in just one word the overall legacy that Gordon Brown the chancellor leaves for Gordon Brown the prime minister to inherit, that word would be debt'. "This is a nation that is seeking to live beyond its means at every level," says The Guardian's Larry Elliott. The trouble is, as James points out above, it looks like Mr Brown's chickens are coming home to roost. The era of low interest rates and inflation that has facilitated the house price boom, which in turn has sent consumer spending (and debt) spiralling, is ending UK interest rates are at their highest in six years, while inflation is at levels not seen in 15 years. None of this is good news for consumers, whose embrace of both property and shopping under New Labour has seen the UK population build a debt pile of more than £1.3trn.
So in terms of your investments, one of the best ways to Brown-proof your portfolio is to avoid stocks heavily exposed to a consumer downturn; retailers are particularly vulnerable if household spending dries up. Pawnbrokers should also continue to do good business bankruptcies keep rising, with 30,075 people becoming insolvent in the first quarter of this year. Albemarle & Bond (ABM) trades on a forward p/e of 20.5 and yields 2%, while smaller peer H&T Group (HAT) looks good value. It trades on a forward p/e of 16.2, and yields 1.4% but has a p/e to growth ratio of just 0.2.
Rising interest rates will be bad news for the property market. Recent housing data hinted that the market may be starting to slow; if you have buy-to-let property, now looks a good time to take any profits you've made. Meanwhile, rising inflation is traditionally good for one of MoneyWeek's favourite assets gold. Of course, Brown's other big legacy is tax, and you can be sure that whoever succeeds him as chancellor will try to find new ways to pick our pockets. Merryn Somerset Webb recently found 29 ways where you could avoid paying too much tax. But among the simplest are: make full use of your annual Isa allowance (£7,000, rising to £7,200 from next April); and ensure you have an up-to-date will so that you at least have an idea of how likely you are to have problems with inheritance tax.
James Ferguson qualified with an MA (Hons) in economics from Edinburgh University in 1985. For the last 21 years he has had a high-powered career in institutional stock broking, specialising in equities, working for Nomura, Robert Fleming, SBC Warburg, Dresdner Kleinwort Wasserstein and Mitsubishi Securities.
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