February 20, 2013

Finest Hour 156, Autumn 2012

Page 42

Market Impacts: Financial  Aspects of the Special Relationship

By Irwin Stelzer

2024 International Churchill Conference

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Dr. Stelzer is an American economist living in London and Washington, D.C. He is U.S. economic and business columnist for The Sunday Times, and Director of Economic Policy Studies at the Hudson Institute, as well as a contributing editor at The Weekly Standard. He is a consultant on market strategy, pricing and regulatory issues for United States and United Kingdom industries.

28th International Churchill Conference, London, England October 2011

I have been asked to discuss the impact on markets and the economy of the Anglo-American relationship, no easy chore.

Fortunately, I have been allotted only twenty minutes, so I can use imposed brevity as an excuse for superficiality.

Let me open with a warning: You have thus far been treated to reports by persons who can claim to have been at the events on which they are commenting; and by distinguished historians who have spent lifetimes analysing the life and times of Winston Churchill, mostly from a British point of view. I can make no such claim: I am here only because the planners of this event seem to have decided that an American economist might provide a nice balance to the real experts on this program; provide a piñata for those more familiar than I with the historical sources residing in the marvellous Churchill Archives Centre at Cambridge, in which my wife spent so many happy and productive hours; and offer living proof that any special relationship that exists can be preserved only if the British overlook our educational failings, sentimental biases, and horrible accents. I refuse to be intimidated. So here goes.

This relationship has been neither uniformly productive nor consistently congenial. I won’t start with the British funding of the American railroad system: there was nothing special about that, since restless British capital funded a good part of many nations’ infrastructures.

Start instead with the man who made the phrase “Special Relationship” famous, Winston Spencer Churchill, and American cooperation with him in his early foray into economic policy.

The assurances of the United States were important to then-Chancellor of the Exchequer Winston Churchill when he decided in 1925 to return Britain to the Gold Standard, a decision John Kenneth Galbraith, writing in 1975, called “perhaps the most decisively damaging action involving money in modern times,” John Maynard Keynes called “a silly thing,” and Churchill himself later called his greatest mistake.2 (See “Churchillnomics” articles in Finest Hour 154. —Ed.)

Whether Churchill would have gone forward with this move without U.S. support we do not know. He did after all have the backing of virtually Britain’s entire financial class, and did see the move as part of an effort to recreate the world he cherished as it existed before the Great War. “No responsible authority has advocated any other policy,” the Chancellor said, I assume meaning that Keynes, who had tried to talk him out of the move, was neither responsible, nor an authority—a position newly fashionable in some ill-advised circles in my country.

Prime Minister Stanley Baldwin, writing to King George V, was unstinting in his praise of Churchill’s budget speech:3

He soared into emotional flights of rhetoric in which he has few equals; and throughout the speech he showed that he is not only possessed of consummate ability as a parliamentarian, but also the versatility of an actor.

Perhaps “unstinting” is the wrong word, for Mr. Baldwin added:

In the case of such a masterly performance criticism would seem to be superfluous and almost unfair…but perhaps it might be said that the speech would have been even more effective if Mr. Churchill had been able to limit its length…. The Opposition… tend to be more impressed with quiet sincerity than impassioned declamation.

Churchill told the House that he was comforted by the fact that the Federal Reserve Bank of New York had pledged $200 million to support the return to gold at $4.87 an ounce, and J.P. Morgan another $100 million.4 We also know that Churchill had discreetly accumulated $166 million to cover payments due that year on loans from the U.S., a creditor that wanted to be repaid—a fact apparently forgotten two decades later when poor John Maynard Keynes was dispatched to negotiate a postwar gift or generous loan from an ungenerous America.

So this early example of the Special Relationship in the area of finance was indeed productive: It helped to produce the Great Depression! The pound was overvalued by some 10%, putting downward pressure on wages, especially in the inefficient coal industry, producing the General Strike in 1926. Along with bursting the stock market bubble in the United States, and some rather misbegotten American fiscal, monetary and trade policies, it set the stage for the rise of dictatorships in Europe.

I exaggerate—but not by a lot. The resulting conflagration was precursor to “Destroyers for Bases”— the next episode in the financial relationship between our countries, on 2 September 1940.

Since this was a barter transaction, and I can figure out neither the value of fifty old destroyers nor ninety- nine-year land rights at no rent in various British possessions, I must rely on Churchill’s private secretary. Jock Colville estimated that this deal was so one-sided in favor of the United States that it com- pared with the relation of the Soviet Union to Finland.

That might be unduly harsh because, in addition to receiving the mothballed vessels, Churchill established the principle of American involvement as an arms supplier to Britain—of America becoming the eventual “Arsenal of Democracy,” as President Roosevelt described it in a 1940 radio address.

We move on now to the consequential and often fraught relations between our countries during and after World War II, so thoroughly and wonderfully chronicled by Robert Skidelsky,5 and therefore needing no repeating here.

My country generously lent money to Britain when it could not be certain it would be repaid, then advanced a loan on terms that many took to be onerous, but that Keynes argued “represented not an assertion of American power but a reasonable com- promise between the two great nations with the same goal: to restore a liberal world economy.”6

Our countries’ next transaction was the Marshall Plan, which directed $2.7 billion to Britain to help finance its dollar deficits in 1948-51. It was “like a lifeline to sinking men” said Ernie Bevin7—”the most generous act in history,” according to Churchill. Enough said.

Let me skip ahead to more recent times, and the financial crisis following the collapse of Lehman Brothers in 2008. Then-Treasury Secretary Hank Paulson was desperately trying to put together a private-sector deal to save Lehman. He had spoken with Bob Diamond and John Varley at Barclays, and been told that they were interested in buying Lehman if certain troubled assets could be excluded from the deal.

Paulson persuaded a group of Wall Street firms to put together a consortium to do just that, and went to bed “modestly optimistic about our chances of saving Lehman.”8 The Special Financial Relationship between America and Britain, one that permitted deals to get done over the telephone because of a fund of mutual trust and because years of doing deals together, could be drawn on.

But Paulson had not reckoned with the language differences between our two countries. British under- statement that allows a downpour to be called “a spot of rain” had misled him. “I had not caught the true meaning when [Alistair Darling] expressed concern about a British bank buying Lehman. What I had taken as understandable caution should have been taken as a clear warning.”

In the event, with a deal clearly in sight, Paulson was told that the Financial Services Authority—a quasi-judicial body responsible for the regulation of the financial services industry in the UK—had declined to approve the deal, and that only the Chancellor of the Exchequer could waive the listing requirements that were troubling the FSA. Which, despite the willingness of U.S. banks to put $30 billion into the deal, the Chancellor declined to do “without a hint of apology in his voice….He offered no specifics….We would get no help from the British….”9 It was hardly proof that a Special Relationship extended at that moment to fraught financial transactions.

It is interesting to compare Paulson’s description of what he clearly believed was less than direct dealing by the British authorities with Gordon Brown’s cryptic, self-exculpating description: “By late Sunday, September 14, it was clear that both the Bank of America and Barclays were pulling out of any rescue operation.”10 There was no hint here that Barclays was forced out of the deal by Gordon Brown’s Chancellor of the Exchequer, or any sense of responsibility for the subsequent fallout.

Which brings us to today, when the interests of America and Britain coincide. Both need the Eurozone to take the steps everyone knows are required to calm markets: bank recapitalization, conversion of a monetary union into a transfer union, German—oops, EU—supervision of individual countries’ fiscal policy. So Treasury Secretary Tim Geithner and Chancellor of the Exchequer George Osborne are one voice urging the Eurozone to take the necessary steps.

But since neither America nor Great Britain is a member of the Eurozone, not even calls from President Obama and preachings from Prime Minister Cameron had much effect. It took a massive political push by Chancellor Merkel to get a bailout plan in place—the details of which are still being developed.

What does all of this mean, as we wonder whether any Special Relationship that might exist— which it is now fashionable to deny—extends to financial matters? We live in a time in which my President declined to retain a bust of Winston Churchill in the Oval Office, and your Prime Minister pulled troops out of Basra, enormously increasing the burden borne by the U.S. in Iraq; a time in which my President decided to help you in the Libyan adventure by “leading from behind,” and in which your Prime Minister decided to ignore American pleas not to cut so violently into Britain’s military capability. There’s more, but you get the idea: We don’t always get along!

But I would argue that when it comes to financial relationships we more or less do get along. Despite some lapses, several of which I have detailed herein:
• America joins Britain in the battle to keep trade free and open.
• Both our countries reflect similar (and in my view mistaken) values by continuing to fund aid programmes despite the fact that both our countries are running unsustainable deficits of around 10% of their Gross Domestic Products.
• America and Britain are alike in urging the powers-that-be in the Eurozone to fix their banks, and impose on them capital requirements sufficient to ensure their viability.
• Both of our countries are resisting the attempts of the European Union to impose undue restrictions on trading in securities.
• French politicians are correct in accusing both of our countries—the Anglo-Saxons—of believing in properly regulated markets, rather than in massive state intervention, although the expansion of government under the present administration in my country, and the interventionist policies of at least one arm of the coalition government in yours must be winning approval in Paris.

All of which is rather “special,” but less important when it comes to economic policy than the intellectual interaction of our countries’ great economists. Three of your greatest economists provided the pillars on which our microeconomic and macroeconomic policies rest:
• Adam Smith gave us a nuanced moral and economic basis for free markets and free trade, for the idea that competition policy is the key to allowing consumers to benefit from the self-interested search for profits, and for the notion that taxes should be limited to those needed to support the vital functions of government, and collected without need for a huge bureaucracy. Those precepts remain the basis for our microeconomic policies, despite some lapses.
• Walter Bagehot provided lessons in monetary policy that still guide our Federal Reserve chairmen. In a crisis, it is the role of central banks to provide liquidity in the amounts necessary to support the financial system. Better that than bailouts. That remains the key ingredient of our monetary policy, although Bagehot’s call for appropriate charges is not always heeded.
• John Maynard Keynes added some wisdom about fiscal policy, and his strictures still dominate macroeconomic policymaking, overtly in the case of what we call liberals, less overtly in the case of con- servatives who feel they must deny Keynes while at the same time voting for tax policies that increase deficits during recessions. The administration and several leading American Nobel laureates insist that the path out of our present difficulties has been mapped out in their dog-eared copies of The General Theory of Employment, Interest and Money. They view austerity as a path to another recession, or worse, citing the malign effects of the programs imposed on Greece and other Eurozone supplicants. They are joined by the Shadow Chancellor of the Exchequer
in urging new programs of demand stimulation, or at least a halt in spending cuts and deleveraging until our economies are strengthened.

I think it fair to say that John Maynard Keynes’s impact on American economic policy in the post- World War II era has been every bit as great as was his sometime friend Winston Churchill’s impact on American foreign and military policy during the war. And probably more enduring. (See “H.W. Arndt, “The Wizard and the Pragmatist: Keynes and Churchill, FH 153:20-25.)

The influence of Smith, Bagehot and Keynes has been reciprocated; Americans have contributed to thinking in Britain. Milton Friedman and others are drawn on by British policymakers who argue with some force that Keynes had it wrong—that government efforts to manage demand are doomed to failure, that monetary rather than fiscal policy should be the politicians’ first port of call, and—most important—that personal freedom is inextricably linked with free markets.

We provided a home for the great Joseph Schumpeter as he developed his theories on the role of entrepreneurs and the creative destruction they wreak in creating dynamic, innovative economies, a vision that British politicians are desperately seeking to make flesh. And we added to the knowledge in both our countries of techniques for quantifying and testing economic theories, for considering what real people do under real conditions, and how their expectations affect policy initiatives.

This is not the place to resolve the dispute between Keynes and his critics, if in fact it can ever be resolved, and I am certainly not competent to do so. Indeed, since Keynes was extraordinarily practical, and willing to change his mind when the facts changed, I can’t help wondering what he might have recommended in a period in which weak economic activity coincides with outsize and unsustainable budget deficits. Would he have said, “Damn the deficits, full speed ahead, run those printing presses,” which is the position of some of his acolytes? I wonder.

There you have it—the ramblings of an economist so conflicted that he admires Keynes and many of his critics, who believes that in the financial sphere at least our countries do have a Special Relationship, often fraught, and often wrongheaded.

Doubt that and do this thought experiment: From all the countries in the world, pick any one that is more closely in tune with Britain or America when it comes to the structure of our economies and the goal of economic policy than we are with each other. Putin’s Russia? China’s centrally controlled economy? France, with its aversion to markets? Argentina, with its embrace of inflation? Japan, with its refusal to get its banking system in order? Greece and Italy with their rigid labor markets?

Our countries might disagree on some issues, even important ones. We might go through periods of strain, but we remain shoulder-to-shoulder in support of market capitalism, regulated so as to pre- serve vigorous private sectors while restraining their excesses, and confident that in the future we will continue to have a special relationship that allows us to sharpen our economic-policy tools.

End Notes

1. John Kenneth Galbraith, Money: Whence It Came, Where It Went (London: Andre Deutsch, 1975), 168.
2. Roy Jenkins, Churchill: A Biography (Basingstoke: Macmillan, 2001), 401.
3. Martin Gilbert, Winston S. Churchill, Companion Volume V, Part 1, Documents, The Exchequer Years, 1922-1929 (London: Heinemann, 1979), 472-73. The speech lasted two hours and forty minutes. See Gilbert, Winston S. Chruchill, vol. V, The Prophet of Truth 1922-1929 (London: Heinemann, 1976), 116.
4. Galbraith, 165.
5. Robert Skidelsky, John Maynard Keynes: Fighting for Britain, vol. 3, 1937-1946 (London: Macmillan, 2000).
6. Ibid., 445.
7. Quoted by Niall Ferguson in The New Yorker, 27 August 2007.
8. Hank Paulson, On the Brink (London: Headline Publishing Group, 2010), 208.
9. Ibid.
10. Gordon Brown, Beyond the Crash: Overcoming the First Crisis of Globalisation (London: Simon & Schuster, 2010), 39.