The MT Diary

Broughton in for the long haul; Pandit's road to recovery; Merv shops on bond street.

by Howard Davies
Last Updated: 31 Aug 2010

It's not much fun running any sort of business in a galloping recession, but in the past year managing airlines has been a special challenge. The carriers had barely digested the implications of the 2008 oil-price spike when premium passenger demand fell off a cliff marked 'Lehman Brothers' on the map.

One of the first things other firms do to reduce cost is to cut back on travel, or at least downgrade anyone who doesn't use the corporate jet. Your diarist has not helped a lot. My carbon footprint has been a tiptoe in the past month, with just one short hop to Zurich to inspect the gnomes.

In the circumstances, it was kind, and indeed brave, of BA's chairman, Martin Broughton, to come in to talk to our students - only a few of whom turn left when they get on the plane. They were suitably grateful and impressed that he was still prepared to venture out and tell his story in public. In 20 years' time - if the world's favourite airline can hang on that long - LSE graduates will populate the Club Class cabin, I'm sure. Who says our captains of industry are excessively focused on short-term returns?

For the same reason, our graduates may also have accounts at Citibank - if there is such a thing as a bank account in 2029. Vikram Pandit dropped in to give a speech and to meet his new recruits - a surprisingly large group.

Although the CEO might be excused a narrow focus on corporate survival, Pandit had interesting things to say about public policy and financial markets. He speaks economics, which endeared him to the boys and girls here, and reflected on how credit will be provided to sustain a recovery whenever it turns up.

Will the banking system be able to supply enough to sustain a global growth rate of 5%, as we have enjoyed for the past decade? It seems unlikely, however much governments recapitalise the system. Regulators are bound to require more capital in the long run, and to constrain leverage. Collapses have also taken some capacity out, capacity that is unlikely to return quickly.

So, unfashionable though it may seem to say so, we may need to think about ways of reopening the securitisation markets. Pandit argues for some kind of government insurance scheme, as it is unlikely that the monolines will return to the field of play. They have an indeterminate sentence in the sin-bin. Just at the moment, I suspect governments do not have the appetite for the idea, but he is right to raise the flag.

The big market news of the month has, of course, been the Bank of England's decision to go shopping for gilts, on an epic scale. Mervyn King is set to become a veritable Victoria Beckham of the credit markets, lugging home cartloads of bonds on a daily basis. Never mind the colour, size or tenor, the Old Lady will take them in.

Opinion on quantitative easing has been divided. Most people think it will work, in a technical sense, and that the money supply will be increased, with consequences for liquidity and spending to follow. The controversy surrounds the eventual implications for inflation.

Will the authorities reverse direction after a while and mop up the excess spending power when the job of restarting the economy is done, cutting spending and raising taxes? Or will the Government be pleased to see a return to double-digit inflation, as a way of reducing the real value of the huge debt burden it will build up in the recession? Market sceptics are plumping for option B, which has a horrible plausibility about it. It has been done before, of course.

But do they take full account of the institutional changes since our last major downturn? The Bank of England now glories in its independence, operating within an inflation target set by the Government. Will the Bank sit by and allow inflation to soar above the range? Would King (or his successor) be happy to write letter after letter, month after month, explaining why the target was being ignored and exceeded? Alternatively, would the Government announce a new, higher target range, to make an honest woman of the Governor?

In certain circumstances it might, I suppose. But for inflation to fool the markets and impose a haircut on government debt, it needs to be unanticipated. If you tell the world that prices will be allowed to rise, the markets will react in advance, and gilts will be ever harder to sell.

So I tend to the view that a return to high inflation is not the most likely outcome. But the concomitant is that I expect an anaemic recovery, as the Bank will be obliged to raise rates and the Government to mop up liquidity, as soon as the green shoots emerge.

Are there any yet to be seen? Not really, though the falling pound has been good for universities recruiting foreign students, and it has filled our stores with tourists brandishing euros and dollars. If you shop in central London, assistants now speak slowly and clearly to you, on the reasonable assumption that if you have money to spend, you aren't a local. 'No Sales, Please, We're British' is the way it goes.

French youths struggle down Regent Street laden with bags from chez Hamleys, or Le Top-shop. There's massive movement of consumer goods from W1 to Gare du Nord. Even their hapless rugby team took 34 English points home from Twickenham, bless them.

Howard Davies is the director of the London School of Economics.

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