Home truths

While US Treasury Secretary Tim Geithner chose a visit to London to declare that there is a very strong chance of the world in general, and the US in particular, coming out of recession in the coming months, I have been reminded during a short visit to the US of the serious dilemmas facing the developed world.

As in the UK, the policies introduced to deal with the economic crisis, vital as they may have been, could well hold back the recovery as governments running up massive debts struggle to pay for the largesse of the past year or so.

Cutting government spending throws more people out of work and removes the biggest stimulus that the developed economies have at the moment. But raising taxes instead can drive away the tax payers, as Alistair Darling was warned forcefully when he introduced a 50% income tax rate.

The US tourist industry is up in arms over past and proposed plans to raise taxes on tourists. Since taxes can be set by cities and states, some places are getting a double whammy.

The recovery of the US dollar against the pound has made the US more expensive for Brits to visit (though the effect is admittedly much less severe for Europeans given the continued strength of the euro).

New York, a popular destination, is horrendously expensive. With taxes and with everyone in hotels, restaurants, tourist buses and taxies expecting bribes (or tips as they are quaintly referred to) you find yourself paying up to 25% on top of published prices. Raising taxes further will start to push US cities off the tourist map as visitors realise that the prices they expect to pay are deceptively low.

It is possible to tax people to the point where they stop paying. Higher taxes on tobacco have drastically reduced smoking. The high fuel taxes that have helped to push petrol and diesel ever higher have curbed motoring and threatened the livelihood of haulage firms. In addition, people go elsewhere if they can – crossing the channel for booze and fags or filling up lorries abroad where possible – and the one group that really can go elsewhere are tourists.

Now the cries of woe in the US tourist industry are admittedly coming from vested interest, as are those uttered in the UK from airlines protesting over the raising of passenger tax.

However, seriously damaging a whole industry is no way to go about rebuilding any economy.

Am I missing something? Part 1
Tips, often demanded with a heavy dose of moral blackmail, are the most visible reminder that the bonus culture is deeply embedded in many societies. You agree a price, yet you are expected to pay more on top for someone just doing their job.

Incidentally, I rounded up a fairly small taxi fare in Washington to the nearest dollar, whereupon the taxi driver insisted on giving me the coins, stating bluntly that either I tipped him a dollar or nothing. He got nothing.

On a somewhat larger scale, Goldman Sachs, a bank that had to be bailed out by the US government, is already back to dishing out bonuses. I do not baulk at the fact that the bank has made profits out of recession. Someone always does.

What gets up my nose is that Goldman continued to pay bonuses last year when it made a loss and is now paying out bonuses well in excess of the profits it is making. This is surely a recipe for another economic crisis.

Am I missing something? Part 2
At long last the consumer price index has fallen below the 2% target rate, finally arriving at 1.8%. The retail price index, which includes housing, now stands at minus 1.6%. Yet I still cannot accept the argument that we face a period of deflation.

The RPI is heavily distorted by the dramatic slashing of interest rates. As these reductions work their way out of the equation, RPI will rise sharply. Indeed, as one reader emailed me to point out while I was away, it is possible to argue that RPI has risen over recent months and that the year-on-year fall is based on figures recorded in the second half of last year.

The CPI has stubbornly refused to fall as rapidly as it rose to its peak of 5.2% last year. With petrol back above £1 a litre and with food in particular failing to drop back after last year’s surge, the threats are surely from inflation rather than deflation.

The decision of the Bank of England to cling on to the last £25 billion earmarked for quantitative easing implies that the possibility of inflation is in the minds of its policy makers. If sterling falls again on concerns over the state of government finances, inflationary pressures will mount. In any event, the rally in sterling that has ameliorated the rise in imported prices seems to have run its course.

So why are many economists still touting the notion that we are facing deflation?