Thursday, April 23, 2009

2009 Budget Madness....

I have a curious streak of optimism that somehow the economic policy insanity will be ended. At some point, I keep thinking, the politicians will 'get it', then knuckle down and face the reality of of the task that confronts them. In my foolish optimism I held out some hope that the budget might see some kind of return to sanity. Instead, what we have is a work of complete fantasy, and a work that will plunge the UK ever deeper into an economic hole.

The part that is most shocking about the budget is the fantasy projections for the future of the economy, and many commentators have already seized upon this. For example, Liam Halligan of the Telegraph has the following to say:

One reason is that Darling’s has made some extremely rosy assumptions about future UK growth. While he admitted our economy will contract by 3.5pc this year, the Chancellor foresees a return to growth of 1.25pc in 2010, with the economy booming once more soon after, expanding by 3.25pc in 2011.

These estimates are pie-in-the-sky. Most economists think the UK will contract next year too. And I know not a single forecaster outside the Treasury betting on growth above 3pc the year after.

Even the optimist in chief amongst the economics columnists, Anatole Kaletsky, had the following to say:

Just as the Treasury, along with the IMF and the OECD and all the other supposedly expert institutions, have revised their forecasts out of all recognition in the space of just four or five months, the numbers published in yesterday’s Budget will be overtaken by events in the next few months.

Quite simply, nobody in their right mind will see the Darling figures for growth in the UK economy as anything but fantasy. The reality at the moment is that the UK has a long way to go before it reaches bottom. We have only gone through the initial stages of the economic crisis, and there is much more bad news to come.

For example, there is the forthcoming meltdown in commercial property, which will send the banking system into a new tailspin. This from the Telegraph this April:

Meanwhile restructuring experts have warned that the quarterly rent bill could be the tipping point that would force a significant number of retailers into administration. Malcolm Cohen, a partner at BDO Stoy Hayward said: "Retailers are already struggling for survival and have been further impacted by consumers reining in on their discretionary spending

This is just the retail sector, but there is likely to be a similar continuing decline in the broader commercial property market as the economy contracts. The bottom line here is that, with consumer spending contracting, the retail sectors absolutely must continue to contract. Meanwhile, despite some optimism in the residential housing market, the trend is still predicted to be downwards for a long time yet.

Another element in the ongoing banking crisis will be continually climbing numbers of defaults on consumer debt and mortgages. Even whilst consumers are paying back debt, due to concerns about the state of the economy and unemployment rising at 2000 people per day, there must be ongoing losses at all the major financial institutions, though figures for this are very hard to come by. A good indication of the problems are the ongoing problems being confronted by building societies, exemplified by the dire state of Dunfermline Building Society (which also made significant losses on commercial property). Meanwhile, consumer confidence remains very low indeed.....

Added to this gloomy picture, there is the massive decline in manufacturing output. The Times had this to say:

Manufacturing output tumbled in the past quarter, with 53 per cent more companies cutting their output than increasing - the lowest level since 1975.

Exports, which have performed more strongly in recent months as the pound has weakened, declined more rapidly in the last quarter than businesses had hoped, with a balance of -39 per cent which is far below the expected -27 per cent and the weakest figure since October 1998.

Companies expect export orders to fall again next quarter, but at a more moderate pace.

The same report also highlighted a continued trend of laying off workers. Inevitably, UK GDP is falling at an astounding pace:

Economists were expecting GDP to have contracted by 1.5pc in the final quarter of last year – in line with the preliminary estimate – but the Office of National Statistics had to revise the figure downwards to 1.6pc.

It is the biggest quarterly fall in GDP since 1980 and the biggest annual fall since the last recession in 1991.

The contraction was aggravated by a sharp revision of the fall in construction output from 1.1pc to 4.9pc in the last quarter, falling consumer spend and businesses cutting back their inventories.

It should be remembered in considering GDP that it measures activity, not actual creation of wealth. As such, large percentages of the activity will be funded through government borrowing, meaning that activity now will have to be paid for by a decline in activity at some future point in time.

Under these circumstances, with just about every sector of the economy reporting bad news, the idea that a genuine recovery will start next year is just pure fantasy. Even the IMF forecast for the UK stands as a sharp contradiction of Darling's forecast, with a 0.4% contraction next year. Within this context, the borrowing forecast being offered by Alastair Darling is pure fantasy, but is nevertheless still alarming. With an ongoing contraction of the economy, the need for greater than forecast borrowing is a foregone conclusion. As the forecast stands, borrowing is predicted to rise as follows:

According to projections in the Budget, public sector net debt, the accumulated stock of outstanding Government borrowing, will reach £1,370 billion in 2013/14.

It should be remembered that, in addition to this, there are many liabilities that are buried. For example, Private Finance Initiatives are not included, but significantly adds to the government's real level of debt. Added to this are the unfunded pension liabilities for the public sector which are believed to be double the official estimate at £1 trillion +, and the underlying problem that the first of the baby boomer generation are now retiring. This will mean less workers are going to be available to fund government activity, whilst healthcare and pension costs are set to soar:

Such high national debt is not without consequences: it leads to more expensive interest payments while the flood of new British gilts into the bond market will crowd out investment that might otherwise have gone into the private sector. Meanwhile, Britain's ageing population heralds a mass of new pension contributions, further obligations to public funds that the government probably does not want to think about right now.

Under such circumstances it is no wonder that many commentators are now questioning whether the government will be able to continue to fund such extravagant borrowing. For example, and article in the Wall Street Journal is pointing out the significant risks in the UK fiscal position, with concerns about quantitative easing (printing money) and the massive expansion in debt:

But a big expansion in quantitative easing -- already huge at 5% of GDP -- carries risks. It stores up trouble for the future, increasing bank sector reserves that will eventually need to be mopped up before they trigger an inflationary surge while adding to the BOE's stock of gilts that will one day need to be sold.

More importantly, it would fuel suspicions the BOE is simply monetizing the government's debt, further undermining the U.K.'s credibility -- and potentially precipitating the BOE's nightmare scenario.

That leaves the BOE in an invidious position. Its own credibility is all that stands between the U.K. and a full-blown financial crisis. Yet thanks to the government's refusal to spell out a credible plan to reduce government borrowing, the BOE finds itself at the mercy of foreign investors, who by the end of last year held 35% of gilts.

It wouldn't take much -- a further collapse in the public finances, another bank bailout or signs of a surge in inflation -- to undermine sterling and prompt the showdown the BOE fears.

The government could yet be forced to deliver a proper budget before the year is out.

The possibilities of a gilt strike, a refusal of markets to continue funding UK government debt is becoming an ever greater possibility. The risk of sovereign rating downgrade is looming, and there have been ongoing problems at gilt auctions - even before the budget:

The scale of the Treasury's borrowing plans -- and continued fears about the UK's ability to recover from the slump and repay its debts -- have raised the prospect that investors may simply refuse to buy all the bonds the Government issues.

The Treasury was last month hit by an "uncovered auction" when investors refused to buy all the gilts ministers wanted to sell.

Also, even before the budget, the £GB has been under pressure, and this can only serve to raise anxiety about the massive issuance of gilts:

There is evidence to support the view that sterling may have moved to a permanently lower level, reflecting a preference shift away from what the UK does best, namely financial services. But the results suggest that around 60pc, of sterling's decline since mid-2007 can be accounted for by a rise in the risk premium associated with holding sterling.

In plain English, overseas investors fear that the UK may no longer be capable of delivering the stability that it was once thought to have enshrined. And given the extent of the government's borrowing, they see a significant risk of inflation ahead. And who can blame them, sterling has form.

From the FT, we have the following:

On Wednesday, for example, the cost of protecting five-year gilts was 95 basis points – meaning it costs £95,000 a year to insure £10m of bonds – up from 18 basis points last summer (albeit down from a peak earlier this year).

But if that is embarrassing enough, the cost of insuring the chocolate giant Cadbury was on Wednesday far lower, around 50bp. A company that peddles chocolate coins, in other words, is currently deemed a better credit bet than the British Treasury itself.

Perhaps the most worrying aspect in all of this is that the markets are still paying attention to GDP as if it were a meaningful figure. As such, they measure the state of the government's debt and the ability to repay are based upon GDP figures. As I have often emphasised in this blog, GDP figures are a fantasy, as they measure activity which includes activity resultant from increase in debt. As such, with the government borrowing soaring, and massively indebted consumers and businesses, current and past GDP figures have been massively inflated by activity resultant from debt. As such, all of the analysts (I assume) are measuring the ratio of debt against a measure which massively inflates the perception of the UK's ability to repay the debt.

I have not covered the details of the budget and have emphasised the big picture of the overall fiscal position. I will not go into the details of the budget, which are quite simply tragi-comedic. However, as an example, I have already pointed out the absurdity of the car scrappage scheme in a previous post. To this we can add the 'green' measures, such as a massive investment in useless wind farms (I have detailed why they are useless in a previous post). As Britain falls ever deeper into a black hole, precious resource is being diverted into schemes which simply can not be afforded. Or there are supposedly going to be measures to trim areas of public spending, about the IFS has the following to say:
“The Government has announced that nearly £6bn of extra efficiency savings will be delivered by the public sector in 2010–11. A large proportion of these savings will be delivered by just two departments: Health and Children, Schools and Families, who have announced new efficiency savings of £2.3bn and £0.7bn respectively – equivalent to 2.2% and 1.3% of their current budgets. As a proportion of their current budgets the biggest savings come from Transport at 3.0% and the Home Office at 2.9%. Local Government and Defence have also identified large efficiency savings, of £0.6bn and £0.45bn respectively, but the Treasury has labelled these as ‘recyclable savings’ –meaning that these departments will not actually have their resources
budgets cut by this amount in 2010–11.”
In fact, as the budget is taken to pieces, it is increasingly being derided from every quarter. Above all else, the commentary on the budget appears to focused not on the details, but on the sheer scale of the profligacy of the government, and how it might be able to finance its massive spending plans. The revised figures for the economy detailed in the budget appear to have created a profound sense of shock to the commentariat, and the reality of how bad the situation is has now begun to sink in.

I have erroneously made a prediction of a run on the £GB, the timescale for which expired recently. Having made the error once, I will not once again put a timescale on such an event. However, this budget, the shocking nature of the soaring debt and plunging revenues, must surely mean that the possibility of a gilt strike and run on the £GB have moved that much closer. Even the most moderate of the commentators are now assuming that, at the very least, the cost of servicing government debt will rise. I had the following to say back in November of 2007, at a time when the crisis had not emerged into the full light of day:
All the while this is happening the government will fall into crisis. With a falling pound, an economy collapsing around them, and an already overstretched borrowing position, they will be faced with ever more expensive borrowing, meaning higher interest rates, or massive cuts in public expenditure. There will be no room to manoeuvre. The only solution will be to cut back on expenditure. Continuing to borrow will be too expensive, and would destroy the value of the pound, as well as creating an even deeper crisis of credibility that the UK government can manage the economy.
As I look at the 2009 budget, the one thing I do not see is the real cutting of expenditure. At the time of writing I could not imagine that the UK could reach this position and still continue to borrow and spend in the way that they are doing. That a government could be so irresponsible was beyond my imagination.

In writing this blog, I have always tried to view the actions of the politicians in a positive light, at least as far as their intentions are concerned. I have seen them as fools, but fools with the right intentions. As I look at the budget and the forecasts provided by Darling, I struggle to maintain such a positive view. I simply can not believe that Darling (and Brown) believes his own forecasts.

If this is the case, and he does not believe his forecast, the only conclusion that can be drawn from this budget is that it is a horribly misguided attempt to create a pre-election bounce in the economy. It is a budget aimed at keeping Labour in power, and is being undertaken at massive risk to the economy in the short, medium and long term.

Quite simply, it looks like the government is willing to risk the entire UK economy in a mad gamble for an electoral advantage. If so, then it is a disgrace.

Note 1: A very lively debate on the last post. As ever, the comments were intelligent and considered, and are one of the most successful aspects of the blog. I increasingly see the comments section as one of the best parts of this blog, and would guess that it is at least as much of a draw for visitors to the blog as the original posts.

Note 2: I would sincerely like to know who might be buying gilts at the moment. If anyone has any information on this, please post a comment or link. The usual source for this information is the DMO, but they will not publish on the current quarter for a long while yet. Are there any other sources that are available now? Thanks in advance for help on this.


  1. I just found this editorial in the Telegraph:

    'The crisis that confronts this country is on a scale almost unprecedented outside wartime. Only those who lived through the Great Depression have faced grimmer economic times.'

    It reminded me of something I wrote a long while ago. This is what I said in 2007 (A Funny View of Wealth - link at top of the blog):

    'It will, in effect, be the most significant crisis to hit the UK since the World War II. The only way out of the crisis will be to alter the fundamentals of the UK economy back to producing more goods and services for export led growth, and away from debt based growth in services. It will be a long, and very painful adjustment that will see the UK lose its place as one of the worlds’ leading economies, and recovery from the crisis will take many years.'

    (the quote is from the conclusion)

  2. After a hiatus in the visible bad news, I get a sense now that the mainstream media is going to 'uncover' the gore fest which is the reality of the UK economy.

    In contrast to those of us fortunate enough to discover this blog, I think the speed of descent will be an enormous shock to most.

    What with a pending credit rating downgrade and a vast borrowing requirement, swift & massive economic humiliation looms large for the UK.

  3. Do you still think that the longer they maintain the illusion, the bigger the eventual mess?

  4. Darling read out the second longest suicide note in history (the first being the 1983 Labour Party manifesto)and made it clear, as this blog has noted, that his brief was to get Labour re-elected at all costs.

    But it looks like George Osborne will be doing the next budget and if anybody thinks that that is the answer, then they clearly haven't understood the question.

  5. A quick update on the post. The Times reports the following:

    'The economy contracted by 1.9 per cent in the first three months of the year, at the fastest rate since 1979, when Margaret Thatcher came to power, as the country sank further into recession, official figures showed this morning.

    The dramatic fall in GDP, the total value of all goods and services produced by a country, is far higher than the 1.6 per cent contraction predicted by Alistair Darling in the Budget.'

    I would like to emphasise that this contraction is taking place whilst ever more printed money is being pumped into the economy, and as the government borrows ever larger amounts of money.

    At what point will these failing policies be halted?

  6. Sorry, the link to the article above:

  7. Hi Cynicus

    There will be more coverage of Gilts on Alphaville in the coming months as they think this is a very hot story:

    Death to Bubble Addicts

  8. This budget is a full-blown disaster. Looking at the figures it is clear that the deficit will much more likely be around 15% this year with no improvement the following year, which means that unless taxes or raised or budget cuts implemented Britain will in all likelyhood lose the confidence of the bond market.
    There is also no future improvement in sight for fundamental reasons discussed on this blog.
    Whoever comes in next has the unenviable task of scaling the deficit down to a more sustainable level. A gap of around 150 billion will have to be closed.
    Default or massive social unrest seem the only two options left.
    Should the IMF have to step in it will face a daunting task considering the size of the deficit.
    A country rich in reserves may seize this opportunity and buy itself favourable policy.

    If I knew where and how I would bet on a default. This budget is a disgrace to anyone who cares about Britain.

  9. I read the reports of the budget with utter amazement at its stupidity. It ramped up debt for years to come and threw hundreds of millions of pounds away left right and centre at anything that looked vaguely fashionable, but with no coherent strategy (not even one I could disagree with!) and no meaningful chance of any return on investment.

  10. Firstly, thanks for an extremely interesting blog. For several years I have argued with friends that the world economy is based on creating, for the most part useless tat and selling it down through the supply chain for the consumer to buy. This consumption has enabled us to live longer and eat better aided by technology, doctors and farmers. Unfortunately the population is increasing, but what happens as natural resources start to run out? Will the slide be gradual as people loose their jobs shifting tat around, or will it reach a tipping point ending in civil unrest? Remember we have 60 million plus people in this country at the most we could feed 30 million as agriculture revets to a pre WW11 non chemical version, what of the other 30 million?

  11. I enjoy your blogs on economics. Are they better informed than your post on GW? I am a little concerned now that I am reading material driven by a subtle conspiracy based mindset and tot real "free" thinking? I hope not.


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