Regular readers can now see many of the views I have long been expressing starting to be mirrored in the press - and it does not make happy reading. Despite this, I read the views with a grim satisfaction. It is not the satisfaction of seeing others coming to share my views, but the satisfaction that the first step in fixing the economy is the recognition of the nature and severity of the problem. With the mainstream media finally confronting the reality of the situation it is quite possible that the politicians will have to start to respond with real plans to address the underlying problems.
One example comes from Ambrose Evans-Pritchard in the Telegraph. He is recognising the impossibility of the funding of so many huge government deficits around the world. He points out that many of the previous supporters of Western debt are now turning off the taps, and that the level of debt raising was in any case increasingly impossible. Perhaps the most interesting comment he makes is as follows:
Traders already whisper that some governments are buying their own debt through proxies at bond auctions to keep up illusions – not to be confused with transparent buying by central banks under quantitative easing. This cannot continue for long.I have long suspected that this has been a part of how the debt has continued to be purchased. When I pressed the Bank of England on the subject of quantitative easing, one of the questions I asked was for them to confirm that they would not be using proxies to purchase bonds in debt auctions (they confirmed that they would not). However, the impossibility of funding such massive debt has kept me questioning how the government might be intervening, and I have recently been trying to find sources for who is buying the gilts at the moment (to no avail). If Ambrose is correct, the government is intervening in the auctions, and my guess that the government is using banks effectively under state control to buy the debt may well be correct.
Perhaps the most vocal in the criticism is another Telegraph commentator, Liam Halligan. His latest article is almost a mirror of my posting on the budget. For example, he notes that the budget does not acknowledge the many forms of off-balance sheet borrowing, and also adds that the bank bailouts are not included:
As a final example from the Telegraph, Tracy Corrigan, details the retreat of investors from the UK gilts market:
Remember, also, the hundreds of billions of pounds of off-balance sheet liabilities – not least the bill for public-sector pensions and the utterly dishonest private finance initiative.
For all these reasons, even Darling's outlandish borrowing totals are just the start of the Government's extra debts. Oh – and by the way, much of the cost of the massive bank rescues isn't in these numbers either. The Budget fine print claims officials "haven't yet been able to calculate their impact […] on public sector net debt".
So these borrowing estimates can only rise – as they have after every Labour Budget since 2001. Already, debt service is the fourth biggest item on the Government's balance sheet. Soon we'll be spending more public money on interest payments than on schools and universities combined.
Of course, the elephant in the room in regards to the quantitative easing is that, at some point, the gilts being purchased by the Bank of England must be sold back into the market. This will need to be done at a time when investor confidence is diminishing (or disappeared), and the issuance of new debt by the government is exploding. From the FT, there is a leading article which expresses cautious concern over whether the government can continue to finance debt:
At least the recently introduced policy of quantitative easing, designed to boost the economy, is helping to support gilt prices. But for how long? The scale of the Bank of England's purchase of gilts under this programme – it is buying £75bn and could return for the same again, if it decides the economic case merits it – is having a powerful effect on the market. But that will be, by definition, relatively short-lived, and at some point that spending, too, will have to be financed.
For the moment, the Bank of England's bulk buying is covering up another unpalatable truth. Other investors are not quite so keen to get involved.
Although UK pension funds hold gilts, they aren't buying much at the moment. Overall, UK fund managers were net sellers last year, and the recession causing lower dividend income this year means they will have less new money to invest anyway. Banks have been buyers, partly to meet new requirements to hold liquid assets, but they now largely have what they need.
Willem Buiter likewise expresses concerns in his blog at the FT, although he is broadly positive about the budget:
Which, of course, is the trick. At the moment, the UK government has little trouble finding lenders, but this can stop on short notice. If gilt investors began to doubt its commitment or ability to close the deficit, the market’s willingness to refinance UK sovereign debt could come to a sudden halt. The government must pre-empt perilously self-fulfilling doubts before it is too late.
Retaining market confidence calls for plausibility: this government must shed its reputation for overly optimistic forecasts. It must also try to avoid the need to roll over a large amount of debt at any one time. The plan to complement auctions with organised syndicates of lenders is a good one. So is the substitution of medium-term bonds for the shortest maturities in sovereign debt issuance. Puzzlingly, however, the government has not increased the share of the longest maturities, despite pension fund demand for more such paper.These steps, although sensible, do not guarantee safety. Like its biblical namesake, economic original sin differs from ordinary sins: whether you are guilty of it is largely outside your control. Nonetheless, the UK government’s only hope is to stick to the straight and narrow
If the necessary fiscal tightening is not forthcoming because different groups and vested interests are engaged in a war of attrition aimed at shifting the fiscal burden to the other guy, markets could easily panic and Britain could face an emerging market-style “sudden stop”, with the rest of the world withholding financing from its public and private sectors.One of the interesting points is that the IMF is no longer seen as an option to bail out the UK. Quite simply, the demands of the UK are seen as too great for IMF funding, and the possibility of the IMF being a safety net looks increasingly dubious. As it is, the IMF is already confronting problems in raising cash to fund its operations.....
To forestall the occurrence of a triple crisis (banking, sterling and sovereign debt), it would behove the UK to apply for an IMF Flexible Credit Line (FCL). Unfortunately, the criteria for qualifying for an FCL arrangement include “ . . . (iv) a reserve position that is relatively comfortable . . . ; (v) sound public finances, including a sustainable public debt position; . . . (vii) the absence of bank solvency problems that pose an immediate threat of a systemic banking crisis; (viii) effective financial sector supervision.” It is questionable whether criteria (iv) and (v) are met. Criteria (vii) and (viii) are obviously not met. In addition, with a £175bn annual borrowing requirement for the next couple of years, the measly $240bn or so the IMF currently has at its disposal is unlikely to make much of a difference.
Meanwhile the Wall Street Journal is also expressing the view that there are increasing concerns in markets over the ability of the government to finance their borrowing:
The plunge [in output] raised fresh concerns about the U.K.'s ability to handle the mounting costs of its financial and economic bailouts. Compared with a year earlier, the U.K. economy shrank by 4.1%. That cast doubt on an official projection this week that the economy will contract by only 3.5% in 2009 and rebound quickly enough to help the government get its stretched finances under control.Even the Times is now accepting that we might have reached the limits, and that a funding crisis looms. I have highlighted the point that is tucked away in their leading article today:
For the people of Britain, the consequences of that imprudence will be with us for many years. It will take nearly a decade to get public borrowing to acceptable levels – if the markets allow us that long – and until the 2030s to get government debt back to the 40% “ceiling”. Whoever wins the general election, we can look forward to years of austerity and tax rises.From the Independent we have another allusion to the problems of financing the government's profligacy (I have again highlighted the point):
There are fundamental questions that all our political leaders – at least those with serious designs on power – need to answer. What services do we want the state to provide? And what can Britain, as a nation reliant on the confidence of international investors, afford?One of the exceptions to the increasingly gloomy views on the UK Economy is the Guardian, which still sees relatively upbeat commentary. As one example, Ashley Seager has the following to say:
It seems that he actually believes that it is possible to turn the problems around with interest rates and printing money, but such delusions are increasingly on the retreat. Another similar positive outlook comes from Krugman at the New York Times, who is also positive about the policy of printing money:
So where is the economy especially weak? Everywhere, it seems. Manufacturing suffered its biggest quarterly fall since records began in 1948, driven by a 50% annual drop in car output, while the much bigger services sector saw the biggest drop since 1979.
Still, there was one bright spot in separate data from the Office for National Statistics that showed an unexpected rise in retail sales in March, driven by higher clothing and food sales. Is that enough to help pull us out of recession? No chance.
At some point, though, the Bank of England's record interest rate cuts, its £75bn of new money for the economy, combined with Darling's recent tax cuts and the big fall in sterling should put the economy back on an even keel. Today's GDP figures, though, suggest that the battle is far from won.
So I’m actually fairly hopeful about Britain; right now, the fact that it’s not on the euro is serving it well.Despite the remaining optimists, there can be little doubt that there is a growing perception amongst the mainstream media that the UK is in very, very serious trouble, and increasing concerns about whether the UK can actually continue to support the proposed levels of borrowing and spending.
I think that, over the coming weeks, there will be considerable interest in gilt auctions, and I would guess that many analysts will looking for cracks in the government financing of debt or the possibility of a gilt strike. Alongside this, there will also be major question marks over the value of the £GB.....
Interesting days are ahead, and increasingly worrying times.