One particular commentary in the Telegraph sums up many of the concerns for the UK economy, as follows:
Is it remotely possible that Mr Brown has succeeded not just in delaying the pain, but suspending it entirely? Here's why not. The key questions are these. Given the amount of policy action that has already been thrown at the problem, how come there is still so little sign of recovery? And by extension, will continuing to provide life support eventually produce the sustained recovery the Prime Minister promises, or will it only bankrupt the country before we get there?When I first started this blog, I suggested that the UK was already bankrupt, and that it was just a question of time before this was accepted. I proposed that it would be necessary for either the UK to print money or default on debt and, lo and behold, the money printing solution appeared from nowhere with the Bank of England inventing justifications for the policy. When quantitative easing (QE- the euphemism for printing money) was finally introduced, I argued that it was nothing more than a method to pay for government profligacy, but nevertheless the vast majority of commentators and analysts bought into the Bank of England's justifications. It seems that they are increasingly rumbling the game:
It has taken a long while, but it is starting to look like the game is up for QE. The Bank of England has described the current ending of QE as a 'pause', but that they may restart if they deem that the economic situation warrants it. The problem that the Bank of England faces is this; they originally justified QE through spreading fear of Consumer Price Index (CPI) deflation, even though no such deflation had yet occurred. They also, as I pointed out at the time, sought to mix in the use of the RPI measures, even though this was beyond their remit. As things stand, the UK inflation rate is high at the moment, and climbing:
Ian Stannard, currency strategist at BNP Paribas, said markets are fretting over how the UK will cover its deficit following the pause in quantitative easing by the Bank of England. The Bank has absorbed £200bn of debt, more than total Treasury issuance over the last year.
"The UK may have difficulty in attracting extra investors to fill the gap. We think they will have to do more QE as recovery falters," he said.
RPI went into deflation, but RPI includes housing costs, which are determined by the Bank of England interest rates. At the time QE started, I predicted inflation being imported through currency devaluation. The same situation applies now, with the £GB continuing to sink:
LONDON, March 10 (Reuters) - The Bank of England's trade-weighted sterling index fell to a fresh 11-month low on Wednesday in the wake of data showing an unexpected fall in British manufacturing output in January.The much hoped for improvement of the balance of trade has also not taken place. In fact, the opposite has taken place. The increase in imports, alongside a devaluing currency, does not bode well for inflation.
The current account situation is also seeing no improvement. As I have suggested before, the importation of inflation through currency devaluation takes time to fully impact, as many contracts and goods in transit take time to adjust to the new situation. As such, we can expect ongoing inflationary pressures lagging the devaluations.
In this circumstance, with inflation climbing, and realistic prospects of even more inflation, how might the Bank of England explain any further QE? When the Bank of England last started QE, they justified the policy with projections of CPI deflation, but the deflation never took place. It might be argued that this was because of QE, but even before the policy might have had an effect, there was no deflation (also, the idea that deflation is an inherently bad thing is something I have contested in previous posts). I doubt the Bank of England will get away with QE so easily this time around, as too many analysts are becoming cynical.
What we are now seeing in the UK is the brewing of a perfect storm. The underlying size of the UK economy, the size of the economy without borrowing, is very much smaller than many imagine. It simply can not support the level of borrowing that has been undertaken by the government. This was true even before the borrowing binge following the onset of the economic crisis, but the difference is now that the borrowing is concentrated in the government rather than consumers. The real size of the economy in relation to borrowing is the underlying problem, but other factors are adding to this fundamental problem.
One of these, which is commonly reported as a reason for weakness in the £GB and gilts (UK government bonds), is the political instability, and the prospect of an ineffective government after the coming election. This from the Wall Street Journal:
NEW YORK (Dow Jones)--The U.K. pound tumbled against the dollar and the euro Monday as investors worried that the upcoming national election could result in political gridlock, hampering the country's ability to deal with its growing debt levels.Such sentiments are not rare, but there are other concerns, and in particular the relative health of the UK economy in relation to other economies. As governments issue record levels of debt, the competition for who is funded is intensifying. Again, it is an argument that I made long ago, and it is now an argument that is gaining a broader airing. Whilst other economies may look very bad, the credit will flow to the countries that look least bad and the UK is not well placed in such a competition. The result is that yields on gilts are climbing, meaning that funding the government is already becoming more expensive:
Yields on 10-year gilts have already crept up to 4.14pc, compared to 3.94pc for Italian bonds, 3.48pc for French bonds, and 3.19pc for German Bunds, though part of this reflects worries about higher inflation in Britain.I undertook a search for 'sterling crisis', and the results speak for themselves. Some examples of the articles including the term can be found here and here. It is the increasing frequency of the discussion that is of real concern. As the £GB falls, as the doubts about fiscal policy gather more weight, as the prospects of a return to QE are discussed, the attractiveness of funding UK government debt diminishes. As concerns grow, the £GB weakens further, and as the £GB weakens the doubts are reinforced. However, underneath it all, the core problem is doubt about the solvency of the UK.
Just as in Greece, it appears that the electorate in the UK are taking their creditors for granted, and have not accepted (yet) that it is possible for the credit taps to switched off. The Labour Party and the Conservative Party are running scared of the polls, and are afraid to propose the cuts necessary to restore the UK's fiscal situation. The Conservatives talk of concern for the credit rating of the UK, but are not offering the policy proposals that might reassure creditors. Meanwhile, the Labour government is suggesting that the coming pre-election budget will be 'business as usual', even whilst a currency and funding crisis is brewing. At some point, the UK electorate needs to wake up and accept reality, but the prospects for this are dim.
In a recent article in the Economist (last week's print edition), they discussed the coming battle between the interests of the older generation and the younger, and the private and public sector. Of note is that, with an increasingly large share of the UK economy in the hands of government, the government us building a client state - where any serious cuts to government expenditure threatens the livelihoods of ever more individuals. The more the government spends, the more people are dependent on government expenditure, and the harder it becomes to develop the political will to cut expenditure. My guess (and it is no more than a guess) is that underlying the uncertain outcome of the coming election is the imbalance between a growing client state, and those in the private sector.
The Economist, which seems to be returning to better analysis, suggests that, in the end, it will finally be necessary for countries like the UK to have reform imposed upon them from outside. In other words, the politicians will need a crisis for them to tackle the structural problems within their economy. It is rather a depressing indictment of the politicians that are supposed to lead us, that they need such a crisis to do what should in any case be done. Within all of this is the concern that the UK is supposed to be a 'mature' democracy, in which the electorate should know better. It seems though, that they lack the maturity to face up to the severity of the economic situation.
The truth is this; if the UK continues on the current course, there will be wider and deeper damage when resolution is imposed from outside, and the wider and deeper the damage the more people who will lose their livelihoods, including the current clients of the government. In other words, nobody will win from carrying on with the current situation. Those who live as clients of the government need to recognise that their interests are inextricably bound up with the private sector. It is in not in the interest of anybody to risk a funding and sterling crisis. In the end, everybody will bear a share of the pain. Somehow, I doubt that this will be learnt before the coming election, but we can but hope....perhaps then the politicians will have the courage to do what must be done?
Note 1: Thanks for the many comments on the last post.
Lemming asks how we might determine sustainable economic growth. I am not sure that there is an easy answer to this in the current system. In particular, the manipulations of the money supply by central banks, in conjunction with fiscal tinkering, serve to bury what the real state of economies might be. A particular problem is that the policy of government 'x' can have unexpected impacts on country 'y', such as the way that QE and zero interest rates encouraged asset price inflation in countries like the US. How is it possible to untangle such effects? I long ago provided (what I believe to be) a solution to these problems, but doubt the solution would ever be adopted.
A commentator called 'D' noted that there is a situation in which government is in bed with select businesses, and suggests that this means not all blame should be placed with the government. I would argue that this is still a problem of government, as government should not put itself in this position. The more honey in the government pot, the greater the number of bees buzzing around the pot. The solution is less honey in the pot, and some fierce constitutional constraints. Sorry, a short answer, but all I have time for.
An anonymous poster corrected me that, in the event of default, somebody still pays; in this case the creditor. You are quite right, but I hope that this was implicit in the rest of the post.
'Rural Idiocy' added an interesting quote as follows:
"The Bank for International Settlements says Britain needs a primary surplus of 5.8pc of GDP for a decade to stabilise debt at pre-crisis levels, given the ageing crunch as well. The figure is 6.4pc for Japan, 4.3pc for the US and France."Certainly food for thought.
As ever, Lord Keynes also posted several comments which challenge the views of this blog. It is always good to see the alternative views presented. As for the other comments, I have read them with interest, but do not have time to respond to them all. However, they reflect the high standards of commentary on this blog, and I feel privileged to have such a thoughtful readership.
Note 2: As with many posts, there is much else that I could say, and many subjects that might demand more attention. For example, I could talk more about the other indicators for the UK economy, but will leave that for this time. If time allows, I may try a full review of the UK in the future.