Finally, The Mainstream Media 'Get it'....

I have already published two posts recently, but could not resist a further post. I have been reading the Sunday editions and it has become apparent that the mainstream media is finally waking up. The Darling budget has finally persuaded the commentariat of the profound difficulty with which the UK is confronted.

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:

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.

As a final example from the Telegraph, Tracy Corrigan, details the retreat of investors from the UK gilts market:

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.

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:

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

Willem Buiter likewise expresses concerns in his blog at the FT, although he is broadly positive about the budget:

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.

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.

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.....

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:

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.

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 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.

Uniquely Placed to Weather the Economic Storm???

Just another (very) quick post in response to some comments that have been posted.

One post, in response to my post 'Economic Growth??' referred me to a speech by Alistair Darling:

'The chancellor on R4 this morning said that as Britain under New Labour has achieved the longest run of continuous growth ever, we are "uniquely well placed to weather the storm..."'

I am almost shocked that Darling can utter such a statement - note almost. The reality is that the UK is uniquely placed to suffer more from poor global economic conditions than (perhaps) any other Western country. I have detailed exactly why the UK is uniquely poorly positioned to 'weather the storm' in the essay 'A funny view of wealth'.

Of particular interest was that Alistair Darling suggested that the credit crunch was not home grown??? A quite extraordinary statement. He also, said that 'over the last ten years we have had strong growth'. This is less surprising as a statement, as it seems some people still believe that this is true. However, the idea that the last ten years represents growth is being shown to be a fiction even as I type. Most of this is covered in some depth in 'A funny view of Wealth' so I will confine myself to a few comments. As I am short of time on this occasion, forgive the less than comprehensive approach.

1. The UK has the highest level of consumer debt in the OECD, which means that consumers must tighten their belts. the government presided over a boom in house prices, and made no attempt to restrain them. On a couple of occasions, arguably, Brown intervened to continue house price growth (e.g. allowing buy-to-let become part of pension provision when there was wobble in house price growth). Furthermore, the government ignored the increase in money supply that was fuelling the consumption and housing booms (the two are inter-related).
2. The government failed to spot the obvious; that low inflation was not the result of sound economic policy, but the result of an expansion of productive capacity worldwide with the rise of the BRIC countries, and the competition that they generated. All the while he took credit for low inflation growth, when low inflation was completely unrelated to government policy.
   
3. The government has been increasing debt during the 'good' times, and any further increase in debt will decimate the remaining confidence in the UK economy. Quite simply, the debt cupboard is bare. Furthermore, even more debt is buried in PFI, and this sits 'off balance sheet'.
   
4. Taxation as a percentage of GDP has risen, and will need to rise further as tax revenues decline with recession, and expenditure increases (e.g. from paying benefits - increase in unemployment). Alternatively the government will need to cut services, thereby further increasing unemployment. In fact, whatever the government does, there is no solution, as increasing tax will further hurt the economy, or cutting services will increase unemployment. In short, increase tax/decrease tax - both will have the short term effect of plunging the economy deeper into recession. For the long term, cutting services is the only answer, but will Gordon Brown have the courage to make that decision? It is also worth noting that, whilst many other countries have been cutting taxation, Gordon Brown increased taxation. The expansion in the UK of the state and increased taxes have created a structural problem in the economy, and there is no way to unwind the problem without severe pain.
   
5. Business has been complaining at the endless increase in 'red tape', and this is damaging the ability of firms to compete.

I could go on, but must rush through this.

As I have said, I have not really had time to post a serious response due to other commitments, but had to comment on such outrageous statements from Alistair Darling (whilst it was still timely). Either he is delusional or he is just lying. I have no idea which, but find lying to be the preferable of the two options. If he actually believes his own statements, then the UK economy is in very, very serious danger.