The UK government claims Britain is a safe haven”. On the surface, that looks true. Ten-year sovereign yields dipped below 2pc during the last week of 2011. As Chancellor George Osborne often points out, UK state borrowing costs are now similar to those of Germany. In fact, they are at their lowest since the late 19th century. For the Tory high command, benign market interest rates are the ultimate justification for their “austerity” programme. The coalition has apparently convinced global investors its commitment to fiscal probity is deadly serious.
Labour’s economics team and their media cheerleaders conversely claim, ad nauseum, that the government has cut public spending “too far and too fast”. The Tories retort that Labour’s old-fashioned Keynesian alternative – to borrow and spend much more – would be disastrous. If Shadow Chancellor Ed Balls got his way, and the government let public spending rip, the UK would instantly lose its triple-AAA credit-rating and the country would have trouble rolling over its huge debts. A creditors’ strike would ensue, resulting in unpaid state wages, a plunging currency, spiking inflation and serious social unrest. On that score, the government is correct.
Throughout much of Gordon Brown’s marathon stint as Chancellor, together with the miserable few years he spent in Number 10, Economic Agenda railed against ballooning government spending under Labour. I’ve taken pot-shots at the Tories too, not least during the early years of David Cameron’s leadership when, heeding the pleas of his spin-doctors rather than relying on common sense, he pledged to match, pound-for-pound, Brown’s deeply irresponsible spending plans.
The Cameroons have grown up a bit since then. They’ve also discovered some backbone. Belatedly, the Tories have dared to explain to ordinary British people what the vast majority of ordinary British people already knew – that the UK was living way beyond its means and there was no prosperous future for a large economy where state spending accounted for 50pc of GDP and rising. So credit, quite literally, where credit is due. Senior Liberal Democrats, too, deserve praise, for backing the “austerity” programme despite fierce opposition from most of their economically-illiterate backbenchers and activists.
The bulk of the British public – surprise, surprise, for they are not stupid – have supported, and continue to support the government’s efforts to bring the UK’s national accounts into the real world. So, for now, the coalition has a bit of political breathing space. Labour’s “spend, spend, spend” position, in contrast, is now imploding.
It was Lord Glassman who last week caught the headlines, when he said: “(Labour) hasn’t won and show no signs of winning the economic argument”, his party “stranded in a Keynesian orthodoxy, with no language to talk straight to people”. Of more political significance, in my view, were the words of the Shadow Defence Secretary Jim Murphy, a Labour front-bencher who commands respect.
Labour’s knee-jerk opposition to fiscal consolidation undermines its aim to win “genuine credibility” with the broad swathe of voters, Murphy bravely argued. “Credibility is the bridge away from populism and towards popularity,” he said. “It is difficult to sustain popularity without genuine credibility”. Amen to that. So the coalition is winning the fiscal argument – and I tip my hat to them.
When it comes to the UK’s fiscal policy, though, not all is as it seems. While the Tories’ hair-shirted rhetoric has helped calm the markets for now, “austerity” itself has so far barely been implemented. Even if the government achieves its much-vaunted aim of eliminating the “structural deficit” (that is, the annual fiscal shortfall, excluding interest payments) over the coming five years, the national debt (the stock of liabilities we must continually service and ultimately repay) will still double. In other words, borrowing keeps expanding like topsy.
Buried in the fine-print of the recent Autumn Statement, for instance, was an additional £111bn of borrowing between now and 2016. That’s equivalent to 7pc of national income and – repeat – is on top of the massive borrowing increase already planned. Gilt sales during 2012 alone will hit almost £180bn. That’s 18 times’ more than in 2000. So the UK isn’t a “safe haven”. Our fiscal position remains perilous. There is no room for complacency in any form, none whatsoever.
So why are gilt yields so low? Quite simply because the UK debt market is being propped up by “printed money” and regulatory diktat. I’ve argued this for a long time now, ever since the UK’s “quantitative easing” programme” was launched, back in early 2009. Originally dismissed as “outlandish” and “irresponsible”, my position is increasingly becoming conventional wisdom. That’s because the evidence is undeniable, at least to those who bother to look.
During 2009 and 2010, the government issued a massive £475bn in gilts. That’s equivalent to more than a third of the UK’s annual GDP. No less than £241bn of those IOUs – more than half – have been sucked up by the Bank of England. In other words, the demand for UK gilts has been strong, pushing yields down, because the majority of them have ultimately been bought by our central bank, using “electronically-created” credits.
The powers that be deny the UK is engaged in Zimbabwe-style deficit monetisation, seeing as the Bank has been buying its gilts off existing investors, many of whom, in turn, have been purchasing fresh ones at more profitable yields. The distinction, between QE and “circular financing”, though, at best, is metaphysical.
An additional net £87bn of gilts have been bought by UK banks – which, to a large extent are being forced to buy them. Such banks are now state-controlled and/or subject to new regulatory requirements requiring them to hold more “high-quality” assets. But are such non-indexed gilts really “high-quality”, when they are denominated in a currency that has been so clearly debased.
Under the QE we’ve already seen – including the additional £75bn announced in October – the UK’s base money supply has already been tripled, as a percentage of GDP, in less than 3 years. This is totally unprecedented. For now, much of that “extra” money remains on the balance sheet of banks that are pretending to be solvent, even though they’re not. It is certainly not being lent out to credit-worthy small firms and households, as was the original intention. When the “credit channel” is restored, though, even if higher reserve requirements are effectively imposed, inflation could soar. And, lest we forget, we have QE3 still to come.
So gilts yields have been artificially suppressed, by money printing and regulatory requirements, together with panic-buying by some foreign investors, keen to stay in Europe for now, but fleeing the Eurozone. The markets don’t actually think the chances of a UK government default have recently fallen. On the contrary, over the last 10 months, the cost of insuring UK 5-year debt, the price of a so-called credit default swap, has surged from around 50 to almost 100 basis points.
Since QE began, the gilt holdings of “non-bank UK investors” – the apolitical pension funds and insurance companies who typically buy gilts – have actually fallen. That’s because they’ve made the professional judgement that yields are unsustainably low. So, while I congratulate the coalition on the courage they’ve shown so far in gripping the fiscal bull by the horns, I strongly urge them not to let go. Low state borrowing costs make for a good headline. But they’re not translating into available credit for firms and households. And they certainly won’t last.