FORGET about the reasoning Moody’s cited when putting the UK on negative watch this week. The problem with the credit rating agencies is not that they are too harsh – they are invariably too soft, too backwards-looking and cautious. Their decisions are always months out of date. Here is the real reason why the UK is facing a long-term fiscal crisis – and why the bond markets were seemingly unperturbed by Moody’s warning shot.
The government is spending far too much: the OECD estimates that public spending on its internationally comparable measure amounted to half the UK economy last year – or 49.8 per cent of GDP, to be precise, following two years where it was just above half. The government’s net debt will jump from £905.3bn in 2010-11 to £1.515 trillion by 2016-17, a massive increase. Once again, the chancellor muddled debt and deficit, two very different concepts, when he pledged yesterday “not to waiver from dealing with the UK’s debts”.
Far from going “too fast, too far”, as some critics claim, George Osborne wants to bring spending down far too gradually: total expenditure will be cut by 0.9 per cent a year in real terms in 2011-12, 2012-13, 2013-14 and 2014-5, 1.1 per cent in 2015-16 and 0.9 per cent in 2016-17, a total of 5.3 per cent over six years. The reductions have barely started. But does anybody really believe this to be feasible? Six years of austerity, during which we will be subjected to an endless, damaging class war to distract the public from the cuts? It will never happen – and there is a general election in the middle.
Even if these cuts were delivered, the revenue side of the equation is predicated on stronger growth than is likely. There is lots of evidence that shows that very large public sectors, very high public and private debt, and very high tax rates on income are bad for growth. Over time, spending will be lower as a share of GDP, which will help – but the government’s refusal to seriously contemplate deregulating the labour market and its anti-business mood-music will reduce investment and growth. Everybody was celebrating yesterday as inflation “collapsed” – but it remains much higher than the Bank’s target and while it is bound to fall further the decline won’t last. By this time next year inflation will start going up again thanks to the lagged effects of QE. Inflation – which remains at 3.9 per cent on the retail price index – cuts real wages and savings and is a drag on demand.
Given all of that, why aren’t bond market investors panicking? First, the UK is trying to do something, unlike many other even more beleaguered nations; and few investors have actually read the fine print of the chancellor’s spreadsheets. They just like the sound of them. Second, the UK retains its own currency: all of its debt is in sterling. It can never technically default. It can just print money in extremis. And third, it is actually already doing this, thanks to quantitative easing. For the last five months, the Bank has bought more gilts than the government has issued – and this will continue for the next few months.
There is therefore a false market in government bonds; yields on gilts don’t reflect the underlying reality, but merely the fact that one part of the state – the Bank of England – is “lending” money to another – the Treasury. It is hard to see how the UK can possibly hope to retain its AAA rating under such circumstances.
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