Inflating away the UK’s national debt
ONCE again, the Bank of England chose to keep interest rates on hold yesterday. It is now looking like it won’t be raising rates until next year at the earliest. Forget about strict inflation targeting; its new policy appears to be to keep monetary policy as loose as possible for the foreseeable future, as long as inflation doesn’t breach an unacceptable threshold (say 6-7 per cent) and that pay rises don’t catch up too much with price rises. The goal is to keep the cost of borrowing down, depress sterling to boost exports, help those with big mortgages and turn a blind eye to rampant inflation, which is slashing the value of wages and savings (and thus cutting consumer spending).
The Bank’s approach – and the very different attitude of the European Central Bank (ECB), which will soon be hiking rates again – needs to be seen in the context of rival deleveraging strategies. There are three ways a country can cut its debt burden. It can actually pay back its debts – perhaps by selling assets, as Gordon Brown did when he auctioned off 3G licenses in 2000 for a ridiculously high £22.5bn and actually cut the national debt (not just the deficit). Such a fiscally conservative approach is that favoured by the ECB and the Bundesbank. Most of the time, however, actually repaying debt is too tough as it involves running a budget surplus, something politicians don’t have the self-control to achieve. The best they can usually achieve is to reduce the rate at which they accumulate extra debt to stabilise or cut debt to GDP ratios.
The second possibility is for a state to default by failing to repay some of its debt or by missing an interest payment. The UK, thanks to the coalition’s austerity policies, is not going down that route, unlike Greece and several other Eurozone countries. The US won’t either, despite its profligacy: it could always print more dollars if it ever were to run out of tax cash. Actual defaults are never painless: they destroy financial systems and impoverish citizens. By law, banks, pension firms and insurance companies have to buy lots of government debt, on the assumption that it is risk-free; default guarantees disaster. The default can be dressed up as a renegotiation or a reprofiling but the litmus test is whether creditors lose out.
Another, legally sounder kind of semi-default is to ditch off-balance sheet pledges to electorates. In many countries, public sector workers have been promised generous pensions, for example. The UK and everybody else will have to go down that road.
The third way to deleverage is to inflate away debt or to slash its value by engineering a devaluation. This is only possible for countries able to borrow in a fiat currency they control. Greece can’t do this as it is part of the euro and doesn’t control the ECB; its bonds are in a foreign currency. The UK and the US, on the other hand, can and are doing this.
True, the British government’s benefit payments go up automatically if prices rise, while index-linked gilts are fully protected from inflation, both in terms of their coupons and of their principal. But while these special kinds of bonds can’t be inflated away, 78 per cent (and rising) of outstanding gilts are not protected in this way against inflation and are thus losing 5 per cent or so a year of their value. Deleveraging is desperately important – it is a shame that once again so many countries will be taking the easy way out.
allister.heath@cityam.com
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