Thursday, May 21, 2009

Stable To Negative

Are we sure this is a Magic Punch Bowl?*


Another day of grim debt news.

The latest monthly borrowing stats are appalling. Net debt has now surged to 53% of GDP, up from 36% just two years ago.

And this morning credit rating agency Standard and Poors has moved HMG's credit assessment from stable to negative, something that immediately whacked the financial markets. S&P now says there's a one in three chance of an outright cut to the UK's credit rating as debt approaches 100% of GDP. That would jack up the cost of government debt, and it's something we didn't even suffer during the 1970s.

In a different part of the forest, Tyler lunched yesterday with a senior and highly respected City-type. We'll call him Mr X, although his real name is gggg ggggg (redacted by Fees Office).

Surveying our watering hole, Tyler noted that since last visiting at the start of the year, things seemed to have picked up. Were we on the mend? Was Mr X tripping over any of those green shoots?

Mr X then proceeded to list scores of said shoots - equity markets up, credit markets up, easier funding, leading indicators turning, even the property market is bottoming. Yes, with June just around the corner, shoots are bustin' out all over. All highly gratifying... time for another drink?

As the FT's Martin Wolf noted yesterday:

"... policymakers have thrown the most aggressive fiscal and monetary stimuli and financial rescues ever seen at this crisis. Finally, this effort has brought some success: confidence is returning and the inventory cycle should bring relief. As Jean-Claude Trichet, president of the European Central Bank, remarked, the global economy is “around the inflection point”.
And in its latest UK assessment, the IMF gives at least a slight nod of agreement:

"... output is likely to continue to contract in the near term, although at a decelerating pace... with quarterly growth picking up gradually through 2010... the significant economic stimulus in train in the UK and other large countries should support the recovery."

So that's all lovely then. Large ones all round.

What an earth is going on? Green shoots in the financial markets, and a credit downgrade for HMG?

Well, the truth is that what's good for the financial markets isn't necessarily so good for HMG (aka UK taxpayers).
The IMF spells it out for us.
First, there's the tricky issue of the printing press. Easy money is great for financial markets in the short-term, but not so great for future inflation. Does that press actually have a reverse gear? And even if it does, how can we be sure the Bank of England knows how to operate it?

The IMF recommends a reassertion of Bank independence, and "transparent communication" on how precisely the Bank intends to drain off all the dosh now sloshing around. But all we've had so far is a stream of opaque analysis attempting to explain why the chunky 17.4% year-on-year growth in the money supply (M4) shouldn't worry us because it somehow doesn't count.

Then there's the disastrous condition of our public finances. In the short-term, government deficits may pump up the economy and underpin the equity market. In the longer term there's the small matter of repayment.

And on that, it's worth quoting the IMF at length (mainly because we agree with it):

"... the success of the current policy package hinges on the continued trust in the sustainability of the fiscal position. A continued strong commitment to medium-term fiscal consolidation is hence crucial... commitments would be strengthened by:

• Targeting a more ambitious medium-term fiscal adjustment path... The focus... should be to put public debt on a firmly downward path faster than envisaged in the 2009 Budget.

• Providing greater clarity on the specific measures needed... The emphasis in current plans to weigh the adjustment toward expenditure reduction is appropriate in light of international experience that expenditure-based consolidations are more durable.


• Allocating any upside surprises to growth or revenue to reduce deficits more aggressively and limit the accumulation of public debt.

• And finally, building a broad public consensus on the critical need for sizeable fiscal adjustment to assist in meeting fiscal challenges."


As we've blogged many times, we need a clearly stated medium-term fiscal strategy, anchored by a robust commitment to cut spending.

Unfortunately, we don't have such a strategy. All we have is a prospective credit rating downgrade.
*Footnote It was William McChesney Martin, the longest serving chairman of the Federal Reserve who told us that the central bank’s role is to “take away the punch bowl just when the party starts getting interesting”. Given our dire straights, I reckon time's up already.

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