Tuesday, November 10, 2009

Turning A False Corner


Not a corner to hurry round

Extraordinary news from the Times this morning:

Poll shows Britons see good times around the corner
People are more optimistic about the economy than at any time for the past 18 months, according to a Populus poll for The Times today.
Its findings come as the best October high street sales for seven years have fuelled hopes that a pre-Christmas surge in spending could confirm the country’s emergence from recession.
Sales rose at an annual rate of 3.8 per cent last month, up from 2.8 per cent in September. Overall sales values rose at their fastest rate since April."

Duh? Do we not have eyes to see the tidings of doom carried elsewhere in the same paper? Another 5000 jobs axed by Lloyds, 700 cut by Ericsson - along with the closure of their UK research base - a ballooning trade deficit driven by all the cars imported under the government's crazed cash for clunkers scheme, etc etc etc.

And that's before we even get round the corner. Once we see what's waiting for us there, we'll look back on this last Christmas spending splurge with a fond nostalgia. And wonder why we didn't stuff the cash under the mattress.

Last week the IMF gave us its own view of what's round the corner, racily entitled The State of Public Finances Cross-Country Fiscal Monitor. It spells out in horrific detail just what a fiscal mess we're in, and just how far our belts are going to be tightened over the next 10-20 years.

The IMF says that by 2014, the world's major economies (the advanced G20 economies) will have racked up government debt equivalent to about 120% of GDP. By all historic standards that is unsustainable, and will make the world economy extremely vulnerable to an uncontainable further crisis.

Indebtedness on that scale will also generate a significant increase in the interest costs of government debt (ie the yield on government bonds). For every one percentage point increase in government borrowing as a percentage of GDP, the IMF estimates that government bond yields are likely to increase by between 0.2% and 0.6%. Which means we have to pay more and more tax just to pay the interest bill.

So far, that bond yield increase has been headed off by the extreme weakness of the global economy and highly expansionary measures implemented by our central banks (eg the Bank of England's purchases of gilts - see here). But just wait until those measure go into reverse.

Action has to be taken. The IMF recommends getting debt back down to a maximum of 60% of GDP by 2030 - ie relative to the world economy, debt has to be halved. Which is an enormous undertaking.

And for the UK, the IMF's analysis is even bleaker. Because our fiscal deficit is so much worse than most other countries, we will need to make just about the biggest cuts in borrowing anywhere in the developed world - only Japan will need to do (slighty) more.

To put some numbers on it, the IMF says that over the ten years from 2010 to 2020, our government will need to improve its so-called "primary balance" (ie its current spending, before interest payments, less its tax and other current revenues) by a staggering 13% of GDP. In cash terms, that's getting on for £200bn.

Now, let's just make sure we all understand what that would mean.

As things stand, it means that public spending on day-to-day needs like teachers and nurses and welfare benefits, would have to be cut by getting on for one-third. Which is an awful lot of bigger classes and longer NHS waiting lists.

Alternatively, taxes would need to be jacked up to the kinds of levels that really do cause revolutions. For example, doubling the standard rate of income tax, doubling VAT, and doubling fuel duty - all at the same time - would still not raise enough (see HMT Ready Reckoner here).

Of course, the hope is that we will be bailed out by economic growth. If the economy grows enough, then some of the extra tax revenue we need will be generated "painlessly", without the need to rack up tax rates.

But just ask yourself how likely that is.

Interest rates cannot be held at their current low levels indefinitely. And when they rise back to more normal levels, indebted households are going to find life very difficult. Christmas and flash new motors will be a thing of the past. Meanwhile, government will be cutting its own spending, further weakening demand in the economy. We are looking at a decade of very weak 70s-style growth. Certainly not the kind of thing to get us out of jail free.

As we've blogged many times, Labour has flown our public finances into the mountainside - again. And once again, we are looking at a pretty grim decade ahead.

Of course, you can't expect normal people to spend their time perusing IMF Staff papers. And maybe it's better they don't know.

But we do expect our Chancellors and Shadow Chancellors to read, inwardly digest, and produce sensible plans for dealing with what we actually face.

Alarmingly, we've still to be convinced that George understands what's really round that corner.

PS The IMF is about to publish another research paper we'll be blogging, on the design and use of fiscal rules. As regular BOM readers will know, we've long argued for the third fiscal rule - a limit on public expenditure. It has been specifically rejected by both Labour and Tories, largely we think because politicos don't like to be restricted in that way. It will be fascinating to see what the IMF say.

Update The credit rating agency Fitch has warned that of all the leading sovereign borrowers, the UK's AAA credit rating is most at risk. That's because we have to make "the largest budget adjustment" - just like the IMF and the OECD say. Fitch says "our stable rating outlook [for the UK] reflected our expectation that the UK Government will articulate a stronger fiscal consolidation programme next year." Translation - we expect George to make some serious spending cuts straight off the bat, and to spell out a quantified plan for getting the UK's debt back below 60% of GDP soonest.

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