Friday, February 19, 2010

The Confidence Thing

But he's not weighed down with debt

As we all know, if you lay 100 economists' letters end to end they still won't reach a conclusion.

Except that this morning's two letters to the FT are packed with conclusions, especially the conclusion that we shouldn't cut public spending any time soon.

Labour peer Lord Layard and nine other eminent economists (including four previous members of the Bank of England Monetary Policy Committee and two Nobel Laureates) wrote in to say that a "short sharp shock now would be dangerous":
"History is littered with examples of premature withdrawal of the government stimulus... Britain’s level of government debt is not out of control. The net debt relative to GDP is lower than the Group of Seven average, and on present government plans it will peak at 78 per cent of annual GDP in 2014-15, and then fall. Even at its peak, the debt ratio will be lower than in the majority of peacetime years since 1815. Moreover British debt has a longer maturity than most other countries, and current interest rates on government debt at 4 per cent are also low by recent standards."
Labour/SDP/Tory/Bray peer Lord Skidelsky and scores of other eminent economists (including BOM's old friend Prof Blanchflower) wrote separately to lay into the other bunch of eminent economists who signed Sunday's letter:
"In urging a faster pace of deficit reduction to reassure the financial markets, the signatories of the Sunday Times letter implicitly accept as binding the views of the same financial markets whose mistakes precipitated the crisis in the first place!
They seek to frighten us with the present level of the deficit but mention neither the automatic reduction that will be achieved as and when growth is resumed nor the effects of growth on investor confidence. How do the letter’s signatories imagine foreign creditors will react if implementing fierce spending cuts tips the economy back into recession?"
Ah yes, the confidence thing. As the great John Maynard told us all those years ago, confidence is key. Because without confidence, investors will not invest and consumers will not consume. Without confidence we face falling off the economic tightrope. Everyone can see that.
But the thing nobody has ever really got on top of is what exactly generates that confidence. And in particular, can deficit spending by governments do the trick?
According to today's economist letters, it can. And in fact, if such spending is cut prematurely, it risks undermining what confidence there is, sending us plunging to our certain doom.
But according to Sunday's economist letter, it is likely to have precisely the opposite effect. Deficit spending means high government borrowing which risks undermining confidence in financial markets, racking up interest rates and sending us plunging to our certain doom.
So who's right?
In truth, we don't know. It's always possible that Layard and Skidelsky are right. But they don't know any more than we do.

Meanwhile, they seem extraordinarily unconcerned about the way the government is running up debt. Sure, on Darling's projections the debt will peak in 2014-15 and then start falling, but does anyone actually believe Darling's wildly optimistic assumptions on growth? Or indeed, his ability to deliver on the unspecified spending cuts he's assuming?

Let's just remind ourselves of that most inconvenient truth: the government is spending way beyond its means.

And we're not talking about the fact that tax revenues have fallen because of the recession. No, we're talking about the fact that idiot Brown pushed public spending way beyond what the government's tax revenues could support even before the recession came along. Between 2000 and 2008, he increased public spending's share of GDP by an extraordinary 11 percentage points, far beyond what the economy could sustain.

That lunacy has left us with a huge structural fiscal deficit, that the OECD estimates to be nearly 10% of our GDP. So the vast bulk of our 13% total deficit this year is structural - ie nothing to do with the impact of the recession on tax receipts and social security payments.

And what that means - quite horribly - is that the eventual recovery from this Great Recession will not actually eliminate the deficit. We will still have to address this structural defict of 10% of GDP (c £150bn pa).

Now Layard et al sort of suggest that actually they do know that. It's just that they don't want to tackle the problem while the recession is continuing.

But the difficulty is that every year we delay means another £150bn added to government debt. And at the current gilt yield of around 4.7% that's another £7bn pa in debt interest payments.

That precious market confidence is already getting frayed. Now that the Bank of England has stopped its huge gilt purchase programme, yields are pushing up, rising 0.3% so far this month. Meaning even higher debt interest payments, and even higher borrowing to fund them. And we haven't even got to our hung Parliament yet...

One other thing - there's been a lot of complacent talk about how our debt situation was a lot worse in 1815 and how that never did us any harm (eg see Layard's letter above). But the world was very different back in the days of the Iron Duke, and HMG was able shaft gilt-holders in ways that would blow up in its face today (eg forcing investors to accept lower interest payments). We are investigating further and will report back.

1 comment:

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