Tackling Our Fiscal Black Hole - People Ain't Dumb

My mate Mervyn told me...

The Governor of the Bank of England is only saying what a lot of us think - whoever administers the forthcoming fiscal austerity risks making themselves so unpopular they'll be out of power for a generation.

It almost happened to the Conservatives last time round. Yes, Thatcher sorted out the economic basket case we had become in the 70s. And yes, Clarke sorted out the mess left after our ill-advised experiment with the European Exchange Rate Mechanism. But only at the cost of making lifelong enemies among those who lost out, and of course among the genteel romantics who staff the Grun and the BBC.

So assumimg Cam wins, he's got one helluva problem on his hands. And doubtless there will be many advising him to stay the axe - just like the wets did back in 1979-81.

But that would be a serious mistake.

First, he needs to remember that the markets really are expecting serious action. As we blogged here, they have already effectively cut our credit rating from its traditional AAA status, and they will be going through George's June emergency budget with a fine tooth comb.

There'll be no room for shilly-shallying - the cuts will have to be commensurate with the scale of the problem. And just in case anyone's forgotten that scale, a BOM correspondent in Singapore has recently sent the following chart produced by Citi Global Markets to advise their clients.

It shows the amount of fiscal tightening needed by each of the major economies in order to get government debt back to the maximum safe sustainable level relative to national income (the maximum level reckoned by the IMF and others to be 60%):

As we can see, with the single exception of Japan, we in the UK have a bigger mountain to climb than anyone else. According to Citi's analysis we need to tighten fiscal policy by a whopping 12% of GDP. In plain English, that means the next government needs to cut spending or increase taxes by £180bn pa (in today's money). Which in round numbers is the equivalent of:

• 
  
  £7000 pa extra taxes/ lower spending per household;
• 
  
  increase in the basic rate of income tax to 65p; or
• 
  
  increase in the standard rate of VAT to 57%; or
• 
  
  25% off total public spending;

So there is no room for hesitation. And no time either. The longer we leave it the worse it's going to get, as mounting debt interest compounds the problem.

And for the those who say it would be better to call in the IMF and blame them, we invite you to watch the TV coverage of the Greek riots. The IMF is no easy option, and the IMF will give us little leeway to set our own priorities.

Comfort there was none?

Well, there is some comfort, and it comes from that old standby in times of trouble: the good sense of the British people. Just consider what one particularly sensible British person said to our ghastly Prime Minister last week:

"I said to him, “What are you going to do about the debt, Gordon? Greece is down and now Spain and Portugal have lost their credit rating. Who’s next?” I’m going on holiday to Canada and I used to get $2.50 to the £1. When I go to change my currency this time I’ll be lucky if I get $1.50."

Gillian Duffy is no swivel-eyed small state economist like yours truly, but she knows there's a serious problem and something pretty major has to be done. I'm betting she speaks for millions of us.

*****

Tyler is now up to his neck in the local campaign, so posting next week will be light. The good news is that the Clegg effect seems to be fading, and although our manor is still awash with LD posters, positive feedback from the doorsteps has put a spring back in our step. Like the man said, trust the people.

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www.gudanggrosiran.com Categories: black holes, debt

Way Too Optimistic

The fiscal projections in yesterday's PBR - just like last April's budget - rest on economic growth assumptions that are ludicrously optimistic.

Here is the relevant table from the PBR (click on image to enlarge):

As we can see, GDP growth is assumed to bounce back in very short order to reach 3.25% pa from 2011-12 onwards. Over the five year forecast period from 2010-11 it is supposed to average 3% pa.

Yeah, right. In a world of over-indebtedness, zombie banks, and tax increases, that just ain't gonna happen, boys.

Consider:

1. The average of independent forecasts for more or less the same period (2010 to 2013) is just 2% pa - and that was collected and published by the Treasury itself (see here page 18).
2. Last time we had to tackle a fiscal crisis even remotely like the current one - in the 70s - GDP growth was pretty close to zero for the following five years: in fact between 1976 Q4, when the IMF arrived, and 1981 Q1, when Geoffrey Howe finally completed the necessary fiscal consolidation, UK growth averaged just 0.4% pa.

So what if we correct the Treasury's fantasy growth numbers? What happens to the projected budget deficit?

As we've mentined before, the Treasury's own rule of thumb says that one percent off GDP increases the fiscal deficit by 0.7 percentage points of GDP. Which as things stand comes to around £10bn in cash terms.

But of course, that's cumulative. If GDP growth is 1% pa lower than HMT's forecast, by the end of 5 years, the fiscal deficit will be running £50bn higher than the Treasury forecasts. Well actually more than that, because by the end of 5 years, with all that extra borrowing, government debt will be £150bn higher than the Treasury projects. Which means interest costs will be higher. And even if we assume the government can go on borrowing at 4% (a very heroic assumption), that's another £6bn pa on the deficit - ie the 2014-15 deficit is £56bn higher.

Which means that if we take the average of independent GDP forecasts, by 2014-15 borrowing will not be £82bn as the Treasury projects, but more like £140bn - hardly any improvement at all on this year's £178bn.

And if we take our post-IMF growth experience from the 70s as a guide, borrowing in 2014-15 will be... gulp... can this be right? £228bn (equals (3.0 minus 0.4) times £56bn plus £82bn).

And you know, it could be even worse than that. Because HMT is making some fairly optimistic assumptions about the recovery of tax revenues from the finance and property sectors. Plus, it's assuming unemployment stops rising in 2011 - back in the 70s, our joyless jobless stagnation saw unemployment go on rising for nine whole years.

Right that's enough. I'm off out now to a fiscal workshop under the chairmanship of Evan Davis. Maybe he's got some answers. Or at least, a stiff drink.

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www.gudanggrosiran.com Categories: black holes, fiscal policy