Archive for November, 2011

Home Truths

This week the Bank of England published its quarterly Inflation Report, and its Governor highlighted the fact that misery in Europe will hit growth in Britain too. From the document itself it looks as though the Bank’s forecast for growth this year and next is a sluggish 1% (it is difficult to be precise as the numbers are published only in the form of a small green chart). The autumn economic forecast of the EU Commission from the week before was even gloomier: Brussels sees UK growth next year at a meagre 0.6%.

One of the key repercussions of slower than anticipated growth in this country will be the impact on our debt arithmetic. This was already looking rocky over the summer. Although the numbers have improved since and we are currently in line with this year’s fiscal targets, the Office for Budget Responsibility is carrying this warning on its website at the time of writing:

Public sector net borrowing was £7.5 billion lower in the first six months of the fiscal year than in the same period of 2010-11. We would need a slightly bigger fall in the second half to match our March forecast of a £122 billion deficit for the year as a whole. In March we forecast that there would be a bigger fall in the second half, but prospects clearly depend in part on wider developments in the economy.

This is not surprising when we consider that their March forecasts were based on assumed GDP growth of 1.7% for this year and 2.5% next. Tax receipts of £588.6bn this fiscal year were projected to rise in line with nominal GDP; losing growth of 1.5% therefore equates to revenue loss of £8.8bn. At the same time, there could be slippage on the expenditure side too. (March’s numbers were based on claimant count unemployment of 1.55m this fiscal year, for example; the current level is 1.6m. And let’s not even think how much extra cash might have to be raised to support our banks in the event of an Italian or Spanish default.)

It is also the sad fact that Britain is not facing these challenges from a position of strength. The budget deficit for this year was forecast to be 7.9% of GDP, and 6.2% for 2012-13. In reality these numbers could look more like 8%+ and 7%, pushing our debt to GDP ratio (on a Maastricht basis) close to 90%. And the March budget envisioned balancing the books no earlier than 2016-17; revised borrowing numbers could push that estimate even further into the future.

There is something of a silver lining in that growth fears are keeping commodity prices contained, and this, coupled with continued weak demand, should see less erosion of wealth and income by inflation. Nonetheless, should the bond market lose confidence in us this would be cold comfort.

Most worrying on this front has been the treatment meted out to France in recent days. Speculation has been mounting that her AAA rating is threatened by – in Reuters’ colourful phrase – “being sucked into a debt spiral” as the economy slows. Ten year French bond yields have risen from 3.1% to 3.6% this month, as compared to 2% in Germany and 2.3% here. And yet compare France’s debt arithmetic to Britain’s: new austerity measures announced only a few days ago are forecast to see a budget deficit of 5.7% of GDP this year fall to 4.5% in 2012. French debt to GDP was 82% last year, in line with ours (80%). French growth is also forecast to be 0.5%-1% next year. In other words, France has stronger debt fundamentals than the UK. But it is France that has been singled out by markets for a beating.

It would appear that Britain’s non-membership of the eurozone is getting us a lot of credit. And given the state of our national finances, we need as much of that as we can get.

18/11/2011 at 3:42 pm 3 comments

The Alternative

This week, Greek Prime Minister Papandreou reminded the world that his countrymen didn’t just invent drama and democracy: they also invented the circus.

Doubtless he saw his shock call for a referendum as a Machiavellian masterstroke – a means of suborning domestic opponents while strengthening his bargaining position abroad. But it was clear within hours that he had overreached himself. (The full extent to which he has done so remains to be seen.)

It is worth looking at some of the consequences for his country should his implicit threat of unilateral default / euro withdrawal ever be carried out.

First of all, the currency. Most commentators assume that unilateral Greek default would entail the sacrifice of eurozone membership. (This is not necessarily true. Neither the default of Cleveland, Ohio in 1978, nor – if you prefer to think of the eurozone as a fractured collective – the default of Ecuador thirty years later resulted in either borrower choosing, or being encouraged to leave, the US dollar. But let’s assume Greece went back to the drachma.) There would be rapid depreciation – indeed, the possibility that the currency could cease to be transferable internationally. (The Icelandic krone threatened this at the nadir of the recent crisis with the result that the supply of imported food was jeopardized.) Even if the drachma were tradeable, immediate, rapid inflation would occur. At the same time, bank deposits and other assets would have to be re-denominated, decimating the wealth of the nation overnight. These twin effects would demolish household and business consumption and consign the country to a further period of sharp economic contraction.

All well and good, say the defaultists. But at least Greece would be free of her debt!

Yes, and no. Greece is still running a budget deficit and in the catastrophe scenario this would get worse. So unless the Greeks wanted total state shutdown, they would still have to borrow money. Who would be the lenders? The EU; the IMF: exactly the same people who are lending to them at the moment. The conditions imposed by those lenders – who would still have effective control of the country’s economy until their loans were repaid – would be at least as punitive as the conditions they’re imposing now. In other words, there would be at least as much austerity to contend with, and possibly more.

The trajectory which is currently planned for Greece amounts to a relatively benign version of sovereign default. The alternative would be harsher, crueller, and much more damaging.

04/11/2011 at 12:26 pm 2 comments

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