Hamish McRae: Rising debt risks UK's safe haven status
Sunday 16 September 2012
So how long can the UK remain a safe haven, with continuing concerns about growth, or rather lack of it, and deteriorating public finances?
It is question that we may have to confront quite soon because while the growth picture is likely to improve, our public finances are becoming quite alarming. And while GDP figures are just estimates that are invariably revised, the amount the government receives and spends are hard ones, derived from what might be called its monthly bank statements.
This week is important because we get the August statement. July was dreadful, a month that usually brings a surplus turned out to be a deficit. So far this year borrowing, far from coming down, has been going up. If the trend during the first four months of the financial year is not reversed in the remaining eight, not only will we miss the borrowing target for this year – and frankly I think that is inevitable – but the central core of the coalition's policy to stop the national debt rising by the end of this parliament will go too.
Most people don't realise how bad public finances are, for opinion polls show a majority think the Government is paying off the National Debt, whereas it is still adding to it at an almost record rate. Most people think the Government is cutting spending, whereas it is still increasing it. But at least it was, until this financial year, adding to the deficit at a slower pace. Now even that modest objective is no longer being achieved. If things don't improve the country will end up borrowing £150bn this year instead of the target of £120bn. (Some £28bn of assets of the Post Office pension fund are being transferred to central government, so if you read lower numbers for borrowing, you have to make allowance for that figure.)
There are two ways of looking at this deterioration. One is to see it in political terms. The coalition will be attacked for failing to achieve its objectives, though since the main thrust of Labour's attacks have been that it was trying to cut the deficit too fast, it would seem a bit rich to accuse it of doing, albeit unintentionally, what the opposition had been urging. But that is politics.
If, come the autumn statement in December, the Office for Budget Responsibility has to acknowledge that the deficit reduction programme is seriously off course then that will be very bad news for the coalition, and that is its problem. But it will also be very bad news for the rest of us because we have to pay the taxes to service the debt.
There is a simple practical point here. The larger the debt the more important it is that the country can maintain very low interest rates to contain the interest payments on that debt. That leads to the second way of looking at the debt overshoot, to see it in financial terms. Will deteriorating national finances undermine the UK's present safe haven status and start pushing up our long bond yields?
To some of us it seems pretty astounding that we have managed to retain the UK's position as a safe haven for global savings, but we undoubtedly have. The most popular measure of that has been the long bond yield: how cheaply can a country borrow? We are a little higher than Germany or the US (and Japan, which is a special case because it has such large domestic savings.) But we can borrow more cheaply than at any time in our history, as the main chart which goes back to 1703, shows.
This may, in part, be because the Bank of England has been financing much of the deficit by quantitative easing, and it may be because other countries' debt is even less attractive.But the fact remains: the UK has maintained confidence among investors. You can see that in the flow of foreign money into other UK assets, including property. With each new wave of concern across the Channel comes another flood of cash. The issue is whether missing the deficit target will undermine that, for there is no way of measuring how secure our status is.
There are at least three separate threats. One is the straightforward one that the deterioration of the numbers triggers a reassessment of the ability of the UK to handle this level of debt. We would not default outright, but we might further devalue the currency. In recent months sterling as recovered a bit, particularly against the euro, but it still stands some 15 per cent down on its 2007 level.
This threat would be compounded if the announcement of a missed deficit target were so mishandled by the coalition that its future became in doubt. It is always hard to assess political risk but the line taken by the opposition on the deficit is almost designed to increase that risk. That is compounded by the lack of any assessment on long-term interest rates of its intended action.
The third threat is more general. It is that this overshoot, along with disruption in global markets, might coincide with a more general shift in the mood of investors against bonds and towards equities. As you can see in the right-hand graph, shares are not expensive by historical standards. They may get cheaper of course, but the advantage of the FTSE 100 companies is that this gives global exposure, for something like 75 per cent of the earnings in these firms come in some form from overseas. That great switch from bonds to equities may be four or five years ahead, or it may even have begun last summer. We cannot know. What we do know is the relationship is abnormal and eventually abnormalities are corrected.
All this will make for a very difficult autumn. The crunch point is a few weeks away, but if these this month's borrowing figures follow August's, we will know that the deficit reduction programme has been blown out of the water. Then the coalition has to decide what it puts in its place.
The action of the Fed, and other central banks, may actually work
So, it is indeed another bout of quantitative easing in the US, with the promise of more to come. The big point here is the one made on this page last week: that the central banks around the world are taking charge.
In a global climate of fiscal retrenchment (albeit somewhat unsuccessful retrenchment in the UK) the main available weapon is monetary policy. The central banks can always print the stuff.
In the light of the soft job market in the US – softer than in the UK – the Fed felt it could act within its mandate not just to do this but also promise more measures if necessary.
And it said: "A highly accommodative stance of monetary policy will remain appropriate for a considerable time after the economic recovery strengthens."
This was the top end of what had been expected and the financial markets responded positively in the UK as well as the US.
The FTSE 100 index is within a whisker of its high point this calendar year, which makes an odd contrast to the relentless negative stories we are use to reading every day. It seems that professional investment opinion is more positive that general consumer and business opinion.
That leads to a big question: might the rise in equity markets feed through into stronger investment demand? In other words, might the action by the central banks actually do what it is supposed to do and stimulate the real economy?
I think the answer is that it probably will and probably has – to some extent – already. If the response of the real economy (and this goes for both sides of the Atlantic) has been disappointing, it is because it was always going to take several years for the most indebted sectors of the economy, consumers and government, to dig themselves out.
The company sector, however, taken as a whole, is cash rich. Even a modest pick-up in business confidence would be hugely helpful.
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