Jeremy Warner's Outlook: Forget golden rule, where's the golden legacy?

Fifty-year gilts
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The Independent Online

The Rehabilitation of Norman Lamont, the chancellor who reputedly sang in his bath after presiding over one of the most humiliating episodes in modern British economic history - the pound's ignominious exit from the ERM - continues apace. Far from being the incompetent of legend, Lord Lamont is depicted in a paper published this week as a veritable superstar whose radical vision helped bequeath a "golden legacy" from which the fruits of economic prosperity are still flowing.

This is admittedly a somewhat biased account from a far from politically impartial observer. The writer, Ruth Lea, is a former director of policy at the Institute of Directors and now a director of the right-leaning think-tank, the Centre for Policy Studies. I somehow doubt she's ever voted Labour.

Yet she's right on the button in attempting to debunk the idea, much trumpeted by the present Chancellor, that he had to spend ages clearing up the economic mess left behind by the Tories and that any economic success we enjoy today is all down to him. Today's prosperity is in fact the result of a much longer evolution in policy, from the structural reforms of the Thatcher years to the later macroeconomic reforms in monetary and fiscal policy, many of the foundations for which were indeed laid under Lord Lamont.

After Black Wednesday, the Government moved quickly to establish a new framework for macroeconomic policy including an inflation target and the first steps towards an independent Bank of England. As we now know, because of documents published this week on the Treasury website under the Freedom of Information Act, the Treasury had in fact considered the case for an independent monetary policy on at least four occasions between 1988 and 1993. There was nothing unique even in the model eventually settled upon, which was just one of a number of policy options that had been examined.

Even the public finances were well on the mend by the time Mr Brown stepped across the threshold of No 11 Downing Street, thanks in part to the politically damaging tax rises that Norman Lamont imposed in his last Budget. Success in politics, as in all walks of life, is largely about timing. Mr Lamont inflicted the pain; Mr Brown has reaped the benefits.

More contentious is the suggestion that Mr Brown has squandered this "golden legacy" by undermining business with ever greater levels of tax and regulation. That case can only properly be argued once the British economy begins to stall, and there's little sign of that happening just yet. Labour has had a truly disastrous start to its election campaign. More or less every initiative has either backfired or been overshadowed by something else. It's even possible to believe that Michael Howard, a no hoper just six months ago, might be in with a chance.

Into this mayhem of gaffes and misjudgements strides the steadying and upright figure of the Chancellor, his name unsullied by the disaster of the Iraq war or the idiocy of the Government's new terror law. The economy is still by far Labour's strongest card, and Mr Brown plans to play it for all it's worth in next week's Budget. Yet if Mr Brown is to be sacked by an ungrateful Prime Minister after the election, it will, I fear, be a less golden legacy that he leaves his successor than the one he found.

In 1997, the public finances were on a sharply improvement trend. Today they are on a deteriorating one. There's nothing wrong with public sector job creation, especially when in true Keynesian fashion it helps counter the downturn going on elsewhere in the economy, but according to Office for National Statistics figures released yesterday, nearly a half of net job creation since 1997 has been public sector.

This may even understate the true position, as privatisation of low paid public sector employment has continued apace under Labour. That cannot be healthy for a tax base that depends ultimately on a vibrant private sector for its sustenance. Maybe Lord Lamont at last has some cause to sing in his bath.

Fifty-year gilts

The Treasury would have us believe that pension funds are clamouring for them. I wonder.

The treat the Treasury has in store, and may even announce with the Budget next week, is a 50-year gilt. The French have already road-tested the idea and the bonds sold like hot cakes. Quick to jump aboard the bandwagon, the Germans are planning one too. Now the Treasury hopes to follow suit. This is hardly a Budget announcement guaranteed to make the voters rush to the ballot box on 5 May in their eagerness to vote Labour, but according to the script it is just what the doctor ordered for fast-maturing defined-benefit pension funds.

The Government has done its level best to kill off the final-salary pension scheme in the eight years it has been in power, but now it wants to come to the rescue by selling a bond which ought to allow a more perfect matching of assets with long-term liabilities.

Never mind the fact that solvency regulation has been reformed in such a way that it drives the poor old pension funds into this sort of instrument, whether they like it or not. A sceptic would sense a conspiracy, silly though it might seem to suggest that the Government has deliberately set the rules so as to require long-term savers to buy more government debt. What a thought.

In any case, I suspect the Government may be overestimating the demand for such long-term instruments, not withstanding the efforts of regulators to rig the market. France Telecom has struggled with its 50-year corporate bond, and with good reason, for few companies survive that long. Governments, on the other hand, are not meant to renege on their debts. Unfortunately, they have a nasty habit of inflating them away instead.

The present fashion for independent central banks provides a better defence against inflation than we've had in ages, but even an independently managed monetary policy is no guarantee and 50 years is an awfully long time. Who knows what violent swings in policy might occur in the meantime? As things stand, there's every reason to believe that central banks will do whatever is called for to contain inflation, but they may have to jack up interest rates quite a way to do so, which in itself would destroy the relative value of bonds bought during a period of very low rates.

What's more, hardly any central bank is consistently successful in containing inflation. For instance, the eurozone inflation rate is at present above target, and the US Federal Reserve has in the past been prepared to tolerate quite high periods of inflation to support jobs and growth. To regard any government bond, let alone one with a maturity date as far away as 50 years, as "riskless" flies in the face of experience.

To the contrary, all the evidence points to bonds being among the most risky class of asset you could buy. In the past, their value has invariably been destroyed by inflation. A balanced portfolio of equities, by contrast, with dividends reinvested, will over time always outpace inflation. There may be limited appetite for 50-year gilts beyond that imposed by regulation or the ridiculous counsel of consulting actuaries, but only among big balanced funds with adequate protection against inflation. Even here, the only purpose of investing in such instruments would be to hedge against the possibility of deflation.

Most pension fund trustees, with big deficits to worry about, will find the 50-year gilt easy to refuse. Banking on the superior returns of equities may be a gamble, but it is the best chance they've got of addressing the deficit, absent of the sponsor coughing up the difference. Invest wholly in bonds, and pensions either become more costly to provide or less generous in the benefit they deliver. No rational private investor would stick his money in a 50-year gilt. What is it about the consultants that they think this a perfectly reasonable thing for pension funds to do?

jeremy.warner@independent.co.uk

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