Election 2010: Debt - A conspiracy of silence
Britain is in a far worse financial crisis than many realise. Drastic action is needed, says venture capitalist Jon Moulton in the first of a series unpicking the issues The IoS believes matter most
Sunday 11 April 2010
In the past week our politicians have put on their most serious faces and addressed the economy. They have got into a wrangle about National Insurance contributions. Labour wants to increase them; the Tories don't. A lot of heat has been generated, much ink spilt. What it suits none of them to tell you, though, is that such talk is tinkering at the margins. The debt that Britain faces is monstrous, and neither Tories nor Labour will admit it. They prefer to quibble about the small change than admit that they are taking part in, in effect, a conspiracy on the British people. To make it worse, much of the media is allowing them to get away with it, presumably because they think – as the politicians seem to believe – that the public doesn't want to hear the bad news. In short, we are complicit in a con.
Let me take you back to the terrible old days of the mid-1970s. The poor country was in a shocking way and we had to be rescued by the International Monetary Fund (IMF). The UK government was told what it had to do and the population suffered. You will have some mental pictures of industrial strife and large-scale job losses in those bad old times.
Thank goodness, it couldn't happen now – or could it?
In 1975 the UK had government interest-bearing debt of about 45 per cent of the total economy (GDP) and the debt was rising at about 8 per cent per year. We then had to crawl to the IMF in 1976.
Today, that interest-bearing debt is about 65 per cent of GDP, rising nearly 13 per cent a year. A degree in economics will not be necessary to spot that things are a lot worse than in 1975.
Actually, quite a few other things were better in the mid-1970s: unemployment was half of today's level. The 1975 decline in the economy was only one-seventh of what happened to us last year. And the UK had much less of the largely unmentioned other debt – mostly, the pensions promises that will have to be paid by future generations, which now represents perhaps 125 per cent of GDP but was near 20 per cent in the 1976 time frame. Not a reassuring background.
The mid-1970s IMF crisis was triggered largely by the fact that foreign buyers of government debt were so nervous of the UK's ability to repay debt that interest rates roared into the teens.
Inflation was a much bigger issue then than now, and foreigners and Brits alike also feared we intended to "repay" our debt with relatively worthless scraps of paper.
So there was a buyers' strike on government debt and we had to be bailed out. Rationally, the currency collapsed in value, and as the cost of importing oil and the like rose, so did inflation. The observant reader may have seen some of this starting to happen in the past few weeks.
Should overseas buyers of UK debt worry about our ability to repay? Well, probably not – we have now come up with a new term, quantitative easing, to replace less attractive phrases like printing money or debasement. So last year the UK government did £200bn (20 per cent of GDP) of this latter-day version of slipping lead into the silver coins to buy roughly as much debt as it issued. So we can always repay with something – it might not be worth a lot, though.
So it really does feel as if the pound in your pocket will dwindle in value as the Government tries to drive interest rates down. Trying to destroy our national debt by letting inflation rip is quite attractive.
At some point the fear is that the debt markets will move their focus from Greece. Horrible but true – we have quite a lot of economic statistics worse than Greece. We might be one of the next to suffer, rather like the big banks a couple of years ago when they many found themselves with too much debt. The markets will probably attack one after another in a loss of confidence.
So here we are spending madly. Put simply, in the past year for every pound of receipts the Government spent £1.36p. And the gap is filled by borrowing. That gap is roughly £180bn a year. Wow.
The last Budget shows borrowing continuing to rise for the next five years. Beyond doubt, there will therefore be an ongoing risk of a market panic with high interest rates and considerable economic effects throughout that period. However, you should not pay too much attention to budget forecasts – the 2008 Budget forecast that last year the Government would spend 99p for every pound it raised. Honest.
As debt rises, the cost of paying interest and making repayments obviously rises, too. To the extent this money is paid overseas, this is money leaving our economy and weakening it. At some point that cost will mean our economy cannot grow – even the Budget predicted a drop in government investment to one-third of last year's level over the next five years, which will not be good for growth.
So how can we get out of this financial hole before our creditors get to us? There are three ways to reduce our national debt: let inflation rip to destroy the debt; increased tax revenues from higher taxes and economic growth; cut government spending.
The inflation route was explored a lot in the 1970s and 1980s; it's chaos and permanently weakens the economy.
Increasing taxes is not going to get there. We need to get £50bn plus in each year to stop the debt from rising in five years' time. Look at the bickering about National Insurance rises – try 10 per cent on VAT as a political idea to make a good dent in the budgetary hole. It's inconceivable that our current politicians would have the stomach to do this. In any case, the tax load would probably become counterproductive with businesses and people moving overseas to less taxing environments.
Will growth get us there? Well, very short-term growth will probably return as the economy restarts. But the fact is that over the past 10 years the economy's ability to grow has reduced – largely because we have moved from 40 per cent of the economy being public sector to 50 per cent.
Civil servants do not really generate growth, so a smaller private sector has to support a larger public sector. We have casually added about a million people to the public payrolls. No one actually knows what the economy's growth potential is and our government merely hopes for the best. However, it does not seem feasible that growth will be enough to plug the gap over the next few years.
Now that really leaves the only route to stability, which is to cut the public proportion of our economy, which means reducing spending, increasing the ability of the economy to grow and reducing the number of civil servants, and probably their pay and pensions. And the numbers are large: we need to take out several hundred thousand public sector jobs. We need to reduce the vast liability for public pensions that clouds our future. The politics – and human costs – of this are not palatable. Tough choices have to be made as to what we can afford.
But, actually, we have to do this. Only the timing is uncertain, because either we work up the stomach to do it ourselves or the debt markets will at some point stop buying UK debt; interest rates will rise, probably rapidly and a lot, and we will be forced into doing it by the IMF and the debt markets on their terms.
A short moral section. Essentially, by enjoying today while stacking up government debt we are simply leaving the cost for our kids and grandkids to repay. Our growth will be their lack of growth. Or perhaps we intend to rob our creditors by inflating the debt away. Either way, we have no grounds for pride in our actions.
As I say, none of our political parties appears to trust the electorate to grasp the dreadful state we are in. The Government has actually increased public spending in more than 20 new commitments this year. The Conservatives talk of no public sector compulsory redundancies and efficiency gains which will at best be just measurable.
Our senior politicians know the reality. They fear that being the first party to say it will kill their electoral prospects.
The political debate talks of a few hundred million here and there – it needs to be about tens and scores of billions. Neither party has plans to deploy actions for the economy remotely commensurate with the size of the problem. Is it possible that it is time for some serious political leadership to emerge? We need radical treatment – not cosmetics.
Jon Moulton is chairman of Better Capital, which has just saved Readers Digest
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