#41. The prettiest horse in the knackers’ yard?


For good or ill, today marked the chancellor’s last chance to set out the economic and fiscal outlook, as it sees it, before everyone gets mired in the pre-election scrum.

Essentially, and from a political perspective, Mr Osborne wanted to leave voters with two main messages.

The first of these was that both the economy and the public finances are improving.

The second is that things would have been much worse under Labour and, by more than simply implication, would deteriorate were Labour returned to office.

Let’s deal with the latter point first, on which the chancellor is surely right. In a recent speech, opposition leader Ed Milliband completely forgot to mention the deficit, but I did not feel deprived of information as a result, since I have no idea what, if anything, Labour’s economic position amounts to.

In the early days of this administration, Ed Balls accused the coalition of cutting too far and too fast. The obvious inference was that he would have cut less deeply, and more slowly. Fair enough, and he is (or perhaps I should say ‘was’) by no means alone in his mistaken belief that Keynesianism could resolve our current predicament. Now, though, he castigates the government for failing to hit its deficit targets, which surely means that he would have cut deeper, or would have increased taxes by even more.

For the record, and at constant 2013-14 values, Mr Osborne has increased taxes by £78bn and cut overall expenditure by just £11bn (though the latter includes departmental cuts of £42bn, offset by increases in debt interest and welfare costs).

Would Labour, to some extent a hostage to public sector unions, really have cut spending by more than Mr Osborne? Would they even have implemented the same freeze on public sector pay? I’m sorry, Ed and Ed, but I’m simply not convinced. It’s a fair bet that debt would have been even higher than it is now, had the heirs to Gordon still been steering the ship.

As an aside, let me explain why a Keynesian solution wouldn’t work. If demand is weak (in what is known as a “de-stocking recession”), government can indeed stimulate the economy by injecting borrowed money.

But this was (and is) a totally different kind of slump, technically a “de-leveraging recession”. It was caused by excessive debt. So, if the government were to put money into the economy, the private sector would have used it simply to pay down its own debt – private debt would have been transferred to the state, then, but demand would not have been stimulated.

In any case, this government hasn’t exactly been un-Keynesian. Far from reducing debt, it has increased it enormously, since public debt is expected to have risen to £1,489bn by next April, in nominal terms a near-doubling from £760bn in April 2010. Rather, this administration has simply slowed the rate at which we add to the debt pile each year. Adjusted to current values, Mr Osborne will have added £670bn to national debt over five years. That’s equivalent to an annual average stimulus of just over 8% of GDP.

This, of course, is where the first of Mr Osborne’s two claims breaks down. It is simply not true that either the economy or the fiscal situation is positive. This year, for instance, the economy is likely to grow by £80bn, but government alone will borrow more than that, to which should be added the big sums borrowed by households, most of it channelled through mortgage debt as our over-valued housing market continues to defy gravity.

And this, I’m afraid, is “same old, same old” – borrow money, spend it, and claim that your income (the economy) has risen.

Now, given that debt (both state and household) has soared, you might wonder why the bond markets haven’t punished us with higher rates (yet, anyway). There are two reasons for this. Firstly, there has been a global inflation of asset markets through QE, which has depressed interest rates world-wide.

Second, Britain looks like “the prettiest horse in the knacker’s yard” – “our economy may look tatty, but just look at some of the others!” If you wanted to move money out of Britain, where would you put it? China, where the debt mountain is very probably even bigger? A Europe forced into brutal internal devaluation through the idiocy of the one-currency, multiple-budgets system? Japan, which has adopted a policy of economic suicide? Russia, which the forex markets tell us is back in the disaster territory of 1998? Or even America, where bond markets remain in vertigo-land thanks to huge QE?

The real measure of our economic position is how much debt we have accumulated, relative to how much growth we have enjoyed. Do this sum, add in our huge current account deficit as well, and you’ll soon see that we are continuing to live on tick.

That most other countries are doing the same, or worse, is a comfort, but only a relative one.

As Mr Cameron has so rightly said, there are “red lights” flashing on the global economic dashboard. At home, the housing market could crunch if the Emperor’s new clothes (the ratio of house prices to disposable incomes) were ever to be noticed, or if interest rates were forced up by a global recognition that asset markets have been inflated artificially.

Britain is not, then, in a good place economically (and I’ve made no secret of my view about some of the things that ought to be done). Fiscally, our spending remains far too high, though let’s give credit to Mr Osborne for the first real cuts in spending since the IMF held Jim Callaghan’s feet to the fire in the 1970s.

This said, the only point that the chancellor really wants voters to take away from his statement is that things would have been worse under Labour.

And he’s certainly right about that.

11 thoughts on “#41. The prettiest horse in the knackers’ yard?

  1. Tim,

    I dont fundamentally disagree with you in saying that Labour will make a huge hash of the economy in the same way the Tories have. However one of the things I like about your writing is that even when we disagree, generally you have a well thought out and argued position. However I think that your views on Labour are not as well put forward as some of your others.

    On another issue I am currently reading John Seddons book ‘systems thinking in the public sector’ Having gone through a ‘Vanguard’ review I certainly see where he is coming from and how you can improve efficiency through his ideas. Obviously by adopting his ideas you could either save a lot of money or hugely improve services. Might be worth a look to see whta is possible?

  2. John

    Thanks for this, and I will certainly follow up on the book. There is certainly huge scope for saving money – something I addressed in my mini-series on corporatism.

    On Labour, I honestly don’t know where they are on the economy. For years, Ed B said that the govt was cutting too much – but now he slates their failure to cut the deficit. Some Labour policies do make sense (house building, for instance), but others (like freezing energy prices) are daft. Be that as it may, I don’t sense an overall consistency or an overall strategy – I wish I could!

  3. Labour should have changed their top team after their leader election.
    It does not make sense that they kept the same people who were present during the boom phase of the last crash.

    This is a problem for Labour but even more worrying it is a bigger for problem for UK because it has allowed the current chancellor to get away with a very short-term focused plans.

    If Labour were a proper opposition, they should have questioned HTB/FLS and examined what happened to the independence of the BoE. Sadly they are also focused on short term populism and nothing else..

    Yesterday SD giveaway shows again that the Tories are keen to inflate the housing bubble to the extremes. Fear for the society where young have to pay high rents or high mortgages. Not wise..

  4. SK:

    I agree with you on every point. I don’t know why Labour didn’t ditch most of Team Brown. They should have made better use of Frank Field and maybe Alan Johnson. They’ve not learned from the post-election hiatus of Labour in the aftermath of Thatcher’s first victory, or the Tories in the aftermath of ’97.

    You are right, too, about the lack of scrutiny. Buried somewhere in OECD (or maybe IMF reports, I read so much stuff) is a comment on how “the Westminister model” results in insufficient scrutiny. Our system is more “elected dictatorship” than democracy.

    This said, public disenchantment with the existing parties keeps increasing, in fact statistically Britain is second only to Greece in its rejection of the old guard. Miliband (who I don’t dislike) has lower poll ratings even than Foot in ’83, suggesting Labour hasn’t a prayer of winning – and the SNP and UKIP can take bites out of their support. The Cons are being outflanked, and the failure of the redistribution Bill leaves the system loaded against them (I noted GO’s lavish attentions to the North yesterday, which he sadly seems to think is only Manchester).

    On SD, it did need reform – but you are right about housing market inflation.

    Our housing stock is a non-earning asset, a sink for capital that could be put to productive use – just imagine if businesses suddenly had access to £3 trillion of cheap capital! But borrowing against inflated house prices, spending some of the paper “profits” and calling this “growth”, has long been the British economy’s idiocy-of-choice!

  5. Again thanks for your helpful thoughts on this. Interesting as you point out that people are beginning to see through the usual “smoke and mirrors” of party politics. Interesting too that GO seems to be distancing himself from the pronouncements of Robert Chote and the OBR even though this was a conservative innovation – and seemingly a good one too. The next election is certainly going to be vital – as you imply it’s a question of choosing the least incompetent to run the asylum. It’s what happens afterwards that is the real worry.

    • Thank you.

      The OBR (which I too approve of) has to walk a fine line. Its forecasting record is truly terrible. (I remember a newspaper refusing to report my 2011 growth forecast of 0.9% because it was “not credible” versus the OBR number of 2.8% or something…..!)

      I read recently that the established three parties can count on only 56% of the electorate to support them; only in Greece is the figure lower, and this is without precedent in the UK so far as I know.

      Much of this support may go to UKIP. But my preference would be for a Charter, as outlined in a previous article – ask all candidates to sign up to a four- or five-point pledge, and don’t vote for those who refuse. It could work if somebody got it going, and it’s a much more voter-friendly idea than any party label, I think.

      What happens afterwards is indeed worrying – all of the major parties propose tinkering, and in ways that don’t upset anyone – whereas we probably need fundamental reform, in ways that upset very many.

      Meanwhile we are living with a lot of fairy-stories – “we can keep on borrowing”; “public sector pension comnmitments can be honoured”; “our current account imbalance doesn’t matter” – none of these is true……

  6. Tim,

    I have to admit I disagree with your impression of the equity and bond markets. Corporate profits in the UK are way up in the last few years, which must go some way towards explaining the stock market (though it might be a little bubbly). Similarly, as long as inflation remains so low I don’t see why bonds would be anything other than a rational investment, since even at low rates you’ll earn a decent return. As soon as there’s any sign of inflation returning I expect the bond market might change. Ambrose Pritchard has been worried about bond vigilantes for a long time now, and they’re still yet to appear. He might want to reassess his models. I’m of the opinion that the next crisis is more likely to appear in China or SE Asia than here or in the US (barring a US high yield bond market default triggered by oil).

    We are in a bit of a pickle in terms of spending though. The problem is, I don’t see how we can sustain a high current account deficit (which we like because this buys us energy, goods and services) and a balanced government budget, since frankly the private sector is stupidly indebted and can’t take on any more debt to keep buying Chinese tat and Norwegian gas. In the short term, the cratering oil price ought to help with this, but given that such low prices are unsustainable in the long run the only realistic path forwards seems to involve a lot less stuff flowing into the UK. In the meantime a government deficit seems inevitable unless we want to slip back into another balance sheet recession.

    • ‘As long as inflation remains low…’ What inflation calculation can we rely on to ensure that the purchasing power of our pounds in those bonds is being preserved? I know that many of the new items in our inflation basket of good are falling in price, like music downloads, trade union subscriptions, and tablet computers, but what about the price of electricity and water? As Tim Morgan has said before, there is no grand conspiracy going on here, but over the decades each time there has been an intellectual debate about hedonics, or substitution, or weighting, the method that results in lower reported inflation tended to win out. The US, to their credit, still publish the underlying data that enables the reversing out of the methodological changes of the last 30 years. If they still calculated and reported inflation the way it was in Reagan’s time, it would be 4% higher every year in recent years. We don’t have the underlying data in the UK, but the drift has been in the same direction.

    • Have a look at MIT’s billion prices project. The discrepancy between their results and those of the CPI in the US is around 1%. I think they have data for the UK but I’m buggered if I can get their site to work. Even shadowstats has inflation declining at the moment, and they’ve got first class tickets on the hyperinflation express. Why not look at the FAO price index over the last few years? Gas futures prices in the UK have been falling for the last year.

      Frankly the government statistics department of every major nation would all have to be in cahoots, because low inflation is the case around the globe at the moment. Given that central banks are actively trying to goose up inflation this would seem to represent a bit of a contradiction.

    • Ah, inflation. Just in parenthesis, the stats authorities wouldn’t have to be in cahoots as such, they would just have to be using the same methodologies, which for the most part they are. I’m sure there’s a systemic understatement of inflation (just as there is systemic overstatement of GDP). But this isn’t a conspiracy, and neither can it be tweaked every now and again. However you look at it, inflation has come down, making deflation likelier.

      Actual figures are only part of the story – governments are concerned also about expectations, which act as an anchor – if we all expect high inflation, we go out and spend our money now, before it loses value – thus worsening the problem. Likewise, if the public buys into deflation, people defer purchases, again making things worse.

      If anyone mentions deflation, economists tend to call for a cross and some garlic – deflation is a scourge worse than Dracula. Actually, history suggests that it isn’t. Periods of high growth (for instance the late nineteenth century) were also periods of deflation. The computer industry has lived with deflation and thrived with it, with the price of computing capacity falling year after year. New technologies, which make things better and cheaper, are inherently deflationary. In a functioning and competitive capitalist economy, the incentive to improve products should logically include greater efficiency and lower prices.

      The real scourge of deflation is that it makes debts bigger, and that’s why the powers that be fear it. Inflation, on the other hand, is implicitly a con – I owe you £1000, but by the time I pay you it’s only worth £950. Government issues me a £1 which, at year end, is worth only 95p. And so on.

      So what’s happening here is deflationary pressure. Now, is deflation logical right now? I’d have to say yes – though asset values are inflated, incomes of all categories (wages, interest on savings, annuities) are under pressure. We are reluctant to resort to debt as readily as we did pre-crisis. So, with incomes weak and borrowing less automatic than it used to be, consumption is reduced – result being deflation. But this, of course, makes our debts grow – which, as the figures show, they are doing anyway.

      In a “normal” recession, confidence is weak, and suppliers de-stock, reducing employment and thus vindicating the lack of confidence. Here, govts can help throuh stimulus. But this is not a normal recession – it’s a deleveraging recession, where people run scared from having too much debt.

      This necessarily reduces the willingness to spend. So, (A) our existing levels of debt are undermining demand; but (B) we still go on adding debt, most of it added by government; whilst (C) deflation increases the real value of that debt; and (D) the authorities inflate capital markets to keep yields (i.e. interest rates) low.

      Bubble followed by downwards vortex, anyone?

  7. Sam

    Thanks for this. I take your point about corporate profitability (though I do wonder whether this is topping out, as it seems to be in the US?)

    My problem with markets can be put in two ways – manipulation, and economics. Starting with manipulation, it seems to me that a large proportion of the huge QE injections of recent years have gone into inflating capital markets, thus (and intentionally) keeping rates artificially low. I take the point about low inflation, but I still wonder if rates are sufficient to attract the capital needed, not least for pension provision and investment in infrastructure. Second, markets seem to me to be discounting a good economic outlook, not a view I share.

    Absolutely agree about spending. During 2008-12, we learned that these levels of state spending aren’t affordable in bad times, but they now look unaffordable in (slightly) better times too.

    I agree with the many who say that further and deeper cuts will come, though I think they can be accomplished if (but ONLY if) we can tackle corporatism. In recent years one of the big stories has been lack of income – not just deteriorating real wages, but lack of income from investments as well. As I set out in an earlier article, we seem to have cut capital values adrift of earnings. From where I look at it there are holes everywhere – in real wages, in the budget, in pension provision, in the household balance sheet, and of course in our current account imbalance.

    A point that I keep on about is the relationship between borrowing and “growth”, the latter being a recycling of the former. Household debt – or rather dependency on it – concerns me more than it seems to concern the BoE!

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