Friday, 24 April 2009

Someone else's problem

It's early days, but Darling's midweek budget is starting to look like a disaster for New Labour.

Although a majority seems happy with the idea of taxing the rich, most people see through New Labour's cynicism. Their sudden discovery of income inequality comes too late to save them.

If the tax hike was meant to be a trap for the Conservatives, Cameron and Osborne have inconveniently stepped aside. They know that the next election is in the bag. New Labour have comprehensively wrecked the UK economy and therefore a undemanding strategy of saying little and waiting should be sufficient to see a Conservative government safely established by June next year.

As an electoral tactic, the budget has failed. However, as Brown contemptuously focused on trying to embarrass the Conservatives, he neglected the core issue that now confronts the UK. Simply put, the question is fiscal sustainability. Brown and Darling are planning for two straight years of deficits in excess of 12 percent of GDP? Can they get away with it?

It all depends on what we mean by "get away with it". Many newspapers today, most notably the Wall Street Journal and the Telegraph, openly questioned whether the UK government can sell the huge quantities of debt required to finance the Darling’s deficits.

There is a strong implication that the UK could be heading for a sudden disaster. Investors may go on strike and refuse to buy government paper. It has happened before, most notably in the 1970s, when an earlier Labour government tried to run up large deficits, which were ironically, significantly smaller than the ones that Brown and Darling are proposing today.

It is of course always exciting to contemplate catastrophe. Moreover, economists and journalists are particularly prone to apocalyptic visions. Personally, I shouldn't be too critical here. I, too, have been known to dabble with colourful language to describe the future.

A more serious and probable risk comes from interest rates. Investors, at least in the short run, will be willing to buy government debt so long as they are adequately compensated. This means if the yield is high enough, the investors will come.

Government debt yields do not live in isolation from other interest rates in the economy. If the government has to pay more on its new debt, this will pull up rates on corporate bonds, mortgages and even personal borrowing.

As a tsunami of government debt hits UK capital markets, the high yields required to finance the government's huge deficits will squeeze out public sector investment and consumption. This is known as crowding out. It was something very familiar to Brown's predecessors - Callaghan and Wilson.

None of this will matter to Brown. By the time government yields start to rise, and bring down the private sector, he will be blissfully drawing his pension and waiting for his knighthood. It will be some else's problem.


Josh said...

Not quite someone else's problem; it is everyone's problem.

Ian said...

Josh, Alice was speaking from Brown's POV. He personally will not have to worry about it. But you are right in that literally everyone else will be affected.

Anonymous said...

They better not dare give him a knighthood. A fair trial is good enough. The man's an imbecile.

Anonymous said...

This budget is going to cost me, now if it meant better education, or better health care, or better public transport, or better anything then OK.

But helping to pay out for a giant ponzi scheme..... Not Happy

Helping paying for big fat bonus for the idiots running the ponzi scheme..... NOT F*****G HAPPY

Liam said...

All those nu-labour voters who used to enjoy browsing the estate agent windows on the way back from work, and watching the value of their homes skyrocket will now realise that this was not money in bank, and moreover they too are going to foot the bill for Brown's debt extravaganza.

DBC Reed said...

As someone who is really,really old,I can remember the crowding- out argument from the days of Wilson and the totally up-himself
Callaghan.Then the the tale was that the public sector was squeezing out the private sector in some kind of competition to borrow.

Anonymous said...

DBC REED: "I can remember the crowding- out argument from the days of Wilson and the totally up-himself Callaghan."

Is the argument right or wrong?

In an expanding economy, such as Wilson and Callaghan benefited from but just thought was normal, you might be able to discount the effect.

In a contracting economy we are currently experiencing and may well continue to experience for at least another decade, it will make a BIG difference.

Man in a Shed said...

I propose putting Darling and Brown on trial after the next general election.

Since society will take at least 30 years paying of their debt, they should be paying of their debt to society by doing porridge.

( Made the same suggestion to John Redwood - he thought it a little extreme - but I think people might come round to it. )

Anonymous said...

Alice great blog.

The plan of the government is to fix the market. A big problem which generates unemployment is companies access to funding and their ability to roll-over debt. At the moment, gilts are seen as preferable to bonds because of the likely losses during the recession.
However, at some point, gilt issuance will swamp the market and the credibility of the UK government will tip the favour back to bonds again, as long as an inflationary problem can be avoided.
Unfortunately of course, that leaves the UK with a funding crisis.
Rock and a hard place.

amigauser said...

The government will have no problem selling its gilts, the banking system is about to be required to buy them as part of their tier 1 capital

You keep saying that the tories have the election in the bag, but by next year the results from all this spending will have started to lower unemployment, moderate growth etc

AntiCitizenOne said...

Income taxation RAISES income inequality as those with rare skills raise their wages to keep relative wages static.

Anonymous said...

amigauser, the banks need AAA rated bonds or equity for tier one capital. Don't have to be gilts.

Absolutely no one outside NuLab believe there is going to be growth next year and employment lags recessions - even assuming your non-sequitur is true