Saturday, 20 June 2009

A day in the life of Alistair Darling

Poor old Mr Darling; with only months left before he faces the wrath of the electorate, he is certain to earn the title “Britain’s worst Chancellor”. During his short tenure at the Treasury, he has been responsible for the largest fiscal deficit in history, coupled with the deepest financial crisis in a century.

The Chancellor is now stuck between a rock and a hard place. The financial arguments in favour of expenditure retrenchment are overwhelming. Both the Treasury and the Debt Management office have pressed the red button. They have told the chancellor that the current policy framework runs the risk of an outright fiscal crisis.

However, Brown's electoral strategy has painted the Chancellor into a corner. The Prime Minister will not countenance any public expenditure cuts until after the election.

Meanwhile, the Bank of England's wild experimentation with quantitative easing has only added to the Chancellor's problems. The BoE is printing money, offering mortgage guarantees and generally building up a huge repository of problems for the future.

Darling is in a deep dark hole and there is no way he can dig himself out.

The Treasury reality check

Every day, Darling has to face his senior Treasury officials, who arrive in his office with ever more alarming numbers about the deterioration in public finances. This year, the deficit could be as high as ₤200 billion.

The numbers will be packaged in memos pleading for expenditure restraint. However, Darling knows his capacity to rein in spending departments is close to zero. The best he can do is to ensure that he can come up with the cash to cover the deficit.

The UK debt blow-out

The message from UK's debt management office is also dire. It has warned Darling about the increasing difficulties in meeting the mounting financing demands from the government. With each passing week, its capacity to sell government paper is being tested to the limit. Although it has a few remaining tricks in its box, such as syndicated commercial bank debt issuance, there remains a serious doubt whether the UK government securities market can absorb such a huge increase in supply.

An increase in government bond yields offers the only hope for satisfying the financing demands of the government. Nevertheless, higher yields undermine the government's stated aim of increasing credit flows to the private sector, especially the housing market.

The Bank of England - Whatever happened to interest rate management?

The Bank of England has deeply disappointed Mr Darling. The monetary policy committee had promised that quantitative easing would bring interest rates down. Last autumn, the committee had, for all practical purposes, lost control of interest rates when it began to cut its policy rate below the rate of inflation. All other interest rates in the economy obdurately refused to decline, most notably mortgage and corporate lending rates.

The MPC thought that wall of money would do the trick, allowing it to re-establish control over liquidity conditions. Instead, quantitative easing has provoked an increasing fear of rising inflation that has pushed up long-term interest rates. In short, the BoE and its wacky ideas about monetary policy only have created more problems for Darling. Despite the unambiguous evidence that quantitative easing has failed, the BoE are likely to persistent in this yield-raising foolishness.

The chief won't listen

Darling understands that the sensible thing would be to cut back on public expenditures. At this stage, the magnitude of cuts wouldn't have to be too dramatic. All he needs is a sustainable and convincing deficit reduction plan, with a modest expression of commitment in this fiscal year. Once markets understand that this year's huge deficit is a temporary event, the government will be able to sell debt at lower yields.

Although the Chancellor has undoubtedly presented the case for fiscal prudence, Mr Brown has countered with his electoral strategy. The Prime Minister wants to paint the Conservatives as the party of draconian public expenditure cuts. This theme would look rather weak if Brown were to start the expenditure retrenchment before the election. Brown wants New Labour to be the party of the public sector, and Darling's desire to establish a modicum of macroeconomic stability conflicts with the strategy.

A 12 percent of GDP deficit is a post election problem.

This “ignore the deficit" game plan runs the risk of a catastrophic fiscal crisis, where investors are unwilling to provide the financing to cover the deficit. However, for the Prime Minister, it is a risk worth taking. If the crisis happens, the election is lost anyway.

If the crisis can be avoided, and some modest economic growth could be restored, coupled with stabilising house prices, then the chances of a new Labour victory increase. If Labour wins, it has five years to clean up the mess. If it loses, it is someone else's problem.

14 comments:

sobers said...

Spot on analysis. I'm beginning to wonder if there is a realistic possiblity of getting a legal challenge against the govt (effectively Gordo) for its actions to stand up in court. The blank refusal to face the fiscal facts borders on criminal negligence.

mark said...

I think the only thing preventing interest rates going through the roof is that the market has already factored in a Tory victory and with it the prospect of some sort of fiscal discipline.

If there is even so much as a sniff that Labour is back in the running or that there might be a hung parliament then rates would be off to the races.

However as long as its Brown/Cameron though I think we all know whats going to happen - party manifestos will be of zero consequence.

mark said...
This comment has been removed by the author.
Matt, Oxford said...

Surely this was all Brown's fault?.

It's a bit harsh to lay the blame at Darling's feet when he's only been in the job a short while. Gordo's economic mismanagement will take years to sort out!

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Anonymous said...

No way. Brown is the worst. Hands down. Imbecile that man.

Np said...

Gordo thinks he needs to keep spending, and hence keep borrowing, to save the Labour vote. We're going down big time to preserve his political needs. We all know that the worse PM of all time, and the worse government of all time will be kicked out at the next GE anyway, so it's money down the drain. If democracy really worked, we should be able to remove this bunch of losers NOW, before it's too late.

DBC Reed said...

Tony Giveaway Barber is easily the worst post-war Chancellor conjouring up the sharpest housing inflation on record in the early 70's from a standing start of near flat house prices (thanks to the previous credit controls and farther back an effective tax on housing [Schedule A]).He brought into being banking collapses, union trouble and the full gamut of problems we now face.The economy has never got over his brief period in office.

Anonymous said...

I nominate Nigel Lawson, he was supposed to know what he was doing, unlike all of the others.

Anonymous said...

Excellent blog

But surely, the Dollar is global reserve currency and as such, all national governments outside the USA have been playing Greenspan's folly for 15 years?

If the US financial system had got its house in order after the DotCom crash, we might have avoided this scenario but NuFascist has played Wall Street's game all along.......with catastrophic consequences....as yet not even beginning to wreak the havoc that is surely due.

NuFascist has been a disaster for the UK but Bush, the Federal Reserve and Greenspan are the biggest villians of all. All nations have been held to ransom by dollar hegemony and even the best intentioned national governments would have struggled to avoid what is around the corner.

All roads lead to Washington, the the Fed as far as I'm concerned. If only Ron Paul had been in the Whitehouse!

APL said...

DBC Reed: "Tony Giveaway Barber is easily the worst post-war Chancellor conjouring up the sharpest housing inflation on record in the early 70's"

'Giveaway', Oh! you mean not taking as much as a Labour chancellor would have.


DBC REED: "He brought into being banking collapses, union trouble and the full gamut of problems we now face."

Never been a bank collapse before in recorded history according to Mr Reed.

Never been union formented industrial 'unrest' either. These inovations were all AB unique contribution.

DBC Reed: "The economy has never got over his brief period in office."

The economy has never got over the Welfare state. Which has got to the state of affairs that 20% of the workforce are paid to do nothing and Labour import labour (from the wreck of eastern Europe - where if I recall correctly, Anthony Barber had little influence, economic or political ) - to work at below subsistance labour rates in the UK.

Anonymous said...

AC: "[Darling] is certain to earn the title “Britain’s worst Chancellor”."

Well, it is true, that would be unfair. Since it is his boss, Gordon Brown who has done the most damage.

But then Darling should have taken the office of Chancellor seriously, not as an opportunity to expand his expense account.

DBC Reed said...

Oh dear I seem to have upset APL.Heigh ho!
As this site is UK bubble I think it reasonable to mention AB ,the founding father/patron saint of bubble economics,who did not just keep taxes level but actually decreased some of them at the behest of Tory Mod Edward Heath (who got rid of the resale price maintenance and put small shops out of business)because Heath wanted to get the UK economy straight for EU entry.Barber was put in charge of EU negotiations and the economy,as a matter of fact.

APL said...

DBC Reed: "Oh dear I seem to have upset APL."

I am sure, we will both survive.

DBC Reed: "As this site is UK bubble I think it reasonable to mention AB .."

Of course it is reasonable to mention AB, it is misleading though, apart as well from being incorrect, to ascribe to him sole responsibility for banking collapses and union unrest. These things had happened before Barber.

DBC Reed: " .. Edward Heath .."

Was a rotten Prime minister.