Thursday, 20 August 2009

It is only a matter of time

When the UK finally slips into a government borrowing crisis, what is the likelihood that we will be told that it was totally unforeseeable? "We never realized that government bond yields could increase to 10 percent overnight".

July's public finance numbers were truly awful. In a normal July, the government runs a surplus. The reason for this seasonality is straightforward. The corporate sector often pays its taxes on a three monthly basis, and July is a big tax month.

However, this July the government ran up a deficit of ₤5 billion. So far this year, the deficit is running at ₤43 billion. This number will soon start to rocket. Typically the government receives most of its revenues in the between January to April as the tax year ends. The last six months of the year, the government always runs a deficit.

The writing is now on the wall for government finances. The UK deficit is unsustainably large. The clock is ticking. Something big is going to happen within the next 12-18 months.

We are now looking at three scenarios. Under the first scenario, the government stops spending, raises taxes and reduces the deficit through an emergency budget. Under the current government this is extremely unlikely, but I still hold out hope that Cameron and Osbourne will do the patriotic thing when they are elected next summer.

In scenario two, the private sector call time on the deficit and refuse to lend more money. Interest rates on government debt will rise and the government will get the message and revert to option one. Be warned. This could happen quickly and may be linked to a sterling crisis.

In scenario three, the Bank of England continues to buy government debt with newly printed cash. The private sector gently exits from the UK bond market as King and the MPC monetize the deficit. This is basically the Zimbabwean economic model. It is likely to have the same devastating effects on growth and living standards here in the UK if the Bank of England and the government persist with quantitative easing.

However, there are precious few signs that the monkeys running monetary and fiscal policy are thinking beyond a nine month horizon. The UK economy is now drifting into some very dangerous territory, and when we do nosedive into a crisis, be ready for the "I didn't see it coming" excuses.


Marchamont Needham said...

Option 1.5 is my guess. The threat of a bond strike forces the government to cut back, but not by half-enough and we end up with the worst of both worlds.

Perhaps you should start a thread on defensive strategies Alice.

Mark Wadsworth said...

Yup. It'll be a mish-mash of all three, such that in future we'll be able to argue for ever about which one it really was.

The Bin Man said...

That doesn't include the repurchase agreements the Bank of England have entered into.

It's largely overlooked that these repo's are of 2 and 3 year duration, instead of the usual 15 day rollovers. The BoE now has no option to extricate itself quickly if needed.
As a consequence Britain's now locked into £675 billion(so far) of toxic debt/assets,if these assets degrade sufficiently (and there's a good chance they will)it will leave a huge black hole in the Treasury accounts, we'll be unable to rollover our sovereign debt and therefore default in 2011.

This outcome is real and the odds are high.

Anonymous said...

The crisis will hit in October: it will be swift and we will wake up Monday morning to see the stock market in meltdown. By the afternoon, Gordon will call an emergency meeting with Alistair and Merv. At 5pm Gordon will emerge from Number 10 and address the media. He will be shaking more than usual, he will spill the bilge about best prepared etc., and then he will talk about a currency devaluation and that it will 'make Britain competitive and the envy of the world.' It will be pure BS, but he will deliver it with confidence and the old biddies who still vote will dribble their food down their fronts...

Anonymous said...

following on from Marchmont N, yeah, a thread with discussion of protection strategies for non-financial people would be a very very useful thing!