I was really irritated by a recent blog post from Paul Krugman. He was writing about UK historical debt levels.....
And you really have to marvel, given that historical record, at the deficit panic now so widespread.
That uptick at the end — you’ll see it if you squint — is what’s driving the Cameron government’s insistence on slashing spending in a liquidity trap. It’s also interesting to note — contrary to what you often hear — that at the time Keynes was writing, and calling for fiscal stimulus, Britain was substantially deeper in debt than Britain or the United States are now.
UK debt levels were higher both after the first and second world wars. Wartime government relied heavily on the patriotism of investors, in particular households, to buy war bonds. That patriotism was not rewarded in the post war period when the value of those bonds were destroyed by decades of rapid inflation. It was a lesson that has lingered in the minds of investors for decades afterwards.
Moreover, the UK financial system before the election of the Meryl-Streep lookalike was largely closed and heavily regulated. It wasn't easy for investors to buy more attractive higher yielding bonds abroad. Capital controls prevented investors placing money overseas. High street banks operated a cartel, controlling interest rates, and keeping them low. British investors were trapped by regulation and post-war government liked it that way.
Economic policies were largely dictated by the heavy indebtedness of the government, who had to limit interest rates in order to keep debt servicing costs down. During the post war period, the UK government ran balanced budgets up to the the early 1970s. Despite this heavy hand of financial repression and tight fiscal policies, the UK economy was regularly subjected to exchange rate crises. Remember the Suez crisis? Or the 1967 sterling devaluation. No, I don't either, but my undergraduate text books told me of sudden reversals of economic policies and decades of sub-standard economic growth.
However, history only takes us so far. The plan fact is that modern bond holders have become very nervous about governments that have debt to GDP ratios higher than 100 percent. Investors don't care that the UK government ran a large war time deficits and conned widows out of their savings in order to fund the fight against Hitler. Investors today care about whether they will be paid the full value of their investments.
Recent experiences in Europe tell us that when a country runs up a debt level of more than 100 percent, investors are unlikely to keep lending. There are no options for a bond financed stimulus. Governments can run up deficits by relying on central banks to print money to make up the difference, but that quickly leads to inflation. The Bank of England is doing this at the moment. It is printing money to finance the UK fiscal deficit. This is why the UK has the highest rate of inflation of any advanced economy. This is also why UK living standards are falling rapidly.
As this week's events in Europe prove, no one seriously thinks that another round of fiscal stimulus is a viable economic strategy. Keynes is a defunct economist, and Keynesianism is, intellectually speaking, a spent force. Mr. Krugman needs to catch up with the moment. This is the age of fiscal austerity.