In These New Times

A new paradigm for a post-imperial world

“QE is a back-door bail-out to refloat insolvent banks”

Posted by seumasach on October 13, 2011

Talking up austerity will never bring down the UK’s debt, Mr Osborne

Liam Halligan


8th October, 2011

I don’t envy George Osborne. The Chancellor of the Exchequer has a very tough job. It should be acknowledged that, since coming into office 18 months ago, Osborne and his Treasury team, not least Danny Alexander from the Liberal Democrats, have acted with courage.

Yet the main achievement of the Coalition so far, for all the resolve on display, has been rhetorical. Osborne, supported by David Cameron, has moved Britain’s political debate into the real world, or at least a bit closer to the real world, with the focus now on the urgent and overwhelming need for fiscal restraint. Beyond the “austerity” rhetoric, though, the actual public finances remain on a cataclysmic path.

For three years after Cameron and Osborne took over their party in 2005, they pledged to “match Labour’s spending plans”. The nonsense the Conservatives spoke about fiscal policy back then was almost as irresponsible as that spouted by Gordon Brown.

The idea you could keep spending wildly while simultaneously saving was captured in the naïve notion that, once in power, the Tories would “share the proceeds of growth”. Osborne and Co. repeated this mantra relentlessly, with the same mindless determination Brown employed in his claims to have “abolished boom and bust”.

During his speech to the Tory party conference in Manchester last week, Osborne was right to maul the Labour legacy. “They thought you could borrow without regard to ability to pay, and saddled this country with the worst debt crisis in our history,” he boomed. All true. “Let us make sure that it never happens again,” Osborne cried. Yes let’s!

Government spending in August was 7.2pc higher than in the same month in 2010. During the 12 months to August, public expenditure outstripped that of the year before, even after inflation.

The UK borrowed around £150bn in both 2009/10 and 2010/11 and will borrow £125bn in this fiscal year. These figures are six-to-eight times average annual borrowing totals during the previous decade.

The entire fiscal debate is couched in terms of “paying down the deficit”. But, again, this doesn’t convey reality. The deficit is merely the nation’s annual credit card bill. The real issue is the UK’s mortgage – the national debt. Net public debt, £581bn as recently as 2008/09, is set to reach £940bn by the end of 2011/12, a 62pc nominal rise in 36 months.

Every year, of course, while the annual deficit falls, the national debt still spirals up. By 2015/16, even with the “austerity plan”, net debt will be £1,500bn says the Treasury – all of which will need servicing by continued interest payments – like any mortgage.

Back in 2009, the UK spent £31bn – around 6pc of total tax receipts – on debt interest. That’s money down the drain. By 2015, debt services costs, according to the 2011 budget document, will be £67bn a year – 10pc of the tax take. These shocking numbers are also underestimates, given assumptions of future “government savings” and, most crucially, benign gilt rates.

Include the cost of “financial interventions”, in other words, bank bail-outs, and public sector net debt is already £2,266bn, according to the Treasury fine print.

We can debate how much of that will be returned if state-run banks are sold, as long as we also discuss the inclusion of £1,100bn of public sector pension liabilities in the national debt, together with all those PFI liabilities. However you look at it, the UK’s “off balance sheet” debts are vast, and not included in the already horrendous numbers cited above.

I mention all this because, just as Osborne expressed in Manchester, “I don’t want anyone to underestimate the gravity of the situation”. The Tories say that “borrowing too much is the cause of Britain’s problems, not the solution”. Why then, is our national debt, having already risen by 62pc in the past three years, about to rise by another 60pc
(of a much bigger number) in the next four?

Some will find this analysis “offensive”. How dare I claim austerity is a myth when public sector employees are losing their jobs? It’s true the UK’s “departmental expenditure limits”, which exclude interest payments and certain benefits, fall between now and 2015/16, implying some state sector job losses. But that needs to be seen in the context of the fact that Brown’s spending was totally out of control. Under the Coalition’s plans, real terms UK state expenditure in 2015/16 will have fallen back to where it was in 2005. That’s excluding massive interest and benefit spending. And by 2015/16, the national debt we’ll have to service will be four times bigger than in 2005. Is that “austerity”? I think not.

“Fiscal credibility is not some abstract concept,” said Osborne in Manchester. “It keeps families in their homes, firms in business, people in their jobs”. Amen to that. If the UK’s creditors lose confidence, debt service costs will spike for firms and households, as well as the Government. But, given these debt numbers, is our current fiscal path credible? When they are finished with the eurozone, that is the question the markets could ask.

Labour says the UK’s cuts are happening “too far and too fast”. In reality, they’re barely happening at all. If you include interest payments, even at gilt yields artificially suppressed by government debt purchases by the Bank of England, the state debt outlook is extremely bleak.

I don’t deny the difficulties of Coalition politics. But, as a credibility-building exercise, the Tories should have apologised for “sharing the proceeds of growth” at last week’s conference. It was a sham of a position which cost them a majority at the last election. What we got instead was not one but possibly two new doses of “quantitative easing”.

Such short-sighted, desperate measures can only do more damage. UK growth is still weak, but QE won’t help. As Keynes wrote in a letter to Franklin D Roosevelt in 1933: “To think output and income can be raised by increasing the quantity of money is rather like trying to get fat by buying a larger belt.”

Yet the Bank of England, with Osborne’s blessing, has said it will reboot its “virtual printing press”, pumping out another £75bn. The Chancellor prefaced this in his conference speech by revealing “credit easing” proposals, under which the state would lend directly to businesses, bypassing the banks, again using money created ex-nihilo by the central bank.

Both policies will generate inflation. Both will debase sterling, imposing “soft default” on the UK’s creditors – which include, of course, numerous UK pension funds. And both these policies are designed, ultimately, to avoid the real problem – which remains a grid-locked banking sector.

UK growth is low because the credit channels are blocked, the result of massive counter-party risk in the interbank market. That’s because our banks, disgracefully, and despite the massive taxpayer bail-outs, have still not been forced to disclose the full extent of their trading losses. QE is a back-door bail-out to refloat insolvent banks. “Credit easing” too, while billed as “relief for small businesses”, will likely see yet more toxic bank debts taken on to the state’s balance sheet.

The Government is “tackling the banks without fear” while “speaking truth to power and wealth”, Osborne told the Tory faithful. The Chancellor has a tough job and deserves credit for making some progress. But if he is to retain the broader electorate’s respect and trust, he will have to do better than that.

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