Published in Business Spectator (Melbourne), 25 October 2012
On Saturday, tens of thousands of protesters took to the streets to decry the government’s austerity policies. Trade union leaders called for an end to budget cuts and privatisation. They also campaigned for new programs to stimulate the economy and even threatened a general strike if the government did not give in to their demands.
What sounds like a familiar scene from Greece was, in fact, in Britain. The main difference between Syntagma Square and Hyde Park was that anti-austerity protests in Britain were peaceful although opposition to economic reform is certainly on the rise in the UK. London may not yet be Athens-on-Thames, but its finances hardly look sustainable either.
Prime Minister David Cameron’s government depends on central bank support, and public spending keeps increasing despite pledges to bring down the massive deficit. While the world has been watching the Continent’s euro crisis with trepidation and fear, the next big sovereign debt crisis may well happen to the north of the English Channel.
Some good news first: The UK has recorded its lowest September budget deficit since 2008. Excluding financial sector support, it was £700 million lower than last year’s figure.
Now for the bad news: In September, the shortfall between revenue and expenditure was still £12.8 billion. Public sector net debt reached £1,065.4 billion at the end of last month – or 67.9 per cent of GDP. For the current fiscal year, the UK government is likely to run a deficit of more than £120 billion (7.6 per cent of GDP).
Under normal circumstances, any government would find it difficult to sustain such large deficits over a prolonged period of time without facing upward pressure on its borrowing costs.
Not so the UK government. Yields on 10-year government bonds have fallen over the past year and are currently just under 2 per cent.
Unfortunately, this has little to do with market confidence in Britain’s fiscal future and everything to do with the Bank of England’s quantitative easing policy.
Between April and September this year, the British Debt Management Office issued new government IOUs worth £70.5 billion. Over the same period, the Bank of England (through its Asset Purchase Programme) bought £54.8 billion in UK government debt. Capital markets only had to absorb £15.8 billion of government borrowing; the rest was taken care of by the central bank. The Bank of England now has UK government debt worth £368.7 billion on its books.
In other words, the Bank of England has become the largest provider of cash to the British government – and it already owns about a third of Britain’s public net debt. It is likely that this will increase, despite the current £375 billion limit of on its asset purchasing activities. In fact, the deficits the UK government is running are so large that without the support of the central bank, yields on UK debt could rise suddenly and strongly.
So what are the chances that the Bank of England would risk such an outcome?
Britain’s central bankers are providing a safety net to irresponsible fiscal policy in the vague hope that economic growth will return and the government may eventually return spending to more sustainable levels. Unfortunately, there are no grounds for such optimism. Despite all the talk of “austerity”, in reality there are no austerity policies in place.
According to this year’s UK government’s budget forecasts spending is on the rise: From £696.4 billion in 2011-12 to £756.3 billion in 2015-16. Any savage cuts in the budget are hard to spot in the general spending binge.
Given these spending increases, who would claim that the Cameron government is delivering any kind of austerity? Well, it is the Cameron government itself – by defining austerity not as spending restraint, but as government spending relative to GDP. In this sense, and only in this sense, do they forecast decreasing government spending: From 45.8 per cent of GDP in 2011-12 to 39.0 per cent in 2015-16.
It looks too good to be true. And it is. The only way the British government’s forecasts add up is by their underlying assumptions about economic growth. According to their wishful thinking, GDP will grow by 2.0 per cent next year and then accelerate, reaching 3 per cent by 2015. That doesn’t sound too optimistic until you realise that the median market forecast for next year only stands at 1.2 per cent and even a triple-dip recession cannot be ruled out.
The UK government’s “austerity” therefore fully depends on achieving growth without adjusting the general spending levels. The question is why, then, were there tens of thousands of protesters in the streets on Saturday? What did they complain about?
As Anthony J. Evans of ESCP Europe Business School argues in a working paper just published by George Mason University, nobody in Britain has an incentive to deny the existence of austerity. The government needs to convince markets that Britain will not be the next country to face a sovereign debt crisis. Besides, the government does not wish to question the health of the UK economy as evidenced by its rose-tinted growth forecasts. The opposition, on the other hand, tries to exploit popular hostility to cuts in public services – and Saturday’s mass mobilisation shows that it is working for them.
In effect, both sides of politics overemphasise a phantom policy agenda. Last weekend’s rally was a loud protest about precious little.
In the UK, there is no austerity – just an optimistic growth forecast. The only reason there is no British sovereign debt crisis is because its central bank is helping out in fiscal policy. But notwithstanding the minuscule reduction in September’s borrowing figures, there is no sign that the situation is likely to improve anytime soon.
To be clear, Britain is not Greece. Under enormous pressure, the Greeks actually had to cut public spending while the British so far are only talking about it. However, unlike the Greeks the British still have their own currency and central bank (and they pay some taxes, too). As long as the Bank of England continues to buy UK government bonds as if there was no tomorrow, they will be just fine.
Britain’s problems will only begin once it’s realised that there is always a tomorrow.