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Comments 43 | Comment on this article
Something important happened this week: for the first time since the start of the financial crisis, investors demanded a bigger premium in return for holding British debt than Spanish. Indeed, the cost of our government borrowing – as measured by the interest rate – is rising so quickly that within a month it could be higher than Italy's.
The fact that Britain is such a risky proposition in the market's eyes has hardly gone unnoticed in the Treasury. Since last week's pre-Budget report, the mood there has been a cocktail of misery and resentment. Misery because civil servants know full well that if they lose the faith of international investors, the resulting crisis will consign the country to an even more hideous decade than they are projecting. And resentment because, fearing precisely this reaction, they recommended more ambitious plans to reduce the eye-watering deficit, only to have them nixed by No 10.
Related Articles Fresh thinking needed on debt Is this the death of the dollar? We're still waiting for a banking shake-up Bank should buy toxic assets, says IMF It's time to call a halt, Prime MinisterMuch of the worry has been over whether Britain will have its credit rating cut, but this is actually something of a sideshow. The credit ratings agencies are charged only with working out the likelihood that Britain will default on its debt – something that has never happened since the UK started issuing bonds in the 17th century, save for a fiddle with a loan from the First World War in the 1930s.
What is far more likely, or so investors fear, is that Britain will inflate the deficit away by debauching the currency: as inflation rises alongside the money supply, every pound we owe will be worth that little bit less. This is what we did in the 1970s – and most other times we have faced a debt crisis. So suspicions that a repeat performance is on the cards are not difficult to understand: the pound has already fallen by around a quarter since the start of
By Edmund Conway Published: 6:28AM GMT 17 Dec 2009
Comments 43 | Comment on this article
Something important happened this week: for the first time since the start of the financial crisis, investors demanded a bigger premium in return for holding British debt than Spanish. Indeed, the cost of our government borrowing – as measured by the interest rate – is rising so quickly that within a month it could be higher than Italy's.
The fact that Britain is such a risky proposition in the market's eyes has hardly gone unnoticed in the Treasury. Since last week's pre-Budget report, the mood there has been a cocktail of misery and resentment. Misery because civil servants know full well that if they lose the faith of international investors, the resulting crisis will consign the country to an even more hideous decade than they are projecting. And resentment because, fearing precisely this reaction, they recommended more ambitious plans to reduce the eye-watering deficit, only to have them nixed by No 10.
Much of the worry has been over whether Britain will have its credit rating cut, but this is actually something of a sideshow. The credit ratings agencies are charged only with working out the likelihood that Britain will default on its debt – something that has never happened since the UK started issuing bonds in the 17th century, save for a fiddle with a loan from the First World War in the 1930s.
What is far more likely, or so investors fear, is that Britain will inflate the deficit away by debauching the currency: as inflation rises alongside the money supply, every pound we owe will be worth that little bit less. This is what we did in the 1970s – and most other times we have faced a debt crisis. So suspicions that a repeat performance is on the cards are not difficult to understand: the pound has already fallen by around a quarter since the start of the crisis; the Bank of England has embarked on a quantitative easing scheme that involves printing enough money to buy the annual economic output of Denmark; and inflation is threatening to leap well above the Bank's 2 per cent target.
Might history repeat itself? You can understand why the market thinks so: we are facing not only the debts from the current crisis (equivalent to those incurred in the Second World War) but a looming bill of almost double the size from the ballooning health and pension costs of an ageing population. Plus, one of the peculiarities of the British debt market – that the Treasury issues bonds that take far longer to mature than most other countries' – has historically made it easy for profligate governments to create the odd burst of inflation without being punished as badly as the Italians or French, whose bonds are short-term, and so need to be rolled over more often.
Yet however much today's politicians may be tempted to try to inflate away their debts, this avenue is in fact far more difficult than it was in the 1970s. First, it would mean throwing away the 2 per cent inflation target that the Bank of England has kept to for more than a decade. Second, investors are far more mobile than 30 years ago: one of the by-products of globalisation is the speed with which capital can be withdrawn from a country. That means, according to the International Monetary Fund, that inflation in single digits – say 6 per cent – would "not make much of a dent in the real value of the debt", because investors would charge the governments higher interest rates if they got even a sniff of impending inflation. Which implies that only inflation in the high double digits – 1970s style – would do the trick.
Third – and perhaps most importantly – governments have, largely unwittingly, sewn safeguards into the debt market which make an inflation strategy pointless. Since the 1970s, we have issued an increasing amount of debt in the form of index-linked bonds, which now account for a quarter of the debt market. These are inflation-proof: the debts increase automatically alongside inflation. Then there are the country's other liabilities: public sector pensions (circa £800 billion), the state pension (£1.4 trillion) and the costs of private finance initiatives (£140 billion), all of which are tied to inflation.
In fact, around four fifths of the state's debt bill is inflation-proof. The only way ministers and mandarins could inflate their way out of the crisis would be to rip up all the contracts that tie these debts to inflation: possible in the case of the state pension (which is one reason why Gordon Brown's pledge to link it to earnings is probably doomed), difficult for all the rest.
And a good thing, too. As tempting as it is for profligate governments, permitting double-digit levels of inflation inflicts a baleful cost on households and companies. If we have forgotten this lesson from the 1970s – where the cost of the strategy was economic chaos and an IMF bail-out – it is just as well that these restrictions ought to prevent, or at least impede, the Government from taking that approach. No, the solution to today's fiscal crisis is the same as it has always been: to cut spending, reduce the deficit and learn to live within our means.
Comments: 43
What nonsense! Recent governments have NEVER devalued as a lazy way of getting out of jail. They do so because they can't sustain unrealistically high exchange rates. But doesn't the author remember the idiotic behaviour of the Conservative government of the early 90s? High interest rates (in themselves inflationary) to prop up an unrealistic rate in the European Exchange Rate Mechanism - we crashed out in 1992 with a forced devaluation and our stagnant, strangled economy quickly started to recover as interest rates dropped, imports became more expensive, encouraging both us and foreigners to buy British. Of course high levels of inflation are bad, although a small amount is necessary for economic growth (so people do better by investing rather than hide money under the mattress). But the wrong exchange rate is very bad.
Unfortunately even cuttting public spending is now not a solution. With annual government borrowing at £200 billion pounds, this equates to 8 million average (£25k py) pay jobs being funded with borrowed money that is even greater than the 6 million public sector jobs and indicating that the whole economy is now dependant on government borrowing. And this does not even take into consideration what the government funds with its tax revenues excluding this borrowing. I am sorry to say that borrow and spend Labour (as opposed to tax and spend old Labour) and Gordon Brown have bankrupted the country to an extent where there is no solution, but only poverty and everything else that goes with it.
Living within your means is all very well and not bad advice. However, what we need is some imaginative thinking to get out of the current debt situation. What we have here is the same old pathetic reaction - cut back on spending. A debate is required on the whole issue regarding monetary policy and the banking industry. Leaving bankers to run banking and the money supply is like leaving drug addicts to control opium production.
Ref: Paul at 10 am The FT sadly got it wrong in the run-up to the crisis, and some would say is still getting it wrong. But the editor did write an article in the summer apologising - most unusual these days and reflecting very well on him. He explained that financial journalists tend to get just a little too close to those managing our financial future. I remember the previous editor got things wrong too in 2000. Then in 2002 or so, his paper complained that investors had been naive in believing in technoogy stocks. I wrote pointing out that, just before the crash, the FT had been advising that ARM was a good buy at £12. I got an apology from hims saying he had checked and this was true. ARM is a first class company, has a great future, but now stands at a more sensible price of about £1.40. My preferred pages for FT comment are the penultimate two pages of the commercial section, generally more downbeat.
Only one way out... Emigrate. If you think I will be staying here to pay the price exacted by this ba****d state in lieu of bailing out the financial aristocracy,and the rest of the great 'socialism for the rich' rescue mission you can absolutely count me out.
Do you seriously think that if Brown and Balls get in next time they will not print and print?? Who pays the piper that calls the tune? The public sector unions who now command a fifth of the workforce. Are Labour going to countenance sacking their supporters? Half the UK is in a state of Soviet serfdom especially in Labour heartlands. Not the same as letting their employers go bust. So it's either TAX TAX TAX or PRINT PRINT PRINT.
There's another solution, though I tremble to mention it. Weimar / Zimbabwe style inflation, which makes the pound literally worthless. Then PFI, pensioners, and index-linked bond holders will have nothing.
Main reason this country is so absolutely wonderful is that we still have, and please God will always have, people like Pedro Verdad (08.44) around. The rest, the people like Gordon Brown and the other dross really don't matter.
Dave 0921am You are obviously not upto date with reality, what you suggest is already happening in the public service and has been for some time especially in services like the prison service and fire service, so stop the sniping which people like you like to do but dont have what it takes to do those jobs yourself. As for the countrys debt this is what always happens with a Labour government, they are very good at spending money but have no idea how to cut debt or live within their means, Gordon Brown has been the worst of the lot even now with things as bad as they are, he plans on spending even more with his pre budget bribe for the GE and billions for overseas funds which we have no way of affording. With Browns continual sabotage of the economy and refusal to come to reality, how can any future government by the Conservatives give a full and honest policy to the people before the GE, when they cannot see the books and damage done until elected which will most likely mean calling in the IMF. Due to Browns refusal to address our debt with any serious intent, our credit rating is already gone and quite possibly any future help from the international money market. Without drastic action now we are certain to be the next Dubai.
Historically, Britain did not inflate its way out of debt. After Waterloo, the national debt stood at 3 times GDP, but most of that debt was held by people with immense political clout. Although the resulting depression was severe--and did indeed cause riots--the policy was sound. The 19th century was a period of unprecedented growth. Even the French, who had historically inflated their way out of debt, saw the light and pursued sound monetary policy, which enabled them to keep pace with Britain's economic progress. Now, there is ample scope for massive cuts in public spending. New Labour have created legions of pointless government employees. I doubt that the mobs would take to the street if a Conservative government decided to hand out P45s to 'diversity co-ordinators' and health and safety officers. But higher taxes would only serve to prolong the agony--selective tax cuts to encourage economic growth would pay for themselves, as the Centre for Policy Studies has argued.
I think it is absolutely bloody obvious that we will inflate the debt away. The Pound has to be overvalued when we are using it to pay people for things when there is sod all they can buy for us with those Pounds in exchange. Our currency must adjust in value - an entirely natural correction in a global economy - with the currencies of those who currently sell to us more cheaply than we can manufacture at home. The Chinas and Indias. When this happens we will again be able to compete in a whole range of sectors in our home market and in export terms. This will mean a surge in entrepreneurialism and in employment - but by then we will appreciate that what our wage buys will be much the same as what one buys in China or India. We are going down, big time, right across the developed industrial West - thanks to the imbalance of Globalism which gives low cost centres of production access to our regional markets. Haven't noticed any politician who wants to be elected telling you that though, have you? No, instead they are busy on MMGW as a licence to print new money, invent new jobs - and hide the truth.
ToDTR on December 17, 2009 at 09:18 AM I hate to tell you,the 'pot' does not exist and never has existed if you are referring to the state pension, it all comes from the current account. Your money was blown on some mad cap government scheme as soon as you paid it in.
In last week's shambolic PBR, No. 10 forced The Treasury to hold off on making any meaningful statement on deficit management. The PBR was well summarized by Vince Cable as "good for boilers and bingo". If left unchecked, Labour will happily allow the economic ruination of the hardworking and thrifty in order to secure the votes of the feckless and indolent. The Labour clientism project - the deliberate creation and nurturing of a culture of dependency in huge swathes of the population to secure their votes - is laid bare for all to see. As you watch the wide boys in The City pocket their mega-bonuses that have been paid for with your tax money and by mortgaging your economic future - and as you watch the value of your hard-earned savings erode away by high inflation and zero interest - just ask yourself this: "who does this government serve"?
Pedro Verdad, 8.44. What exactly was the point of copying and pasting a Jeremy Clarkson article into the comments section, without acknowledging the author?
To the posters complaining that inflation is theft - it is if you have savings, but if is beneficial if you have borrowings against an asset, ie. a mortgage on a house, as your debts too decreases in real terms. Obviously, that's providing your wages inflate too of course.
Hopes of parliament waking up are mere fantasy. We vote these idiots in more becasue of our party allegiance than their ability and then stand around fuming blaming parliament for being useless. Pension age has remained unchanged in almost a century while life expectancy has gone up by 30 years. "Final Salary" pensions are just insane - income dependent during the longest, least economically productive and most socially expensive time of your life is decided on the shortest, most economically productive and least socially expensive time of your life. I fear that the only option will be for the markets to destroy this mad world the loonatic baby-boomers bequeathed to us and start again from zero.
Excellent article. I see a fudge coming with a portfolio of government spending cuts PLUS some rise in taxes and some (within limits) rise in money supply. BUT if economy worsens with a new and worse wave of unemployment, property falling, unsustainable personal debt etc, the choice may be between monetary conservatism and economic disaster, OR inflation and a different kind of disaster. Edmund is right, the RISK is real.
A comforting article. Inflation could ruin those who have been prudent throughout their lifetimes. I resent suffering lower interest rates on my capital to support those who have lived on debt. Short term thinking by Labour in anticipation of the next election is only putting off the inevitable cuts required.The sooner the population lives within their means the better.
You say the pound has already fallen by around a quarter since the start of the crisis; but how come that latterly (this week) the pound is strengthening against the Euro. A couple of months ago it nearly reached parity, today it is at 1.12 Euros??
The DT and The Guardian have had a terrible financial crisis and recession. Most articles are political rather than rational with a healthy dose of scaremongering thrown in. If you wish to get a more objective view on the current crisis I recommend dipping into the Times, FT and Economist.
Highly contentious I know but consider this: If we are in such bad shape, is there not justification to eliminate spending eg Climate change (1.5 Bn pledge by Brown), international development (?? Bn), and EU subsidy( ??6 Bn). The EU is particularly odd - why are we, a bankrupt nation, giving money effectively to poorer EU nations who are not bankrupt and will likely grow while we stagnate potentially????????
Good article. The only problem is that you are looking at it from an economists viewpoint and not from a politicians. The reality is that as soon as you start cutting expenditure you will have mass riots and social unrest. The reason is that people are over indebted and the country is over reliant on Govt created jobs. In addition, people were encouraged to take on debt by politicians and now these people have been shafted by those very politicians. Do you really think that they will simply sit still and say 'ok I will loose my job, house etc'? What you are advocating is not reality, however 'right' your arguement may be. What the solution may be I am not sure, but I will not be at all surprised if the IMF is not involved within 18months. If the Conservatives have got any sense they will tell the population about the dire economic problems now and the measures neeeded to combat it and not fall into the trap being created by NL.
Correct Edmund, 150,000 Poms do it every year, EMIGRATE, Oz is looking for skilled workers, No dole or other benifits for two years, but you won't need them, there's good,well paid jobs down under, and a guarantee your job will not be threatened by cheap,unskilled foreign immigrants.Come on down, you will not regret it.
No matter who wins the election surely the right thing to do is put 2np on direct income tax while keeping other indirect taxes under control,council tax should not be allowed to rise this way we take the hit but don't feel we are under siege from all sides When Darling reduced vat he increased fuel duty to keep fuel at the same price when vat goes back up don't hold your breath for fuel duty to go down.
For GORDON BROWN there is almost an incentive to hold the line for the next three months until the GE by using every short-term delaying tactics...promises of tax rises after his government has left the scene of the crime. By 2011 the POUND will be flying without any wings...just overweighted with trade deficits. Our all-purpose dirivatives trading banks have ruptured the engine of our economy...we have stopped dead in our tracks. Something must give...after GORDON BROWN sabotaged our future. The next Conservative government is already doomed with a scheduled appointment with the IMF.
One of the things that needs to be cut, are the pensions paid to the public sector. But as Edmund says, this cannot be cut at all. You cannot inflate away the real value of them, as they are index linked. And no doubt you cannot change the contract, as that would be a breach of the human rights of those with the contract. So you will just need to sack them, and get new people in on affordable pensions contracts, which means defined contributions. This is going to happen, whatever anyone in power tries to do. Cos if they dont address it soon, foreign investors will demand higher and higher rates of interest. Sooner or later the government will be in a position where it cannot inflate, nor can it ever raise enough taxes on the private sector to cover its expenditure. And when that point is reached, the currency will collapse, if the government doesnt cancel these contracts. Lets hope it doesnt get that far, and that the contracts are modified sooner rather than later.
Pedro 08.44. Brilliant!
My wife and I have paid into the pot ALL our working lives!, This should be shared between ALL of the British people, FIRST AND FORMOST! this before anyone else! come on parliament WAKE UP!.
Very sound and lucid advice, Edmund. Its message is entirely out of sync with the current Zeitgeist, so the strategy has every chance of working. It reminds me of a multi-panel cartoon Georg Grocsz did for a German Weimar Republic satirical periodical called Simplicissimus, which cartoon was called "How do I become rich?" The first panel was captioned "Marry into wealth," another "Pick up cigar stubs off the sidewalk," another "Film a movie," the most ominous and prophetic frame was "Start a political party," which showed the nascent NSDAP Party going about its synagogue-smashing business, but the very last frame showed the muscled back of a Ruhr miner wielding a pick axe having a go at a coal face captioned "Anything but work!" The Nineties and the Noughties were a good run for the money, if one were playing the ponies, but the "bank" always wins. Nothing like honest sweat to lend resonance and worth to one's perception of self. Pity about the pensions, though. Hope the obligations can be honoured. Thousands of retired steelworkers in the 1980's here lost out owing to predatory buyouts of defunct mills which were bought by predatory investors out solely to rob the pension funds.
By the way, congratulations to Kim L on her selection to the "Boring for England squad" at the 2012 Olympics... Edmund, don't forget the other side of the cost cutting equation, ie wealth creation. China & India are leaping ahead due to reversing their state central highly regulated socialist theories, in favour of much more freer markets. It's not just higher taxes killing UK here, Tony B-Liar's adoption of Europe's highly regulated processes has curtailed & inhibited job creation & entrepreneurial drive in the UK. We need to free business from the Health & Safety/Human Rights quagmire so that jobs are created here as well as more dynamic less regulated countries, which will do more to pay down debt than simply cutting back Labour's administrative hell.
The issue of inflation is seen solely for the most part in the light of the current financial crisis. Governments can and do (sometimes unwittingly) provoke inflation. But against greater global demand for finite commodities and resources, the main impetus for long-term inflation is global, non-governmental, and ultimately irresolvable without some form of military conflict. Overall I think the Telegraph's finance coverage to be far and away the best in the mainstream media. But sometimes the financial analysis gets too tied up to critiques of government policy; I agree in the short to medium term, government policy needs to be changed radically; in the longer term, we are largely hostages to fortune on a national level. So buy gold, commodity trackers, and defensive stocks to protect your individual wealth.
I've given the matter a great deal of thought all week, and I'm afraid I've decided that it's no good putting Peter Mandelson in a prison. I'm afraid he will have to be tied to the front of a van and driven round the country until he isn't alive any more. He announced last week that middle-class children will simply not be allowed into the country's top universities even if they have 4,000 A-levels, because all the places will be taken by Albanians and guillemots and whatever other stupid bandwagon the conniving idiot has leapt on. I hate Peter Mandelson. I hate his fondness for extremely pale blue jeans and I hate that preposterous moustache he used to sport in the days when he didn't bother trying to cover up his left-wing fanaticism. I hate the way he quite literally lords it over us even though he's resigned in disgrace twice, and now holds an important decision-making job for which he was not elected. Mostly, though, I hate him because his one-man war on the bright and the witty and the successful means that half my friends now seem to be taking leave of their senses. There's talk of emigration in the air. It's everywhere I go. Parties. Work. In the supermarket. My daughter is working herself half to death to get good grades at GSCE and can't see the point because she won't be going to university, because she doesn't have a beak or flippers or a qualification in washing windscreens at the lights. She wonders, often, why we don't live in America . Then you have the chaps and chapesses who can't stand the constant raids on their wallets and their privacy. They can't understand why they are taxed at 50% on their income and then taxed again for driving into the nation's capital. They can't understand what happened to the hunt for the weapons of mass destruction. They can't understand anything. They see the Highway Wombles in those brand new 4x4s that they paid for, and they see the M4 bus lane and they see the speed cameras and the community support officers and they see the Albanians stealing their wheelbarrows and nothing can be done because it's racist. And they see Alistair Darling handing over ?4,350 of their money to not sort out the banking crisis that he doesn't understand because he's a small-town solicitor, and they see the stupid war on drugs and the war on drink and the war on smoking and the war on hunting and the war on fun and the war on scientists and the obsession with the climate and the price of train fares soaring past £1,000 and the Guardian power-brokers getting uppity about one shot baboon and not uppity at all about all the dead soldiers in Afghanistan, and how they got rid of Blair only to find the lying twerp is now going to come back even more powerful than ever, and they think, "I've had enough of this. I'm off." It's a lovely idea, to get out of this stupid, Fairtrade, Brown-stained, Mandelson-skewed, equal-opportunities, multicultural, carbon-neutral, trendily left, regionally assembled, big-government, trilingual, mosque-drenched, all-the-pigs-are-equal, property-is-theft hellhole and set up shop somewhere else. But where? You can't go to France because you need to complete 17 forms in triplicate every time you want to build a greenhouse, and you can't go to Switzerland because you will be reported to your neighbours by the police and subsequently shot in the head if you don't sweep your lawn properly, and you can't go to Italy because you'll soon tire of waking up in the morning to find a horse's head in your bed because you forgot to give a man called Don a bundle of used notes for "organising" a plumber. You can't go to Australia because it's full of things that will eat you, you can't go to New Zealand because they don't accept anyone who is more than 40 and you can't go to Monte Carlo because they don't accept anyone who has less than 40 mill. And you can't go to Spain because you're not called Del and you weren't involved in the Walthamstow blag. And you can't go to Germany ... because you just can't. The Caribbean sounds tempting, but there is no work, which means that one day, whether you like it or not, you'll end up like all the other expats, with a nose like a burst beetroot, wondering if it's okay to have a small sharpener at 10 in the morning. And, as I keep explaining to my daughter, we can't go to America because if you catch a cold over there, the health system is designed in such a way that you end up without a house. Or dead. Canada's full of people pretending to be French, South Africa's too risky, Russia's worse and everywhere else is too full of snow, too full of flies or too full of people who want to cut your head off on the internet. So you can dream all you like about upping sticks and moving to a country that doesn't help itself to half of everything you earn and then spend the money it gets on bus lanes and advertisements about the dangers of salt. But wherever you go you'll wind up an alcoholic or dead or bored or in a cellar, in an orange jumpsuit, gently wetting yourself on the web. All of these things are worse than being persecuted for eating a sandwich at the wheel. I see no reason to be miserable. Yes, Britain now is worse than it's been for decades, but the lunatics who've made it so ghastly are on their way out. Soon, they will be back in Hackney with their South African nuclear-free peace polenta. And instead the show will be run by a bloke whose dad has a wallpaper shop and possibly, terrifyingly, a twerp in Belgium whose fruitless game of hunt-the-WMD has netted him £15m on the lecture circuit. So actually I do see a reason to be miserable. Which is why I think it's a good idea to tie Peter Mandelson to a van. Such an act would be cruel and barbaric and inhuman. But it would at least cheer everyone up a bit. This is a splendid rant from Jeremy Clarkson which I wish I had written.
An important error: contrary to what the author states, there is a problem in rolling over maturing debt in a market saturated by the issuance of new debt, it’s just that roll-over is but a small percentage of the total issuance planned for the next four years. The risk of default is also much higher than implied given that in four years we will still be borrowing £80-90Bn annually of which £60Bn will be needed to pay interest. When a country needs to borrow to cover interest the risk of default is shall we say material, whatever its past history. But that’s only the plan and it will never happen; the reality is that market will not lend us enough to default on a truly epic scale. The government has spent the last year flogging debt out the front door while the BofE buys it in through the back door, thus the amount of Gilt debt in the market has remained relatively stable. A neat trick now over and 2010 will test the market appetite for a phenomenally expanding Gilt stock. I tell you now, the appetite isn’t there. California here we come!
Get the army out of the quagmire in Afghanistan. Halt all foreign aid. Instantly fire anyone who has the word / words "gender", "equality", or "outreach" in their job title. Hold a referendum on our membership of the EU - a "no" vote would save 40 million a day. The negative effects would be . . .? Halt all child benefit payments to immigrants. Halt all benefit payments to those who express a desire to see Sharia law in the UK. This would be just a start in reducing debt and cutting out the dead (foreign) wood.
Yes, it's called death.
Inflation is theft. Every chancellor for the past 50 years has indulged in theft and deception. Never ever trust a politician.
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