Credit & Credibility
By the author of My Own Economics
If you hadn’t noticed, Her Majesty’s Government is in quite a lot of debt, an increasing amount of debt in fact because it runs a budget deficit (borrows more than it gets in in order to fund its commitments). As with any good problem, there’s a good battle raging over how to solve it. There are lots of ideas but they are mainly split between right-of-centre and left-of-centre political persuasions. I don’t often get Political but I fear I have to here due to where the Political parties have aligned themselves, not out of my own Political feeling I should add (of which I have very little!).
Putting aside the Political arguments across the House of Commons floor, of which we are all growing increasingly tired, there’s actually some real economics here. The government needs to borrow money, both to roll over existing debt and also fund future liabilities. This debt is sold to investors through Gilts, UK government bonds. The market for these is thankfully very liquid, with plenty of buyers (excluding the Bank of England!) willing to give the UK government their money in return for a very low interest rate and the promise of the return of the original sum after a set period. This interest rate is fairly free-floating in relation to other government debt and its price is basically determined by one thing – the fiscal and economic credibility of the government the investor is funding. The more credible the economic plan, the lower the rate, that’s how markets work. Putting aside the recent downgrade by Moody’s and the other woeful fiscal indicators we’ve seen in recent months, the UK has managed to retain an incredibly low Gilt yield compared to its balance sheet.
Put simply, the reason we can access such cheap CREDIT is that we have relatively high economic CREDIBILITY.
The next issue to confront is how to restore economic growth. Many are calling for a ‘stimulus’ package that would kick-start the economy, this would be paid for by borrowing at the very low interest rates we have secured on the international bond markets. This is putting the cart before the horse however – we have such low rates purely because we are NOT embarking on a stimulus and are keeping spending under control as far as possible. The minute we start loosening fiscal policy and therefore decrease the certainty of our treasury, our Gilt yields will shoot up exponentially in relation to the size of any stimulus.
Even Larry Summers, economic advisor to President Barack Obama, suggests that when countries secure low borrowing rates, they can start increasing spending to generate growth – it’s classic Keynesianism. But this ignores the fact that the very reason we have secured such low rates is that we are NOT increasing spending.
Keynesian economics was all well and good in a post-WW2 Britain but in the globalised financial markets of the 21st century, digging holes and filling them in again just leaves us all staring into a gaping void.