Scottish-born economist - Angus Deaton - recently published his new book - An Immigrant Economist…
George Osborne, Britain’s vandalising exchequer gave his Conservative Party Conference speech yesterday in Manchester. The Transcript is courtesy of the New Statesman. Like everyone I scanned the speech for signs that the British Government was prepared to suspend its ideological arrogance for the sake of the economy, which the people had entrusted them to revive. No such luck. Instead the nation was presented with a self-satisfied denial of the basic problem that is sending the British economy into reverse gear after showing some signs of recovery about the time the national government changed hands. The problem for Britain is that the Government has outlined the wrong problem and proposed the wrong solution.
His classic line I thought was:
But borrowing too much is the cause of Britain’s problems, not the solution.
If he had been referring to the private domestic credit binge then I might have agreed. But, in fact, he was constructing the crisis in terms public borrowing that accompanied the fiscal stimulus – which on any reading of the data underpinned the nascent growth that has now petered out.
He claimed that a “British economy freed from its debts; growing strongly; spreading prosperity to all our people” was the “prize” that had all British people had to keep their eyes while being “careful not to talk ourselves into something worse”.
Last night on Australian TV, the Australian Broadcasting Commission’s Four Corners program ran a documentary they called – Poor Kids. It is a very sad tale. It is about deepening child poverty in Britain.
The incredible fact is that in the advanced world the younger generations are facing higher poverty rates than their parents generation at a time when average per capita income is generally rising (after taking a hit during the worst stages of the crisis). The reason is that inequality is rising and persistently high unemployment is concentrated among disadvantaged groups. The bankers and their cohort are once again doing very well – helped along by government bailouts – but the unemployment living in inadequate state housing face very bleak futures.
It is hard to see George Osborne’s message providing any hope to the kids and the parents in the story. Eurostat report that youth unemployment in the UK has risen from 15 per cent in 2008 to 19.6 per cent in 2010 and now stands at 20.4 per cent.
But the Four Corners program also shows how unemployment among the adults dramatically reduces the opportunity set available to their kids.
So it is laughable (in the tragic sense) to hear Osborne tell the conference delegates that their fiscal austerity program is designed:
so we can fulfill that solemn promise to the next generation … we will leave the world a better place than we found it.
There is no doubt the current policy set will leave Britain in a worse place than it was in 2010. It is already sliding downhill from where it was in May 2010 and it will get worse.
Osborne then conducted some causal analysis and concluded the the crisis was “created by the mistakes of human beings” which is not a very remarkable finding. The only problem is that his list of “mistakes” is the wrong list.
First, the last government borrowed too much money.
They thought you could borrow without regard to ability to pay, spend without regard for value for money, all on the premise that boom would never end in bust.
They saddled the country with the worst debt crisis in our history.
There is no public debt crisis in the UK. It is a total fabrication of the conservatives to, first of all, win office, and then, to renew their traditional attack on the Welfare State and trade unions and ensure that a higher proportion of real income is transferred to the privileged.
Since 1971 (or thereabouts), the British government has never had an issue with meeting all its sterling obligations. It may have spent unwisely but that is a separate issue from whether it was always solvent.
I also wondered about the historical veracity of the claim that this was the “worst debt crisis in our history” – just in terms of the history of public debt ratios in Britain.
My conclusion is that Osborne lied to the assembled audience in Manchester.
The following graph cobbled together from data I have accumulated largely from the British Treasury sources shows net public debt as a percent of GDP in Britain from 1900. The longer time series tends to put “currency” into perspective. Further remember that for much of this period the British government was operating with a convertible currency system which places more financial constraints on it that at present (with a fiat monetary system and a floating exchange rate).
The ratio peaked in 1947 at 237.94 per cent reflecting the war effort and the residual of the Great Depression. If you then ask what followed in the recovery period after the Second World War you will realise that the British government introduced a comprehensive Welfare State including the Nationalised Health Care system and the economy grew strongly until the mid-1970s, all the while reducing the public debt ratio.
Coupled with information from the UK Guardian’s Datablog (Spreadsheet Download) we can see the history of the public net debt ratio (as a per cent of GDP) since 1946 in Britain. The last two years are the Conservative-Liberal Democrat coalition which for all intents and purposes is Conservative.
The evidence doesn’t support the conjecture that the Labour Party ran up more debt than the Conservatives.
He then blamed the banks:
… who ran up staggering debts of their own, buying financial instruments even they couldn’t understand.
The banks and those regulating them believed that the bubble would never stop growing, that markets were always self-correcting, that greed was always good, that their ponzi schemes would never collapse, and that none of the debts would ever turn bad.
I agree that the banks were instrumental in loading too much debt onto a poor risk base and because they were involved in a “pass the parcel” game (pushing securitised but unfathomable “assets” onto third-parties they didn’t really care.
Finally, he blamed the Eurozone for designing a flawed monetary system. I agree completely with the fact that “Our European neighbours plunged headlong into the euro without thinking through the consequences” but the flawed design did not cause the crisis nor is it prolonging it.
The poor design is a problem but even with that the ECB has the capacity to ensure there is enough spending in the EMU to stimulate growth. The reluctance of the Euro leaders to unleash that capacity and instead to impose harsh austerity onto the suffering economies is the reason the Eurozone is going backwards.
Eventually a new government has to stop blaming the past regime and take responsibility for the state of the economy. The Conservative Government was elected in May 2010 at a time when growth was resuming and unemployment was falling. For a time, the fiscal stimulus of the previous government maintained growth even though the Tories were promising austerity.
As the fiscal austerity starts to bite now and the economy goes backward and unemployment rises again there is only one entity to blame – the current British Government.
The events in the EMU are not to blame. The past Labour government is not to blame. It is all down to the fiscal austerity that has been imposed on the domestic economy.
We then moved on to hear what he was going to do about the obstacles “to jobs and prosperity”.
At that point his classic statement was heard:
But borrowing too much is the cause of Britain’s problems, not the solution.
He rejected public borrowing claiming it would jeopardise “the priceless fiscal credibility that this government has earned with the international markets” and drive up interest rates.
Clearly he lacks a feel for the empirical world. Why has Japan enjoyed zero interest rates for 2 decades despite having deficits and public debt ratios that make Britain look positively dwarf-like? Why are yields low and falling in the US?
Obviously, he doesn’t want to acknowledge an understanding (if he has it) of how interest rates are set and the monetary operations associated with budget deficits (which place downward pressure on the central bank interest rate target).
He had the hide to claim that fiscal austerity (“the deficit plan”) had “brought us the stability other nations today crave”. I don’t define stability in terms of a real economy that is heading back into recession and a labour market that is shedding jobs. That is an unstable situation. I also don’t see any “monetary” instability in other fiat currency-issuing nations (for example, the US or Japan).
In outlining how the British government will “help business create new jobs” he said “low interest rates” was crucial. Maybe, but the Bank of England sets the interest rate rather than the Treasury.
He gave a curious example of high rates of interest in the Eurozone but then said “Our budget deficit is bigger than the lot of them – but here in Britain our market interest rates are today just 2.5%” which would suggest that budget deficits have very little to do with interest rate determination in a fiat currency system. The comparison with Greece, Portugal, Spain or any other EMU nation with Britain completely misses the point that the EMU nations are not operating within a fiat monetary system.
The second part of the plan (other than low interest rates) is “to get credit flowing in our economy”:
Credit means investment. Investment means jobs.
I always find it curious that public debt is bad but private debt is good especially given that the financial crisis is really about excessive private debt fuelled by an out of control banking sector. The reason the private sector is not spending at present is because they have too much debt overall.
So why would Osborne think the solution lies in expanding private debt? Why is it sound to replace public spending with private debt if private debt is excessive in the first place?
He then outlined a scheme that he is trying to say is “similar to the National Loan Guarantee Scheme” (which they advocated in Opposition) but looks more like a borrowing scheme.
The details remain somewhat obscure. He said that the Government has “set the Treasury to work on ways to inject money directly into parts of the economy that need it such as small businesses” which he called “credit easing”.
As best one can work out “credit easing” might see HM Treasury purchasing billions of pounds worth of bonds issued by SMEs to provide working capital to these firms to overcome their lack of access to bank loans.
Osborne explicitly said that it might “help solve that age-old problem in Britain: not enough long-term investment in small businesses and enterprise.”
The Wall Street Journal article (October 4, 2011) – U.K. Unveils New Stimulus Plan Amid Cuts – reported that:
An aide later said the Treasury would sell gilts and use the proceeds to buy corporate bonds issued by such businesses.
The WSJ also noted that “small companies generally don’t issue bonds”.
The UK Guardian article (October 4, 2011) – Credit easing – what is it? – was more helpful.
It said that:
Credit easing could involve banks packaging up small- and medium-sized firm’s debts and selling them on as securities to the Bank of England. George Osborne and the Treasury are still trying to work out exactly what their version of “credit easing” looks like but it is likely to involve buying corporate bonds – IOUs issued mainly by big companies – rather than bonds issued by the government (which is what the Bank of England’s “quantitative easing” is).
Which addresses the fact that small businesses do not issue corporate debt instruments.
So the plan seems to involve the banks packaging up “small company loans and overdrafts into so-called securitisations which could then be bought” in the corporate bond market.
The Guardian says that the UK Government “is trying to avoid the Treasury making direct loans” to ensure the operation is deficit neutral. Instead it seems that they want to induce the banks to make more loans by pushing the risk on the Treasury.
So it is a guarantee type scheme and if the loans work out they deficit would not be impacted.
According to the latest Small Business Support – May & June 2011 – published by BBA, which is the “leading trade association for the UK banking and financial services sector” the reason that small business is not borrowing that they are actually trying to reduce their debt levels.
The BBA says:
The average monthly value of new term lending in the first half of this year, of £500mn a month, is only slightly lower than throughout 2010, but net lending has contracted more (£332mn a month) than last year. This reflects the appetite of small businesses to pay down their borrowings and, in an uncertain environment, with trading confidence fragile, build up cash reserves. The average monthly rise in deposits (£473mn a month) is significantly higher than in any year since the financial crisis, generating a record level of £58bn.
The Report also says that “(t)he aggregate value of deposits in small business current and deposit accounts is strong”.
In a related publication – Lending to UK businesses and individuals which allows one to compare the lending to SMEs and small business against business in general.
The following graph shows the rate of grwoth in the stock of lending (not seasonally adjusted) to all non-financial corporations (PNFCs), small business and SMEs from March 2008 to May 2011. There were some missing observations for small business.
The data shows that during the reduction in the growth of lending to small business and SMEs is not out of line with all firms.
The problem facing the UK economy is a lack of demand. Cutting public demand at a time when private demand is weak and being driven by a lack of confidence will not solve that problem.
There is too much private debt and the only responsible path for the national government is support the process of private debt reduction while stimulating growth via expanded budget deficits.
The British Government clearly eschews that responsibility.
That is enough for today!