Monday, February 22, 2010


In the lead-in to the general election in a few months the sore-head-in-hands debate about government borrowing and the national debt is especially politically venal. One effect is to rule out discussion on whether public spending cuts are necessary at all? The debate is focused by 67 economists and their supporters validating Darling's wait to see if recovery is secure then 'cut later' and the 20 economists and their supporters backing Osborne's let's not wait 'cut now'. The 67+ say that cutting now is foolish and arguments for doing so are without any rigorous proof. The 20+ say it is a matter of market confidence and thereby elevate appearance over substance.
There is also underlying this a fightback by monetarists and general equilibrium theorists apalled at the whole world apparently re-embracing Keynesian thinking.
At least the Keynesians have empirical macro-economics models and the National Income accounting system to rely upon. They 67 are not just theoreticians, but aware of the only models that predicted credit crunch and recession, which were Keynesian - emphasising the accounting link between net acquisition of financial assets and trade balances, which pre-crisis had globally become very extreme that is not central to FSA, Bank of England and other similarly expert views.
The 20+ opponents take their ideas from relatively isolated factors echoing and being echoed by the limitations of media comment and debate. Some of their supposed fears are for loss of confidence in UK that might hit the currency and even of a buyers strike for UK government debt. But is this reality or merely political flag-waving - is there really a possibility of banks refusing to buy gilts in the £200 billions of auctions in 2010? Buyers regularly threaten partial strikes to lever a discount in the primary market. But there has never been such a strike to my knowledge and indeed there cannot be one now because financial services firms are hungry for government debt including by being forced to buy and hold onto twice as much as normal to shore up their capital solvency. In the UK especially there is the usual high demand for long-dated debt by insurers and pension funds. Gilt maturities are well balanced between short, medium and long dated. Demand, respresented also by annual turnover in the secondary gilts market trading is at least £3 trillion (official DMO figure). With new issuance last year and this the turnover should nearly double. It should be double this already, but even with less than half, probably less than one quarter, truly available at any time for trading, turnover seems low, indicating pressure on banks and others to hold their gilts and the effect of uncertainty on pace of future base rate rises.
The only purpose of strike rumours is to generate small primary market discounts, a moot matter when £198bn has been 'bought in' this year under QE. Government has about £300bn in gilts that it could 'restructure' and sell directly into the secondary market without changing National Debt. Some, perhaps politically-minded commentators, e.g. Daily Telegraph, say they fear a "re-run of 1976 IMF debacle" and a "full-blown (government) funding crisis", or perhaps some would welcome precisely that if only it can be manufactured before the general election 1976 was a crisis for Labour but not a full blown one - that was Black Wednesday 16 years later for the Conservatives when the cure was, following my advice given on Tuesday, as I like to think, to withdraw from the EMS currency snake. '76 was a crisis of confidence' without doubt, and it was political, but the UK never did not have to draw on the IMF standby credits provided i.e. there was an over-reaction to current economic data that was subsequently revised upwards as is most often the case with UK National Income data.
Some commentators want to characterise National Debt at more than double the official total (including public sector pension future liabilities + off b/s liabilities). This is a silly argument, and could be more devastingly applied to private sector indebtness - and arguably should not be so applied to estimating pension fund shortfalls as if pension funds should not take sensible account of future premium and investment income. If public sector debt should be so calculated gross (without net balance) then why not include all the liabilities of the nationalised banks as well for another £3 trillions plus £1 trillion plus of BoE/HMT off balance sheet repo swaps with assets of the banks?
Gross debt is important to know, but so are the the full balance sheet of assets, liabilities and collateral, worth in the government's about £1.5 trillion at market prices, plus another £2.5 trillions at the nationalised banks excluding funding gap borrowings.
Nearly half of the National Debt is today internal to government, merely representing debts between various arms of government including the more than one quarter held by Bank of England which offsets its t-bill etc. off budget/off b/s borrowings from HMT? Commentators have been very unclear about how to interrpet
UK government borrowing of £200bn in 2010-11 while at the same time having bought £198bn in under QE in 2009-10? The same question arise in the politicised debate about US Federal debt.
Even if UK National Debt triples in ratio to GDP compared to pre-crisis levels, this will be because income and corporation tax receipts not only fell but are taking a few years longer than normal to recover. This will only happen if the private sector is not pulling its weight in dragging recovery forward sooner. The 20+ economists cannot say why government deficit spending constrains the private sector from gaining recovery sooner?
Public spending cuts won't help, and if new debt issuance is any less than planned, there will also be an unmet demand I calculate, from the banks and others. Then UK financial sector firms will have to buy a lot of foreign government bonds with predictably higher external account deterioration including in the trade balance, which continues needing to be financed.
New global and EU financial risk regulations are enforcing banks to triple their holdings in capital reserves of government bonds; they have to get these from somewhere? In fact, we can say, there is a level below which government borrowing and outstanding debt dare not fall - quite apart from questions of delivering positive or negative growth impulses to the economy, and also of restructuring debt when base rates significantly change or shift from one trend path to another, and also funding redemptions when it is considered this should be budget-neutral.
There is too much politics based on counting on only the fingers of one hand. The media is full of hyperbole about the "vast unprecedented scale" of new government debt issuance. Average net borrowing was £30bn for a decade after gross issuances of about £50bn annually. In the past decade, UK National Debt stable when not slightly falling remained stable in ratio to GDP, but only until the credit crisis and recession struck. Redeptions should rise and of course were overtaken tenfold by QE. - See: table 2.B
Today, National Debt is about £850bn (over 60% ratio to GDP, rising to 78% medium tern. But, let us not ignore that in the same period UK personal debt doubled in a decade to £1,400 billions (to more than 100% ratio to GDP) and total (gross) private sector debt doubled to nearly 500% ratio to GDP i.e. private sector gross debt is 6-7times greater than that of the public sector, and 10 times more ater deducting government internal debt, half of which is non-marketable.
Of course, there are asset (including future expected income streams) and collateral offsets, but government has these too and of such better credit quality than the private sector. It must be obvious that Government has in gross debt terms been far more prudent that the private sector and in net debt terms also. It has officially over £600bn in financial assets before the crisis, which with nationalisation and asset swaps has now increased depending on how one chooses to measure it (whether or not to include off-balance sheet items) to 4-6 times this.We should not buy into Prof.Rogoff (one of the 20+)'s absurd interpretation of the correlation between high national Debt and low economic growth as if the former dictates the latter and not the other way about?
Why should over-leveraged private debt not worry us as a cost to UK economy now and in the future? Is the historically-high private debt not also a burden on UK citizens and tax payers?
Gross UK National Debt equals only the total of 6 biggest UK banks' funding gaps (850bn), gaps that the banks found they couldn't refinance cost-effectively, or at all, hence their technical insolvency problems!
The UK banks lost £1 trillion in capital writedowns and defaults that government made good for them using off-balance sheet swaps, of which in time the banks will recover 30-50% of nominal losses and same again from sell-offs, then same again in medium term in net interest income plus more than same again in asset value recoveries as another 90% recession-effect loss temporaily hits heir capital reserves. One consequence however of Government stepping in where private sector failed is that it will generate £2-300bn in medium term gains for taxpayers sufficient to cover a third to half of medium term budget deficits (a complicated accounting). This gain is threatened by the Conservative (and others) idea of selling out of the banks cheap sooner rather than later!
Finally, there is another attempted rewriting of history gaining traction among some of the fiscally most conservative media, to say that "financial market didn't cause the crisis" (S.Telegraph (21 Feb), that it was "fraud" (by which is meant some theory of 'printing money and risking inflation), political incompetence, "guaranteeing bank bailouts" that "warped risk incentives and stopped financial markets from working"! This view aligns with one of the effects of the debt crisis debate, which is to divert the subjective impression of the credit crunch nd recession from focusing on the banks to blaming government - it is a perverse aspect of the 'better government is smaller government' ideology to blame anything scandalous on government sins of either omission or commission.
That is either sublimely and very subtly true or simply the most absurd wishful thinking? Governments may be to blame in how far credit boom growth was tolerated, for ignoring worsening external trade & payments balances, and even giving up social housing provision, and in how certain other matters were handled. A favourite bete noir is to blame too much or too little regulation, or incompetent regulation. But, regulation is an international matter.
If such errors should be centre-stage, in this government was surely also encouraged by financial markets who over-leveraged in 'interbank' and related credit derivatives, and not least the fast growth in banks' funding gaps. But, it is debateable what powers the Bank of England (responsible for systemic macro-prudential risks) and the FSA (responsible for individual firms' micro-prudential risks) to ensure they are listened to by banks and others before the credit crunch. To this should calumny should be added the irresponsible diversion by banks of lending to finance, mortgages and consumer credit while not growing (even decreasing in real terms) lending to 'productive' sectors especially exporters. Banks (and others) chased highest short term profits and ignored macro-economic risk diversification and liquidity risks. The credit crunch was not unprecedented, except in its scale and global systemic effects.
Banks are ignoramuses in macro-economics not because they lack the resource to do better, but because they are in the habit of choosing to be so. They prefer having a very poor or no understanding of the role they play in the wider economy, which in much of economic history was deemed below their pay or profits grade. That for some years has been a major sin of mossion. If the private sector is ever to substitute for government as the only engine of growth in a recession, to lessen how much government has to apply Keynesian deficit-spending reflation in a recession, this has to be led by banks. But, so far, they have shown themselves far from ready to do so! Banks and markets are deleveraging and continuing to do so - is that how anyone sensibly thinks they should be allowed to continue? The government must feel very frustrated by the terms of the media debate much like Alice at the Mad hatter's Tea Party. More borrow & spend to make recovery more likely - "That's nonsense" as a policy according to some,such as Liam halligan writing in The Sunday Telepgraph, a policy that should have died in 1979 he says when Callaghan siad it was no longer an option. It is after that when the 'end to boom and bust' became a buzz-saw of markets and a conservative mantra that Labour aped in the 1997 election as basis for giving the Conservative Government a good kicking over how public finances were in a mess, which was as far from being true or fair as the claims offer in political reserse today - poetical justice perhaps. I doubt Callaghan when Prime Minister really understood what Peter Jay tried to teach him, Keith Joseph and Margaret Thatcher about Chicago monetarism. Keynesianism was clearly not dead or ineffective, despite all the rhetoric to the contrary. It was applied by Ken Clarke in the 1990s and by Brown in 2001 when he kept UK for first time in over a century from directly following the USA into recession! Anyone wishing to dispute this have to explain how else within a politically acceptable timeframe the economy can otherwise recover other than by government alone getting its boots on and mucking the economy out of it ordure-covered recession?
Note: Andrew Rawnsley's book serialised in The Observer, for all the storm in a teacup generated about whether Gordon Brown is a bully or not, rightly or unfairly so, Alistair darling emerges as a hero of the hour, and Gordon too, in addressing the crisis most valiantly and I believe (firmly know) most successfully.

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