At the beginning of the month the Prime Minister insisted, during a TV in interview with Andrew Marr, that public spending will continue to grow at just under 1% in spite of the fact that his Government is looking to borrow £175 billion this year. We simply cannot go on like this in a world of fantasy money, living well beyond our means. Actually, the PM was being disingenuous: his figure can only be reached by statistical acrobatics and including all the interest payments on our ever growing debt. Even under the Government's own plans there are going to be substantial cuts in departmental budgets. The reality is that all the political parties have recognised the fact that the deficit has to be cut. Despite this, there is still a growing divide in British politics: not so much about what is to be done, but about the speed and extent of the doing of it.
The Government argues that much of the deficit is a stimulus to the economy and that we must not cut it while we are still in recession, otherwise the recession will be made worse. I take a very different view. I think the real threat is the reduction in growth and the stifling of our economic recovery that will occur with rising interest rates. For me, therefore, the key objective is to keep interest rates low and the principal danger to this is the Government's burgeoning debt, so the quicker we cut it, the surer will be the economic recovery.
The Government borrows money by selling gilts -gilt edged securities, so called because the Government is such a credit worthy borrower. Recently the Bank of England has been buying up to a quarter of the Government debt in issue -a process called 'quantitative easing' (and equivalent to the printing of money). It is difficult to know what effect this may have had on the course of the recession. This increase in the supply of money was designed to boost the economy, but we have no way of knowing what would have happened otherwise. Perhaps the recession would have been longer or deeper, but equally, it might have made no difference at all. In any event, the policy cannot continue indefinitely and it must stop soon. The more one has of anything the less value it holds, and money is no different. Printing more money risks inflation. So, the Bank of England will have to cease buying gilts at a time when the Government is looking to sell nearly £200 billion of them this year, and just when the markets are starting to get the jitters. Pimco, the world's largest holder of these types of securities, has announced that this year it will be a net seller of UK gilts and not a buyer. The credit rating agencies have begun to hint that the UK's AAA credit rating may be down-graded, basically they are saying that we are not quite as gilt edged as we once were. This will mean that the price of gilts will fall forcing the government to pay a higher rate of interest on the debt, and as interest rates rise businesses and mortgages will be hit, delaying our recovery.
The reason the markets are losing their enthusiasm for gilts is that they were not impressed by the pre-budget report and the lack of any clear plan for the reduction of the Government's deficit. This week the Government brought to Parliament its Deficit Reduction Bill -as if the mere passing of a law will reduce our deficit. In my thirteen years in Parliament I have seen some pretty daft bills but this one really takes the prize. It simply requires by law that the deficit be reduced without saying how. As to what will happen if the law is broken, well, you might imagine that the Chancellor would be hauled off to the Tower of London but unfortunately not, because the bill is quite toothless. It states that any duty which 'has not been complied with, does not affect the lawfulness of anything done, or omitted to be done, by any person'. So, little wonder then that the financial markets were not impressed by the Government's determination to reduce the deficit. Indeed, I suspect that the reason they continue to buy our gilts at all, is in the expectation of a relatively swift change of government which they believe will usher in an effective strategy to tackle the deficit. If this prospect diminishes we really will be in trouble because the gilt buyers will demand very much lower prices (meaning higher interest rates) to compensate them for the risk of continuing to lend to such a profligate borrower. This is why the prospect of a hung parliament fills me with dread. We need a government with a majority and a mandate to dish out the medicine and tackle our debt problem. As Richard Lambert of the Bank of England's monetary policy committee has said 'history tells us that these are really difficult nettles to grasp but if you grasp them in a clear and bold way, the pain lasts for a shorter period'. |
