Prudence but slow growth - 17th July 2011

Despite our obsession with the abuses of the Murdoch gutter press, of much greater significance is the financial storm that continues to visit the Eurozone: market concern has resulted in Italy paying record interest rates to cover its debts and the country has to embark on massive reductions in government expenditure and increases in taxation; on 12th July Moody’s credit rating agency downgraded the Irish government’s credit rating to ‘junk’ status; a day later another agency downgraded Greek government debt to CCC-, the worst possible rating; all of which has raised speculation about the ability of Spain and Portugal to be able to pay their way.

In the US deadlock continued between the President and the Congress on whether to raise the legal limit on their national debt, failure to agree could lead to the unthinkable, namely that the USA could default. In the developed Western economies of the world budget deficits and the growing sovereign debt remains the principal economic problem that we face.  The surprising fact is that Britain’s budget deficit is among the worst: it is certainly much worse than those of Ireland and Portugal, and it is as bad as that of Greece. So why is Britain considered a financial safe haven?

We are seen not as part of the problem but, like Germany, as part of the solution: we have made a substantial loan to bail out Ireland; and we have just increased our contribution to the International Monetary Fund.

The answer to the question boils is the confidence that the financial markets place in our determination to reduce our own deficit with the programme of cuts that the Government has announced. It is for this reason alone that we are able to borrow at German rates of Interest rather than being charged the crippling rates now being paid by Ireland, Portugal, Greece, Spain and Italy which inevitably restrain economic growth.

Just because we have taken our unpleasant medicine it doesn’t mean that we can now necessarily look forward to economic growth. There are three elephants in the room. First, the eurozone countries still facing their financial crises are themselves important export markets for our goods and services. Second, our own domestic consumers are themselves burdened with debt and are cutting back expenditure on goods and services as they struggle to clear some of their debts. Third, inflation is rampant, squeezing consumers’ disposable incomes and reducing their ability to spend on goods and services. The strong growth of the emerging economies in the rest of the world has been driving commodity prices up, and the weakness of Western currencies including Sterling have driven the prices of any imported goods and raw materials up even further.

Given these rather depressing economic facts, the unemployment statistics released last week (and completely swamped in the news by the Murdoch saga) were not too discouraging: the number of people in work increased during the last quarter and unemployment fell during the quarter. However, the number of people on Jobseeker’s Allowance  rose by 24,500 between May 2011 and June, up 50,900 on a year earlier -although much of this rise is accounted for by welfare reforms which are moving claimants who should no longer be on Incapacity Benefit onto Jobseekers’ Allowance.  Most encouraging has been the continued growth of private sector employment, which rose by 104,000 between December 2010 and March 2011 and by 520,000 over the year to March 2011.

Given the financial climate raging around us there is no guarantee that this modest improvement will continue at the same pace: it way well slip back. The fate of Greece, Ireland, Portugal, and Italy however, must serve as a warning to us that we cannot solve our problems by spending money that we do not have, and leaving future generations to pick up the bill.