Debt junkies

The Guardian somehow believes that we are living under 'austerity'

Today’s Guardian editorial is headlined ‘The Guardian view on the austerity delusion: economies cannot cut their way to growth’. The newspaper evidently believes that Britain is still in a period of ‘austerity’.

Austerity in the 21st century has never been properly defined. After the Second World War, it meant paying back debt and rationing. Today, the government is still borrowing over £100 billion a year with no intention of reducing the debt and public spending is at an all time high, so ‘austerity’ means little more than ‘not spending as much as the Guardian would like’.

The Guardian says…

Austerity didn’t produce economic growth. The confidence fairy is as unreal as the one looking for children’s teeth. But the political rhetoric has not gone away. Every major UK political party wants more economic growth, and the message is that to grow the economy means bearing down on the deficit.

Is that really the message? The article the Guardian links to is about Labour’s plans to change the ‘rules’ to allow it to borrow more for ‘investment’. This doesn’t sound like hair-shirt fiscal stinginess. The author of that article notes that there is a risk that this will unsettle the bond market, of which more in a moment.

The Office for Budget Responsibility forecast in March that the UK economy would grow by about 2%. This looks wildly optimistic. The International Monetary Fund sees two years of about 0.5% growth. It is a dangerous delusion to think that economies can cut their way to growth.

The IMF’s track record for predicting growth is poor and the data they used for their latest prediction is already out of date. More importantly, the government is not trying to cut its way to growth. It aims to maintain spending in real terms while getting more money from higher taxes and fiscal drag. It aims to cut the national debt as a proportion of GDP to demonstrate to investors that the UK isn’t turning into Argentina, thereby keeping the cost of borrowing at a vaguely manageable level.

Higher interest rates have also resurrected old fears about western nations’ public debt, and the idea that they are determined solely by “market forces”.

Interest rates are only partly dictated by market forces in the age of central bankers, but there is an economic logic behind them. And fears about public debt are well founded. Interest on the debt is expected to cost the government (ie. the British taxpayer) £110 billion this year.

But bond vigilantes don’t exist. What is being exposed are financial institutions’ speculative bets. The crisis for Liz Truss began when pension funds started dumping UK bonds, sending the long-term interest rates on gilts soaring and forcing the Bank of England to step in.

But the reason they had to ‘dump’ (i.e. sell) the gilts was because bond yields had risen in the wake of the mini-budget because the mini-budget and the promise of further tax cuts were considered to be inflationary (as I said at the time) which would, in turn, lead to interest rates being higher than expected.

The pension funds’ speculative bet was that inflation and interest rates would stay low forever. That was already looking risky by September 2022 and the mini-budget pushed it over the edge.

The price of government bonds will go down if investors think (a) the government will default or (b) inflation will make them worth less, in real terms, after 10 years. There was no risk of the government defaulting in 2022 but the inflation risk was clear. Would you lend someone £1,000 for ten years at 2% interest when inflation is going to average 5% over the decade? No. If you have any sense, you will demand an interest rate that exceeds 5%. That doesn’t make you a vigilante. It means you are responding rationally to market forces.

On Friday Jeremy Hunt, the chancellor, said “difficult decisions” lie ahead on the public finances. He was looking at the recent sell-off in government bonds, and the rise in their yields, pointing to higher debt interest bills.

That is the chicken that has come home to roost and it one reason why we need to get inflation, and therefore interest rates, down.

Central banks won’t let governments default in their own currency. But they are happy to go along with the idea that fiscal extravagance makes a bond-market attack on heavily indebted governments likely. Mr Hunt is signalling that it is spending on the poor, not the rich, that needs to be cut.

This is just a word salad. It starts with some Modern Monetary Theory sloganeering (“central banks won’t let governments default in their own currency”) that is meaningless without context before portraying investors as somehow predatory and finishing with a random comment which (if you click on the link) turns out to be about withholding benefits from people who turn down work.

Until 1984 the postwar consensus was that economic growth was secured through the fiscal stimulus of an enlarged budget deficit and quiescent rate policy, while regulation and price controls kept inflation in check.

If this is supposed to be a description of the post-war Keynesian consensus (which ended in 1979, not 1984) it is unfair on the Keynesians. Keynes argued for deficit spending during recessions to prevent unemployment which would then be repaid during the good times. The idea that Keynesianism involves constant, large scale public borrowing in good times and bad is a more recent bastardisation of Keynesianism and is patently unsustainable.

Mr Hunt’s predecessor, Nigel Lawson, argued that the reverse should be the case: growth would be obtained by doing away with government regulations, and inflation brought down by cutting the budget deficit and aggressive rate hikes.

Yes. And it worked.

Economics is a religion where rhetoric persuades voters to believe bad policies can have good results.

No it isn’t and the Guardian shouldn’t say something so silly. Economics is a social science which produces testable hypotheses. Some of these hypotheses have been proven right so many times that they should guide policy. For example, printing too much money creates inflation and investors will demand a higher yield on a bond if inflation is high.

All this came tumbling down in 2008 with governments pumping trillions into the world economy to save it. It is another crisis – around inflation – that has seen a public who had abandoned the old faith find comfort in it once again. If history is any guide, their conversions won’t last long.

This strikes me as gibberish. What is the Guardian trying to say in this editorial? It wants more borrowing, that is clear, but it doesn’t mention how high the current rate of borrowing is and it seeks to avoid the big lesson from the mini-budget, which is that there is a limit on what governments can reasonably expect to borrow and that ‘austerity’ was not a ‘political choice’.

The point of cutting the deficit is not to create growth but to cut the deficit. Jeremy Hunt’s modest target of cutting the debt as a proportion of GDP was necessary to calm the bond markets. Can anyone seriously argue that the bond markets did not need calming? That, along with the increasingly huge interest payments the government is saddled with after 20 years of profligacy, requires the deficit to be cut.

If you want even more public spending you should demand higher taxes. That would be a respectable left-wing position to take and yet neither the Guardian nor the Labour Party seems interested in doing this (aside from some financially trivial stuff like taxing non-doms and charging VAT on private school fees).

Meanwhile, the Conservatives want tax cuts but won’t say what public spending they will cut to facilitate it.

And so British politics is reduced to two parties trying to find ways to borrow as much money as they can - on top of the £2.6 trillion debt already amassed - and letting future generations worry about what to do about it.