Saturday, January 22, 2011

The political cost of repairing the UK economy

The UK's CPI annual inflation rate rose to 3.7% in December 2010. The RPI- which includes mortgage payments- rose to 4.8%. The Bank of England continues to hold the Bank rate at a record low of 0.5%, while issuing over £200 billion of reserves to pay for asset purchases. The banking system is being bailed out by a negative interest rate of close to 4%.

Yet to pay for this the United Kingdom has created record public sector deficits. According to the ONS, at the end of November 2010 total public debt- not counting the interventions to recapitalise the banking system- was £863.1 billion, or to put that into context, 58% of GDP. The current cost of those additional interventions is not small. It is currently estimated to be about another £850 billion, and although it is highly unlikely that the eventual total cost will be more than 10% of this number, for the present it is a sum that still requires to be financed for the next several years.

Total UK public sector debt is therefore about 120% of GDP.

However, the UK private sector debt numbers are far more scary. PWC estimated that at the end of 2009, total debt was already 540% of GDP, up from just 200% in 1987. More to the point it highlighted the sharp acceleration in total indebtedness since 2000. Slowing, never mind reversing these trends will be exceptionally difficult without major economic dislocation.

The primary driver of the huge surge in private sector debt was the dramatic increase in house prices over the same period. Since 1990, nominal house prices have doubled.

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So the exposure to house prices is now a critical driver of the UK economy. Rescuing the debtors has been the primary political as well as economic goal both of the Labour government of Gordon Brown and now the coalition.

Yet, the price of this rescue is undermining long term investment and destroying the value of the Pound as a store of wealth. despite the long delays, the recovery- however tentative it is at the moment- is now going to require higher interest rates.

Everyone knows this- which is why the cautious are delaying their moves in the housing market. Yet this is risking a further banking crisis- if house prices really stall again, then the government could be caught between the urgent need to cut their own deficit, the surge inflation that their own increase in VAT will help to fuel and the drastic loss of confidence that a major house price fall will engender. Then the UK will be back in the 1970s with Stagflation returning with a vengeance.

Certainly that is the message that Ed Balls- benefiting so well from the unfortunate publicity about Alan Johnson's marriage which proved a convenient moment for him to become shadow Chancellor- will be making time and again. Yet Ball himself, beyond insisting on the politically popular "No to Cuts" is not providing much salvation- his inflationary laxness will be even more dangerous in the long term.

Austerity is a necessary policy- even the most basic analysis of UK indebtedness shows that-but Balls will attack it in any way he can.

The problem is how to steer between the Scylla of stagflation and a house price meltdown and the Charybdis of a debt meltdown and an inflationary explosion.

I see no British politician yet speaking as though they understand the scale of the bind the UK is in. It certainly isn't Ed Balls, whose policies in government did so much to create this crisis in the first place.

1 comment:

Western Independent said...

"Elephant in the room" is a dreadful cliche but seems very appropriate - you might find my post earlier today of interest http://westernindependent.blogspot.com/2011/01/labour-another-problem-another-brother.html