7th December 2010
Back from my travels around Africa – to find the British deeply angered over the loss of the World Cup and behaving like very bad, and rather sad losers. With the exception of a student minority – the British remain deeply complacent about, and indifferent to looming government cuts, the fragility of our banking system, and the threats that both pose to the British economy.
So quiet and complacent is the population that ‘Cage against the Machine’ – 4 minutes and 33 seconds of soundlessness – will very likely echo the national mood and become a Christmas hit this year…
Some of this equanimity is induced by the centre-left Guardian whose columnists preach resignation and submission – to ‘the left’ and to rebellious students. The voice of one columnist, Deborah Orr, is stridently assertive in its economic analysis:
” Making some cuts in national spending is necessary at present” Ms Orr argues confidently “because the bond markets, which lend money to countries, tend to see nations unwilling to stop piling up ever larger structural deficits as larger credit risks (because they are), and hike interest rates on their lending accordingly. This is what is actually happening. It is the situation we are in, like it or not. No metaphors are needed to explain it.”
Ms Orr must have the ear of the government of Ireland, because they have proved most willing to follow her matter-of-fact advice “to stop piling up ever larger structural deficits” by making “cuts in national spending” Over the last 2 1/4 years the Dublin government has slashed government spending by €14.6bn, and is today budgeting to cut another €15 bn over the next four years. Despite these massive cuts, and promises of cuts, the bond markets are not satisfied. Why might this be? Perhaps because far from the cuts obeying the economic law laid down so firmly by Ms Orr, the opposite has happened.
Instead of falling as expected, the Irish deficit nearly doubled from 7.2% of GDP to 11.6% of GDP – sending the bond markets, the IMF, the ECB, Germany, Portugal, Spain, Belgium – and the Euro – into a spin.
As we have argued in these columns before: governments can cut public spending, but they can’t cut the deficit. That depends on how the rest of the economy reacts to the contraction in government spending.
Furthermore, the Irish government deficit – indeed the deficits of all governments – will only recover when the economy recovers. Not a moment before.
On this side of the Irish sea, the British people have barely noticed the crisis in Ireland. They remain relaxed as they prepare to dodge the weather and splurge on credit cards this Christmas. As far as Josephine Public can see, the economy is chuntering along happily, and all seems well with the world. That might of course have something to do with the fact that the British government has not yet followed the advice of Ms Orr, or the example of Ireland. British government spending rose in the third quarter of this year, and as Bloomberg notes this rise in government spending fuelled economic growth.
But we feel it only fair to warn: the British are about to follow the Irish into the Slough of Despond – and to lose the confidence of the bond markets. After rises in government spending there will be cuts of about £9 bn in this financial year. In line with Ms Orr’s advice, the cuts will be savage next year – £41 bn – and will be made more painful by the hike in VAT to 20% next January.
Add to that gloomy prospect the exposure of our banks to the troubles in Ireland, Portugal, Greece and Spain. According to IMF’s Staff Report for 2010 Article IV Consultation, the UK has “sizeable exposures vis-à-vis the United States, where the commercial real estate sector remains an area of particular concern, and a number of advanced economies in Asia and Western Europe, including those EU members currently in the spotlight of financial markets.
“Specifically, claims on Greece, Ireland, Portugal, and Spain account for about 14 percent of GDP—a similar proportion as for French and German banks, although UK bank claims are more strongly concentrated on Ireland. Negative shocks in any of these markets could necessitate further write-downs and weaken UK banks’ capacity to support the domestic economic recovery with adequate credit supply.”
Methinks the militants at the margins are better prepared for this shock, than the complacent millions at the core….