The knife edge on which we perch so perilously has never looked sharper. IF nothing else goes wrong in the wider global economy we could have a chance of getting through eventually without a sovereign debt collapse. But it will be a close run thing .
Christina
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TELEGRAPH 3.10.09
What happens when the borrowing stops?
For all the talk of recovery, the future looks grim for our public finances, says Jeremy Warner.
Let's move on, for the moment, from discussion of Gordon Brown's record on the economy, now cruelly exposed by the recession, and take a look at what the mess in the public finances means for the future.
With the budget deficit rising by the day, what are the risks of Britain, or any of the other advanced economies, succumbing to a sovereign debt crisis? So far, there's been surprisingly little sign of one. The markets seem happy to finance what would once have been seen as ruinously high public borrowing. Yet all it would require for us to be tipped into just such a calamity is that the world's still-fragile recovery stalls.
To the dismay of the Treasury, which is still trying to convince the markets that its plans for addressing the deficit are credible, the possibility of fiscal meltdown was raised afresh this week by Olivier Blanchard, the chief economist at the International Monetary Fund.
According to the IMF's latest forecasts, Britain's gross national debt will have surged to 98.3 per cent of GDP in five years, while the "structural deficit" – the level of borrowing required to fund government spending after the economy recovers – will remain stuck at 6.2 per cent, well above average for an advanced economy.
Structural deficits of this magnitude are unsustainable for any length of time. Unless the problem self-corrects, much more draconian spending cuts – and/or tax increases – than either of the two main political parties admit to will become inevitable.
Some reports slightly distorted Mr Blanchard's remarks, so let me first outline exactly what he did say. For starters, he thought that some form of fiscal stimulus has to continue as long as private demand remains weak, even though it means a very rapid accumulation of public debt in countries such as Britain. At some point, however, this support has to end, or serious issues over the sustainability of the debt will arise.
He went on to say that the reform of retirement and healthcare benefits – where costs are due to spiral because of ageing populations – will have to be tackled sooner or later, and that it may even require a fiscal crisis of the kind that is being talked about to force Western governments to confront the issue. He concluded that the present trajectory for growth in national debt ought, none the less, to be just about affordable.
Sadly, this prognosis assumes that the IMF's forecasts for global recovery are met. There are other scenarios where a fiscal crisis – which in Britain would most likely to take the form of a collapse in the currency and a paralysing increase in interest rates – becomes a possibility. For instance, if the recovery falters and private demand does not pick up, the temptation for governments to continue with the life support, via unsustainable deficits, would be high. The markets would punish the biggest miscreants, forcing the politicians into unpalatable cuts in retirement and health benefits. Again, it should be stressed that Mr Blanchard doesn't consider this the most likely outcome. Vast though the growth in sovereign debt is, he thinks it manageable – assuming some fiscal consolidation once the recovery becomes entrenched.
This is just as well, as without the present stimulus the British (and world) economy would still be hurtling into the abyss. A premature withdrawal of support could even make the deficits bigger, by tipping us back into recession. Even so, finance ministers are walking a tightrope.
Of course, we shouldn't exaggerate the dangers. Much of the current, terrifyingly swift deterioration in our finances is automatic, in the sense that recessions cause the tax take to fall and spending on benefits to rise. As the economy recovers, budget deficits in the richer nations will automatically narrow. By the same token, as the financial system further stabilises, it will be possible to withdraw the support given to the banking sector.
But what makes Britain different is the substantial structural deficit, which will remain long after the recession is over. The problem is that the Government mistook the windfall revenues generated by the City and the housing market during the boom for a permanent addition to the tax base, and increased its spending accordingly. As a consequence, it will be left with a gaping shortfall even after the economy has recovered.
For the time being, the Treasury is still able to borrow on relatively favourable terms. But this may have more to do with the Bank of England's programme of quantitative easing (QE) – under which nearly half of the outstanding supply of government debt has been bought up with newly created money – than the credibility of the nation's fiscal plans. QE has kept interest rates lower than they would otherwise be. What happens when it ends?
Eventually, the exceptional monetary, fiscal and financial-system support must be unwound. In the meantime, Britain's government-in-waiting will have to pray that the IMF's central forecast of a sustainable recovery holds true, and a full-blown fiscal crisis is averted. If not, there will be unpleasant consequences: for example, we knew that the retirement age would have to rise, but it had always seemed too far in the future to worry about. Now, there is every possibility it will happen in the next parliament.
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