John Warren on the ‘Broad Shoulders’ disequilibrium.
David Cameron and Danny Alexander’s favourite metaphor is an appeal to the security offered by the UK’s “broad shoulders”, which is used inspirationally to inflate the Scottish electorate’s declining faith in the financial stability of Britain. Let us examine the nature of these ‘broad shoulders’. In a gesture of magnanimity I will use as evidence only the British Government’s own statistics in the UK Budget 2014 (HC1104, March 2014).
By 2018-19, five years from now and at the far end of the OBR’s forecast horizon, and all going to plan, Britain will have finally eliminated its budget deficit and produced a “small surplus”. Of course the Government has not yet met any of its deficit reduction targets since coming to power in 2010; so it would be very reasonable to conclude that in 2019 Britain’s budget will still be in Budget deficit. But let us remain improbably magnanimous about the Government’s prophetic powers. The problem is that the deficit is only one part of a much bigger problem; because the burden of National Debt will in any case have risen further, significantly over five years, because deficit elimination is only a miraculous appearance at the very end of the planning period. After 12 years of pain we remain mired in debt.
The Government acknowledges that “high levels of debt increase vulnerability to future shocks and cost pressures” and quantifies the warning signs of Britain’s special vulnerability when debt crosses the IMF guidance red-line “where gross government debt levels are above 60% of GDP”, which should trigger official detailed analysis of the risks (B.4, p.89).
In 2018-19 the Government’s own forecast of gross Government debt is 85% of GDP; and that assumes everything goes to plan – which of course has never happened (B.4, p.89). Even if we meet the plan we are still well above the IMF risk threshold. One of the factors that expose Britain to greater risks than other countries is its excessive economic dependence on the financial sector (the City of London) “which in the UK is one of the largest in the world relative to GDP” and “is a potential source of contingent liabilities” (B.16, p.92). The City of London, on which the Government rests so much of its hope for the future, and which has so much power over British policy at home and abroad, therefore does not even reduce the risks to Britain’s financial security, but actually adds to the threats to Britain’s economic stability.
Let us quantify this; indeed let us use the government’s own estimate of the effect of another financial shock, conveniently based on “another shock of the magnitude of the financial crisis” (ie, typically another City of London Credit Crunch) (B.17, p.92). According to the British Government this “could leave gross debt over 120% of GDP”: double the IMF risk threshold. This is a level only reached by three countries in the world; Greece, Italy and Japan (B.17, p.92). Furthermore, even if the Budget assumptions are met not merely over the next five years, but long-term, Chart B4 (which assumes no financial shocks), shows the results from two different paths of debt-to-GDP, with the less optimistic of the two, but by no means an improbable path (1.4% deficit), appearing to show British debt still to be at the 60% warning threshold in 2036; no less than 22 years from now, and almost 30 years after the crash (p.95). Indeed even if, much more realistically, we assume an illustrative but smaller ‘shock’ than the 2007-8 Credit Crunch (an economic set-back calibrated in size and timescale more typical of post-WWII/20th century experience) suggests on Chart B5 that by 2036 British debt-to-GDP is still almost 80% (the level of debt-to-GDP the Government predicts for 2015-6) (p.97). In short we are achieving effectively no advance on debt levels at all. We are going nowhere. We may very fairly draw the conclusion that there appears to be no hope-inducing way out of the British economic morass. We are stuck not just with the debt – and the risks.
The Government acknowledges that levels of debt-to-GDP above 100% “would be a cause for concern”, which is perhaps a statement of the obvious, but more important is the acknowledgement of the IMF’s sobering judgement that “financial markets do not
however wait until the maximum sustainable debt level is breached and start charging higher interest rates at lower debt levels”; in London’s case, an ironic example of being hoist with your own petard (B.17, p.92). There is also a probable correlation between high levels of debt and low growth rates, a grim warning about the underlying nature of the so-called economic recovery, but that is not an issue that will be further pursued here (but see B.25-B.29, p.94-5).
At last we reach the issue of interest rates. Debt interest in 2014-15 is forecast at £53bn (7.2% of Total Managed Expenditure) (Chart 1, p.5). This is forecast to rise to £59bn in 2015-6 (it would have been £69bn had there not been a ‘consolidation’ adjustment for 2015-6) (1.80, p.27). This is at a time when interest rates have been at historic lows over a long period; a fact that cannot be separated from the deep and lasting impact of the Credit Crunch. This too will pass and interest rates will unquestionably rise; in the Government’s words “a high stock of debt also means the UK is more exposed to future interest rate rises”; for example, a 1% rise in Government bond yields would add £8bn to interest payments on debt by 2018-9 (B.13, p.91).
According to Table D.2 ‘Determinants of the OBR central fiscal forecast’ market short-term rates are 0.5% in 2013-14, will rise to 2.0% in 2016-7 and rise to 3.1% in 2018-19 (p.107). Lacking other clear indicators supplied in HC1104 this suggests a consequential rise of at least £12bn in interest payments by 2016-7 and £20bn in 2018-9 (given no material change in debt levels). Unfortunately the later debt interest payments appear not to be given (I wonder why?), but if we assume that the budget deficit is eliminated by 2018-19, and assume that the debt has peaked at that level then, from the figures actually given above, a very rough estimate could suggest that the underlying debt payments could perhaps reach around £79bn (or equivalent to £89bn before the ‘consolidation’ exercise). Perhaps this is wrong, but if I have not missed illuminating evidence presented in HC1104 on this matter, then I invite the Government to publish the figures.
In addition, if interest rates rise to 5% or above – a risk that cannot be entirely discounted given the parlous state of Britain’s finances – then on this very rough basis perhaps we could see debt interest payments rising towards £90-£100bn per annum. Perhaps not, but I would be interested to hear a categorical Government assurance that it cannot happen, or a clear statement of the scale of the risks such a scenario entails; as Better Together never cease to remind us – what we want in Scotland is certainty.
Broad-shouldered Britain? It seems rather that the more Britain borrows, the more it pays, and the more it grimly it hangs on to the louche, speculative instincts of a City of London that is responsible for so many of our ills and is the source of so much of the risk; the “contingent liabilities” to which the Government constantly, and ominously, refers (B.13, p.91; B.16, p.92; B.24, p.94). Broad shoulders? somehow I don’t think this works any more. The emperor has no clothes, and the status quo will no longer wash in Scotland.
This Government loves the populist appeal of Beer and Bingo; so allow me to suggest an equivalent appeal to the gamblers and speculators of the City of London: Britain, they should know, is a ‘busted-flush’.