Even Britain has now abandoned austerity
The Age of Austerity is over. This is not a prediction, but a simple statement of fact. No serious policymaker anywhere in the world is trying to reduce deficits or debt any longer, and all major central banks are happy to finance more government borrowing with printed money. After Japan’s election of Prime Minister Shinzo Abe and the undeclared budgetary ceasefire in Washington that followed President Obama’s victory last year, there were just two significant hold-outs against this trend: Britain and the euro-zone. Now, the fiscal “Austerians” and “sado-monetarists” in both these economies have surrendered, albeit for very different reasons.
Much attention has been focused this week on the chaos in Cyprus. Coming after the Italian election and subsequent easing of Italy’s fiscal conditions, the overriding necessity to keep Cyprus within the euro — and its military bases and gas supplies outside Russian control — will almost surely mean another retreat by Germany and the European Central Bank from their excessive austerity demands. But an even more remarkable shift has occurred in Britain. The Cameron government, which embraced fiscal austerity as its main raison d’etre, was suddenly converted to the joys of debt and borrowing in this week’s budget.
Of course, the rhetoric of British Chancellor George Osborne’s budget speech gave no hint of his Damascene conversion. On the contrary, it ridiculed “people who seem to think that the way to borrow less is to borrow more.” But Osborne’s trademark sneers could not disguise the meaning of the policies and numbers he presented.
Long after the U.S., Japanese, Chinese, Canadian, Australian and most European governments, Britain has finally been forced to accept Keynes’s “paradox of thrift”: A government that tries to reduce its borrowing during a recession generally weakens the economy so much that it ends up increasing its total debt. Conversely, a government that expands deficits during periods of weak economic activity, or finds ways to encourage private borrowing and discourage private saving, usually ends up lightening the national debt burden.
Osborne’s budget numbers presented a textbook example of Keynes’s paradox. In last year’s budget, Osborne predicted that government debt would peak at 76% of GDP in fiscal year 2014/15; but this week, despite (or because of) another year of Draconian tax increases and spending cuts, he has projected the government’s debt burden to keep rising for a further two years, to 86% in 2016/17. Contrast this with the U.S. budgetary experience, where the debt ratio has already stabilized near Osborne’s original 76% target, despite (or because of) the Republicans’ refusal to raise taxes and the Democrats’ refusal to cut spending on anything like the British scale.
This contrast suggests that the main reason for Britain’s inability to stabilize its debt burden has not been any lack of fiscal effort but, on the contrary, the impact of excessive austerity on economic growth. And while Osborne will never publicly admit this, the big surprise of his budget is its implicit acceptance of this Keynesian view.
Instead of trying to reduce borrowing any further or aiming for a balanced budget, as it originally promised, the British government has now accepted that deficits will keep rising in absolute terms and will still be worth 6% of GDP by the next election in 2015. That would leave Britain with by far the highest deficit ratio among the major economies after five years of unprecedented austerity. Meanwhile the U.S., with comparatively little fiscal effort, is projected to reduce its deficit to just 2.4% by 2015.
Now for the good news. The British government’s decision to accept huge deficits for the foreseeable future instead of trying vainly to reduce them was strong evidence of a long-awaited policy U-turn from over-zealous fiscal tightening to U.S.-style economic stimulus. But Osborne’s speech contained two even clearer signs of a surprisingly radical “Plan B” to start undoing the deflationary effects of the government’s original economic policies in time for the 2015 election.
The first shift away from austerity was predictable, but turned out to be more radical than generally expected: The Bank of England’s mandate was changed, from targeting 2% inflation at all times, to stabilizing inflation at around this level over the “medium term,” while recognizing “the trade-offs between inflation and output variability” and noting that “monetary activism has a vital role to play in the Government’s economic strategy … [and] commitment to fiscal consolidation.” In other words, Britain has effectively imported the U.S. Federal Reserve’s “dual mandate” of managing both inflation and unemployment, with the kicker that the BoE must print money to ensure that government deficits are financed at rock-bottom interest rates.
A bigger surprise than this demand for more “activist” monetary policy was the radical new destination proposed for the money to be printed by the BoE. Britain has decided to create a new bubble in house prices and mortgage borrowing.
While Osborne repeated his mantra that “you can’t cure a crisis caused by debt with more debt,” he will now do exactly this by creating a British equivalent of government-guaranteed Fannie Mae mortgages to offer what the U.S. would describe as “sub-prime loans.” The government whose excessive prudence has discouraged banks from offering mortgages worth more than 75% of a home’s value, will now guarantee borrowers who have a 5% deposit the additional 20% loans they need to qualify. In doing this, the Treasury will expose itself to any falls in house prices beyond 5% — and this exposure will not be included in national debt statistics.
In short, Britain will imitate the off-balance sheet financing of Fannie Mae that helped to trigger the 2008 crisis, and will use this mechanism to create £130 billion of “high loan-to-value mortgages over three years,” which will be much more leveraged than Fannie Mae’s “conforming” loans. (The U.S. equivalent of this sum, in relation to GDP, would be roughly $1.5 trillion.) This new policy can be criticized on several grounds — for example financial imprudence, or inflating house prices or unfairly subsidizing borrowers — but excessive austerity is not among them.
PHOTO: Britain’s Chancellor of the Exchequer, George Osborne, holds up his budget case for the cameras as he stands outside number 11 Downing Street, before delivering his budget to the House of Commons, in central London March 20, 2013. REUTERS/Stefan Wermuth