Thank you, Gordon Brown

November 11, 2010

BRITAIN-INFLATION/–Laurence Copeland is a professor of finance at Cardiff University Business School. The opinions expressed are his own.–

If the economics profession has sunk in public estimation in the last two or three years, it would hardly be surprising. Our failure to predict the crisis is something which cannot be simply brushed aside lightly, as some of my colleagues would love to do.

To ordinary folk, claiming to be quite good at explaining and even forecasting events in normal conditions, but admitting we simply can’t handle crises makes us about as much use as a doctor who knows how to treat ingrowing toenails and flatulence, but hasn’t a clue about how to deal with heart attacks or cancer.

Nor is that the only charge which could be levelled at the British profession. One could forgive any politician who felt bewildered by the sheer fluidity of the positions taken by the hordes of macro-economists offering advice, solicited and unsolicited, on the direction policy should take. After all, the overwhelming majority of the profession appears to be in favour of expansionary monetary policy (aka QE2) with an eye on keeping sterling weak against the euro and, if possible, the dollar (hence also against the yuan). Yet most of the same people were enthusiastic advocates of Britain joining the euro zone, in spite of the fact that the option of driving down our exchange rate in the way they advise is only open to us because we have stayed out of the single currency.

Likewise, many colleagues are equally confident in opposing too rapid a reduction of our budget deficit  – “After all, we aren’t Ireland/Greece/Spain/Portugal……” they snort, whenever anyone points to the possible risk of delaying the cuts, as they  would like us to do.

On this point, they are right, of course – we are in a very different situation from Ireland and the sunkissed PIGS. But why are we so different?

It’s certainly not because we have been running a tighter ship – in 2009, our deficit was 11.5% of GDP, compared to 14% in Ireland and Greece, 11% in Spain and a mere 9% in Portugal, and by election time, in May this year, our deficit was estimated to be running at 12% of GDP, compared with only 9% for Greece and less for every other EU member. Moreover, our accumulated debt, although less than many other European countries, still stood at 68% of GDP last year, 4% higher than Ireland, which is under intense pressure these days.

No, the reason why UK gilt markets are not so far showing any sign of stress and our debt repayments are insurable for a premium less than a tenth as high as for Ireland – 57 basis points (i.e. 0.57%), compared to a staggering 574 b.p. for Ireland and 452 b.p. for Greece – is because the markets realise we are free to print our own money. In other words, we can (and I still believe will eventually) print pounds to pay our debts, which are almost all denominated in sterling – default by inflation, which is not a credit event in the sense covered by the insurance of credit default swaps. The difference between the UK and the peripheral euro zone amounts to no more than this: we have not lashed ourselves to the mast of the euro. For the same reason, the U.S. is free to print as many dollars as it needs to avoid a formal legal default, so its debts can also be insured for a modest 43 b.p.

Nobody should misread these spreads as evidence that the markets regard Britain and America as responsible borrowers – far from it. As a yardstick, one need only look at Japan, which in spite of having debts amounting to over 200% of GDP can still borrow for up to 30 years at well under 2%, less than half as much as we and the U.S. have to pay, a differential which reflects the market’s betting on the likely value of the two currencies a generation from now.

Of course, the mainstream of the British economics profession is not alone in trying to have it both ways on the euro. LibDems have always reacted like Pavlov’s dogs to anything with a euro prefix. In the interparty negotiations in Westminster’s smoke-free rooms, if not in public debate, one would hope the LibDems are not being allowed to forget for one moment how much worse Britain’s situation would be if we had now been in the euro zone, as they would have wished us to be. Indeed, some people might expect them, along with the eurogroupies in my own profession, to show a measure of shame-faced humility these days. Alas, those of us old enough to remember the ERM fiasco will know not to hold our breath.

One of the many ironies of Gordon Brown’s career is that, in his arrogant defence of his right to wreck the UK economy without interference from Europe, he stood almost alone against the Blairite rush to join the euro zone.  As such, he may well have saved us from the fate of Greece or Ireland. It was certainly not, as T S Eliot would have it, “the greatest treason…. To do the right deed for the wrong reason.” It was just sheer good luck.

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The main reason we are not in the debt position of the PIGS is the debt profile. The downturn in the economy – caused by the banks * – resulted in a slump. A fall in economic activity resiults in a fall in government income. That part of the UK debt was of the PIG type – to cover current expenditure in the crisis. In contrast to taht small element of the accumulated debt, most of our historic debt is investment related and with a very long term. The median UK bond is for 14 years. IE we have until 2015to pay off half of it and the other half starts to be paid off after that. Osborne plans to pay off the whole lot in the term of this parliament.
Greece in particular was borrowing to pay off borrowing, never advisable for individuals, companies or countries.

* I do not recall the IEA ever suggesting additional regulation of financial institutions. Please do not respond that it was Brown’s error that permitted the collapse of the banking sector.

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