When a politician asserts in a confident tone that he knows that public spending must be cut by £25 billion in the next Parliament you know he is wrong. There are no statements of economic truth that are as if they were sacred texts carved in stone. Economics is a subject of nuances, the likelihood of an event occurring are possible or probable, never so certain that they can be cast in stone. Even such a renowned sceptic as Simon Jenkins ( The Guardian, 8th January, 2014) states that everybody knows that public spending must be cut by £25 billion in the next Parliament. He falls into the trap of quoting economic think tanks such as the IFS that say it must be so, yet he has castigated such think tanks in the past for the fallibility of their predictions. If I can misquote Kierkegaard who said that public opinion is the dogs opinion, the same can be said of the consensus of economists. It’s invariably wrong, why were so many economists caught by surprise when the economy crashed in 2008/9. The few that got it right can be numbered on the fingers of one hand.
Two things can happen in the next Parliament, either the economy can grow faster than expected or slower than expected. Never as predicted by the economic forecasters, they don’t have the insight of Gods. If the economy grows faster tax revenues will grow faster than expected so public expenditure will need to be cut by less than £25 billion or if more slower by more than £25 billion. The IFS report will include these caveats in small print at the end. That is the part that politicians choose to skip, because they want to facts that will fit their purpose, not truths.
There is one thing that economists learn in their first year course which they then promptly forget. They learn that all economies are dynamic, that is they are constantly changing in what are often unpredictable ways. Acknowledging this makes the art of economic forecasting very difficult, only if economic forecasters ignore this insight can they make predictions about future trends.
II Real Wonderland Economics
Westminster in in a ferment of excitement about George Osborne’s proposal to put into law that there should be a limit on government expenditure. This is despite the failure of the EU to ensure that the countries that signed up to the Euro should limit their budget deficits to 3% of their GDP, which nearly all found impossible to achieve. Only a politician could believe that passing a law will make the impossible possible.
If George Osborne gets his wish there will be statutory limits to what the government can borrow. Yet nobody can know what a future borrowing requirements might be. Governments always need to borrow to cope with emergencies. There will be at some future time be a flu pandemic, which will require an immediate response. Does the government limit its response and let thousands die because the extra borrowing needed to fund a response would lead to a breach the agreed borrowing limits? Unfortunately we cannot say with any certainty that the government would prioritise saving lives over breaching the borrowing limits. Once such laws are passed they tend to become regarded as part of the hallowed texts of government and should be followed to the letter of the law. All that could be said with any certainty is that George Osborne’s proposed new law will hamper any future governments ability to deal with any future crisis.
There is something very strange about the public sector deficit. It involves a financial sleight of hand. To bail out the banks in 2008/9 the government had to borrow between £28 and £32 billion from the financial markets. Two of the big four banks were effectively bankrupt, but given the large sum to be borrowed all the banks would have contributed to the loan. Therefore there is the strange situation of the two of ‘bust’ banks lending money to the government to be given back to them as bail out money. This borrowed money was used to recapitalise the banks, through the purchase of shares in these banks. By some strange cleansing process bad money from Lloyd’s/HBOS and RBS became good money when passed through the cleansing hands of government. Too put it more simply the two bankrupt banks were lending money to themselves or financing their own bailout. When the financial community clamours for budget cuts to balance the books, it should be treated with scepticism given the chicanery it is prepared to countenance to maintain business as usual.
Even if the majority of the funding came from other banks, they were largely zombie banks kept afloat by state guarantee. In the year 2009 the British government stated its willingness to guarantee all the banks liabilities against default. This guarantee amounted to 86% of the UK’s GDP in 2009. A major run on the UK banks would have ruined UK Plc and its people. What do the people of the UK get from the financial community in return for this self sacrifice? Lectures about the spend thrift government and the need to mend its ways. Not a hint that the city has learnt anything from its foolish past prolificacy.
III A proposed solution to the budget deficit crisis
There has been something unmentioned in this debate about for the need for public spending cuts. The £25 billions of cuts is probably equivalent to about the total of the government money remaining invested in the banks. Why is there no suggestion that part of the cut in public expenditure could be financed in part by cuts in the funds lent to the banks? The reason given is that to sell the bank shares now would result in a loss, because their sale price is far below the purchase price paid by the government. To save the banks the government overpaid by billions for relatively worthless shares. If the government off loaded its current shareholding it would cause a catastrophic fall in the share price of both RBS and Lloyd’s/HBOS that would result in their bankruptcy. All that can be done is to sell those shares off gradually over a period of many years, as the price of those shares has rises.The financial community understands this all too well and in an incredible act of hypocrisy it insists that everybody other than them should pay for the misdemeanours of their community.
There an alternative solution that would cut public spending by a large sum and ensure that the city bears the cost of the bank bailout. Consols are a type of borrowing little used by governments today. They are government securities that do not have a date for redemption. I remember my economics teacher telling our class in 1965 that the country was still paying for the Crimean War in 1854, as the government still paying interest on consols issued at that time. The government should be prepared to force the city to accept the undated securities equal in total to the bank bail out fund. This could be done by exchanging securities with a fixed redemption date for these new consols. The bank bail out debt could then be parked in a special fund which could be run down if and when the government sold its shares in the bailed out banks.
The advantage of having the debt in the form of consols is that the government repays them at times at which it is convenient to them. There is also a penalty that bankers could face in any future speculative crisis. These undated securities are very price sensitive so in any future speculative frenzy they are likely to see their holdings of securities devalued so will they share in the losses experienced by the rest of the country. Unlike now when any speculative frenzy is always a ‘win win’ situation for the banks.
In the government accounts this bank debt should be shown separately and be excluded from the total of government borrowing, as is any money raised by PFI schemes. It would be one giant ‘suspense account’ whose debts were owed neither by the government or the city.