Is the UK’s AAA rating now also under threat? Looks it


3:31 pm - December 2nd 2011

by Duncan Weldon    


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Just how safe is the UK’s AAA rating?

I ask because if I worked for a Ratings Agency I would currently be going through the OBR’s new forecasts and asking myself again and again, how long can I continue to give this country the top rating?

Consider the facts. The OBR has rather helpfully (in Box 4.4) provided some international comparisons of the UK’s debt and deficit position.

As they note:

Relative to the main European countries, the UK deficit remains high in 2013. The UK’s Treaty debt levels are now close to the euro area average.

As can be seen our deficit compares unfavourably with France, Italy and Spain whilst our debt, although better than either Italy, is higher than Spain’s and very similar to France.

Our growth doesn’t compare too well either. The latest EC forecasts have the UK growing at 0.6% in 2012 and 1.5% in 2013 not very different from France at 0.6% and 1.4% (the OBR forecasts are higher).

Furthermore the fact that austerity is now due to stretch into another Parliament reintroduces what a ratings analyst what call ‘political risk’.

The straight forward thing is that whilst the markets and press and gripped with speculation about France losing its triple A the UK has a higher deficit, similar debt and similar growth.

What’s more I still think that the OBR’s growth forecasts look to be on the high side, something which today’s Economist appears to agree with me on:

The economy will grow by just 0.7% next year, and by 2.1% the year after. Even these figures look too sanguine

Fitch has already fired a shot across the bows:

However, the deterioration in the economic and fiscal outlook implies that net public sector debt will peak at 78% of GDP compared to the previous OBR forecast of 70% in 2014-15. On a broader measure of government debt used by Fitch in international comparisons, the UK government will become the most indebted of any ‘AAA’-rated sovereign with the exception of the US (‘AAA’/Negative Outlook). UK government debt is on this measure projected by the OBR to peak at 94% of GDP and compares with Fitch projections for Germany and France of 83% and 92% respectively.

As with some other major ‘AAA’-rated sovereigns, unless off-setting measures were adopted, the capacity of UK public finances to absorb adverse economic and financial shocks that would result in yet higher public debt while retaining its ‘AAA’ status has largely been exhausted.

The problem isn’t that the government hasn’t been ruthless enough in cutting – it’s simply that the economy isn’t growing. And as the case of Italy demonstrates low growth can be as much of a problem as high deficits for bond investors.

Could it be the case that the great economic surprise of 2012 is the UK being placed back on negative outlook?


cross-posted from Touchstone blog

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About the author
Duncan is a regular contributor. He has worked as an economist at the Bank of England, in fund management and at the Labour Party. He is a Senior Policy Officer at the TUC’s Economic and Social Affairs Department.
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Reader comments


It can’t be. Osborne said due to the coalitions quick thinking we have come out of the dire mess and are safe. 🙁

2. margin4error

The deficit was never going to be under control in five years. One would like to imagine the tories were not so stupid as to have believed their policy was genuine, and that it was just a sensible position to take to win votes and justify rolling back the state.

But if they don’t do something significant to get growth up soon, then our AAA rating will have to be at risk. The reason it was absurd to talk of a downgrade before the election was that the UK has, fundementally, one of the world’s most powerful economies. That in itself meant there was obviously scope for brining the deficit down. The longer we don’t – the more at risk we become.

And if the Tories can’t protect our rating – because growth has failed – their message to the public will be one of failure, while Labour will be saying – in effect – “we told you so”.

The public would probably like little more than to vote for a party who offers them the prospects of fewer cuts and better growth – with no worrying about a credit rating attached since the tory alternative doesn’t protect that anyway.

“Furthermore the fact that austerity is now due to stretch into another Parliament reintroduces what a ratings analyst what call ‘political risk’”

Only somebody without a clue about British political history could conclude there is any risk that a UK government would default as a result of a political decision.

Nightmare scenario for Osborne

What we need is a really big public spending binge, to reassure the ratings agencies.

What could possibly go wrong?

Is the UK’s AAA rating now also under threat? Looks it

As a general rule, if your borrowing costs go up, that makes the case for more borrowing weaker, rather than stronger. It is not really going to do anything for the credibility of the left if it keeps insisting that Osbourne ought to borrow our way out of debt.

7. gastro george

Why should we care? The ratings agencies have had Japan rated below Botswana, and they didn’t give a hoot. Our chance of default is precisely zero.

8. Frances_coppola

I think the UK is likely to be downgraded at some point once the Eurozone starts to break up – which could be any time after next week. But I don’t think it’s reasonable to compare the UK with Eurozone members such as France and Italy. They have effectively adopted a foreign currency as their national currency, they have no control of monetary policy and are unable to issue currency. Therefore default is a real possibility for them if they are unable to meet their financial obligations. In contrast, the UK is a sovereign state which determines its own monetary policy and issues its own currency. It would only default if it chose to do so – and historically the UK has never done this. For these reasons the UK is a better bet in terms of likelihood of default than any Eurozone country, so should retain a higher credit rating despite its awful debts and dismal economic performance.

There is one crucial difference – the UK isn’t in the Eurozone, meaning it can become more competitive through devaluations, and has the Bank of England as a lender of last resort, a role which the ECB can’t adopt without a significant shift in German policy. And a cut in credit rating isn’t the end of the world – interest rates on US Treasury binds didn’t jump following their downgrade.

10. Leon Wolfson

@8 – What rot. We have zero prospects of growth. A+ is the BEST which we should have at this stage…several banks did the calculation using the rating agency’s own methods.

This doesn’t mean borrowing costs will change, of course, any more than America’s did. The rating agencies are a dark joke.

What it DOES mean is that Osborne is blowing smoke out his…

11. Frances_coppola

@10 Leon

Whatever our growth prospects – which I agree are minimal – the fact remains that the UK is less likely to default than Italy or France simply because it has control of its own monetary policy and issues its own currency. Italy has already been downgraded and is likely to be knocked down further, and France’s AAA rating is bound to be significantly reduced very soon as it is way too high. Even if the UK is downgraded to the extent you suggest it will still be a better bet than any Eurozone country. That doesn’t mean its borrowing costs would remain low after a downgrade – they would still be likely to rise, just not to the dizzy heights of Eurozone debtor countries. The UK is too closely tied to the Eurozone to retain its AAA rating or its low borrowing costs once the Eurozone starts to fall apart.

12. Leon Wolfson

@11 – I’m pretty much suggesting that the ratings are a mockery. They don’t even apply their own methodology.

13. Frances_coppola

@12 Leon

What is much more important than credit ratings is how markets view UK government debt. If they start to think the UK is looking a dodgy place to invest they will move their money somewhere else and interest rates will have to rise to entice them back. UK borrowing rates are already being artificially depressed by QE – how much printing would the BoE have to do to stop UK borrowing costs skyrocketing if there was a market run on gilts?

14. So Much For Subtlety

2. margin4error

And if the Tories can’t protect our rating – because growth has failed – their message to the public will be one of failure, while Labour will be saying – in effect – “we told you so”.

Sorry but how could Labour get away with that?

The public would probably like little more than to vote for a party who offers them the prospects of fewer cuts and better growth – with no worrying about a credit rating attached since the tory alternative doesn’t protect that anyway.

Sure. They are bound to pick the Zimbabwe solution over the Italian one.

You’re actually making the case that because the government is too incompetent and spineless to balance the budget that we should just borrow and spend our way into the Third World?

Planeshift

Only somebody without a clue about British political history could conclude there is any risk that a UK government would default as a result of a political decision.

Why? Britain had no history of stagflation before we did either. We are being ruled by Baby Boomers and their off spring for whom history and tradition holds no appeal and exists mainly as something to be broken and replaced. Why would they stick to Britain’s tradition, such as it is, for fiscal rectitude? There is some structural reason why we can’t follow Argentina down the gurgler?

15. So Much For Subtlety

7. gastro george

Why should we care? The ratings agencies have had Japan rated below Botswana, and they didn’t give a hoot. Our chance of default is precisely zero.

The Japanese are massive savers. They have to be. They have a weak welfare state. The Japanese government owes a lot of money to the Japanese people. The British are not savers. We owe a lot of money to other people – mainly Arabs and those nice East Asians who save so much. The Japanese cannot take their money home with them for a variety of reasons. The Chinese and Gulf Arabs can.

Thus we have a much higher risk of capital flight, causing rises in interest rates, which may well reach 7% or so and hence default is inevitable.

The Germans and French owe more per capita than the EU average – more than Italy. Something like 39,000 euros per person. There is no chance this will be repaid. The Europeans will have to openly default or go for a “soft” default through deliberate inflation. The British government is not much better off and will have to as well. If I were a Gulf Arab in charge of someone else’s money, I would be looking at Hong Kong.

Now now, you must not talk down the British economy. Only Osborne is allowed to do that. He has been doing it for the last 3 years.

And then wonders why demand has fallen off the edge of a cliff. Never mind, I’m sure he will offer up some more austerity. The elites favourite.

17. Leon Wolfson

@13 – Inflation’s already bad enough, yes.

@15 – Well, that just proves you have a poor grasp of the hammer the Chinese are busy poising above their economy.

“There is some structural reason why we can’t follow Argentina down the gurgler?”

Several:

Non party political civil service, especially at treasury
Independent bank of England, and OBR
Dominance of financial industry in London with direct contacts with government
Large pool of experts in finance and economics, with academic institutions as backup
Rigid class system
Constitutional Monarchy
Absence of a mass market left wing newspaper
Non-elected second chamber with record of willingness to ignore popular opinion
Strong judiciary with track record of making decisions against current government
electoral system that rewards being on the centre ground
Career structure of politicians that provides an incentive for behaving (how else to get the lucrative non-exec directorships?)

19. So Much For Subtlety

18. Planeshift

Several: Non party political civil service, especially at treasury

Sorry but we have not had a proper non-party civil service for some time. Well among the junior staff perhaps. But since Blair, any new government sweeps out senior management and replaced them with their own. Since Thatcher perhaps.

Independent bank of England, and OBR

Pretty sure Argentina has an independent bank. Not that the Bank of England is. It is obliged to follow government policy and is largely stacked.

Dominance of financial industry in London with direct contacts with government
Large pool of experts in finance and economics, with academic institutions as backup

A financial industry that is powerless to protect itself from the most asinine stupidities. And experts who are mainly divided and incompetent.

Rigid class system

Hasn’t existed for thirty years.

Constitutional Monarchy

How is that going to prevent a meltdown?

Absence of a mass market left wing newspaper

Was Peron on the Left or the Right?

Non-elected second chamber with record of willingness to ignore popular opinion

Now more or less entirely a creature of the executive so in so far as this was true, it is not any more.

Strong judiciary with track record of making decisions against current government

But only attacks the government from the Left. In other words, likely to be entirely in favour of policies leading to said gurgler.

electoral system that rewards being on the centre ground

And Argentina did not?

Career structure of politicians that provides an incentive for behaving (how else to get the lucrative non-exec directorships?)

Threats?

20. Leon Wolfson

@19 – True, the class system is not rigid, it’s ossified.

You’re upper class, so of course you think it’s just fine, stiff upper lip and whatnot, punishing the lower orders will save the day!

21. gastro george

@15 “We owe a lot of money to other people – mainly Arabs and those nice East Asians who save so much.”

Less than 25% of UK bonds are held overseas.

@19 – the point being that these factors, and others, combine to ensure that the majority of pressure for making political decisions comes from the upper class, who would have most to lose from a default, and already have several institutional and structural barriers in place against the extremely unlikely event of a british government deciding to attempt to default.

Argentina is based in an area of the world with frequent defaults, economic crisis, and political instability, itself having suffered its fair share of these. The idea that the UK – based in Northern Europe and surrounded by stable social democractic economies without any of the same regional features – is remotely similar is just barmy. Standard political illiteracy from the right.

23. So Much For Subtlety

21. gastro george

Less than 25% of UK bonds are held overseas.

Although that doesn’t say much if the ultimate owner is overseas, but they use a British vehicle to hold their bonds. Put it another way, foreigners now own over half the office space in the City of London. They own about 40% of all shares traded in the UK – 45% of the FTSE 100. Given Britain’s savings rate is a pathetic 1% or so, this is not surprising. If British banks have money, it is because nice foreigners give them money.

Planeshift

the point being that these factors, and others, combine to ensure that the majority of pressure for making political decisions comes from the upper class, who would have most to lose from a default, and already have several institutional and structural barriers in place against the extremely unlikely event of a british government deciding to attempt to default.

Sorry but if you start with a false premise it is no wonder you can come up with nonsense. The upper classes do not exert any influence on British politics. Nor does it follow they would lose from a default. The Middle Class might and that will be one reason we have not had one up to now. But you have not managed to point out what these institutional and structural barriers are.

Argentina is based in an area of the world with frequent defaults, economic crisis, and political instability, itself having suffered its fair share of these.

Indeed. And in the old days, a Briton’s word was his bond. Those days are over. We are run by a political class that despises that world. They are reported on by a media class that despises that world. We no share hold to those values. We are a lot more like the Argentinians now than we were then. You cannot claim that Britain’s dead society is anything other than a quaint memory. What our new political masters want to do is another matter. Given they think the laws of economics do not apply to them, there is a non-trivial risk of default.

The idea that the UK – based in Northern Europe and surrounded by stable social democractic economies without any of the same regional features – is remotely similar is just barmy. Standard political illiteracy from the right.

I don’t think similar is the right word. I don’t think I used it. However Germany is also in Northern Europe and was surrounded by social democracies. It still had hyperinflation. There is no reason why we should not. It depends entirely on the character and strength of will of the political rulers of Britain. In other words, we’re screwed.

@ gastro george

Botswana is a better credit than japan. They have almost no debt and earn lots from their natural resources. Japan has so much debt that the inerest payments alone take up a massive part of their tax revenues, despite super low interest rates. If not for their enormous USD reserves they would have been downgraded ages ago.

You are technically right when you say only approx 25% of gilts are held by foreigners. Unfortunately the data is muddied by a lot of gilts b eing held in UK arms of foreign funds. The real amount of bonds held by foreingers is a lot higher in reality.

@ duncan

Your argument essentially harls back to “cuts vs growth”. You argue we can’t cut our way out of deficits/debt, and then in as many words say that if we weren’t cutting spending we’d easily grow our way out.

What youy have there is an ideological position against austerity. You DON’T have any evidence that your position would actually work.

Firtsly, even if the UK returned to trend growth it would take years to even eliminate the deficit. Debt would still be piling up and debt/gdp would be over 100% somewhere. The UK simply hasn’t seen high enough EM style growth rates – even in the labour boom years – to make that policy work.

You almost make the bold assumption that not cutting spending, or in your parlance a keynesian stimulous – would actually boost growth. We can probably agree that it would a little, but there is enough evidence to say not enough, at too great a cost with the economic multipliers being under one. The US, which hasn’t really managed to cut any spending, and has had several big stimulous style spending inputs, hasn’t really benefitted from them.

A stimulous plan of large magnitude is almost gauranteed to result in a downgrade or worse. The stimulous is likely to cost more than the growth it delivers, would increase borrowing costs and interest payments, as the extra issuance overcomed demand, let alone the market sentiment fiscal incontinence would bring. It would leave the UK with no more tools or ammo if it didn’t work or another recession took place – it’s the financial equivalent of the “hail mary” pass in american football. If it works its a miracle, but you say hail mary’s because it’s incredibly risky and almost never works.

25. Frances_coppola

Tyler

You are being a little unfair to Duncan, I think. Not cutting spending is not the same thing as Keynsian stimulus, which would involve a large INCREASE in spending funded either by debt issuance or by printing money. There are plenty of nutjobs around who are proposing exactly that, but as far as I can see Duncan isn’t one of them. The ones who want to borrrow lots more cite the low yields on gilts, ignoring the fact that those are only low as they are because of flight from Eurozone debt and the depressive effect of QE. The ones who want to print lots of money are often the same people who say inflation is a good thing because it reduces the value of debt, ignoring the catastrophic effect that high inflation has on people’s incomes and savings – or alternatively they convince themselves that somehow UK production can magically increase overnight sufficiently to mop up the increased money supply. I don’t recall Duncan suggesting either of these.

You completely ignore the depressive effect on the economy of private sector debt. I know I’ve said this before, but concurrent deleveraging of private and public sector drives the economy into recession unless exports increase or there is significant FDI – neither of which look likely. You say Duncan provides no evidence that austerity doesn’t work. But you provide no evidence that it does – and there is a growing body of evidence that austerity measures in a tanking economy with an external deficit are a very bad idea indeed.

26. gastro george

@24 Tyler

“Your argument essentially harls back to “cuts vs growth”. You argue we can’t cut our way out of deficits/debt, and then in as many words say that if we weren’t cutting spending we’d easily grow our way out.

What youy have there is an ideological position against austerity. You DON’T have any evidence that your position would actually work.”

And neither do you. In fact, if we look at current policy, we see direct evidence that it isn’t working.

27. gastro george

@24 Tyler

“Botswana is a better credit than japan.”

GDP: Japan $5 trillion, Botswana $14 billion
Inflation: Japan 0%, Botswana 7%
Current account: Japan +$194 billion, Botswana -$0.3 billion

I’ll leave you to your dream world.

You should really try and get Bill MItchell to write for this site,

Who is in charge?

http://bilbo.economicoutlook.net/blog/?p=7838

@ gastro george

Your figures, when relating to credit are irreleent.

Try debt/gdp. Off the top of my heaf japan is around 220% and botwanas is one of the lowest in the world, well under 40%. The point being that if you lend them money the chances of you getting it back is very high. The actual total size of the economy is pretty immaterial.

@29: “Try debt/gdp. Off the top of my heaf japan is around 220% and botwanas is one of the lowest in the world, well under 40%. ”

Try this Wikipedia entry on the debt-to-GDP ratios of sovereign states:
http://en.wikipedia.org/wiki/List_of_sovereign_states_by_public_debt

The 2010 figure from the IMF reported there for the UK was 75.5 pc. For Germany, the comparable figure was 83.96 pc. For France 82.22 pc.

@ bob B

Thanks for the link…from IMF data Japan indeed has 220% debt/gdp and botswana 13%.

So when gastro george starts arguing about credit ratings and agencies, he might want to have a look why a country is assigned a rating. It isn’t a perfect science, but some small countries do deserve AAA whilst some economic powers don’t.

Now I have a bit moretime i’ll respond properly to a couple of comments above.

@ 25 Frances

To be fair also to Duncan he does not advocate increasing spending…nor does he advocate austerity either. At the end of this comment i’ll give you a simple worked example why growth alone can’t solve the UKs current problem.

You rightly say I have ignored private debt. It is a massive issue, but one the govt has limited control over. It does affect credit ratings etc, but in a more removed manner. In short, for the “austerity” debate i have indeed ignored it.

@ 25 Frances/25 Gastro

I never said austeritywould be painlessor fun, or even that it would necessarily lead to increased GDP growth (though evidence suggests that if a country does manage its finances in a proactive manner they tend to return to trend growth quicker). I am sayingthat austerity is the only way the UK can go forward without being swamped byit’s increasing debts. Not cutting, even if spending stays static, with a budget deficit as big as it is, quickly leads to enforced cuts or a debt trap. Growing your way out of debt, as I will show now with a simplified example, is near impossible when you have such a significant budget dedficit.

so, on to the example.

I am going to use some simplifications. First, i will ignore inflation. Second, i will assumethat all current govt debtand its interests payments are contained within current govt spending. i’m going to use round numbers:

UK GDP = 1600b
UK budget deficit = 10% GDP
UK GDP growth = 2% (which is above trend – i’m goingto be overly fair tothe growth people)
UK tax revenues = 40% of GDP
UK debt funding costs = 2.5% per annum (roughly 10y Gilt yields)

The above numbers are rough for calculation purposes, but close enough to the true figures. If someone cares to, they could build a spreadsheet where you can alter every variable and also include inflation.

The calculation I am using is pretty simple:

(initial deficit + increase in spending) – (increase in govt revenues) = final deficit

So in year 1, the government is running 160bn deficit after tax reciepts of 640bn. That 160bn of NEW debt costs the government 4bn a year in interest costs. Growth of 2% means GDP goes to 1632bn. Govt revenues now are 653bn.

So for year one, the budget deficit has reduced from 160bn, to 151bn (160+4-(653-640)=151).

Looks promising, right?

Year 2 comes around. the funding costs for 151bn of NEW debt is again 4bn (151 x 2.5%). GDP grows 2% again, now to 1665bn, and govt revenues are now 666bn. Unfortunately, the government has taken on more new debt, so in this static scenario we have to do the following calculation:

(164+4-(666-653)=155

The new budget deficit is now 155bn. It’s going UP despite good growth, low interest rates and no increases in spending except for debt interest payments.

The problem really lies in the fact that GDP growth is cumulative, where debt interest payments increase both cumulatively (interest on interest) but ALSO additively when you have a large budget deficit (you have to pay interest on all debt, not just new debt).

Simply put, when you have such a large budget deficit it swamps everything elseand outruns growth. It leaves you choosing cuts to bring it down more quickly, or forced into cuts when debt interest payments eat into other budgets. if you don’t bring the deficit down though you end up in a debt trap, where it becomes harder each year to balance spending becase you effectively have to cut more just tostay standing still on the deficit. You find yourself in the Greek or Italian situation, where interest rates go up, compounding the problem as no-one will lend to you as neither growthor austerity can manage the deficit down fast enough.

if you run the same test for a combination of austerity (cutting 1% of GDP per year off the deficit) and lower growth (say 1% again) we get these numbers:

Y1: (160+4)-(646-640)-16 {for cut in deficit through 1% cut in spending} = 142
Y2: (164+4)-(653-646)-32 {for cut in deficit though 2% cut in spending} = 129

Basically the spending cut term, equivalent to 1% of GDP per year in this example, dominates the resultant deficit term.

33. gastro george

Tyler, people have been predicting a debt crisis in Japan for many years, and those predictions have been as accurate as the predictions about the rest of the economy from neo-liberal economists.

Japan has a massive, profitable economy, and has few external debts – so it has no problem sustaining any internal debt.

@ Gastro George

Tell you what- you invest your money in Japan then. I’m pretty confident in my view that Japan will suffer a debt crisis of some form in the next decade unless they manage to dramatically weaken the yen. They simply have so much debt it acts asa drag on growth. Their demographics are terrible, and the only thing that would pull them out of a debt crisis is their currency reserves….but that would be at the cost of an even stronger yen, smashing their exporters.

I notice you haven’t bothered to comment on my “austerity vs growth” post…..

35. gastro george

@34 Tyler

“I notice you haven’t bothered to comment on my “austerity vs growth” post”

No, cross-posting.

You’ll probably disagree, but you’re stuck in pre-fiat currency world. A monetarily sovereign country doesn’t need to finance itself through bond issuance. A monetarily sovereign country can always print enough money to cover internal debts. That does not need to lead to inflation.

36. Frances_coppola

Tyler,

Great example which is completely undermined by the exclusion of private debt. Government finances simply don’t work that way – they are in equilibrium with private finances and you cannot consider one without the other.

I’m not arguing that action is not needed to cut the deficit at some point. But any attempt to do so when the private sector is both highly indebted and net saving and the UK has a trade deficit is doomed to failure. The reason is that when a government cuts its deficit, the spending gap that is left falls on the private sector, which is forced either to dis-save or take on increased debt to close it. If the private sector is unwilling or unable to use savings to close the spending gap, and is unwilling or unable to take on extra debt because it is already highly indebted and/or because banks are reducing their risk profiles, then in the absence of increased exports and/or FDI GDP must fall. This negates the effects of the deficit cuts and forces the government into more debt.

That’s why you cannot ignore private debt – it has a direct impact on the ability of government to control its spending and cut its deficit. I’m quite happy to do a worked example myself to explain this, if that would help you.

Gastro George

Strictly, the MMT argument that a sovereign currency-issuing government does not need to issue debt to cover its deficit is correct, but I’m personally uncomfortable with the idea of governments not having the discipline of having to fund interest payments on their debt. I don’t trust politicians to handle such a powerful tool as debt-free fiat money creation responsibly.

37. gastro george

@36 Frances

“I don’t trust politicians to handle such a powerful tool as debt-free fiat money creation responsibly.”

But your problem then is – who do you trust?

One of the main problems today is that people have forgotten that the topic used to be called “political economics” and not economics – because it’s not a pure science and political judgements are called for. The neo-liberal era has been about the progressive removal of the possibility of government (read democratic) action – when that is exactly what is now required.

Leaving it “to the markets” or “to the technocrats” will get us nowhere.

38. Frances_coppola

@37 Gastro George

The decision to issue debt is still a political decision. It just makes the real cost of deficit financing rather more obvious and therefore gives an incentive to politicians to keep deficits under control. Deficit spending is not cost free, but printing money makes it appear so – which is why it is dangerous.

@35 Gastro

You’re wrong there. You can print money to pay off debt but it will weaken the currency, massively spike inflation (which unsterilised money printing by definition leads to), lead to much higher interest rates and almost certain credit downgrades. You forget also that private debtors can’t print money, so you don’t solve their problems, but you do massively increase the cost of living through higher interest rates for them aswell and inflation.

Put it this way, i’ve just got hold of a framed set of all Zimbabwe’s notes and coins since independence. It’s a pretty illuminating piece showing just how unsterilised money printingdoesn’t work. ((the frame was the most expensive part)).

@ Frances

It’s hard to model private debt simply, and you are part right but part wrong. Consumers ARE indeed heavily indebted, but corporates are sitting on massive cash piles at the moment. They’re not investing because of various factors, but the cash is there.

Likewise, it is government debt which primarily drives credit ratings (which this article is about), and government debt which drives interest rates. Should the UK be downgraded or fall significantly off the austerity wagon, you would almost certainly see Gilt yields go higher….which pushes interest rates for the private sector higher, and compounds the problem of an indebted private sector with a new propensity to save.

So while my example is as you say not a perfect example, it does illustrate well the point i’m trying to make.

40. gastro george

@39 Tyler

Hark the cry from the orthodox, “Zimbabwe!”. There should be some form of Godwin’s law to cover this. Zimbabwe’s economy was stuffed before hyper-inflation broke out, as was Weimar Germany’s. The hyper-inflation was caused by the stuffed economy.

Inflation is driven by excess demand over supply. With today’s unemployment and slack factories and shops, there is hardly a problem with supply. It has to be managed, yes. But hyper-inflation is not inevitable.

@ Gastro George

Care to tell me then where Zimbabwean inflation is now, with their economy still doing badly, but with the country using the USD as acurrency?

About 3% you’ll find.

Yes the economywas doing badly pre-money printing, but the idea that you can simply print money to pay off debt with no adverse effects is simply ludicrous. And no, it’s not the same as QE (which is sterilised money printing – it has to be withdrawn from the economy at some point).

Inflation, as you correctly say, can be caused by an increase indemand over supply (though your argument that demand is low now rather begs the question why CPI is over 5%). Hyperinflation is a different animal though, caused by a lack of confidence in the fiat currency. Printing money to pay off our debt would easily cause that.

Hell, why stop at printing money to pay off debt? If, as yousay, we can do it indefinitely without any problems, why do we have to have taxes? and why aren’t we all millionaires and drive Ferraris? If the government can simply print money why do we have anypoverty at all?

Hark the cry from the orthodox, “Zimbabwe!”. There should be some form of Godwin’s law to cover this. Zimbabwe’s economy was stuffed before hyper-inflation broke out, as was Weimar Germany’s. The hyper-inflation was caused by the stuffed economy.

Zimbabwe’s economy was originally stuffed by the Government’s printing money to pay for the war in the DRC and the off-budget cash payments to “war veterans”. Round and round we go…

43. gastro george

@41, 42

I’m not denying that Zimbabwe printed money willy-nilly – to support the war or pay political favours. I’m talking about causality here. If the Zimbabwe economy was stable, then wars are usually “affordable” as long as the government desires it (pace Iraq and Afghanistan). But with a tanking economy and no revenues, then printing money was the only possible outcome. But the money printing was required by the lack of resources in a tanking economy, not vice versa.

CPI is over 5% because not all inflations are equal. Part of that is tax increases (hey, I could reduce VAT by 5% and reduce inflation at a stroke!). Part is commodity price increases. What the rise in CPI isn’t is wage inflation, and reducing unemployment by growing the economy is not likely to increase wage inflation for a long time.

And you really must stop hyperventilating. First Zimbabwe!. Then Ferraris-for-all! That’s economics for the first form.

If the Zimbabwe economy was stable, then wars are usually “affordable” as long as the government desires it (pace Iraq and Afghanistan). But with a tanking economy and no revenues, then printing money was the only possible outcome. But the money printing was required by the lack of resources in a tanking economy, not vice versa.

Zimbabwe’s economy was stable up until about 1998. It tanked after the war in the DRC and the off-budget payments were paid for by printing money. It then really tanked after the 2000 referendum loss and subsequent land seizure programme. It then really, really tanked after the collapse of the remaining domestic economy due to high inflation, high interest rates and no foreign exchange.

The underlying reason that the Zimbabwe economy tanked was that poor spending decisions were paid for by printing off more money. You can blame the poor spending decisions for this, of course, but they were only even technically possible because of the printing money decision.

Zimbabwe for hyperventilators 101

http://bilbo.economicoutlook.net/blog/?p=3773

@ Gastro

The economics for first years part is the bit when you sayprinting money would have no effect on inflation and would allow the govt to simply and easily pay off debt.

It really wouldn’t, and would end in disaster. There are somany examples of this, let alone Zim and the Weimar republic.

if you do think it could be done though, as i say, why stop at just closing out govtdebt. the govt could then issue more debt (financed by money printing) and spend it on whatever it likes, surely? Why doesit only work for the debt we already have and not new debt?? Think you have a logical flaw in your argument.

47. gastro george

@44

I think we can agree that bad spending decisions are, well, bad spending decisions. So I guess your point is that politicians are untrustworthy, and therefore some self-imposed restraint needs to be placed on them – for example by making a rule that expenditure must be “funded” through bond issuance. Or something similar.

You see, I’m not so far from that kind of position. For all Tyler’s hyperventilation, I’m not advocating throwing money out of windows. As I said, the situation has to be managed. Excess liquidity has to be mopped up where it exists – otherwise that would be inflationary. Bond issuance could be part of that – and there is probably a role in using bonds as long-term savings vehicles for pensions and the like – which would be a more constructive way of looking at them, because they never “fund” monetarily sovereign governments.

So restraint is necessary – but let’s manage the situation, not impose arbitrary rules that are only designed to preserve the status of the rich and the City, and do nothing for the lives of ordinary people.

48. Frances_coppola

47 Gastro George

Bill Mitchell’s analysis of Weimar and Zimbabwe is the perfect explanation for my distrust of politicians. Both episodes of catastrophic inflation were primarily caused by disastrous political decisions. I’ve recently read a lot of material about episodes of hyperinflation in various countries over the last century. All the writers agree that hyperinflation is caused by monetization of fiscal deficits coupled with inept and irresponsible political decision-making. Often there is supply-side shock too, as in Weimar and Zimbabwe – but not always, so I don’t think this can be regarded as a primary cause.

Currently Venezuela is going down the same road – printing money to fund spending it does not have the productive capacity to support. Inflation will follow as the night the day, and it will be because of the irresponsibility of Venezuela’s politicians.

39 Tyler

The UK will be downgraded if its economy worsens and/or its borrowing continues to increase. Both of those are likely if the government attempts to cut spending while the private sector is net saving. Yes, “the cash is there”, but if corporates don’t want to use it no power on earth can make them do so – and I would remind you that although the corporate sector has high levels of cash at the moment, it also has very high levels of debt. BIS reports that the corporate sector’s debt to GDP ratio is about 120%. Household indebtedness is about 100% of GDP, which is high enough to be a serious dampener on domestic demand. I would venture to suggest that depressed domestic demand is one of the reasons why corporates don’t want to invest at the moment.

Ignoring private debt creates unrealistic expectations of austerity programmes. Cutting public spending to restore primary balance is on the face of it a simple and quick solution to fiscal drag. But once you factor in private debt levels it is evident that it simply isn’t going to work. There are no simple and quick solutions to the current economic mess.

49. gastro george

@46

I’d still prefer to leave decisions in the hands of (at least marginally) democratic politicians than technocrats, financiers or arbitrary rules.

50. gastro george

Other people also seem rather sanguine about public investment: http://www.guardian.co.uk/commentisfree/2011/dec/06/standard-and-poor-austerity-eurozone

“Just as the Bank of England entered some numbers into a computer and deposited the sums in the accounts of private banks, so it can provide “liquidity” to finance government investment. And it can do so at very low, sustainable rates of interest. These funds will in due course be recovered when employment is created, income generated and taxes paid.”

@ Frances

So what would you do? Serious question….

In my opinion, austerity is the only real option, as without it interest rates are bound to go up, which is bad for govt finances but terrible for the huge private debts the UK has accumulated. The growth plan is unlikely to get people spending if any space they have is taken up by higher interest bills.

@ Gastro

You still don’t seem to get it.

QE is sterilised long term by the bond issuance/repurchase it uses as its mechanism. It is not just putting money into bank accounts.

Short term liquidity from the FED was against other collateral. it wasn’t just giving banks money. It was done as banks weren’t lending each other money, or in the right currencies, so the FED effectively stepped in as an intermediary.

I would seriously think before using Ann Pettifor, with her rather strange ideas about how finance actually operates, as an example of how it should operate.


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