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Thursday, 20 May 2010

Shaft

Can you hear it? In the distance? It sounds like a low rumble: traffic? distant thunder? It's getting closer and then you see it. It's the sea drawing back from the beach and the noise is the sound of billions of pebbles tumbling over each other as the waters roll back.

Now the sound has changed; if anything the tone is lower. This time it's the seas returning and as the waves approach the shallowing sea shelf, they back up behind each other, pushing, pushing and the front waves grow and grow. Now there's no mistaking it - it's a tidal wave and it's heading straight for you.

I'm not talking about the devastating Asian tsunami which wiped half a million lives off the face of the earth. I'm talking about the shed load of financial grief that is about to be visited upon us over the next few months and years.

The figures are ludicrous. The Office of National Statistics gives the UK government deficit for the calander year 2009 as £159.2 billion (11% of the value of what our economy produces in one year - gross domestic product (gdp)). The total gov't debt: that's the amount outstanding of all the borrowing governments have done over the years is £950.4 billion or 68.1% of gdp.

Now we're a big country; we're a wealthy country (not as wealthy as we could be) and we are in control of our own monetary policy - we can set our interest rates and our currency is floating. All this sets us apart from Greece - we're not in such dire straits - yet.

One of the ways to reduce our debt is to expand the economy - much of the annual deficit was because of the very sharp recession in the past couple of years. Tax revenues fell off a cliff because businesses - especially the financial sector - made little or no taxable profits. Also, businesses closed or retrenched leading to increased unemployment and increased gov't spending in the form of benefits.

As we move (tentatively it seems) out of the downturn the economy should grow - soaking up the unemployed - reducing benefits, increasing the number of tax payers - companies will make profits - increasing the tax revenue.

But that would not be enough to bring Government finances back into balance. Even if the economy returned to its earlier levels of activity our Government would still have to borrow from the markets.

For Greece, borrowing from the markets became prohibitively expensive. Why? The long  answer is that the economy is shot to pieces; gov't spending is excessive and tax collection is inefficient. that's why Greece has such a mountain of debt. The more immediate answer is that much of Greece's borrowing is relatively short term and much of the debt falls due to be repaid within a  short space of time. Normally, gov't could roll over debt or borrow to repay debt falling due. In Greece's case the public finances are so bad that they haven't the money to either pay off existing debt or seek to roll it over. As a result the markets are closed to the Greek government. No one wants to lend because they don't think they'll get it back. That's the immediate problem and that is why the EU is bailing Greece out.

In the longer term the problem is, if anything, even more unpleasant. First, it has to get it public spending under control. That means, cutting pensions, salaries and bonuses of its very large public sector. It also has to increase its income - by increasing taxes (VAT) and the efficiency of tax collection. For a country used to lax controls on spending and tax collection such measures are extremely unpopular.

However, its main challenge is growing its economy and improving its efficiency. Here it is stymied, because it is in the Eurozone. It cannot devalue it's way out of this. One way to begin to rebalance an economy is to devalue. Exports are cheaper and imports dearer. It can't change it's interest rates so the cost of finance to business etc is higher than can be afforded. Faced with these constraints it has to restructure its economy; but these constraints make that extremely difficult.  Similar concerns affect the Spanish and Portuguese  economies. In Spain's case, one industry distorts its economy - construction. It was the fuel that helped the country's rapid growth, but now it is a huge burden around its neck; with massive debts and stagnate growth.

Today, in England, if you haven't lost your job, or gone onto short hours, you wouldn't know that we'd gone through the worse economic crisis in a generation. That mortgage payment is possibly lower now than previously, your credit card debt may be slightly cheaper. OK you'll have noticed that prices in the shops are higher - that's the falling pound and the cost of utilities and services just seem to go up and up no matter how many regulators there are. If you're a pensioner or supplementing your income from the interest on your savings you'll be suffering . Two years ago you could get 6.5 % on your savings, now you'll be lucky to get 2 or 3%. But overall, it doesn't seem as bad as people have made out.

That's the tide going out. In the next few weeks and months the waves will break over our heads and it'll be difficult.

We're not as bad as Greece or Spain: except... Except like Greece we have a large public sector which is gobbling up money. Expect to see reduced services all round - especially in local authorities. Central Government, especially the Treasury, dislike local authorities. They suspect them of being inefficient, profligate and over powerful. Except like Spain we have one over dominant industry - the financial sector.

There was much talk in the Election about rebalancing the economy; all parties are agreed that we don't produce enough, we import too much and export too little and we rely overly on one sector. Vince Cable is in charge of business and his job is to bring about that rebalancing. Except like Greece we've become used to an economy that grows through consumption not production. And we've financed that consumption through debt and not investment.

The trouble is that we're not in the best position to effect the necessary change. If change is to take place shouldn't it be from a position of strength? This Government sees our strength in the private sector - what that means is unclear. Nigel Lawson, Thatcher's Chancellor saw strength in the financial sector. He saw nothing wrong with us producing little as long as we produced financial products. Now we have to reverse that, or at least ensure that if the banks implode again we won't be completely shafted.

It's going to be a long haul. We don't have the same pressures on us as do the Greeks; our debt is more evenly spread, much of it is long term - we're not in the position of not being able to refinance it. But we're living beyond  our means and we simply can't afford all the services we have come to expect - unless we're able to increase the tax take.

The tax increases required to balance the books are eye watering. 10p on income tax. The cuts in public expenditure draconian. If you exclude the ring fenced services - 20 % and more for some programmes.

So when the tsunami comes expect to have the ground sucked from under your feet, as services are cut, and your head smashed in as you pay more tax. If you're one of the one in four unfortunates life's going to get a great deal more unfair and desperate.

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