What Happens When The Debt Crisis Really Does Hit Britain

Once again, George Osborne has been busy with the kind of scaremongering, and talking down of the UK economy that sent it into a tailspin last year. At the beginning of 2010, Osborne, as part of the Tories Election Campaign, began to come out with the most ridiculous scare stories that put Britain on the same kind of level as the basket cases of Europe such as Greece.

From an Economics standpoint it was illiterate. There is, of course, no comparison between Britain and Greece, or between Britain and Ireland, or Britain and Portugal. Britain is more akin to Japan, which also has a huge fiscal deficit, has had one for the last 20 years, and yet, which still has record low interest rates. Japan's deficit like Britain's are largely composed of long term debt, and most of it is owed to Japanese citizens, not to foreigners.

Japan like Britain has control over its own interest rates, and currency. The main difference between Japan and Britain is that Japan has a large trade surplus.

Right up to the time of the Election the Liberals were opposing the Tory plans for Cuts. As I pointed out in my blog Liberal Economy With The Truth, in an interview with Sky News Deputy Political Editor, Joey Jones, David Laws confirmed that the deficit was being hyped up.



In fact, as I also pointed out in my blog Cuts Inflation & Interest Rates,

“Yet, even in the area that the Liberal-Tories placed most of their attention in justifying the need for immediate deep Cuts, their narrative has collapsed. In January 2010 the UK was paying less than 4% on its borrowing via the Ten Year Gilt. That figure continued to fall from that figure even prior to the Election. The Liberal-Tories attempted to claim credit for this falling Yield, saying that it was a consequence of their Cuts agenda. But, the FT last weekend had a chart (page 23) showing that, in fact, having fallen from a level of 3.6%, down to 2.9% in July, the yield on UK 10 Year Gilts then rose fairly steadily to around 3.7%, where it currently sits. That is a 25% increase in yield from just after the Liberal-Tories Cuts Budget was announced in June, and is consistent with the rise in yields on the Bonds of other countries that have initiated similar policies in Ireland, Greece, Spain and Portugal. The conclusion is that either the Big Capitalists and Financial Institutions who buy these Bonds believe that the Cuts will be detrimental to their interests, or else as Ed Yardeni put it, they simply don't believe Governments will make the Cuts,”

And today, after a year of Liberal-Tory Government, and economic policy the Yield on the UK 10 Year Gilt stands not at the 2.9% it had fallen to as a result of Labour policies, but at 3.79%, having risen earlier to 3.85%! In fact, contrary to the argument that Osborne was making today that Portugal applying for an EU Bail-out justified the Liberal-Tory policy of Cuts, the opposite is the truth.

One after another, economists and analysts on CNBC and other business channels have pointed out that the real problem for Greece, Ireland and Portugal is lack of growth. The ausetrity measures they had already put in place before they had to seek a bail-out had not worked. They had made things worse. Now, even with the bail-outs, these economies are being asked to cut even more, further reducing the potential for growth, whilst at the same time being asked to pay exorbitant interest rates as part of the bail-out to the EU.

On what rational basis does it make sense that economies already in trouble should be asked to pay 6,7 or 8% interest rates compared to the 3% being paid by Germany? The whole point of these economies being part of a single economic bloc, a single market, a single currency area, and giving up control of their interest rates and currency was that they should be able to enjoy the same borrowing costs etc. as the more propserous economies!

As I have pointed out before, in fact, Portugal has not faced the same problem as other PIG economies. It did not run up a large deficit on the back of increased Public Spending, and borrowing on the back of an asset bubble as did the US, UK, Spain, Ireland etc. Portugal's deficit results simply from the fact that its economy lacks the dynamism and resources to grow rapidly. Trapped within the Eurozone, with first interest rates, and a currency that were too high, and then suffering from the effects of the Credit Crunch and downturn of the European economy, it simply found that it could not pay its way in the world. It had to borrow simply to survive. Had it been able to borrow at the same rates as Germany, and to use that borrowing to finance investment in its economy that was needed, it might have created the potential for growth that would have enabled it to pay its way, and thereby avoid a worsening deficit.

The lesson from that for Britain should be clear. The UK economy was de industrialised under Thatcher during the 1980's, as British Capital found that it could make much higher rates of profit locating production in low wage economies overseas, particularly in Asia.

To keep the economy going, and to avoid the kind of social explosions that began to arise in the Inner Cities as real wages began to fall, British Governments from the late 1980's opened the monetary spigots even wider, and financed a credit bubble that gave the impression that living standards were rising by replacing wage rises with the ability to borrow, large amounts at low interests rates. This explosion of the Financial Sector of the economy, of fictitious Capital, went hand in glove with the Big Bang in the City, which made London the world hub of the Financial Services industry, and led to an unhealthy reliance of the British economy on Financial Services. That is why when the Financial Meltdown came, Britain was particularly badly hit. This was part of a long term change and decline in the British economy as set out in my blog Answering Cleggy's Questions.

Britain now needs to restructure its economy, and that implies lots of investment in new types of productive capacity, particularly in high value production, and that also requires large amounts of investment in infrastructure – the plans to introduce “high-speed” broadband, for example are a joke, by the time they are implemented they will be ten years behind what some economies such as South Korea and Singapore already have today, the plans for “high speed” rail will be equally out of date by the time they are implemented – and in education and training of workers. Yet, the reality of the Liberal-Tory policies is the exact opposite. It will mean an increasingly uncompetitive economy, and an increasing impossibility of covering the deficit or interest payments.

When the Liberal-Tories came to power, the economy was growing as a result of the fiscal stimulus introduced by Labour. The recovery appeared to be strengthening in the same way that such policies had had that effect in the US and elsewhere. The consequence was that unemployment was falling, and with it the deficit was being reduced, borrowing coming in lower than had been anticipated. Interest rates, as indicated earlier, were low and falling. But, the effect of the Liberal-Tory scaremongering and talking down of the economy soon had its effects on what Keynes called the “animal spirits”, the psychology that affects consumers, and investors.

Having been told how dire things were by the Liberal-Tories consumers believed them, and acted accordingly. They pulled in their horns, and began to spend less, and save more, worried that tomorrow they might not have a job – a likely prospect if they worked in the State Capitalist sector, or in an industry dependent on it. Businesses began to do likewise as they saw consumers spending less.

The Bank of England had attempted to do what it could to persuade people to keep spending, by going even further into debt – despite the fact that the Liberal-Tories kept up the narrative that the problem had been caused by too much debt, and the country maxing out its credit card. The Bank's Deputy Governor, Charlie Bean, admitted that the reason for the maintenance of such ridiculously low interest rates, despite inflation soaring to more than twice the target rate, was to persuade people there was no point in saving, and that they should spend their savings.

But, as the animal spirits began to feed into that area of the economy that had bubbled up more than most, and financed the continuation of spending by equity release – the Housing Market – with month after month declines beginning from the second half of 2010, it became clear as I pointed out in my blog Why Charlie Bean Could Be Disappointed, that there was a considerable incentive for consumers to save as much as possible even at such low interest rates, because measured against falling house prices, that were declining by 1% or more a month, the value of money against property was rising very rapidly.

It seems inevitable now that the next domino in the line to fall – Spain – will begin to come into the firing line very soon. Unlike Portugal, it did run up a big deficit on the back of a ridiculously huge property bubble that has yet to burst, despite more than a million empty properties overhanging the market.

Like the rest of the Spanish economy it is being maintained on the back of a fiction. The Spanish regional banks, the Cajas, are massively exposed to a fall in the Spanish property market. If the properties on its books were valued at anything approaching a realistic level, most of them would already be bust. The Spanish Government has been attempting to rescue this situation by encouraging them to merge, and is proposing to nationalise some of them to ensure that they are recapitalised.

In other words a re-run of the situation in Ireland prior to it going bust. Some of the proposed mergers of the Cajas have already foundered. The big Spanish Banks, which have considerable exposure to the Portuguese Banks – one reason Portugal was encouraged to seek a bail-out before they went bust taking some bigger European Banks down with them – are also massively exposed to the Cajas. Today's rise in the ECB Interest Rate could be the first step in the collapse of the Spanish Banking system. First will come a collapse in the Spanish property market as the bubble bursts. That will collapse many of the Cajas, which have to be nationalised or taken over by the larger Spanish Banks. Those Banks will attempt to do that rather than see their loans to those Cajas disappear, but that will probably just lead to the collapse of those larger banks, or at least the need for them to be massively recapitalised, which could only be done by the kind of State intervention seen in the UK, US, Ireland and so on.

But, this would be from a Spanish State already facing huge questions over its own creditworthiness. It is in the context of a Spanish economy that is likely to be contracting due to its own austerity measures, and which already has more than 20% unemployment, and more than 40% youth unemployment; the kind of figures you get in a Depression!

But, in reality the UK does not face this problem. Because Spain does not control its own Monetary Policy it cannot simply print money to cover these debts. The UK can. The problem for the UK is not Public Debt, but Private Debt. As I pointed out in my blog, UK Debt The Facts, private debt, the debt that every individual racks up on store cards, credit cards, student debt, mortgages and so on, is TWICE the figure for Government debt. Unlike the Government, which can simply print more money to cover its debts, individuals cannot do that without risking a long gaol sentence. But, more than that, what the Liberal-Tory Government's policies amount to is not reducing the amount of debt, but simply transferring Government debt to individual private debt. The Government is reducing some of its spending by reducing the wages and pensions of Government workers.

But, in so doing it means that those workers have to increase their own debt to retain the same standard of living. The same is true with the increase in Tuition Fees, and so on that transfers the Government's debt on to individual students. The Cuts in services mean that individuals will now have to buy them, and if they are already at the limit of their budget they will have to borrow to finance them. The same is true with the reductions in Benefits and Tax Credits.

So we already have a massive amount of private debt built up at least over the last 40 years as a result of the loose money policies of successive Chancellors after Tony Barber, that was encouraged by Governments to mask the stagnation in real wages.

That private debt, already standing at twice the Government debt is about to get much, much bigger as most analysts have indicated. It is doing so at a time when global interest rates, including the interest rates in the UK are rising. It has been illustrated by the fact that some fixed rate mortgage products have already disappeared, and Banks and Building Societies are demanding much higher deposits, and interest rates. It is being indicated by the steady rise in home repossessions and the rapidly rising number of people in arrears on their mortgage payments. A similar sharp rise in the number of people who say they cannot get to pay day before their money runs out has been recorded.

I was told the other day about a house repossession where the Bank had auctioned the house for £79,000, it having been bought only two years ago for £130,000. Another identical house in the same street sold recently for £118,000.

That is an indication of what happens when forced sales begin to rise, and the more such a firesale takes hold, the more rapidly prices collapse as happened in Ireland over the last year where prices fell 60%, or as happened with the rise in interest rates in the UK in 1990, when house prices collapse by 40%. As I've pointed out before on any measurement, UK house prices are massively overpriced. On a long term basis, the usual relation between wages and house prices is 3.5. Today it is more than 5. That implies that house prices would have to fall by around a third, or wages would have to rise by about 40%!!! But, in fact, the real relation has to be with take home pay, or disposable income, and in the current conditions that is going to be falling not rising. For large number of people thrown on to the dole as a result of the Cuts, things will be even worse. Using another metric, its been calculated that over a long period house prices rise by 4% p.a. Taking a three bedroom detached house that I know was bought for £2,000 in 1960 that would mean that today its price should be around £15,000.

In fact, its today valued at around ten times that! Finally, as I have shown previously taking the figure just since 1970, on an inflation adjusted basis, house prices today are around four times the figure they should be.

The debt crisis that has swept through one European economy after another will come to Britain. But, it is not the Public Sector deficit that will prove to be the problem, but the debt of millions of individuals. It will lead to mass defaults on credit cards and store cards, with huge implications for the banks and financial institutions that stand behind them. But, the latest figures also show that the economy having shrunk in the final quarter of 2010 has not recovered. Retailer after retailer has announced large falls in their sales and profits.

Analysts are talking about a year long sale, as retailers try to get customers in through the door. Many look set to go bust, and as I said recently some of them, such as Dixons are already blaming Government economic policies for the situation. But, the long expected and awaited crash of the property bubble must follow as sure as night follows day. I'd expect prices to fall on the above figures by anything between 75% and 90%, and that will have huge consequences. It will affect many of he calculations that Government has made about extracting wealth from people in old age to cover nursing care. It will mean that the Banks and financial Institutions will get hammered, and require the Government to pump even more money into them, having to print huge amounts of it to finance the operation. And under those conditions of another round of “Socialism For the Rich” as the Capitalist State bails out the banks, it will become impossible to insist on yet further austerity measures, or else widespread social unrest is inevitable. But, the other consequence is that for the first time in at least a generation, it will become possible for ordinary workers to be able to afford to buy a house.

In fact, out of that destruction is likely to come the basis of recovery.