Monday, 8 August 2011

Markets Destroy Tory Arguments

For over a year the Liberal-Tories have been telling us that draconian austerity measures were needed. They said that unless Britain reduced its debt and deficit the international markets would attack Britain, forcing it to have to pay higher interest rates in the way they had done with Greece, Ireland and Portugal. Like pretty much all of the Liberal-Tory economic analysis, and arguments it was crass, illiterate, and wrong. Now the market reaction to the downgrade of US Debt to AA+ from AAA, has once again proved it wrong.

Today was the first day of trading after S&P downgraded the US Credit Rating. If there was going to be a big market reaction to that, today would be the day it would happen. In fact, as I'd suggested last week, there has been virtually no reaction whatsoever. But, the market reaction has disproved the Liberal-Tories prognosis, more clearly than any of the other evidence of the last year, that they were wrong. Over the weekend, Liberal-Tory spokesmen like Cable and Hague were wheeled out to crow that the downgrade of the US, meant essentially an upgrade for the UK. They repeated all the same old nonsense about that being a reflection that they had saved Britain from the brink that Labour had led the country to.

So, you would expect then that as they claim Britain had been upgraqded compared to the US this would be reflected in the coparative interest rates and currency performance, were their argument correct. What has happened? This morning the US 10 Year Treasury is trading with a yield of 2.5%. The UK 10 year Gilt on the other hand is trading at 2.7% and rising!!! The UK is having to pay a yield that is 10% higher than the 2.5% being paid by the US with its AA+ rating!!! Go figure.

But, not only that, but despite the US downgrade, money was clearly flowing towards the US, and away from the UK. Cable - the exchange rate relation between the dollar and sterling, not the politician - showed that the dollar had risen by a third of a percent against the pound!

Why? Because unlike the UK, which is going back into recession due to the austerity measures introduced by the Liberal-Tories, and which means that profits will fall, and the deficit is rising due to lower tax colelctions and higher benefits payments, the US is continuing to grow, though at a slower pace than it has been doing. But, also the real reason that both the UK and the US, along with Germany and Japan, have seen the interst rates on their Bonds fall, and remain low is that the Capital Markets know that none of these economies are actually going to default on their debts. That cannot be said for economies like Greece, which has already defaulted, or for Ireland, Portugal, Spain or Italy. Its one thing to get back a few perecent less on your Capital as a result of inflation or a devalued currency. Its another to lose all of your money, or even 20,30 or more percent of it through an actual default, which is what investors in say Greek debt are facing.

The same reason is why the Bank of New York Mellon, which is thought to be one of the safest banks in the world, is now charging people to deposit their money with it!!! The fear of default, or a crash in asset markets such as shares and property is now so great that some people are prepared to pay just to not lose their cash by putting it somewhere else!

But, as I've said before, the Liberal-Tory argument was crass to begin with. At the beginning of 2010, prior to the Election, UK 10 year Gilt Yields were standing at around 3.2%. After the Liberal-Tory, June austerity Budget, they rose steadily. By the Autumn of 2010 they had risen by more than 20% to a high of 3.8%. In fact, as the data show, not only has the Liberal-Tory economic policy cratered UK economic growth, but the consequence of that has been to actually increase rather than reduce the deficit! If they were correct that should have meant yields continuing to rise. In fact, they have fallen. Why? Because, the crisis in the Eurozone has led Funds and other investors to seek safer homes for their Capital. They have gone to those economies such as Germany and Japan, that have large trade surpluses, and they have gone to economies such as the UK and US, which have massive assets at home and abroad that more than cover their debts, and which more importantly are able to simply print money to cover their debts should they need to.

But, the other part of the Liberal-Tory argument was false also. They claimed that they had to introduce the austerity measures, because Labour had been reckless in its spending. But, that wasn't true either. For the first three years of the 1997 Labour Government, they stuck to the Tories Budget plans. In the early years, they were running Budget Surpluses and paying off the National Debt. They began to spend more to act counter-cyclically during the global recession of 2001, and continued to do so in the downturns of later years, as well as to begin to repair the damage to Public Services, such as the NHS, that 18 years of Tory misrule had brought. But, in fact this spending although representing large percentage increases still did not bring it up to the average of previous Governments.

In fact, the average ratio of deficit to GDP under Blair-Brown was lower than it had been under Thatcher-Major!!! Only, in 2008/9 did that change radically, as Britain like most other countries attempted to prevent the Financial Meltdown turning into a global Depression. The increase in the deficit during that period was equal to the increase in the whole of the previous seven years.

As Richard Portes of the London Business School said on CNBC this morning some of the problems in Spain, and Italy seem resolvable with a suitable restructuring of their economies. The same is true of the US, but given the economic policies of the Government, and their determination to keep digging us into a bigger hole, it is difficult to see where any demand in the economy is to come from. With growth non-existent and the path towards a new recession on a steep downward course, with that causing the deficit to rise, and with a weak and weakening pound pushing inflation ever higher, how long befoe the ratings agencies turn their attention to Britain?

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