The UK is now well into its election season and the main political parties are firming up their economic strategies for the next parliament should they be elected. Last time around there was a large element of fantasy in their plans as none of them faced up to the difficult problems posed by the UK banking crisis on the UK fiscal deficit and national debt. If we step back in time to the last election debate then I pointed this out on April 15th 2010.
If you look at the three published manifestoes there is a hole in each of them of a similar size, £30 billion. So in truth none of them are being transparent and honest in their spending pledges…… This is just over 2% of our Gross Domestic Product (GDP). Put another way it is around a quarter of the annual cost of the National Health Service.
In itself the concept of politicians misrepresenting the truth is hardly a surprise but this did matter as we ended up with two of the main parties in coalition. The problem highlighted above was exacerbated by the fantasy economics of the UK political establishment where we were quickly assumed to grow by 3% per annum perhaps forever! Reality was not so convenient as we were supposed to be approaching at a fiscal balance by now (-1.1% of GDP this year and a surplus next) whereas we continue to borrow at quite a substantial rate which looks set to be around 5% of UK GDP. Quite a miss and it has had quite an effect on the size of our national debt which the original Office of Budget Responsibility forecasts post the June 2010 Budget told us this.
public sector net debt (PSND) to increase from 53.5 per cent of GDP in 2009-10 to a peak of 70.3 per cent in 2013-14, falling to 69.4 per cent in 2014-15 and 67.4 per cent in 2015-16;
Wouldn’t it be nice as the Beach Boys sang if that were true?! Instead reality for the UK national debt sang along with Jeff Lynne and ELO.
You took me, higher and higher
It’s a livin’ thing,
We find ourselves reviewing a national debt that as of February was in fact of this size.
At the end of February 2015, public sector net debt excluding public sector banks (PSND ex) was £1,468.5 billion (79.6% of GDP).
Sadly for the OBR its credibility has sung along to the same song as the error count has risen.
Takin’ a dive ‘cos you can’t halt the slide
Oh but one clear difference between then and now is that this time around there has been some inflation it looks as though six manifestoes will matter on a national scale as opposed to three back then.
Does it matter?
The question is partly rhetorical and partly valid. The driving force behind even asking to it is because in the intervening five years something which impacts the dynamics of this area has changed very substantially. You see the cost of a financing new UK borrowing has plummeted. If we look back to the previous election then the UK benchmark ten-year Gilt yield rotated around 4% per annum and now it is 1.6% so borrowing now only costs 40% of what it did then at that maturity.If we look at the annual running cost of the 30 year Gilt it has fallen from 4.5% then to 2.34% now for another substantial drop. Even index-linked Gilts (UK inflation linked Gilts use the Retail Price Index) are costing very little extra right now as RPI inflation is at a relatively low 1% as even the oil price has come to help in this area.
This has created what you might call a perfect storm for the financing of our national debt. Contrary to the claims of our political class this windfall in pretty much a worldwide trend as for example a country I expect to default which is Portugal also has a 1.6% ten-year bond yield! Much of this has been driven by the actions of the world’s “independent” central banks who have used this “independence” to do what the political establishment in these countries would have struggled to do in their own name driven asset prices higher ( The FTSE 100 closed last week at a record 7089 last week) and bond yields lower. Of course they will not discuss the way that they have received a windfall as all sides of the political debate can gain by spending more or as seems more likely claiming to be fiscally prudent. Indeed the coalition government is deliberately being fiscally imprudent right now by paying 2.8% for one-year debt and 4% for three-year debt of which the latter is by far the most expensive form of UK national borrowing right now. But in an election atmosphere where it is know that the over-65s are proportionately likely to vote not even opposition parties seem likely to point this out!
Fans of Keynesian style economics would be pointing out that now is a time that the UK could and indeed should be borrowing. After all it is historically cheap- in some instances very close to all-time lows- meaning that the rate of return on projects financed by the debt needs only to be at a low-level as well.
The rub as Shakespeare would put it is that returns look set to be low too especially if we consider our troubled productivity figures.
The Capital Problem
The numbers and bond yields looked at above only consider the interest or running costs of our debt. If we look at the potential capital burden then we get quite a different picture as the annual review of the Debt Management Office highlights.
The DMO raised £153.4 billion via gilt sales in 2013-14; this was the sixth year in a row that the gross gilt sales programme has exceeded £140 billion, over which period the size of the gilt market has more than quadrupled to almost £1.4 trillion.
This is a problem as we will have to refinance the debt one day and the cost of a considerable portion of it is outside our hands. We have just seen UK inflation pushed lower by the oil price and it could just as easily do the reverse and leave us with a substantial bill for 23.6% of our national debt.
If we put that into numbers then a 1% fall in RPI inflation reduces the annual UK debt cost by around £3.5 billion. So the recent fall in inflation due to the oil price is saving us around £5 billion a year. This is a big impact because it applies to all our index-linked debt. By contrast falls in bond yields take time to build as they apply to new and refinanced debt only but if we use some rules of thumb and try to estimate the impact then changes since the last election could be worth around £10 billion a year.
What is austerity?
This is a question we have regularly debated on here. At the moment the various UK political parties are mostly being considered as applying austerity going forwards according to the mainstream media. But as you can see from the quote above our national debt has tripled with nobody having any particular plan to pay it back. On that road what is called austerity has in fact been much more like Keynesian economics! Especially if we consider the annual fiscal deficits which we have run.If we look at the coalition government you could argue it loosened its plans from around 2012 which everyone now uses as a starting-point.
So to coin a theme introduced in the comments section recently how much of a fiscal deficit is that threshold for it to be called “austerity” these days? As it is plainly no longer zero.
I expect there to be much misrepresentation over the coming weeks as we head towards the General Election on May 7th. However my purpose today was to highlight the underlying financial situation concerning our fiscal deficits and debt. I doubt many others will be analysing the fortunate situation we find ourselves in because that will mean admitting that they have spent the money.Oh Well! Of course should the favourable debt circumstances reverse and in particular the inflation ones we may well see Cilla Black again.
Meanwhile on we go with Labour saying they will fully fund all new policies with no extra borrowing. The Liberal Democrats say they will borrow £80 billion less than “no extra borrowing” with the Conservatives who you might think would plan to borrow even less suddenly telling us this.
Our manifesto will commit to a minimum real-terms increase in NHS funding of £8bn in the next 5 years.
No wonder voters get confused!Meanwhile the NHS lumbers on as something which apparently cannot even be questioned a bit like the previous situation with immigration. This troubles me and I write as someone who has seen his parents get good treatment from the NHS in recent times albeit some of it was chaotic at times. Which part of the extra spending will be real growth and which just inflation?