by Alex Porter, Economy Editor
This month, in a single week, the British pound fell 3 percent against the US dollar.
There are varying accounts among financial analysts as to the causes of sterling’s fall. One reason given is the UK bank’s exposure to Spain, which Moody’s has warned could soon be downgraded. Others point to the UK economy’s integration with and heavy debt exposure to Ireland, which Moody’s did actually downgrade last week by 5-levels to Baa1. Such a grade is just shy of the ‘junk’ category.
No doubt sterling’s weakness is partly attributable to these factors, however the brutal reality is that the real underlying problem is the growing realisation that borrowing by the British government has spiralled out of control.
On Tuesday last week the Office for National Statistics (ONS) said that UK government borrowing for the single month of November was £23.3bn. The figure is a record outstripping the previous highest month at £21.1bn by £2.2bn.
The following chart illustrates the magnitude of the problem as UK government debt nears £1 trillion:
Graph courtesy of www.FGMR.com
Earlier this year, UK government revenue (the blue line) once again began to grow. The media reported this as an indication that the British economy was on the mend after the shock of hundreds of billions of pounds being spent bailing out Northern Rock and the UK government’s rescue of most of Britain’s major banks in the aftermath of the collapse of Lehman Brothers.
But facts are chiels that winna ding – the figures tell another story. The chart above shows that expenditure (the red line) remains on the same upward trajectory, escalating unrestrained every quarter.
Some argue that the government should borrow and spend in order to ‘stimulate’ the economy. It is. However government debt is now rising at roughly the same rate as revenue growth and the gap is not closing. We might deduce from this that increases in government revenues are now dependent on increasing the government’s deficit. If true then the £10.2 trillion (forecast UK debt by 2015) question is what happens to government revenues if the markets, believing these debts are not going to be repaid without devaluing the currency further (quantative easing), stop lending to the UK government?
Clearly, Britain PLC is running straight into a brick wall.
The ConDem government believes that austerity is the answer and have planned £81bn in public spending cuts along with a hike in VAT next month. However, as we see above, if government borrowing stops government revenues will decline. To make matters worse putting tens of thousands of public sector workers on the dole will mean less income tax revenues and a larger social security spend. Reducing public sector payroll and benefit payments will be mean less expendable income and so a drop in VAT receipts and retail sector performance.
Public confidence in the ability of austerity to solve Britain’s sovereign debt crisis is plummeting with more people now believing it will have negative economic effects (43 percent) than positive (40 percent). Indeed the evidence from countries around the world who have taken the austerity medicine such as Argentina is that austerity dramatically worsens economic performance.
Is there a third option for the UK treasury?
The ConDem government could cut expenditure by ending Britain’s military involvement in Afghanistan and Iraq, scrap Trident, declare its banks insolvent, repudiate the bailouts, renogiate PFI and change to a non debt-based system of money.
These policies will, one imagines, be resisted and so the UK government’s third option is quantative easing (QE) also called money printing or devaluation. This policy inflates away debts (monetisation). If a government has no money to pay its debts it can simply print more and pay that way. This devalues investments denominated in sterling and so it would only be a matter of time for the markets to calculate that UK debt will be repaid in money that is losing value. These international investors are sophisticated and will move to currencies or other investment categories which yield not just nominal returns but actual profits.
Are there any benefits from currency depreciation? Well, despite a recent 20 percent devaluation against key trading partners there have been no discernable benefits at all (see above table). At the same time the euro which has been relatively stronger has nevertheless seen Germany’s unemployment figures reach record lows.
Scotland’s Exit Strategies
With Britain PLC on the brink, Scotland has now no choice but to review its options.
On the table is the Scotland Bill which is the product of the Calman Commission’s recommendations. World-renowned economists and business leaders have called these proposals “dangerously flawed” and “unworkable”. This Westminster legislation will leave Scotland exposed to the UK economy and some observers speculate that that’s what it’s meant to do.
Also on the table is economic independence. This policy is supported by Scotland’s eminent Council of Economic Advisors (CEA) and means Scotland taxes itself to pay for its own public spending. Scotland would be protected from the UK’s deficit and so the surplus in Scotland’s accounts (GERS) would stay in Scotland and could be reinvested in public services and support Scotland’s university sector which because of the UK austerity measures now faces serious budget cuts.
The most serious downside to this option comes from the UK’s monetary policy. If the ConDem government and the Bank of England continue to devalue sterling which seems likely then all imports into Scotland will become more expensive and this will drive up inflation meaning a serious diminution of Scots’ standard of living. This problem will multiply as UK interest rates are raised to curb inflationary pressures.
Perhaps the most sensible exit strategy for Scotland may then be independence. With independence Scotland could issue its own currency creating the economic stability that Scottish businesses and institutions need in order to plan for the future with confidence.
The post-independence Scottish government would need to launch a national debate and referendum on which currency Scotland should use. The euro is under extreme pressure and there are increasing forecasts of its imminent demise. Perhaps the best example to follow then would be the Norwegian kroner. With a world-class oil fund Norway has no need to devalue its currency and so can guarantee the wealth of its citizens – the second richest in the world.
As 2010 draws to a close and minds turn to the Holyrood elections in May, the stakes could not be higher. As the realities of austerity are internalised by the electorate the SNP will point to the failure of the unionist ‘UK umbrella’ argument where Scotland is supposedly protected from global market volatility by the scale and prestige of the UK economy. The Labour party in Scotland will argue that independence is merely a constitutional argument unrelated to economics and draw attention to the ConDem austerity cuts.
With the Scottish electorate increasingly worried about job prospects and paying the rent the economic case which holds the most water will determine who forms Scotland’s next government.