Why Britain has to slash its overdraft

Jun 08, 2010, 04:01

David Stevenson

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Today, Fitch Ratings had its say on Britain's national overdraft. It wasn't pretty.

"The scale of the UK's fiscal challenge is formidable and warrants a faster pace of medium-term deficit reduction than set out in the April 2010 budget", says the credit ratings agency's Brian Coulton. In other words - "you lot need to cut back fast and hard."

So what? It's hardly fresh news. David Cameron had already softened us up for big cuts. The action needed to tackle the deficit "will change everyone's way of life", he said.

And actually, despite what Cameron said, things aren't actually any worse than we already thought, says Jeremy Warner in The Telegraph. Cameron's warning about the UK government having to spend £70bn a year on interest servicing costs alone within five years weren't new. And in fact, "interest costs as a percentage of GDP were actually higher in the 1980s".

In other words, Britain has been in big financial messes before – and has lived to tell the tale. So is Fitch over-egging things?

Sadly not. The credit rating agency makes two key points. Since 2008 the UK's budget deficit – how much we're overspending each year – and the national debt – how much we owe in total – have deteriorated more rapidly than those of any other AAA-rated country. Also, the 'primary deficit' – which strips out interest payments – has now grown to almost twice that of the 1970s and early 1990s.

That's bad enough. But here's the nub: the world is changing fast and the markets who lend the cash to plug the gaps between tax and spending simply won't wear such rapidly-rising deficits any longer.

Almost every other European country is now slashing spending hard to keep the global money-men happy. So Britain has to follow, whether it likes it or not. Because if we don't, we'll lose our cherished AAA rating, which means we'll have to pay more to borrow. So our national interest bills will climb anyway. And that would leave us stuck in a vicious circle.

So what now?

First, our new government is likely to act to cut even harder than it was planning. Tax rises could prove to be even nastier than had been expected.

Second, as governments cut back, any economic recovery is likely to fizzle out, as John Stepek said in yesterday's Money Morning.

Investment–wise, that's bad news for commodities and China. But it's much better, as we've stressed for a while, for defensive stocks that don't need economic growth to make their money. We look at one such sector in this week's issue of MoneyWeek magazine. If you're not already a subscriber, get your first three copies free here.

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  • 1. Howard

    (08 June 2010, 07:26PM)  Complain about this comment

    The government should consider increase the sales of gilts to the general public, not just by NS&I, but to create a fluid transparency gilts market for the public via stock market; ISAs. Interests should be paid monthly and tax free.
    This way the interest payment could be reduce (has to be at a lower rate than averaged bank saving accounts), and also all the printed money will go back to the UK public, not overseas investors, nor super rich private bankers.

    Down side? It might attract too much saving money from highstreet banks and damage their capital ratio.
    But so what? They are broke anyway.

  • 2. Howard

    (08 June 2010, 07:28PM)  Complain about this comment

    Encouraging public say in the budget cuts actually paved a path for the con-lib government to reduce foreign aid and army purchase (trident and aircraft carriers). As long as there is strong public support (very likely I believe), the gov't can drop their election promises.

    Nice move.

  • 3. Alex

    (09 June 2010, 12:04PM)  Complain about this comment

    To my mind the country cannot and could never afford the 20% increase in public sector workers that Labour created.

    Since the tax receipts of the country are unable to bear that level of public sector employment there are two choices.

    Reduce public sector emplyees back to 1997 levels, or cut all public sector wages by 20%.

    Alternatively a combination of the two, perhaps a 10% pay reduction combined with a hiring freeze and allow attrition to do it's work.

    These are the hard facts of life that public sector employees must accept, just as all private sector employees who are lower paid, have poorer pensions and less job security than there public sector comrades.

  • 4. RK

    (09 June 2010, 04:26PM)  Complain about this comment

    is the problem that UK has a weak private sector?

    and that banks are extracting far too much money from the country for their "services".

    as usual there are a raft f wise-guys trousering money they didn't earn - how UK can become more transparent and less corrupt is a big challenge.

  • 5. Timbo

    (10 June 2010, 03:18AM)  Complain about this comment

    Even if they put all the excess public workers on the dole, that would still result in a saving to the economy.

  • 6. Alex

    (10 June 2010, 12:54PM)  Complain about this comment

    It's not necessary to fire any public sector workers, a 20% across the board paycut is what is required. All that would do is restore the historic balance where public sector workers earned sligntly less that private sector workers in return for

    - gold plated pensions
    - longer holidays
    - greater job security

    Currently they enjoy all of the above plus higher average wages than private sector workers.

  • 7. webcontrarian

    (13 June 2010, 05:56PM)  Complain about this comment

    1. Should we listen to rating agencies who failed to notice banks and insurance companies were about to go bust?

    2. How many buyers of UK gilts are affected by the rating agency view?

    3. It does not follow from the desirability of a smaller deficit that government spending cuts will bring it about, it is quite likely they will not.

    4. The idea that the public sector is better paid is an arithmetical fallacy that derives from moving the lowest paid across to the private sector.

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