Could a bond market shock start in Britain?
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MoneyWeek Editor
John Stepek Nov 20, 2009
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You might have thought that Britain's debt problems had been dealt with in the Queen's Speech.
Her Majesty, speaking on behalf of the Government earlier this week, banned fiscal irresponsibility. She must have had difficulty keeping a straight face. Gordon Brown has promised to introduce a bill that'll see the UK government's deficit cut in half in the next four years.
It's a worthy goal. But he's not the man for the job. And with Britain's debts growing even more rapidly than expected, we may find the markets run out of time and patience before we have the chance to elect someone else...
Britain doesn't need pointless new laws...
A law to ensure that pupils get a 'good' education. Another to make sure that child poverty is abolished. The Queen's Speech didn't read like a manifesto, so much as a letter to Santa Claus. These are all nice aspirations, but saying you're going to legislate for them doesn't actually bring these worthy goals any nearer. You have to follow up words with actions.
That's the hard part. Because for all that Gordon Brown says he's going to pass a Fiscal Responsibility Bill to make sure Britain tackles its debts, there's been no sign that anyone believes he's the man to do the job.
Everyone knows by now that Mr Brown is a master of saying one thing and doing another. You and I might call that 'lying'. In politics they have a more sophisticated view of such things. It's tagged as "stealth" or "spin" or "presentation". But it amounts to the same thing - you can't trust a word he says.
It needs action on debt
You can get away with a bit of lying in politics. People tolerate - nay, expect - a certain amount of pragmatism and sleight of hand. But you can go too far. And the trouble for Mr Brown is that after years of 'Golden rules' that get broken, and Budgets that contain all the really life-shattering, business-destroying announcements in the small print, very few people are naïve enough to believe that he is anything but a tax-and-spend merchant at heart. The idea that he has any plans to rein in spending and do anything that might threaten his very slim chance of re-election next year is seen as ridiculous.
Unfortunately for the rest of us, we're at a juncture where credibility matters. Britain's public finances are in a mess. Yesterday showed just how big that mess is. UK public borrowing hit a record high in October. It shot up by £11.4bn, which was around double what analysts had been expecting.
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The national debt is now sitting at just under £830bn, around 59% of GDP. It was 'just' £695bn in the same month last year. The Treasury is still saying that it will have to borrow £175bn this year, but it's looking far more likely that this could hit £200bn or more.
The problem is two-fold. Businesses aren't making as much money, so tax receipts are diving. Corporation tax revenues were down 25% year-on-year, and are now at their lowest levels since 2004, reckons Citigroup. Meanwhile, spending on benefits is rising, as more and more people lose their jobs. Government spending rose by 10%. In other words, the government's income (tax receipts) is falling, while its spending is rising sharply, even if you ignore all the extra bits and bobs of stimulus.
So things are worse than most people had expected, and there's no clear sign of when they'll improve. That means that someone needs to come up with a plan which indicates how Britain is going to get its public finances in order. As Alan Downey at KPMG told City AM this morning: "There are tough choices ahead. But it would be unrealistic to think we will get answers from this government about where the axe will fall."
Thus far the markets have given Britain the benefit of the doubt. Gilt yields have remained low and stable, and foreign investors have kept handing over their money to the British government. The general sense has been that this stalemate will continue until the general election, and then investors will expect some sort of plan.
Markets are getting more jittery the closer the election comes
But the closer the election comes, the more jittery markets are getting. Concerns about the potential for a hung parliament – which could paralyse the government – are being voiced regularly. And if shocking public debt figures keep rolling in, or some other new spasm of panic grips the global economy, maybe they won't be so patient. And of course, quantitative easing has meant there's a willing and price-insensitive end buyer for gilts – the Bank of England. If and when that stops, demand for gilts could weaken significantly.
Japan's public finances are in a much worse state than ours, many point out, with government debt a staggering 200% of GDP or thereabouts. But as my colleague Cris Sholto Heaton pointed out in a blog the other day, Japan can get away with this for now: Japan and China: mad investments make sense for locals. The country is gripped by chronic deflation, so even the pitiful yields available on Japanese government bonds look good to the Japanese savers who own around 95% or so of them.
The problem for Britain is that we don't have chronic deflation. In fact, we'll probably see quite a spike in inflation over the coming months, particularly if the VAT cut is reversed on schedule. Certainly most people expect that to go into reverse before long. But if inflation keeps surprising on the upside – as it has a habit of doing – then gilt investors have another reason to feel jumpy.
David Stevenson writes about the potential consequences of a 'bond market shock' (Will the government bond market blow up?) where prices of government bonds fall and yields rise sharply, with a knock-on impact across all asset classes - in the current issue of MoneyWeek, out today (if you're not already a subscriber, you can claim your first three issues free here). Where such a shock could start, no one can be sure. But we certainly can't dismiss it being Britain.
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