There’s only one way out of the UK’s mess: default
John Stepek Nov 20, 2012
The ‘austerity versus stimulus’ debate continues to grip the pundits on the political and business pages.
Broadly speaking, if you lean towards the right, you believe in austerity – but you still want tax cuts. If you lean to the left, you believe in stimulus – even although it means massive implicit bail-outs for the banks and the asset-rich wealthy.
It’s all a lot of rubbish.
When economies get into the kind of mess that ours are in, there’s only one way out – default.
The question is merely whether you do this the hard way or the easy way…
It’s not about austerity versus stimulus
The austerity versus stimulus debate is a red herring. Both paths lead to hell – the only difference between them is which groups of people take the most pain.
Assuming you’ve allowed your economy to be sucked into a catastrophic credit bubble in the first place, then the best route out is through default. That puts the pain squarely on those who most deserve it – careless lenders.
You only need to look at Greece to realise this is true.
Yes, labour costs are falling, which means that Greece is becoming a bit more competitive, although it’s still way behind Germany. And yes, a drop in imports combined with a very small rise in exports, has helped the state of its finances.
But what’s really behind the little progress Greece has made is not austerity – it’s defaulting on its debt.
As James Mackintosh points out in his FT column this morning, “Greece’s improved current account is mainly down to two factors: collapsing imports and cuts of several billion euros in interest payments after the government defaulted on its bonds.”
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So the real lesson to take from Greece and its fellow eurozone pariah nations, is not about the effectiveness or otherwise of austerity. It’s that you’re going to default in the end – but only when your back is against the wall.
Greece was denied the option of printing money, which is the stealthy way to default. So the country had a choice. It could either cut costs the hard way, by cutting spending, raising taxes - and defaulting on its debt. Or it could quit the euro and return to the days of devaluation and inflation – and also defaulting on its debt.
Austerity is hard work. It’s not surprising that many of us thought that Greece would go for the second option, and dump the euro in disgust. It may yet do so. Or it could be ejected by other members of the eurozone, fed up with its slow progress.
But ditching the euro would be embarrassing. It would also be a terrible step into the unknown. Given the choice between grinding wage cuts and tax hikes, or the complete wipe-out of every savings account in the country that a return to the drachma would bring, which would you choose?
What choices will Britain make?
The big question for anyone living in the UK is: when Britain’s back is against the wall, what choices will the government make?
It wouldn’t take much to shake confidence in this country. Another slump into recession, maybe. Or clear evidence that this government’s spending cuts, promises and forecasts are no more believable than those of Gordon Brown. Or perhaps a bond market panic as the coalition tears itself apart over Europe, or Nick Clegg’s injured pride.
So what will the government do when that day comes? Would it bite the bullet and start reforming the tax system and trying to tackle the bad debts that have left a big chunk of the economy in the hands of zombies? Or would it call on the Bank of England to print more money and bail it out?
I think we all know the answer to that one. Osborne has already tapped the Bank for £35bn. Sir Mervyn King has put it on his tab behind the bar with a nod and a wink, but I’d be amazed if the Bank of England ever sees that £35bn again.
And what comes next, when markets realise that the UK is trying to plaster over a broken economy with printed money? A further 20% drop in the pound? Consumer price inflation taking off and becoming a headline issue (I’m guessing that 7% is the magic level that would trigger a proper public outcry)?
Will the government try to fill the hole in its finances by targeting pension pots? Osborne is already apparently considering cutting the amount you can put into your pension once again. Or will it take a look at corporate cash piles and decide that some of that money should be coming its way, as my colleague Merryn Somerset Webb has regularly warned?
The fact is, Britain will face some very tough choices before this crisis is finally over. You need to position your portfolio to take account of this. Have a look at this week’s MoneyWeek magazine cover story for more on why the UK faces hard times ahead. If you're not already a subscriber, get your first three copies free here.
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