Why the budget will cost us all a fortune
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Associate Editor
David Stevenson Apr 23, 2009
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Emperor Nero fiddling while Rome burned and crew members rearranging the deckchairs on the Titanic are two classic cases of people turning a blind eye to a crisis. But both are probably apocryphal.
Sadly for Britain, Alistair Darling's budget actually happened.
The economy's heading south fast, while the state coffers are in the biggest peacetime mess ever. Yet all we got from the Chancellor was a bland acceptance that his earlier forecasts have proved utterly wrong, along with a load of rose-tinted rubbish about "the country's strength" and "a confident and successful Britain".
The trouble is, when reality finally hits home, Mr Darling will have to admit that his hopes for a storming 'recovery' in 2011 were just as flawed as all his other forecasts. And that to return the budget to any sort of balance, we'll face higher long-term interest rates, as well as raised taxes – and not just his new 50% top rate for higher earners – for many years to come.
Regardless of who's in power…
The Chancellor is alone in his optimism
As recently as November's Pre-Budget report, the Chancellor was still trying to pretend the British economy would only shrink by 1% this year. That's gone right out of the window – the official view is now for a fall of 3.5%.
Even that guess is still behind the curve - Capital Economics reckons the UK will shrink by 4% this year. But worse still, Mr Darling is pinning his hopes on a 1.25% pick-up in 2010. And even more unbelievably, in 2011, on Planet Darling, the hope is for 3.5% growth.
Amazing! No City analyst is anywhere near that upbeat. "Economic historians were trying in vain to find examples of developed countries that managed to recover within 12 months after so significant a one-off drop in growth", says The Telegraph.
This isn't just a debating point for economists. It matters a lot. Because how fast the economy grows or shrinks determines how much tax the government gets, and how much of that tax it has to spend on the likes of welfare benefits as job losses jump. Which in turn dictates how big an overdraft the public purse will run up.
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The economic news is the worst it's been for years
On both counts, yesterday's pre-budget news was dire. UK dole queues are now at their longest in 12 years, stretching by 177,000 in the three months to February to 2.1m, while jobless claims rose a further 74,000 in March. That's far from the end - most forecasters expect unemployment to hit 3m or more by the end of next year.
So it's little wonder that the government deficit has tripled to £90bn in the last fiscal year. That's the biggest shortfall since World War Two.
The Chancellor now claims that will rise to £175bn this year - up a cool 50% on his guess five months ago. He also reckons the shortfall will start to fall next year, but even then it will take until 2013/14 for the annual deficit to drop below £100bn.
The trouble is, the Chancellor is about the only person who believes these numbers. Why should anyone trust a politician who claimed just last November that the UK would suffer a mere temporary dip before recovering this summer?
What's the real size of the national debt?
So how big is the national debt really? Capital Economics believes the government's shortfall will hit £200bn in 2009/10 and stay above it for several years, "but even then, these estimates might be too rosy, given our view on the recession's length and severity".
All that money has to come from somewhere. Some will be printed by the Bank of England – although that's no answer as we've explained many times in Money Morning (Why quantitative easing won't work). But much will have to be borrowed. Sales of UK government bonds – gilts – are now forecast to be £220bn this year, much higher than expected. That's already pushing up gilt yields, i.e. long-term interest rates, as the market fears the Treasury will need to offer higher returns on all the extra bonds it must sell.
Otherwise, a "buyers' strike", when investors refuse to fork out the cash the government needs, looms. That really would spell trouble, pushing interest rates sharply higher – or in the worst-case scenario, resulting in a trip to the International Monetary Fund.
The next few years will be very painful
As for the rest of the shortfall, we'll have to stump it up in extra taxes, which will have to rise and stay high for ages. It all points to the next few years being very financially painful for us Brits. As the Telegraph's Ambrose Evans-Pritchard says, "tighten your belts". By the time we, and our children, have repaid Mr Darling's national debt, this budget will be a distant memory.
What does all this mean for investors? It's yet another reason to keep avoiding conventional gilts, as we've said several times already – the supply of British government debt is only set to get even larger. And again, it's another good reason to avoid any stocks reliant on the UK consumer's discretionary income, such as non-food retailers. Between the government and the recession, British people aren't going to have much cash to spare for the next few years.
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