The debt delusion

Cameron's Conservatives are economic illiterates

I am sick and tired (tired!) of listening to Tory politicians, free-market economists and right-wing pundits go on and on about our national debt, pushing the ludicrous idea that we are going to default on it. These are the same close-minded ideologues who spent years promulgating the virtues of the neoliberal, deregulated, financial capitalist model that so utterly and miserably failed in the autumn of 2008. So you can imagine how my stomach churned this morning as I read the Guardian's front-page headline: "Cameron: UK could default on its debt".

I'm sorry, but this is nothing short of economic illiteracy and political posturing. The Conservative leader said:

You can get to a level of government debt where, not that it becomes certain that people will cease to lend you the money, but you start running risks of them demanding higher premia, higher interest rates. Or you run the risk of not being able to meet your obligations.

This is pure and utter nonsense. Suffice it to say that we are not going "bust" and David ("I have never predicted that it is going to happen") Cameron knows this. However, as I have neither the time nor the inclination to deconstruct the Tory position on debt in any detail, let me point you in the direction of others who are far more knowledgeable on this subject than the Tory leader and his ill-informed speechwriters.

1) The economist Paul Ormerod, writing in the New Statesman in May:

Why . . . have the media become fixated by the projected increase in debt? The figures are big, almost unimaginably so. But when the British experience is put into an international context, the hysteria does not appear to be justified. As I write these words, for instance, I read that the Italian government has revised upwards its forecasts for public-sector debt relative to GDP. In 2009, Italian debt will be 114 per cent of GDP, rising to 118 per cent in 2011. On a comparable basis, Britain's figures are 72 and 87 per cent, respectively. These Italians, we may shrug, they do things differently. But what about the prudent Germans? In the 1997-2006 decade, before the present problems started to materialise, German public-sector debt relative to the nation's economy averaged 64 per cent. In the United States, the average was 61 per cent, and in Japan (due to its own recession of the early 1990s) a huge 164 per cent. In the UK, it was just 46 per cent. And literally every government is projecting large increases in debt.

Again: should this worry us? Well, we can usefully think of the ratio of debt to GDP as being similar to the size of an individual's mortgage relative to his or her income. And just like a domestic mortgage, there are two separate components, the interest payments and the eventual repayment of the capital sum.

So, in the UK, for example, the government offers for sale what are known as gilts -- from the phrase "gilt-edged", meaning that if the British government and not Johnny Foreigner backs them, you are certain to get your money back. The gilt states the interest that will be paid, and the date the government will repay the holder (who may very well not be the original purchaser, as gilts can be traded just like shares). The repayment date could be in just a year, or two or three decades hence.

But unlike with a personal mortgage, repaying the capital sum isn't something governments, at least those in stable western democracies, have to worry about too much. When one tranche of gilts comes up for repayment, it isn't usually a problem for the government just to issue a new set if it wants to. Obviously, if all the £1.4trn debt came up for renewal at the same time, there might be problems in persuading investors to refinance the whole lot. But provided the Bank of England is reasonably professional and astute, the repayment dates can be spread out over time.

Since the Second World War, all governments have had an important ally in their programme of rolling over and refinancing their debts -- inflation. When a pension fund, say, buys part of a new issue of gilts, the amount that the government agrees to repay on the due date is fixed in money terms. But inflation means that when payback time comes round, this fixed amount is worth much less.

2) The Nobel Laureate and Princeton University economics professor Paul Krugman, writing on his New York Times blog in July:

Hmm. My attention has been on other things, so it's been a while since I looked at British bond rates and CDS spreads. But here's where they are right now: ten-year bond rates at 3.737, compared with 3.337 for Germany; CDS spread at 71 versus 35 for Germany. Really not so bad. But, but, wasn't Britain supposed to be hurtling toward bankruptcy?

3) The former director of the Institute for Fiscal Studies Andrew Dilnot, writing in the Times in December 2008:

It's a record! Debt here, debt there, all greater than ever -- and the recession scarcely begun. Well, yes, if you take cash figures, if you ignore the effect of inflation and ignore the size of the economy, as if a £10 debt meant the same to your granny in childhood as it would in 2008 to someone in their earning prime. Only then is the number of pounds of debt "a record". Play this game with the National Debt and we find that it has hit "a record" in about 50 of the past 60 years.

4) The chief executive of the government's Debt Management Office, Robert Stheeman, speaking to Channel 4 News's economics correspondent, Faisal Islam, in May:

It [the challenge of weekly auctions of government debt] is a major one, and the numbers are extraordinarily high, I wouldn't want to pretend otherwise. At the same time we do have one big advantage and that is that the major government bond markets have become extremely liquid and extremely efficient . . . and I'm often asked: can the market take this -- and the answer is, yes it can . . . I'm genuinely confident that it will be doable and that everything that makes our market work -- not just ourselves, but the banks who help us sell our debt and the whole investor community, domestic, internationally -- will support the programme.

5) The Financial Times's chief economics commentator, Martin Wolf, writing in the FT in April:

. . . why should such a temporary increase in the fiscal deficit be terrifying? UK net public debt -- forecast at 61 per cent of GDP this year -- remains well below the average of advanced country members of the G20. At the end of the Napoleonic and second world wars, UK public debt was close to 2.7 times GDP. Yet even this triggered none of the hyperinflationary consequences now widely feared. As the IMF also notes, even a 100 percentage point increase in the debt ratio should require an offsetting shift in the primary fiscal balance (with interest payments removed from spending) of no more than 1 per cent of GDP, provided fiscal credibility is maintained.

6) The Financial Times columnist Samuel Brittan, writing in the FT in March:

Nothing I have said will convert people who have an instinctive fear of governments getting into debt. Let me therefore cite the distinguished English historian Lord Macaulay: "At every stage in the growth of that [national] debt the nation has sent up the same cry of anguish and despair. At every stage in the growth of that debt it has been seriously asserted by wise men that bankruptcy and ruin were at hand. Yet still the debt kept on growing; and still bankruptcy and ruin were as remote as ever." Harold Macmillan, as chancellor of the exchequer, quoted Macaulay in his 1956 Budget speech and remarked how the national debt had risen from £6bn in 1914 to £27bn in 1956, representing 27 and 146 per cent of gross domestic product respectively -- about twice what is now in prospect. Yet these percentages were reduced in the postwar phase without any heroic reserve or 'sinking' funds, through the simple forces of economic growth and inflation creeping at a rate not much above current inflation targets.

Of one thing I am sure. If we had the misfortune to engage in a major war, we would have far higher deficits and debts than anything now in prospect and few except some pacifists would worry. The second world war was financed in the UK with a 0.5 per cent bank rate. Why should it be more alarming for governments to get into debt to put people into useful work satisfying human needs than to borrow for guns and tanks whose only aim is to kill other human beings?

So Cameron and Osborne would do well to brush up on their Macaulay, if not their Keynes.

On a side note, much of the media coverage of this story has focused on how the leading credit rating agency Standard & Poor's lowered its outlook on Britain from "stable" to "negative" on 21 May and said the nation faced a one-in-three chance of losing its AAA rating. However, far fewer papers devoted column inches to the fact that, on the same day as the S&P warning, the other two major credit rating agencies, Moody's and Fitch, affirmed the UK economy's "stable" outlook and said they had no plans to review that outlook. But even if they did, and they joined S&P in issuing gloomy warnings about potential downgrades, the man in charge of raising money for the government by selling debt, Robert Stheeman, seems remarkably unperturbed:

A credit rating is a significant factor, looked at by international investors in particular. At the same time, a credit rating is ultimately just that: it's an opinion by the credit rating agency. I don't think it would fundamentally change the way international investors view our debt. It could mean they might demand fractionally more in terms of yields, [but the difference] could easily be imperceptible.

Then there is the issue of the agencies themselves - when will they be downgraded? Their failure to predict defaults on mortgage-backed securities, and their doling out of triple-A ratings to what turned out to be junk assets, helped cause the global financial crisis in the first place. As Professor Kevin Gallagher of Boston University pointed out last month:

The rating agencies have serious conflicts of interest, face little-to-no competition, constantly fail to predict defaults and accentuate the financial crises they've played a big role in creating. These issues need to be addressed to put this crisis behind us and prevent the next one.

Mehdi Hasan is a contributing writer for the New Statesman and the co-author of Ed: The Milibands and the Making of a Labour Leader. He was the New Statesman's senior editor (politics) from 2009-12.

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Angela Eagle is set to challenge Jeremy Corbyn. But many still hope for Tom Watson

Labour's deputy leader is the potential candidate most feared by Corbyn's supporters. 

The vote of no confidence came. But Jeremy Corbyn didn't go. As anticipated, the Labour leader declared just 20 minutes after his defeat that he would not "betray" his supporters "by resigning". Having never enjoyed the confidence of MPs to begin with (as few as 14 voted for him), he is unfazed by losing it now. His allies are confident that he retains the support of a majority of Labour's selectorate. 

The likeliest resolution is a leadership contest in which Corbyn is challenged by a single "unity candidate": Angela Eagle (as I predicted on Monday). Labour's former shadow first secretary of state, who impressed when deputising for the leader at PMQs, has been ready to stand for months. MPs speak of her enjoying support "across the span" of the Parliamentary Labour Party, from the "soft left" to "moderates" to "Blairites". A source told me: "It is no surprise that colleagues are turning to her. She is very much considered a tough, Angela Merkel-type figure who can lead the party through this difficult period." There is no sign that the backing of her own constituency party (Wallasey) for Corbyn will deter her. 

Other potential candidates such as Dan Jarvis, Yvette Cooper and Chuka Umunna have relinquished their ambitions for now. But two names still recur: Owen Smith and Tom Watson. Smith, who first revealed his leadership ambitions to me in an interview earlier this year, would run as a competent, soft left alternative to Corbyn. But it is Watson who the Labour leader's supporters fear most. He comfortably won last year's deputy leadership election and is renowned for his organisational abilities and trade union links. For these reasons, many regard him as a more formidable opponent than Eagle. "Fourth in the deputy leadership election to first in the leadership election in 10 months is a big challenge," an MP noted. 

But as deputy leader, Watson has long regarded it as his duty to preserve party unity above all. A challenge to Corbyn, pitting him against most current members (including a significant number who voted for him), unavoidably conflicts with this role. For this reason, Watson's supporters hope that a combination of pressure from MPs, some unions (who are expected to meet the Labour leader today), council leaders and members (who are "absorbing" the no confidence vote) could yet persuade the leader to stand down. Under this scenario, Watson would automatically become interim leader, either steering Labour through an early general election or presiding over a multi-candidate leadership contest. 

Should Corbyn refuse to resign today (as most of the rebels expect), some still hope that Watson could be persuaded to run. But assuming the Labour leader automatically makes the ballot paper (a matter of legal dispute), a contest between himself and Eagle is likely to ensue. Having won the backing of just 40 of Labour's 229 MPs in the confidence vote, Corbyn would struggle to achieve the 50 MP/MEP nominations required to qualify. 

A final, little-discussed scenario involves Corbyn agreeing to step down in return for a guarantee that John McDonnell, the shadow chancellor and his closest ally, would make the ballot. This would ensure the far-left representation in the contest and reduce the possibility of a split. But it would run the risk of merely replicating the present schism in a new form.  

George Eaton is political editor of the New Statesman.