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How to pay for the pandemic? Stark decisions faced by the Chancellor 

The scale of Britain’s borrowing and debt binge caused by the Covid-19 lockdown has never been greater. Last month borrowing rocketed to £62.1billion.

That number should start to ease down as people return to work and the nation’s shops open. Nevertheless, Britain, like much of the advanced world, is staring at a deficit and debt abyss this year.

Borrowing is projected by the authoritative Institute for Fiscal Studies (IFS) to hit 15 per cent of total national output, which is more than at the time of the financial crisis, and the greatest level since the Second World War – although that is below the wartime peak.

In the short period from April 1 to May 19 the Debt Management Office issued a staggering £90.2bn of gilt-edged stock to help finance Chancellor of the Exchequer Rishi Sunak schemes

In the short period from April 1 to May 19 the Debt Management Office issued a staggering £90.2bn of gilt-edged stock to help finance Chancellor of the Exchequer Rishi Sunak schemes

In the short period from April 1 to May 19 the Debt Management Office issued a staggering £90.2bn of gilt-edged stock to help finance Chancellor of the Exchequer Rishi Sunak schemes

Britain’s outstanding debt is already at nearly 100 per cent of national income and the Office for Budget Responsibility (OBR) reckons it is heading for around 110 per cent, undoing much of the good work of more than a decade of budgetary restraint.

In the short period from April 1 to May 19 the Debt Management Office (DMO) issued a staggering £90.2billion of gilt-edged stock – Government bonds, or IOUs – to help finance Chancellor of the Exchequer Rishi Sunak’s vastly expensive jobs furlough scheme, and to compensate for the loss of tax revenues.

That represents 41 per centof the £220billion that the DMO, an outpost of the Treasury, intends to issue between April and July. 

In case the DMO fails to haul in cash from gilt sales quickly enough to pay the bills, the Treasury has asked the Bank of England for an uncapped overdraft facility.

A good appetite for gilts from the Bank, UK domestic investors and overseas means the Treasury has not needed to use the overdraft so far.

But the truth is that a fiscally responsible government cannot allow borrowing and debt to balloon uncontrolled.

Britain’s debt mountain 

  • £62.7bn Borrowing last year
  • £54.8bn Borrowing forecast in March Budget for this year
  • £298.4bn Latest official forecast for borrowing this year
  • £62.1bn Borrowing last month
  • 42% Fall in tax receipts last month
  • 52%  Rise in government spending last month
  •  97.7% – Debt as percentage of GDP
  •  £1,888,000,000,000 Current national debt
  • £2,262,000,000,000 Debt forecast for end of 2020
  • £62.1bn Borrowing last month
  • 42%  Fall in tax receipts last month
  • 52%  Rise in government spending last month 

So the big, still-unanswered question is: how will this ever be paid for if future generations are not to inherit an enormous burden?

Higher Taxes

The monitors at the IFS already have suggested that tax rises are inevitable. But the Tory manifesto for the December 2019 election (remember that?) ruled out any increase in the current Parliament to three of the big tax groups – income tax, national insurance and VAT.

Moreover, if we accept the view of the International Monetary Fund, the Bank of England and the OBR that we are heading into a slump of Great Depression proportions, then hammering the economy with increased taxes on incomes and spending would be economic suicide.

The only feasible tax rises are those on wealth, including housing, fuel (which could be disguised as a green levy) and, possibly, a temporary/emergency surcharge on National Insurance to fund the NHS. This was a device used by Gordon Brown when he served as Chancellor.

Tax relief on pension funds might also be vulnerable. But all of these would be deeply unpopular and it would take great bravery to introduce big tax rises at the present juncture.

Spending Cuts

Public support for austerity is extremely weak after more than a decade of taxpayer sacrifices since the financial crisis.

The Government already is committed to improving funding for the NHS and to deal with financing for social care in the wake of the vast loss of life in the hard-pressed care home sector.

In addition, it is backing a big infrastructure roll-out, from the high-speed rail link from London to the North (HS2), to better roads, bus services and bicycle lanes. 

Higher unemployment levels will also place the Government under pressure to strengthen universal credit and other benefits on a more permanent basis.

Further haircuts on wages and pensions in the public sector look difficult to force through after the role it has played in navigating through coronavirus. The options are extraordinarily narrow.

Britain’s outstanding debt is already at nearly 100 per cent of national income and the Office for Budget Responsibility reckons it is heading for around 110 per cent

Britain’s outstanding debt is already at nearly 100 per cent of national income and the Office for Budget Responsibility reckons it is heading for around 110 per cent

Britain’s outstanding debt is already at nearly 100 per cent of national income and the Office for Budget Responsibility reckons it is heading for around 110 per cent

Living with Higher Debt

Britain may be able to sustain higher borrowing and debt levels over the short to medium term (one to five years) provided there is a belief among investors, domestic and global, that there are rules designed to bring down the burden in the long term.

The UK is in the good position of never having defaulted, which means that it enjoys good credit ratings. In contrast, Argentina (with a population of 45m) has defaulted on its debt 11 times in the last century.

It is possible to live with a high level of indebtedness for quite a long time. Japan, since the 1990s, has been able to sustain high debt levels of more than twice national output.

This is because of the willingness of its citizens, institutions and the central bank to buy Japanese government bonds in vast quantities in preference to other savings.

The hope would be that, by not adopting draconian tax rises and public spending cuts, the UK economy could grow sufficiently fast to start shrinking the scale of borrowing and debt as a proportion of GDP.

Such a policy might be tolerable if UK interest rates remain low and if overseas investors – the kindness of strangers – are willing to buy sterling assets.

In the recent past, Norway’s sovereign wealth funds and Middle East potentates have shown themselves willing to put their trust in Her Majesty’s Government.

Wiping out Debt Mountain

New Bank Governor Andrew Bailey raised the volume of QE by £200bn in his first week

New Bank Governor Andrew Bailey raised the volume of QE by £200bn in his first week

New Bank Governor Andrew Bailey raised the volume of QE by £200bn in his first week

Quantitative easing (QE), which occurs when the Bank of England buys Government debt, means that gilt-edged stock can be issued in the knowledge that some of it will be parked on the central bank’s balance sheet.

New Bank Governor Andrew Bailey raised the volume of QE by £200billion in his first week, to help cope with tensions in the financial markets, bringing the UK total to £645billion. 

The suggestion is that it could seek authority for a further £100billion of purchases next month.

The concern is that such steps could stir up future inflation. But analysts say this is different to the causes of hyper-inflation in Zimbabwe, Venezuela and Weimar Republic Germany.

In Britain, the Bank of England is independent of the Government in setting monetary policy, the amount of credit in the financial system. 

The Bank buys gilts in what is called the ‘secondary market’ from banks and insurers, along with specialist gilts brokers. 

So, instead of creating or printing money, the Bank is buying up existing debt at commercial prices.

The declared goal is to sell gilts back into the market when conditions are right, or hold them until maturity.

The big danger occurs if a central bank is required to buy the bonds directly from the Government, which amounts to turning on the printing presses.

The Bank’s independence and a strict inflation target mean that QE is on a tight rein.

Data shows that the Bank of England’s holdings of gilts are at 34 per cent of GDP. 

That is substantial, but it compares with 49 per cent for the European Central Bank, 38 per cent for the Federal Reserve in the US and 115 per cent for the Bank of Japan, so should be sustainable.

Britain’s outstanding debt is already at nearly 100% of national income and the Office for Budget Responsibility reckons it is heading for around 110%

Britain’s outstanding debt is already at nearly 100% of national income and the Office for Budget Responsibility reckons it is heading for around 110%

Britain’s outstanding debt is already at nearly 100% of national income and the Office for Budget Responsibility reckons it is heading for around 110%

Conclusion

The UK is not known for making extravagant policy decisions. My belief is that it will adopt a combination of policies to cope with higher borrowing and debt.

The Treasury will outline less stringent fiscal rules, which allow the Chancellor more headroom on borrowing and debt, with a clear path to gentle reductions over this Parliament and the next.

The Bank of England will act as necessary, both to support credit conditions and growth, and to ensure any excess supply of gilts is mopped up.

Should underlying inflation move beyond the 2 per cent target, the Bank of England will disgorge some of its gilts positions, mopping up excess liquidity.

All of this could be blown off course if the UK economy performs extremely badly, provoking a full-blown sterling crisis and a retreat from UK assets.

That is why the markets require the assurance of clear borrowing and debt reduction targets.

Source: Daily Mail – Articles

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