U-turn ahead

Last year the Conservative party and the Liberal Democrats seized power after the 2010 general election and since then the ruling coalition has taken austerity measures, spreading the rumour that UK was on the fiscal brink. They cut governmental employment by 460,000 workers, and slashed public spending including the educational budget and infrastructure. They also raised VAT from 17.5% to 20% this year, which is partly responsible for a rise in commodity prices. The Liberal Democrats, who had pledged to vote against any rise in university tuition fees before the election, tripled the fees last December.

Nick Clegg, the leader of the Liberal Democrats, claimed that when the coalition formed Britain was on the edge of bankruptcy. David Cameron, the current Prime Minister, claimed that the bond markets were demanding austerity and so if Britain did not introduce immediate cuts, we would lose the confidence of the bond markets. Debt hawks often say that debt repayment is a cost to the country.

Readers of Felix may be aware that the Deputy Prime Minister has told lies in terms of not only tuition fees but also the fiscal state of this country in order to justify the coalition’s policies. Every schoolboy knows (or should know) that a government cannot go into bankruptcy like a private business. As long as Britain has its own currency, it has the power to print money. Governments can only be in default if they have incurred debts in another currency, that is, if they cannot finance their external current account deficit (which includes interest paid abroad). Iceland, which has its own currency, Iceland Krona, was in default in 2008 because they could not finance a large amount of external debt. What about the U.K? According to George Irvin, a Guardian columnist, about 80 % of public borrowing is from the domestic market- what economists call the “non-bank public”. To those who buy UK government bonds – either directly or through pension funds – British bonds are financial assets on which holders receive a payment totalling £34bn per annum. The remaining 20% is either held by government departments or is owned by foreigners. Most public borrowing appears as liability on the government side of the ledger, but as an asset on the ledger of domestic bondholders. Roughly speaking, therefore, UK citizens are Britain’s creditors, not debtors.

Cameron’s argument does not stand up either. Paul Krugman, who won the Nobel economics prize in 2008, says that Cameron has invented “invisible bond vigilantes” which do not exist. Actually the bond markets were demanding no such British austerity. They rather punish the measures Cameron has taken. UK citizens may well remember who the last two countries were to be downgraded by the bond market. The answer is Ireland and Spain, which took immediate austerity measures, that is, Cameron-style. Indeed, the bond markets got angry, and the interest rate of the Irish governmental bond soared to 9% because these policies cause a serious recession. (There is an inverse relationship between bond valuation and interest rates; the low rate means that the price of a bond is stable.)

Prof. Krugman said that the austerity measures by the Conservative/LibDem coalition had a lot to do with ideology: they have used the deficit an excuse to downsize the welfare state. He said in a New York Times column:

“The British government’s plan is bold, say the pundits – and so it is. But it boldly goes in exactly the wrong direction.”

He also predicted that the Britain in 2011 would look like Britain in 1931 or the United States in 1937, adding that premature fiscal austerity would lead to a renewed economic slump.

A recent economic report is likely to confirm Prof. Krugman’s prediction. The Office of National Statistics said on 25th January that GDP fell 0.5 % in the previous quarter. George Osborne, the Chancellor of the Exchequer, seems to continue his austerity measures, while the opposition counterpart Ed Balls said that Osborne must urgently re-think their reckless plan to cut the deficit too far and too fast. Concerned about this country’s economy, Balls required the coalition to start prioritising growth and jobs.

Joseph Stiglitz, who won the Nobel economics prize in 2001, also criticises Osborne’s fiscal policy. Britain, where the economy contracted in the fourth quarter, is already seeing the fallout, he said at an investor conference in Moscow on 2nd February. He added that austerity measures adopted by the UK coalition government were not justified.

Although Cameron and Osborne often exaggerate the budget deficit of UK, referring to the PIIGS debt problems, the U.K’s deficit problem is completely different from PIIGS. Unlike the UK or USA, Eurozone nations cannot print money to pay their debts with their own wills; they cannot take advantage of devaluation in terms of export by expanding money supply, either. It is the only European Central Bank (ECB) that can conduct monetary policies in the Eurozone. Let’s consider the current account balance from 2002 to 2009 for 4 countries: Germany, Iceland, Ireland and Norway. Germany was in surplus constantly, while Ireland was in deficit due to disadvantageous exchange rate of the Euro. Iceland improved the figure dramatically, and Norway kept a favourable balance. Since the latter 2 do not belong to the Eurozone, they can freely control monetary base to make themselves more competitive in terms of export.

The coalition’s austerity measures are not justified currently because UK has the power to take appropriate monetary policies. UK citizens should be more sceptical about the coalition’s statements. This country is going in exactly the wrong direction.

Illustration by Josh Yerrell