Squaring the circle
In the UK and the US, governments are promising to spend more. Even though they don’t have the money — and the money they have is daily losing value thanks to inflation — they will spend more because that’s what their voters demand. Bowing to this demand, trying to square this circle while pretending it’s pain-free, is a dangerous delusion.
Wolfgang Schäuble, president of Germany’s Bundestag and a former finance minister, put the matter much better than I can. He wrote in June this year: “Many governments focus on the ‘easy’ bit of Keynesianism — borrowing — and then postpone repayment of their debts. This leads to continually expanding sovereign debt. Sooner or later, inflation looms. Keynes saw this as a major threat, citing its potential for ‘overturning the existing basis of society’.” Schäuble’s view isn’t popular right now — more than 140 academics wrote a letter in reply saying “it’s time Europe stopped fetishising fiscal discipline”. But being unpopular doesn’t mean he’s wrong.
In the UK the Chancellor, Rishi Sunak, who delivered his 2021 Budget on Wednesday, is a fine rhetorician and probable future leader of the Conservative Party. Sunak said before he delivered his Budget, which always is a chance for some theatrical flourishes tucked into the serious bits, “we will continue to support public services, businesses and jobs while keeping our public finances fit for the future”.
Sunak’s promise of a ‘plan for growth’ is hollow; it pledges that which he cannot deliver — pain-free economic growth. The UK has an aging population and a poor growth record — the pension system, welfare, health and care services are going to make ever-greater demands on government finances. UK productivity growth is the kind of mythical creature — an underpowered slug maybe — that J. K. Rowling might dream up. The OBR estimates that the UK’s potential growth rate is about 1% a year.
Unless economic growth can be remarkably improved then the only way of squaring this circle will be higher taxes, more newly-created money, or budget cuts elsewhere. Of the three, only the second might elude the attention of all but the wariest voter. Sunak said: “I want to reduce taxes — by the end of this parliament I want taxes to be going down not up”. How odd then that, according to the Office of Budget Responsibility (OBR), a Treasury offshoot which gives independent economic forecasts and analysis of the public finances, says the overall tax burden will rise from 33.5 % of GDP recorded before the pandemic in 2019–20 to 36.2% of GDP by 2026–27 — its highest level since late in Clement Attlee’s post-war Labour Government in the early 1950s. And the state carries on growing: spending on health, social care and pensioner welfare has grown by two-thirds as a share of GDP since the late 1970s, from 8.9 to 14.2% of GDP, as society ages. Spending on debt interest and defence has almost halved as a share of GDP in that time reflecting falling interest rates and the end of the Cold War. By contrast, capital spending on housing, transport, and other infrastructure is lower than in the late 70s, although gross public investment (including that on health and other areas) reaches 5.0% per cent of GDP by 2024–25, its highest sustained level for 40 years.
There’s no doubt that the UK is recovering from the ‘scarring’ caused by the Covid-lockdowns — the OBR estimates that the fiscal deficit for 2021–22 will be 7.9% of GDP, down from its previous forecast of 10.3% and almost half the size of 2020’s shortfall. But there are rocks ahead. As one commentator says: “Is what’s coming next going to produce a sudden reverse and some kind of downturn next year? During the pandemic many of the initial assumptions of economists and policymakers about the impact and recovery time turned out to be wrong. Now, who knows? It’s never been less clear. Hence an abnormal level of nervousness. That’s the real context for the Budget”.
Britain’s national debt has grown 418% since 1995, against economic growth of 94%. Government gross debt at the end of December 2020 was £2.68 trillion ($3.7 trillion), equivalent to 104.5% of gross domestic product (GDP); our indebtedness as a proportion of GDP is now about 2.5 times bigger than it was at the height of the global financial crisis in 2008. Britain now owes £32,383 ($44,559) per capita.
That’s trivial compared to the US. America’s national debt is almost $29 trillion (£21 trillion), the federal debt to GDP ratio is now 127.5% and the debt per citizen is more than $86,000 (£62,000). The US Social Security benefits for more than 70 million Americans will rise by 5.9% next year , the largest cost of living adjustment (COLA) since 1982.
Shrinking dollars and pounds
These kinds of astronomical debts are affordable only because interest rates are so low. Interest rates are so low only because inflation has not been a threat for many years, so it’s been a no-brainer for governments to load up on debt. Fiscal discipline — balancing the books — is for the birds. If interest rates are lower than the increase in national income, the relative debt burden will shrink with it.
But even a small interest rate rise of 1% would mean the UK had to pay around £25 billion ($35 billion) more in interest on its national debt. Nevertheless, some argue that the UK’s debt is not an albatross around its neck but an opportunity: the UK-based charity Jubilee Debt Campaign says the UK government can use the cheap costs of borrowing to invest in tackling “key problems while also saving public money in the future” in
• The climate emergency and just transition
• The cost, availability, and quality of housing
• The major weaknesses in our social safety net
All of these are huge-ticket items, and will break any notion of fiscal rectitude. Perhaps voters will say they can live with that, but the consequences for the purchasing power of fiat money, paper currency, could be diabolical.
As for today, the US and the UK are approaching the point where they must decide whether to tolerate higher inflation (punishing all those who are unable to negotiate higher wages) and reduce their national debt costs, or raise interest rates, hopefully thus squashing inflation, but letting their debt costs spiral. A Catch-22 if ever there was one; squaring this circle will require a Houdini-type effort.
Inflation however, is clearly no longer “transitory”, as the US Treasury Secretary, Janet Yellen, has long insisted. This week her tune subtly altered; she told CNN that “the inflation rate will remain high into next year because of what’s already happened. But I expect improvement by the middle to end of next year — second half of next year… I don’t think we’re about to lose control of inflation”. No longer a passing event, but still under control nevertheless. Maybe in six months we will be told ‘no longer under control, but we’re on the case, don’t panic’.
For the past five months, the US consumer price index — the federal government’s preferred inflation measure — has been above 5%. In the UK the Bank of England’s (BoE) new chief economist has said that inflation, which dipped to 3.1% in September, is likely to rise “close to or even slightly above 5%” in early 2022. Jack Dorsey, the billionaire co-founder of Twitter, has posted a tweet: Hyperinflation “will happen in the US soon, and so the world”. Typically, hyperinflation sees the rate of inflation rise by 50% each month. Dorsey’s opinion needs to be contextualised — he’s a huge fan of Bitcoin and sees the cryptocurrency as uniting the world and bringing universal peace.
President Biden’s administration is trying to find a Congressional compromise that might get his climate and social security proposals, now about $2 trillion (£1.45 trillion) rather than the original $3.5 trillion (£2.45 trillion), passed. One exasperated Democratic Senator has called it a “getting nowhere negotiation”. Biden’s popularity has plunged deeper than any other US president since 1945 in his first nine months in office, according to a Gallup opinion poll. His latest wheeze to help pay for this is a tax on unrealised capital gains from stocks and bonds. The tax would apply to people who make more than $100 million a year (£72.64 million) for three years in a row or if one makes $1 billion (£727 million) in annual income. The people impacted by the tax would be able to take a deduction if their assets plunge in value. Yellen said this ‘billionaire’ tax, being written by the Democrat Senate Finance Committee Chairman Ron Wyden, with input from the US Treasury Department and the White House is not a wealth tax, but “a tax on unrealised capital gains of exceptionally wealthy individuals”. A tax is a tax is a tax.
Climate change agenda
On top of all this, the world is clamouring for more spending to combat global warming that’s attributed to human action. The UK government has nailed its colours to a ‘net zero strategy’ — a “binding target to reach net zero emissions by 2050”. The US is committed to reducing greenhouse gas emissions by 50–52% by 2030 compared to 2005 levels. Cost estimates for Biden’s’’green new deal’ have been put as high as $93 trillion (£68 trillion) over 10 years; but some argue that doing nothing would come at much higher cost: “Passing a Green New Deal, or something like it, may sound expensive up front, but Republicans should see it for what it is: a sound investment that will generate the greatest returns imaginable — a liveable planet”.
Whatever one thinks about the necessity or desirability of this target it is going to cost a fortune, costing on average “more than £50,000 for every family in the UK or more than £32 each week every week for the next 30 years” according to the UK energy trade union GMB.
Rishi Sunak committed that the UK government’s day-to-day spending must be balanced by revenues within three years. For the time being, the UK government, like the US government, is saddled with what economists euphemistically call ‘deficit financing’, which simply means borrowing and/or creating money to plug the spending gap. There is an air of unreality about long-term forecasts; after all, the government of which Sunak is a member needs to obtain re-election by May 2024, and Biden’s Democrats face a presidential election the same year.
In the next three years much can happen, much can go wrong, many economic forecasts can become absurd; black swan events (such as the entirely unforeseen rise in gas prices) can sail into view. Holding onto monetary value in the midst of inflation, tax rises, currency devaluation, becomes ever-more essential today, tomorrow, forever.