This article examines how it is we came to have high unemployment, zero economic growth, falling living standards & massive debts.
Creating the illusion of prosperity
Between 1988 and 2007 Britain, along with most of the rest of the world, experienced a huge credit boom which sent the price of stocks, commodities, bonds and property to historic levels.
During this period of asset price appreciation and low borrowing costs, many of us felt wealthier and enjoyed luxurious lifestyles of new cars, second homes and increased consumption. Much of this new found affluence however was created by massive increases in public spending and private borrowing, and it was a period in which debt grew much faster than income.
If there is one thing a credit boom is good at, it is creating the illusion of prosperity
As property prices rose, individuals used their homes as cash points withdrawing £300 billion in equity, believing that they could simply pay off what they owed from the rising value of their assets.
Between 1999-2000 and 2009-10, UK government spending increased by 53% in real terms and between 2003 and 2010 government and individuals in Britain borrowed an average of 11.2% of GDP every year. That meant that each additional £1 of national output cost £2.18 – something that was clearly never sustainable and in reality was little more than a gigantic Ponzi scheme.
The fact is that basing national growth on ever greater borrowing was always a policy doomed to fail.
Who to blame?
I know it’s fashionable to lay the blame for the current economic mess at the feet of “greedy bankers”, and I’m not saying that the bankers shouldn’t share the blame, nor that they shouldn’t be held accountable for their actions, but it is important to remember the role of government in creating the crisis. After all, it was government that increased money supply at double-digit rates year after year and kept interest rates artificially low which fuelled the destructive credit bubble. It was also government that crippled the regulatory oversight which let the bankers run amok.
To quote Dr Tim Morgan of Tullett Prebon “The conduct of the economy under ‘Team Brown’ was a tale of grotesque incompetence which began in hubris and ended in blame-shifting.”
Chart of UK Public Sector Net Debt 1975-2011
Notes: UK public sector debt rose steadily from 2001 to 2008, however the creation of the Bank of England’s Special Liquidity Scheme and Bank Recapitalisation Fund in response to the global financial crisis together with the bailouts of Northern Rock, Royal Bank of Scotland and Lloyds Banking Group increased the size of Britain’s public debt dramatically. The Bank of England has increased the size of its balance sheet by a staggering 1000% in the last 10 years.
From bad to worse
In response to the global financial crisis of 2008/ 2009 the UK government stepped in to prop up spending and prevent private sector deleveraging causing a dramatic increase in the size of its balance sheet and making the public debt burden considerably bigger.
Mired in debt
Britain, as with many other Western countries, has lived beyond its means for many years and in doing so has amassed considerable debts and it’s a debt burden that continues to grow.
According to the McKinsey Global Institute, Britain’s total debt, that is, private, public and financial sector debt is the second highest in the world.
Anyone that thinks Britain isn’t one of the PIIGS is very much mistaken
Official figures put UK government debt at £966 billion, which is equivalent to 65% of GDP. However the official numbers massively understate our true level of indebtedness. If we were to consider public debt under the stricter Maastricht Treaty definition, by which the debts of the Eurozone members such as Greece and Italy are judged, the figure is £1.11 trillion, or 75% of GDP.
Were we to include the effects of the financial sector interventions the picture gets worse still with total government debt reaching £2.24 trillion, or 147% of GDP. And if we include the current unfunded public sector pension obligations (which stand at around £1.18 trillion) and the government’s commitments under PFI contracts (which are another £170 billion), total public debt in the UK comes to around £3.59 trillion. This is equivalent to 242% of GDP – far higher than Greece’s 127% of GDP – and it’s a situation that is getting worse.
The government is projecting that the level of nominal debt will continue to rise to £1.28 trillion by 2016. However these figures are based on the government’s assumption that the deficit will be reduced from 9.7% of GDP last year to 1.6% by 2015-16, which is something I find increasingly unlikely.
More important than our overall debt level however, is our ability to service it, and the UK’s colossal debt mountain is only manageable if the markets remain convinced of our commitment to debt reduction (allowing us to keep our AAA credit rating) and the economy avoids recession.
In summary then, we have high unemployment, zero economic growth, falling living standards & massive debts because the credit boom is over. The problem is that G20 governments refuse to accept that following an inflationary boom you should have a deflationary bust which serves to cleanse the excesses and malinvestment from the economy and wipe the debt clean.
This natural process sets the scene for the rise of a new wave of prosperity but rather than getting the deflation over with, central banks have taken on massive amounts of new debt in an attempt to keep the broken financial system going. More on this in part two.