George Kerevan: The unfolding tragedy of coalition economics

TO STIMULATE or not to stimulate – the economy, I mean – that is the question? After Wednesday’s dire GDP figures, there is no gainsaying we are in double-dip recession. Europe is already there and the US and China on their way. Are there any convenient policy rabbits waiting to be pulled out of hats?

Despite much rhetoric to the contrary, the coalition is already leaning (in its normal two steps forward, one step backwards fashion) towards a modest fiscal stimulus. It has eased Alistair Darling’s ferocious cuts to capital spending and delayed eliminating the structural deficit by two years, till 2017.

Last week, in anticipation of the black GDP numbers, David Cameron and Nick Clegg announced a raft of new infrastructure projects. Of course, if you analyse the plans in depth, there is no new cash and no timetable for these fantasy projects, but at least it shows the coalition is shifting ground.

Mind you, that’s because the economic ground has already given way beneath its feet.

Labour, which has a solid lead in the polls, is cock-a-hoop at the coalition’s difficulties and is demanding a temporary tax cut to boost consumer demand.

My old friend Bill Jamieson is also advocating (in these pages) a temporary tax cut, to boost business and consumer confidence.

I’m not against a cut in VAT. We are certainly in a scenario when maintaining confidence is a necessity, especially in the run-up to Christmas.

After three successive quarters of negative growth, even the bond markets would accept some extra public borrowing. UK government securities are a lot safer than eurozone ones and the funds have to put their cash somewhere.

But – and it’s a big but – a modest tax cut is not a cure-all. Most of the coalition’s big public spending cuts are still to kick in.

To date there’s been plenty of talk about austerity, but apart from the VAT rise and cuts to the building programme, there’s been less austerity than you might imagine.

Last year’s ostensible reduction in public borrowing was actually the result of a massive fiddle in which the Treasury nabbed the pension assets of the Royal Mail to pay off debt. It can only do that once.

The UK is stuck in an economic trap. A modest tax cut will be swamped by big public spending cuts. But if we abandon the spending cuts, the UK will lose its triple-A credit rating, the markets will demand higher interest rates, and confidence will really fly out of the window.

One alternative (or supplement) to tax cuts is a monetary boost, or Quantitative Easing (QE). This would involve the Bank of England printing more money and using it to buy bonds, thus pumping more liquidity into the banking system in a bid to expand lending. In fact, the Bank of England has already done this to the tune of £375 billion.

I remain a strong advocate of more QE. Opponents claim that QE is hyper-inflationary (so where’s the hyper-inflation, chaps?), and that QE to date has merely ended up in bank vaults, rather than being lent out.

The latter point is true, largely because the coalition has ordered banks to build up their capital reserves. Solution: we probably need another £500bn of QE to crank up money supply to where it would have been if growth had continued after 2008.

The UK needs the credit taps full on, especially if America enters double-dip recession, which looks imminent.

Bill Jamieson, at whose feet I normally worship, suggests that the UK economy does not have a liquidity problem. He says that industrial companies are currently cash-rich but won’t invest. Again nominally true.

But this was also a feature of the Great Depression. In the 1930s, the biggest firms in the US and UK accumulated high liquid assets to earnings, effectively adding to deflation. Meanwhile small firms went bust as banks cut off loans. We are repeating this cycle in the UK and US. It’s a cycle we have to break out of through massive credit expansion, which will have a positive impact on confidence.

And if you’re really worried about banks sitting on their cash reserves, there is a simple solution. Just follow the lead of the Danes and charge those banks a rate of interest for depositing their inactive cash at the central bank.

QE has another advantage, as I’ve argued here before. It results in an increasing proportion of the National Debt being owned by the Bank of England – currently around a third. In other words, we owe money to ourselves. The taxpayer is paying £18bn per annum in interest to the Bank of England, which is owned by the taxpayer. Why not cancel these debts to ourselves, simultaneously boosting the UK’s credit rating and saving that £18bn. Use the cash savings to cut VAT and fund a massive investment in construction.

Sadly, I don’t think Chancellor Osborne has either the imagination or guts to do any of this. But it should be within his ken to do something about the construction industry, which is where the economy is really broken (though perhaps not as much as the Office of National Statistics is suggesting).

House construction in Scotland last financial year was down 36 per cent compared with 2008. Yet building houses is faster to begin and complete than, say, a new railway. Solution: let local authorities borrow and contract with private volume house builders to supply new homes – immediately. As rental income (and later sales) cover the cost of borrowing, the net impact on public spending is neutral.

I predict that next year’s Budget will be mildly expansionary, if only because Cameron needs to keep the coalition together and Osborne needs to keep his job. The danger lies in the Chancellor’s timidity. A modest fiscal injection will do little for growth. We are in Macbeth territory rather than Hamlet: “If it were done when ’tis done, then ’twere well it were done quickly”.