Calls for pro-growth policy are increasing as austerity loses its appeal, but the laddies in London are not for turning, writes George Kerevan
FORGET Murdoch and the Leveson Inquiry. Wednesday’s unexpected news that Britain has entered a double-dip recession is the real political game- changer. It does not matter if the disappointing first-quarter GDP data is revised upwards a year from now (as I suspect it will). The immediate bad news, coupled with a dawning realisation that the euro crisis has entered a new stage, has shifted market opinion. Investors are starting to favour growth over austerity. It’s time for Plan B.
The success of François Hollande in the first round of the French presidential elections, not to mention the big vote for Marine Le Pen (who wants the franc back), has reopened the austerity-versus-growth debate on the Continent. Hollande proposes a growth pact to sit alongside the fiscal compact (aka austerity pact) agreed last year at Germany’s insistence.
Hollande’s demands were reinforced on Monday, when the Dutch coalition government fell apart because it could not muster enough votes to support further budget cuts.
Then, on Wednesday, the dovish head of the European Central Bank, Mario Draghi, came out in support of a new growth pact – essentially declaring war on the hawkish German Bundesbank. Draghi’s pro-growth stance – which implies he might pump more money into Europe’s ailing banks – helped steady the markets this week. Spain and Italy had no trouble selling new bonds, a sign that investors are starting to prefer growth over austerity.
The German chancellor, Angela Merkel, also made encouraging remarks, suggesting that if Hollande wins in the second round on 6 May, she might agree to a growth pact. If she does, that will put major pressure on David Cameron and George Osborne.
Famously, Cameron rejected the original fiscal compact last year, which isolated him from the rest of Europe. But could Cameron also reject an international growth plan when Labour is 11 points ahead in the polls?
Lacklustre growth has deprived the Treasury of expected tax revenues. As a result, the coalition has had to extend its schedule for abolishing the annual budget deficits inherited from Gordon Brown to seven years, rather than five. The last time we had seven lean years of austerity in a row was when Joseph was running the Egyptian economy. Unfortunately, if you promise seven years of austerity, businesses will sit on their cash rather than invest it to create jobs. The economic engine is stuck in neutral.
Labour is reaping the political benefits, though the coalition’s flat-footedness – from jerry cans to terrorist appeals – is now beyond parody. However, Labour remains unconvincing when it comes to Plan B. Partly because it caused the debt crisis in the first place. Partly because it was Alistair Darling’s massive, pre-election cuts to capital spending that helped trigger slower growth. And partly because the current shadow chancellor, Ed Balls, has come up with no way of funding expansion except more public borrowing – something the markets may be loath to underwrite unless interest rates rise steeply.
How can we fund growth and still put the UK’s public accounts in order? One novel solution stems from the Bank of England’s quantitative easing (QE) programme. QE is a polite name for when the Bank prints money. In recent years, the Bank, which is state-owned, has bought £350bn of UK government bonds on the open market with “electronic” cash it created. Which is another way of saying that the government lent money to itself.
Currently, total UK national debt stands at the equivalent of 63 per cent of gross domestic product (GDP). However, 22 per cent of that is “owned” by the Bank of England as a result of QE. The Treasury pays the Bank some £18 billion per annum in interest on this holding.
If the Treasury and the Bank of England agreed to cancel these bonds, the national debt would fall miraculously to a mere 41 per cent of GDP – very low by any standards. Plus government spending would be slashed by £18bn a year. That would cut this year’s planned borrowing by 15 per cent. Alternatively, it could provide precisely the fiscal boost needed for growth – without adding to borrowing. That’s enough cash to reverse last year’s VAT rise or fund a huge increase in infrastructure spending.
Too simple, you say. There must be a catch. Actually, the government has just done something similar and got away with it. At the beginning of this month, the Chancellor transferred the assets of the Post Office pension fund to the Treasury. He then “cancelled” £9bn of government bonds in the portfolio, meaning the Treasury no longer has to pay the interest.
Certainly, if the Treasury cancels the £350bn in bonds held by the Bank of England, it will expose the fact that the Bank has (effectively) been printing money to fund the government. Of course, everyone knows this is the case anyway, and that the US government has been doing the same thing. But there is a quiet conspiracy to ignore the obvious lest it frighten the natives.
However, there are ways round this. First, rather than cancel debt, the Bank and the Treasury could agree to convert the Bank’s current holdings of time-dated bonds into “perpetual” ones. In other words, new bonds with no redemption date, so the Treasury never has to pay back the principal.
At the same time, the Treasury (as owner) could order the Bank to pay it an annual dividend equal to the interest earned on these bonds – meaning the Chancellor keeps his £18bn per annum to spend as he pleases. Hey presto, the Bank’s books are in order, the economy grows, and the markets can pretend nothing happened.
My worry is that Osborne will stick to austerity. And that the Bundesbank will declare war on a European growth pact, plunging Europe into a second great depression. Neither understands that a man-made economic crisis can also be unmade using a bit of imagination.