Sovereign debt and the interest rate time bomb

So far the UK appears to have come off lightly compared to Greece. This is owing to the huge devaluation in the UK currency, which means a lot of the hit on living standards which Greece is now taking from wage cuts is happening in the UK from surging import prices and a rate of inflation well above wage increases. It has also owed a lot so far to £200 billion of money printing, something Greece cannot do for itself as a Euro memebr. This has kept UK official interest rates and government borrowing rates artificially low. It gets a lot tougher when rates rise further: then the taxpayer gets sandbagged by the increased costs of servicing the rising debts. The state borrows more to pay the interest!

I always thought it a nonsense that we could solve the bank bad debt problems by transferring them to the state. The state can no more afford them than the banks. We needed to manage the bad debts as well as possible at as little cost to both banks and taxpayers as possible – instead this government bailed them out too readily after condemning them and their weaknesses in public to worsen the trouble.

Meanwhile the UK went into the recession with too much borrowing, and increased the borrowing as a “fiscal stimulus” when that very stimulus has helped choke the private sector with the public sector pre-empting all the credit. There is a great deal to sort out rapidly if we want a happy ending to Mr Brown’s ruinously expensive experiment in expanding the state. Otherwise, just like Greece, the markets will force bigger cuts in our public spending, and threaten us through higher interest rates with little or no recovery to help us pay the bills.

Promoted by Christine Hill on behalf of John Redwood, both of 30 Rose Street Wokingham RG 40 1XU

23 Comments

  1. Simon2
    May 2, 2010

    I don't understand the Tory position on interest rates, as far as I can tell, just like Brown , they want to keep rates pinned down at all time lows, rewarding the reckless and penalising savers who rely on income. Which is it to be?

    We are in the throes of a renewed house price boom, inflation is WELL above target, but rates are STILL rock bottom. We need neutral rates of at least 5% to avert another house price / debt driven crisis in future.

    ps. shared ownership (part buy part rent) is a joke, scrap it now.

    1. Brian Tomkinson
      May 3, 2010

      Simon,
      I agree. No one seems to care about those with savings whilst many of those still in work with mortgages are much better off during this recession. The same mistakes are being repeated but the politicians are too busy trying to get re-elected.

      1. James Clover
        May 3, 2010

        Couldn't agree more. Not once has the failure of the Brown regime to tackle the problem of house prices and the excessive lending which is necessary to pay them been commented on.
        For the health of the economy, and the sake of young people wanting to buy a house, but are not from comfortable backgrounds, with parents who can help them along, a plan must be devised to allow house prices to keep at their present level or even slowly sink, until the good old days, when a decent house could be bought with two and a half times your annual salary, return.
        Alas Brown, and our poor deluded nation, rejoiced at rocketing house inflation- one of the most egregious examples of stupid shortsightedness in recent history.

      2. Simon2
        May 5, 2010

        I saw David C on TV last week answering a question from a woman worried about rates rising like in the 80's. The answer was all about keeping rates low, notice how when talking about keeping rates down you never hear about pensioners or savers who rely on their savings income, it's all about helping borrowers and those up to their necks in debt. No mention that low rates are what got us in this mess either, it's amazing how no journalists point this out to the politicians (not that I've ever seen anyway).

        I can't see anything really changing under the Tories on the house price front, not if they're all for recklessly low interest rates. Looks like the next generation can only aspire to owning half a house with one of these pathetic shared ownership schemes under Labour or the Tories and the great housing wealth gulf will get ever wider and society will be worse of as a result.

        If the Tories get in power I will offer my time for free to consult on housing matters from a first time buyer perspective if they're interested.

  2. oldrightie
    May 2, 2010

    It does seem as though Labours' strategy to hide the real dreadful state of our finances may well have worked. Were the painful truth known then The Conservatives would be at 50% plus in the polls. Mind you they still might be on Thursday!

  3. Quietzapple
    May 2, 2010

    If the debt is largely internal, as ours is, exchange rate is a relatively minor factor.

    We finished paying our WW2 debt while Gordon Brown was Chancellor, contrast with the sell offs (and failure to diversify our reserves) under Mrs Thatcher who sold the "family silver" as her contribution to keeping us out of Carey St.

    You may know, John, how did we avoid repaying our debt from the Napoleonic Wars, which I gather we never accomplished in those halcyon days when Pitt (whom your Party claims as a Tory, while he said he was a Whig) was PM and invented graduated Income tax, and Melbourne and Wellington succeeded him?

  4. Chris
    May 2, 2010

    If the Conservatives win, is there any way that the state of the public finances can be made clear immediately so that the whole country knows exactly what a mess Brown had left the economy/finances in and so that the Conservatives are not blamed for it in subsequent months? I realise this sounds very simplistic and I presume would cause the markets to take fright, but I think so many in the country do not realise the scale of the problem and many Labour voters are like ostriches with their heads in the sand. I actually think they need the message hammering home to them. Immediately following on from this "catharsis" Cameron could immediately spell out a bold and radical plan of action to tackle the situation, which hopefully would give the market confidence, and enable the long slow recovery to begin. I am no fan of Simon Heffer, but I see he advocates bringing in the IMF straight away to bear witness to the current state of the economy. At least this would seal Labour's fate and destroy their reputation, and in particular Gordon Brown's, of being prudent managers of the economy.

    Reply: Yes, we need a quick audit overview from an independent source to explain the background to the 50 day budget.I believe this may happen.

    1. alan jutson
      May 3, 2010

      Chris

      This is what I have been suggesting for many, many months now, and the review should include all off balance sheet stuff as well, like PFI and Public Sector Pension Liabilities.

      Figures should not be open to be challenged, so they should be overseen by a completely independent organisation.

      Then and only then, can the full extent of the complete and utter mismanagement of the last 13 years be clear.

      Wait for a shock, it is always, but always, worse than it at first appears. Just like any Company in Administration or Receivership.

      1. simon
        May 4, 2010

        If UK PLC was a football team it would be docked at least 9 points for financial mismanagement !

        Crystal Palace narrowly managed to avert disappearing without trace so there is hope for Britain .

  5. Norman
    May 2, 2010

    The real challenge for the next government will be changing the outlook of government from the statist view that has prevailed the last 13 years to one of private sector taking precedence.

    Let's hope for a Conservative government that is up to repeating the medicine given to the economy in the 1980's.

  6. ManicBeancounter
    May 3, 2010

    Mr Redwood,

    That we went into the recession with too much borrowing have been my thoughts for a while. This structural deficit created in the boom years largely represents the gap that needs to be closed by tax rises and spending cuts. The cyclical part will largely be eradicated by a long and sustained recovery.

    By my estimates the rise in national debt from 2001 to 2007 and the structural deficit inherited from this period will account for up to half the projected national debt of £1400bn on 2014.

    There may be a flaw in my calculations, but what is clear is that a structural deficit created in the boom years will add to the national debt through every year until cleared and the extra interest payments will constrain government expenditure for a generation.

    I have nade an (inadequate) attempt to graph a comparison of the Labour reality with the prudent approach of maintaining debt as a constant percentage of GDP during the boom years.
    http://manicbeancounter.wordpress.com/2010/03/21/

  7. RObert George
    May 3, 2010

    John, I will be writing to the next PM recommending you be asked to leave Parliament and become the next BOE Governor.

    No one else seems to have a clue.

    PS provided all the powers of the FSA and the office of Statistics fall within your purview.

  8. Javelin
    May 3, 2010

    The change in the economic cycle is correlated with a change in mood. The underlying economic dynamics always shifts long before the mood changes.

    Goldmans is curently being punished in the senate hearings because a few far sited traders realised this and took the opposite side of the gamble on house prices. Politicians in the States are trying blame Goldmans for understanding the reality of the economics when they let mortgages out too freely to blue collar workers who couldn't afford them. You don't see US bankers coming after HSBC who also avoided mortgage backed CDOs for the same reason. Politicians let house prices rip in the US and the UK and house prices are taking off here again.

    Having looked after CDSwaps IT at one of the above banks I would strongly urge the Government to raise interest rates until house prices come down a further 20% so that the economics come back into line with affordabity. When the economy starts to pick up house prices will inflate and so will prices. Taxes will go up, but salaries won't.

    I would start by putting a 40% capital gains tax on second homes.

    As I have said before it's harder to come out of a recession than go into it. If house prices don't come down It will all end in tears, big bloody tears. Not only will the Tories get blamed for the cuts they will get blamed for house prices crashing. Better to set a mood of austerity, blame Labour and bring house prices down asap.

    1. Javelin
      May 3, 2010

      Just wanted to add a point of clarification

      Coming out of recession is harder not just because business has to rebuild itself. That's not the problem because unprofitable businesses have hit the wall. There is an over supply of labour so business should expand.

      The problem coming out of recession is inflation. Specifically the difference between consumers and business cycles. Business demands capital and this pushes demand for investment and materials up. Consumers are still taxed from the previous boom and have low weight in salary negotiation. They are thus squeezed by taxes and interest rates and demand for houses and goods fall.

      Dropping house prices will, over a few years free up money to be spent to help business expand.

    2. Mark
      May 3, 2010

      I agree that house prices need to be managed down – and by rather more than 20% relative to incomes. Putting CGT up on second houses won't achieve that unless you announce it a year in advance, so that there is a panic sell-off ahead of the new tax (CGT is only charged on crystallised gain). It might cause chaos for those renting from private landlords though – they'd all want to sell with vacant possession, so tenants would be thrown out. On balance, I don't think this is the way to do it. Much better to use higher interest rates and large deposit requirements, and tough balance sheet control on the mortgage related parts of bank balance sheets.

      Banks are going to have to find £440bn in mortgage funding by the end of next year anyway if they don't lend a single penny extra on houses. Either they will pay up in the market for those funds (over one third of the total mortgage borrowing – talk about borrowing short and lending long!), or they will be funded by the BoE and added to National Debt which will create a sterling/gilts crisis and high rates.

  9. Richard
    May 3, 2010

    The bail-out of Greece seems to be an error of the same category as the UK bank bail-out. What ought to be happening is a restructuring of the debts, withdrawal by Greece from the Euro and a market-driven solution to Greece's economic problems. There is supposed to be a clear no bail-out clause in the Euro treaties. Those who have lent money to the Greek government ignoring this should bear the consequences, just as bond holders in the insolvent banks should have had to do.

    Whatever theoretical arguments there are in favour of Euro membership, are now trumped for good by the revelation that membership of the Euro carries with it uncapped liability for the taxpayers of member countries for the debts of more profligate members – with little control over them.

    1. APL
      May 4, 2010

      Richard: "Those who have lent money to the Greek government ignoring this should bear the consequences,"

      I believe a large proportion ~ 25% of Greek government debt is held by French banks, that might explain why the French government is so vocal in demanding the Germans pay the Greek bill.

      But at least the French are being consistent. The CAP is a scheme to benefit the French agricultural sector. Why not the Euro used to benefit the French finance sector?

  10. Lindsay McDougall
    May 3, 2010

    Gordon Brown has been on the hustings this morning, listing prospective Conservative cuts – some real, some imagined – and in every case (like a mantra) stressing that it is the middle classes who will suffer.

    There is only one thing that the middle classes – particularly those with children – need to be worried about. It is debt and its consequences.

    Show it graphically. Draw public expenditure in the shape of a child and subdive the area according to types of expenditure. Respesent capital expenditure, our investment for the future, as a bright colour. Under Labour, it will be shrinking. Show the components of current expenditure in various pastel colours. Under Labour, the total will be broadly flat. Show debt interest as a black, malignant tumour. Under Labour, it will double by 2014/15 to about 10% of all public expenditure.

    Then look at the long term future if the deficit still isn't dealt with. It is truly horrific, with debt interest like the cuckoo in the nest.

    We have much greater scope for dark propaganda than Labour but for some reason we have not used it. Not too late.

  11. APL
    May 4, 2010

    "May 3 (Bloomberg) — The European Central Bank joined the international rescue of Greece, saying it would indefinitely accept the country’s debt as collateral regardless of its country’s credit rating, underpinning gains in the bond market."

    Mr Redwood, do you have an opinion on the above quote from Bloomberg?

    Reply: It's what they have to do to save their single currency. The ECB has a need to help stabilise Greece and prevent a default.

    1. APL
      May 4, 2010

      JR: "It’s what they have to do to save their single currency."

      To accept debt as collateral REGARDLESS of the countrys credit rating.

      If Germany is going to be the country expected to fund this madness – what is the difference between reparations after WW1 and the massive transfers of resources from Germany to failing states that we seem to be considering now?

  12. Javelin
    May 4, 2010

    China is rumoured to be raising interest rates on June 10.

    I think that will change the mood in the markets.

  13. David
    May 4, 2010

    Brown has deceived and confused voters about UK debt, the defecit, and halving it in 4 years, so voters think that is fine.

    They do not see that he means halving the amount UK govt needs to borrow each year, that is added to the debt.

    And crucially 'Brown Debt' will have 'Brown Interest' of about 10% of all govt spending, approx equal to all defence spending, or half all education spending!

    So 2010 UK debt is £850Bn and Brown spends £167Bn more than govt gets in tax. So he borrows that and adds to the total.
    Result UK debt rises to £1,017Bn.

    In 2011 UK debt is £1,017bn and needs loans of £150bn. Total debt £1,067Bn. And so on to 2014 when UK debt hits £1.45Triliion.

    Per head now UK declared debt is about £24,000. By 2014 it will near £50,000. Brown has hired an extra 1m onto State pay and pensions so all their costs have to be paid, instead of urgent hip operations, teachers and police. Brown's choice of debt and more State staff means less money available to spend on front line services.

    The declared debt hides Brown's off balance sheet PFI and pension costs. True debt is near £3Tr now. By 2014 it may near £5Trillion.

    Brown has deceived voters and media. Even experienced jounos think UK debt is only £167Bn and will be halved in 4 years, so why the worry?

    Brown will hit the poor most as all the State funding goes on interest payments, and paying the salaries and pensions of non working State employees.

  14. Lindsay McDougall
    May 5, 2010

    Only one more day's campaigning to go. Some reminders:

    The failure of Gordon Brown and Mervyn King to use the right sort of inflation target led to the house price bubble and the bust that followed.

    Labour has severly curtailed liberty.

    Both Labour and the LibDems will fail to deal with the deficit and saddle us with tremendous debt – and debt interest.

    The LibDems have disasterous policies on Europe, the Euro and immigration. It is only necessary to quote from their manifesto.

    The dog that didn't bark has been major set piece speeches from senior back benchers. The Conservative campaign has been far too presidential and it may yet cost us dearly.

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