To these warnings must now be added the comments of Simon Johnson, a former chief economist at the IMF, who over the weekend said that the UK should be seen in the same category as Greece and Spain. Not since the 1970s and Britain’s humiliating flight to the IMF has the UK’s financial credibility been in such doubt.
Given how apparently parlous our position, is it not a little rich for the British Prime Minister to be joining with other European leaders this week in advocating extreme fiscal austerity as the solution for Greece? Even the Conservatives would shrink from applying such a squeeze on Britain, and the existing Government’s plans come nowhere close. Unless willing to take similar medicine, will not Britain end up in the same boat?
Like earthquakes, fiscal crises tend to arrive suddenly and without warning. They are characterised not by the advent of some new and previously unsuspected negative, but by a gradual ebbing away of international confidence which eventually reaches a tipping point.
The dangers for Britain are all too apparent, yet we are not yet there. Here are a number of reasons for believing the UK won’t end up like Greece. First is that unlike financially distressed members of the euro, Britain has its own currency. The chances of outright default are therefore so negligible as to be barely worth considering. In extremis, Britain can simply print money to pay its debts, and arguably has already done so through quantitative easing.
Obviously, it will be a major blow to Britain’s international standing if it loses its triple A credit rating, but in truth the rating is something of a red herring, and is not the major issue here. For years, Japan has rubbed along with a less than top notch credit rating, yet government bond yields have remained lower than any other advanced economy.
The greater threat to UK gilt yields comes instead from the currency. If international investors doubt the credibility of the currency, a la Jim Rogers, they will hedge the risk by demanding a higher interest rate.
In the past, domestic demand has mopped up the vast bulk of UK debt issuance. The unprecedented scale of the deficit means that at least for the next several years Britain must rely increasingly on international funding.
What’s more, two important sources of domestic demand – quantitative easing and banks under instruction to improve their “liquidity buffers” – are coming to an end just as the quantity of government debt flooding on to the market reaches its peak. In other words, government funding is about to become that much more vulnerable to international confidence. Full: http://is.gd/82EJI
