28th May 2010
“I’m afraid to tell you there’s no money left”
“Dear Chief Secretary,
I’m afraid to tell you there’s no money left.
Kind regards – and good luck!
Liam”
This has to be the most remarkable financial quote of 2010 so far
It tells you all you need to know about how bad the UK government’s debt problem is. But before we all head for the hills in panic, there are a number of good reasons why – bad as it is – the debt situation is not as bad as the doomsters would have you believe.
The letter was written by Liam Byrne, Labour MP and out-going Chief Secretary to the Treasury (the government minister who worries about the bills) to David Laws MP his short-lived replacement. If anyone knows how bad things are Mr Byrne does.
The numbers are indeed awful
In the year to April 2010 the UK government had to borrow £156 billion (£156,000,000,000) to cover the difference between what it spent and the taxes it received. This deficit is 11% of the annual income of the entire UK economy for a year (measured as GDP) and is the largest in Europe according to some measures.
For every £4 the government is spending, it borrows £1. If you borrowed at the same rate you would soon be in trouble with your bank and the same is true with the UK government. Total government debt reached £893.4 billion in April 2010. That number represents 62% or nearly two thirds of the nation’s annual income (GDP). By the time it stops growing, the debt is forecast to be over 80% of GDP. The UK has never borrowed so much so quickly without being involved in a world war.
But if things are so bad …
Why are we not – like Greece – having to go cap in hand to the IMF and the EU for a bail out?
The big reason is credibility. Credibility is important because it means the UK government’s creditors (the people who are owed the money) have faith they will be repaid and so demand a lower interest rate – which means lower taxes (or less vicious cuts in spending). Credibility is a precious and fragile commodity, but there are several good reasons for believing it can be maintained.
Five good reasons for believing credibility can be maintained
First, whilst £156 billion is an awfully big number it is smaller than expected. A year ago the forecast debt for 2009/10 was nearly £180 billion. The Treasury has been good at getting the bad news out of the way quickly, setting low expectations and then exceeding them. This is good for credibility. Greece’s problem is that they kept disappointing their creditors by announcing higher than expected borrowing figures.
Political stability
Second, the new coalition government has brought important political stability. The coalition was formed remarkably quickly so the markets had little time to fret. The coalition government has the desire and ability to increase the taxes and cut spending. With many measures already announced and a budget due on 22nd June, the coalition is also acting at the speed necessary to keep credibility with the government’s creditors.
We’ve been here before
Thirdly, the shame of the Labour government going cap in hand to the IMF in 1976 kept them out of power for nearly 20 years and shaped the mindset of a generation of civil servants and politicians. But the good news about 1976 is that whilst the UK has got “previous” in terms of getting into trouble with debt, it also a record of paying that debt off. There is a direct analogy with personal finance. A person with a good history of repaying debt will have a much better credit rating than someone who has never borrowed before and suddenly needs to borrow a large amount.
A large pool of forced buyers
Fourthly, past governments have set things up so that there is a ready market for UK government debt (something other countries do not “enjoy”). Pension funds, life assurance companies, banks and other institutions are obliged to hold UK gilts as capital to back up their financial promises. So the UK has a large pool of forced buyers of government debt.
Time is on our side
Finally, the UK has a longer time period to pay back the debt than many other governments. Government debt is like an interest only mortgage; interest is paid during the loan period and then the original loan amount is repaid at maturity. The average maturity for UK government debt is about 11 years. This compares with 6-7 years for the US and 2-3 years for Greece. So whilst the UK government is borrowing heroic amounts of cash, it has more time on its side than many other countries in a similar position.
Not as bad as the doomsters would have you believe
The UK government has a large debt problem – there’s no denying it. But it’s not as bad as the doomsters would have you believe. How the country gets out if this mess and what that means for your financial planning and investments is a subject to another Briefing Note coming soon.
This Briefing Note represents Tim’s view on 28th May 2010. Please contact him if you have any comments about this post.
