23 Feb 2013

The UK’s economic strategy: double AA, triple dip, single-minded

So Britain is no longer rated AAA by all the major credit ratings agencies. First the positives: Moody’s move is more a reflection and a reaction, rather than the prospective cause of market mayhem for Britain. The agency has noticed a small fire in our house rather than being the arsonist in an impending inferno. Since December I have been reporting that financial markets fear that a less unstable Eurozone is focusing market attention here. Britain is losing the market “ugly contest”.

There is a journalistic meme circulating that it definitely does not matter, because the US and France lost their AAA and their borrowing rates did not go up. This is spurious extrapolation. Britain is not in the same position.

The US hosts the world’s reserve currency, and its bond yields declined amid the flight to safety after S&P scrapped its AAA. Likewise France is¬†basically a sub-region of the eurozone. When they lost their AAAs there was little prospect of a concomitant sharp fall in their currencies.

Sterling is a lesser reserve currency, and it is plausible that safe haven flows could reverse. To the extent that it dampened down sterling of its safe haven premium, that’s probably good for the economy. If it continued into a larger devaluation, reinforced by monetary policy and deficit doubts, then the overall impact could be inflationary and overall more concerning. We just don’t know how this will play out. It’s wrong just to declare that it definitely does not matter.

This does, however, show up the incoherence of the coalition’s plan to on the one hand, try to rebalance the economy towards exports, and on the other boast about Britain being a safe haven that pushed up demand for and the value of sterling, damaging exports.

The Treasury position at the moment is nonsensical. Losing the AAA doesn’t matter, but look we’ve still got two other AAAs that we don’t want to jeopardise. And by the way if we don’t stick to exactly the same plan, we risk being downgraded again by Moody’s, which really does matter, until it happens, after which we will say it is irrelevant.

What we are really seeing here, is the disappearance of a straw man. The idea that Britain was going bankrupt. We never were. We have very long debt maturities averaging 13 years, versus half of that for problem nations. We have a Bank of England with a massive electronic printing press that it is willing to use. Deficit reduction was always just an intermediate target, the target for any government should be growth, jobs and living standards.

At the moment Britain is getting not much deficit reduction, not much credit from the rating agencies, no growth, some jobs, and declining living standards. We have the prospect of a triple dip, and we’ve lost the triple A. The chancellor remains rather single-minded, immediately promising to redouble efforts on his deficit plan.

The government’s best card is to say, that such was the state of private sector indebtedness, that we were always going to lose the AAA in prolonged period of near zero growth, the deleveraging hangover from the world’s biggest credit binge (under Labour).

That rather begs the question of whether the deficit plan would have had the same flavour and timing, with the benefit of hindsight. On capital spending the government has already conceded it made mistakes. The front-loaded VAT rise used to fund income tax cuts, also had an impact on growth and confidence. Boris Johnson wants the government to pipe down on the austerity rhetoric, and it’s clear that it impacted business confidence in autumn 2010. The credit easing scheme that eventually turned into “funding for lending” was a year too late.

So it’s surely time to think a little more radically. Reasonable people will disagree on whether that is massive tax cuts for entrepreneurs, or massive stimulus for the ¬£310bn of infrastructure investment that the government admits Britain is lacking. Or a bit of both. Housebuilding is a no-brainer. But surely this should start a debate on what has not gone right? Perhaps Labour could be tempted to share some of its secret plans. This might end up being good news. The straw man has been blown over. Now a chance to actually think about how to grow the economy.

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