Harsh home truths keep the economy stagnating

Columnist

Thursday 23 August 2012

CAN it really be that, only seven years ago this month, a quarter of a million people, all dressed in white, encircled Edinburgh in the campaign to Drop the Debt of developing nations?

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Iain MacWhirter

It seems like a different world, now that countries like Britain are drowning in their own debts – which make the debts of African countries look like small change.

While Bob Geldoff was hurling expletives at the G8, Britain was indulging in the greatest borrowing binge in history. This wasn't just government borrowing, which rose to an unsustainable £155bn per annum in 2010. The real big spenders were you and me, the householders of Britain, who embraced debt as no generation has ever done before. Household debt in Britain is now off the scale, at 150% of GDP – heading towards £2 trillion. There is no precedent for this in British economic history.

If you add in the debts of British banks, unfunded public sector pensions and PFI deals the debt mountain rises to 507% of GDP, according to analysts McKinsey – that is four times national earnings, and this has actually risen since 2008. Spain's total debt by the same measure is only 385% of GDP. But here's the really scary thing: many economists say the only way to get out from under this massive debt burden is by spending more in the hope that this will revive the economy. In truth, there seems little option, because government cuts are only making the debt situation worse. Last month's borrowing figures showed that, because of a collapse in tax revenues, the government borrowed £600m in July when it was supposed to return a surplus £2.8bn. Even business organisations like the Institute of Directors are now calling for a "growth strategy" including a massive house building programme, investment in green jobs and infrastructure projects. This is music to the ears of Labour's Ed Balls, because it is exactly what he has been calling for. It's been an appalling week for the Chancellor, George Osborne. His "omnishambles" budget has been followed by double-dip recession, making a nonsense of his promise to eliminate Britain's deficit within four years. The business organisations that applauded his public spending cuts are now urging him to spend more. The Chancellor had hoped that the 25% devaluation of the pound would boost British exports, but because of low growth in Europe this hasn't materialised. He expected private companies to invest and create jobs to replace those lost in the public sector. Instead, companies are sitting on £700bn that they won't invest because they lack confidence in economic growth. But the inconvenient truth for politicians of the Left, as well as the Right, is that it is going to be very difficult to increase spending without risking a Greek-style sovereign debt crisis. The truth is Britain never stopped borrowing. Government borrowing this year, according to RBS, is on course to rise to £150bn again – the level every political party leader agreed was unsustainable in the General Election two years ago. It is only because the Eurozone economies are in a state of perma-crisis that this hasn't led to a debt crisis here. We may be reaching what might be called Peak Debt in Britain, where it is no longer possible to use Keynesian spending policies to jump-start the economy. At Peak Debt, families become utterly focussed on removing the crippling debt burden. They save, pay down debt, cut up credit cards and avoid shopping malls. The Government becomes so worried about the cost of borrowing that it is forced into ever greater rounds of spending cuts, creating more job losses, more recession. Treasury economists scan retail sales figures in the desperate hope of a spending upturn. But there is no way that the debt-fuelled consumer spending splurge of the noughties can be repeated because of the overhang of private debt that has been left in its wake. Millions remortgaged their homes in the mistaken belief that house prices only ever went up. They didn't. It is only near-zero interest rates that are keeping many of them in their overpriced homes. When interest rates rise, as eventually they must, there will be a harsh reckoning. But this may be the only way to ensure that the economy gets started again. America's economy is now growing following a house-price "correction" of about 33%. This drove down the debt ratio, and allowed ordinary families to get back into the property market. This has boosted the economy because, when people move house, they spend. Labour mobility improves as people are freer to move around. Finally, the collapse of the housing bubble has released for productive investment capital that was going into property speculation.But the house price crash hasn't been painless. A quarter of homes are "under water" in America, meaning they are worth less than their mortgage. This has caused much misery, even though most mortgages in the US are "non-recourse" loans, which mean that, if borrowers cannot keep up the payments. they can hand back the keys and walk away. In Britain, by contrast, the mortgagee has to keep repaying the debt even after they're driven out of their home. Grant Shapps, the UK housing minister, admits British house prices are "ludicrously high", but there is little sign the Government intends to do anything about it, so great is the fear of negative equity. The Bank of England and the Treasury have been pursuing policies like near-zero interest rates, tax breaks for buy-to-let landlords, and quantitative easing (printing money) which are designed to stop house prices falling. If they do fall, the banks that hold the dud mortgages might go bust, and a wave of home repossessions would fill the media with family misfortunes. So the debt detente that has taken place in America is unlikely to happen here. Millions of first-time buyers will remain priced out of the market and left paying excessive rents, preventing them starting families, setting up home, starting businesses or getting on with their lives. Welcome to stagnant Britain, where the financial resources of the country are dedicated to servicing the debt pile. And Government policy is skewed to maintain a housing Ponzi scheme.

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Harsh home truths keep the economy stagnating

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