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The UK enters the Age of Austerity
By Marco Pietropoli, 21st October 2010
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Chancellor of the Exchequer George Osborne unveiled the plans by the UK's coalition government to balance the books by the end of this parliament. For details of the spending review, click here .
My feeling is that it was a missed opportunity to implement the cuts that are really needed. The 19% cuts in government spending was a great political move to wrong foot the opposition who had called for a 20% cut.
The UK public had been braced for larger cuts and was broadly in support. It will be a lot more difficult to revisit this in a year's time when the pain starts to bite and union militancy is in full swing.
The reality is that the Chancellor has left himself very little room for maneuver. I am not the only person that thinks this may be the case, click here for further details.
The numbers are based on fairly optimistic economic growth assessment and there is no provision for an economic shock like a war or another financial crisis. With higher inflation caused by increasing commodity prices, slow job & wage growth and a continuing lack of credit it is difficult to see how the UK can grow as predicted. This is especially relevant as Europe is entering severe austerity as well and the US is still not managing to create any jobs.
I know that everyone believes that interest rates will never rise, but they will over the next few years and this will a have devastating impact on the economy. The longer we wait to increase Base Rates and the more money we print, the sharper the increases will have to be.
The vast majority of mortgages are on variable interest rate. The UK population is convinced that money should be free (many people are paying less interest on their mortgages that the rate of inflation ). If money is free then it is not worth anything and we have much bigger problems.
I know, I know this all seems so far fetched, but as food prices rise, oil rises and our imports become more expensive you will understand what I mean. Another way of putting it is to say that if you devalue money, you will need more of it to buy things.
If growth surprises on the downside there will be a natural increase in welfare costs and less tax revenue. Further cuts will be needed to implement the deficit reduction plan. The risk is then of a downward spiral in economic activity. I feel that getting the pain out of the way as quickly as possible is by far the best option. This is especially relevant as the coalition is fairly united at present and if cracks start to appear, it may be far more difficult to implement further cuts in public spending.
The idea that the Bank of England can simply keep printing money to sustain economic growth is farcical. Central Banks as there to:
• Oversee the financial system,
• Provide emergency support in times of financial crisis,
• Provide short-term monetary stimulus and tightening in a counter cyclical fashion
• To safeguard the long-term stability of currencies and control inflation.
Central Banks are certainly not there to try an engineer long-term economic growth. If we go down the route of printing money ever time there is a problem, we will wake up in a few years time with hyper-inflation. Inflation is very high relative to interest rates as things stand anyway. Further quantative easing will certainly weaken the Pound further and create even more inflation.
You can try and manufacture very low interest rates all you like, but you can't force people to borrow and banks to lend. Interest rates can't really go much lower and the UK population is geared up to their eye balls anyway. There are not that many balance sheets left to leverage, so further money printing may have very little positive effect.
The reform of the welfare system is well overdue. It would have been far better to carry out reform when the economy was stronger and jobs were plentiful. But Labour perpetuated and unsustainable system and now we have to go through the pain of sorting it all out when we are weak.
It is simply unsustainable to have a system that rewards those that can't be bothered and continually increase the taxes on those that work hard. It is also unsustainable to continually increase taxes on a shrinking private sector to fund an ever increasing public sector. We might as well all become communist and have done with it.
In 2000 the UK public sector accounted for 35% of GDP , now it is more than 45%. By definition the private sector needs to be much larger than the public sector as taxes need to fund government spending. It is going to be very painful for the government to retrench in difficult economic times, but I don't think we have any options.
Medway Independent Financial Advisor
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